DISCLAIMER: The stock discussed in the following post is a very illiquid French small cap. The author might own the stock. Please do your own research. Do not blindly follow recommendations neither on this blog nor anywhere else.
Sometimes investment ideas are created from quite random events. I was looking into my database for interesting French stocks (as always). Out of interest, I thought that I want to tackle a French software stock next.
Among the few software stocks I just picked randomly the company called “IGE + XAO SA” because of its strange name. And guess what ? This company is creating CAD software for electrical installations with Gerard Perrier, my last stock pick as one of the major clients.
So despite the rather expensive valuation numbers, I decided to dig a little bit deeper.
“Tradition” Valuation metrics:
P/E Trailing 14.2
Dividend yield 1.8%
Market cap EUR 61 mn
Not so exciting at first. However, when I ran IGE through my checklist, it scored very high (20 out of 27), at par for instance with Vetropack and AS Creation mostly due to the following facts:
- great free cashflow generation (FCF on average 1.2x Earnings !!!)
- rock solid balance sheet with ~15 EUR net cash per share
- Management owns 20%+ of company, CEO & founder still on board
- company started to significantly repurchase shares again in 2012 (Sharecount decreased by 20% since 2008)
If I would take into account net cash and the share repurchases, IGE would even met my P/E and dividend criteria, scoring 22 out of 27, equal with Tonnelerie.
So the result from the checklist is clear: Dig deeper !!!!
Business model / “Scuttlebutt”:
The company is mainly a Software company which, according to their Webpage offers the following products:
The Electrical CAD Software Specialist and you….
For over 26 years, the IGE+XAO Group has been a software publisher designing, producing, selling and ensuring the maintenance of a range of Computer Aided Design software (called “CAD”). These CAD software products have been designed to help manufacturers in the design and maintenance of the electrical part of production processes. This type of CAD is called “Electrical CAD”. IGE+XAO has built a range of Electrical CAD software designed for all the manufacturers, which functions either with an independent computer or with a company network.
So this is a very specialized “niche”. If I search for the German “Elektro CAD” in Google, it is already clear that IGE is not the only one offering this kind of Software.
The first question I would ask myself: “General” CAD Software is used everywhere, so can’t just the general CAD packages take over this job ? Well, according to this site ( a competitor) , this doesn’t seem to be so easy.
There seems to be also some competing products, for instance I found this German discussion board where different E-CAD or CAE systems are discussed. One of their main products, CADdy seems to be based on a old German DOS program and has been developed further by IGE.
Overall, I think that with specialised software like this, one should see quite significant network effects, i.e. if one product gains dominance, than this will be self-sustaining as there is little incentive to use different programs of that complexity for instance when you switch firms. I browsed a little bit in CAD forums and this has been confirmed quite often, for instance here. So once a program in this area is used and people are educated on this program, they will want to use it further on. What I found interesting is the fact that in this forum, A German IGE +XAO employee actively moderates everything which has to do with their products.
I think this is also the reason why they have 70% market share in France according to their 2011/2012 investor presentation. Which, of course, makes gaining market shares in other countries quite difficult.
This 70% market share might also explain the nice margins the company is enjoying. 20.9% Operating margin and 18.4% net margin are clearly not something one finds easily, not even with software companies.
ROE looks OK with 20%, however we should not forget, that basically all the equity is basically net cash and only a small part of that is really needed.
Those margins are on par or even better as heavyweight software champions like SAP or Dassault or CAD expert Nemetschek. Teh only difference is that those companies are much more expensive
As it looks for now, their business isn’t subject to the overall slow down in the French economy. In their latest half year report from the beginning of April, they still show solid growth rates of 5%. Net income didn’t grow due to higher tax expenses, but that should be a one time effect.
Net profit margin development
One thing that puzzled me, was the development of net margins. We can see that with one exception (a jump in 2008), Net margins increased steadily from 7.4% in 2002 to a fantastic 18.4% in 2012.
In my opinion, this creates a series of questions:
- how did they achieve this ?
- are those margins stable ?
- do we have to expect reversion to the mean at some point in time ?
- what would be the “Mean” for margins ?
In order to understand better the increase in margins, I compared 2002 with 2007 and 2012 in the following table:
|2012||in % of sales||2007||in % of sales||2002||in % of sales|
|Net interest reslt||0.3||1.4%||0.3||1.4%||0.0||0.2%|
The interesting thing here is that the improvement in the margin can almost be fully attributed to the decrease in percentage points to the decrease of external purchases / services. To me this looks like the typical “economies of scale” at a software companies. Once you have written the code, selling additional licenses increases the margin.
I found an interesting interview in French from 2009 where the CEO has been asked the question. His answer was (my translation):
- in everything related to aerospace etc., there are only Japanese and American competitors which do not seem to cross borders
- for industrial installations, there seem to be local competitors in each country
- in everything which is related to buildings, Autodesk is considered the main competitor
I think there competitive position is quite good. Their current niche is still to small to really interest a large player to enter on a “green field approach”.
Looking at the stock price alone makes me ask myself why I didn’t discover the stock already last year when it was really really cheap. On the other hand, the more important point will be: What is the intrinsic value now ? Is there still enough upside ?
As a hobby investor, I do not have access to management, However i watched on Youtube some interviews with the CEO (for instance here. The general impression was quite good. The only thing that I noticed is that the CEO is also active as the head of the local commercial chamber as well as some function at the local airport. This might lead to additional business contacts on one side but maybe distract him from the companies at other times.
Picture of the CEO:
Renumeration for the CEO was 250 k in total for 2012, that is quite OK for such a succesful year. Compared to the value of his shares (~7 mn EUR), I think the interest is quite well aligned with shareholders.
A few words here because for a small French company, the shareholder structure is rather unusual. There is no majority shareholder.
The 2 top shareholders
Irdi Midi Partners 14.1%
Odysee Ventures 12.3%
are French private equity companies which ahve reduced their stakes lately. On the other hand, Amiral, the well known French value investment firm has recently increased their stake from ~3% to 9%.
That means howver that in theory the company would be “available” for a competitor to buy. Maybe this explains the quite shareholder friendly policy of the company which is ussual for France.
Edit: Longer term shareholders seem have double votes, so the Management plus IRDI might still have the majority, but how long ?
Comparables: Just for fun, lets look at some other Software companies. I picked out 5 others:
|Name||Rev – 1 Yr Gr||OPM||EBITDA Mrgn||3Yr Avg ROE||R&D/Net Sales:Y||EV/EBITDA T12M||EV/T12M EBIT|
|IGE + XAO||4.8%||22.9%||23.9%||18.2%||25.0%||6.8||7.1|
|DASSAULT SYSTEMES SA||13.8%||24.7%||29.3%||14.6%||18.1%||16.8||20.0|
Although its maybe not really fair to compare them, people pay for the same kind of profitablity aroound twice or three time as much for the larger companies.
This could be clearly also a function of better growth prospects, on the other hand it could also indicate what a potential buyer could be willing to pay.
As a French company, IGE is clearly subject to a worsening of the situation in France. With 73% of sales in France, there will be clearly problems if France goes into a real deep depression.
Another risk as with all cash rich companies could be that they use their cash for expensive acquisitions. So far, they haven’t done it but one never knows.
Overall, I think IGE + XAO makes a compelling investment case:
+ high margins and return on capital, rock solid balance sheet
+ capital light software company with good local competitive postion
+ for a French company surprisingly share holder friendly
+ potential target for buy out or take over
The major risk is of course the overall developement of the French economy. Nevertheless this is also the reason why one can buy this excellent company at a very attractive price.
I will therefore add IGE & XAO to my portfolio. I assume that I could have purchaes ~300 k EUR of shares over the last 6 weeks since I follow the company at ~42.50 EUR per share, making it a 2% position in my virtual portfolio.
Final remark on sizing /portfolio risk
The 2% portfolio weight might look a little bit small compared to the enthusiasm of my review. On the other side, my total French exposure now has hit 20% gross (~18.5% net of hedge). This is of course a quite conncentrated bet on France not going down the drain. So I try to limit my exposure within this concentrated bet on France by having a kind of “basket” approach and spread to different companies. Let’s see how this one works out…
ThyssenKrupp issued their quarterly earnings today. Together with Lufthansa, Thyssen has one of the largest “pension holes” in the DAX index.
As we all know, from 2013, IFRS 19 requires to fully reflect pension liabilities “on balance”. Interestingly, in their Investor presentation, IFRS equity is not mentioned at all.
So one really has to go into the interim report to look what happened.
And again, at a first glance it doesn’t look so spectacular:
Shareholders Equity end of March is around 2.8 bn EUR, 0.77 bn less than stated for September 2012, in line with the losses. However when we look into the developement of the equity position of page 32 of the report, we can see that closing shareholders equity has actually been 7.6 bn in September 2012.
In contrast to Lufthansa, they hide their restatement in an “insignificant drop” of retained earning from March 2012 to September 2012 in an amount of ~4.2 bn EUR. Lufthansa had spread their restatement over 2 years. So there seems to be quite some leeway how to do this.
So to sum it up: Thyssen Krupp has lost ~ 4.8 bn of equity or -63% and management doesn’t even bother to disclose this to shareholders in their presentation. Well, who cares about equity anyway ?
One final remark: Thyssenkrupp uses 3,6% to discount the liabilities, which is quite high. Many other companies use 3.2% for EUR or less. As a proxy, one would multiply the difference times 15-20 in order to see what to add in percentage points to the pension liabilities.
So to scale this, we would for instance multiply 0.4%*15= 6%. With total pension liabilities of 8 bn EUR, we would need to deduct a further 500 mn EUR from equity in order to compare them with more conservative companies.
In any case, I think Thyssen will need to raise some equity capital pretty soon.
A friendly reader forwarded me a current equity research report from JPM about IVG.
Not surprisingly, they estimate the value of the share as zero:
Our EVA based European
Valuation Model implies zero value for IVG ordinary equity as a going concern, while a DCF driven revaluation implies zero equity value on the existing balance sheet. We therefore lower our Mar-14 EVM based price target from €2.22 to €0.01, and await the announcement of restructuring plans over summer 2013.
Although one might wonder, why they had a 2.22 EUR price target before. Much more interesting is that they actaully come up with an asset value for the IVG portfolio which looks as follows:
Although they use slightly different adjustements, thei asset value is very similar to what I calculated a couple of weeks ago:
|Intangibles||251||0||253||0||100% write off|
|Inv. Property||3,964||3,398||3,654||2,920||scaled to 7% yield|
|Financial Assets||189||142||174||131||25% discount|
|equity part||95||71||84||63||25% discount|
|DTA||404||0||336||0||100% write off|
|Asset Management||275||318||1.5% of AUM|
|Marekt value caverns||163||140||50% of disclosed adj.|
Additionally, they calculate “Bull” and “bear case” scenarios:
The bear case scenario clearly would not leave a lot for convertible holders.This clearly shows the risk of the implicit “leverage” of the secured loans via the convertible.
Although the JPM research looks a little bit superficial especially with regard to the liability structure, it is definitely worth to look at in order to get a better feeling for the underlying property values.
Their base case would imply even “full recovery” for the convertible and hybrid, although I think they haven’t modeled the liability structure correctly.
In general, their asset valuation does not look to different from mine,so for the time being I don’t see a reason to sell the convertible at current levels. Also there seems to be no reason to approve any debt for equity swaps.
However both, equity and hybrid capital seem to be clearly out of the money in most scenarios if one takes into account the full liabaility structure.
David Einhorn’s Q1 investor letter. German IPO Evonik is one of his new stocks.
Wexboy on Donegal Creameries. Nice jump in the share price.
Great post on US insurance valuation from Aleph Blog
Overview of topics and speakers at the famous Ira Sohn conference in New York
MUST READ: Graham and Doddsville newsletter Spring 2013
Today I sold, both the KPN Shares and the rights .
All in all, I got around 2,91 EUR (1.68 for the shares, 1.23 EUR for the rights) which results in a gain of ~ 11.5% before trading cost. Quite a nice outperformance against the AEX with ~ 3.5% in the same time period.
Nevertheless, this was clearly a “bumpy ride” as the chart for the rights shows:
The optimal timing would have been to buy on the second day of the trading period. I guess this was the result of the very short time period between announcement of the terms and the start of trading.
I heard that for instance US investors were completely taken by suprise and couldn’t actively trade the rights.
Main reason for selling was that I was not sure if I want to exercise the rights and I have some other, in my opinion better ideas in the pipeline. Also I am not really optimistic about KPN in the long term.
In general, those “deeply discounted rights issues” are interesting special situations for a short term trade but have to be handled with a lot of care and patience …
Someone asked me why I don’t show annualized returns for my single portfolio stocks. In my opinion, annualized returns for single stocks are pretty meaningless. The KPN Trade would have been an annualised 280% but what does such a number say ? As my investment strategy includes a lot of “sleeping” stocks, I think that showing annualized returns on single stock level do not provide any benefit at least not for me. Much more interesting than an annualized return per stock is the potential gap between the current price and intrinsic value.
Lufthansa AG, the large German airline company has a serious problem with pension liabilities. Some people even call it the “flying pension plan”. In the past, under IFRS, they could defer the recognition of higher pension liabilities over a very long-term via the so-called “corridor” method.
However in 2013, IFRS 19 changed this. Now, pension liabilities have to be fully recognized in equity via OCI (other comprehensive income).
This is what Lufthansa wrote in their 2012 annual report:
Change in accounting standard IAS 19 will lead to higher pension provisions
The Group runs defined benefit pension plans for staff in Germany and abroad, which are funded by external plan assets and by pension provisions for obligations in excess of these assets.
In the context of these defined benefit pension plans, the amendments to the accounting standard IAS 19, Employee Benefits, applicable as of 1 January 2013, mean that actuarial gains and losses from the revaluation of pension obligations and the corresponding plan assets are recognised immediately and in full in equity, without effect on profit and loss. One important effect of this retroactive application of the standard
will be that the balance of actuarial losses previously carried off- balance-sheet will be offset against equity at one stroke as of
1 January 2013. After accounting for taxes, this will reduce Group equity by EUR 3.5bn. The change in the accounting standard does not result in higher pension payments, however, nor does it establish an obligation to make additional contributions to fund assets.
When I read their Q1 2013 report, I was however really puzzled:
On the very first page the show that the equity ratio remained relatively constant (15.4% against 17.7% at year end). Based on the information above (3.5 bn pension off-balance sheet liability) and 8 bn equity, the equity ratio should have been dropping by almost a half.
Further on, they write the following in the quarterly report:
The revised version of IAS 19 Employee Benefits (revised in 2011, IAS 19R), application of which has been mandatory from 1 January 2013, had a substantial influence on the presentation of the assets and financial position in this interim report.
The revision caused pension obligations and other provisions under partial retirement and similar programmes to go up by a total of EUR 3.8bn as of 1 January 2013 compared with the financial statements for 2012.
On the same page the reiterate the almost unchanged equity:
Shareholders’ equity (including minority interests) fell by EUR 262m (– 5.4 per cent) to EUR 4.6bn as of the reporting date. The decline
is largely due to the negative after-tax result of EUR – 455m, offset by an increase of EUR 166m in neutral reserves from positive changes
in the market value of financial instruments. The equity ratio of 15.4 per cent was lower than at year-end 2012 (16.9 per cent).
So wtf happened ? How can you increase liabilities by 3.8 bn and equity remains unchanged ? Even if we look at my “beloved” OCI statement (page 23) we can see that OCI statement, we can see that OCI is in fact POSITIVE ?
Dark Side of IFRS Accounting: Restatements
Before it gets to exciting, let us introduce to an instrument from the “Dark side” of IFRS accounting: The so-called “Accounting Restatements”.
An Accounting restatement means, that already “closed” accounting periods will be “opened up again” and the P/L will be retroactively changed. Usually this is done, when real errors (or fraud) are detected and the auditors force the restatements. In some special cases however, very creative CFOs use this tool to shift losses into the past and bury them in the hard to read (and understand) part of the accounts.
How to detect ?
Well you can either try to understand the “change in equity” portion of the balance sheet. Which is quite hard sometimes. Or you perform a quite simple check:
Just look at the equity of the last report (here annual report 2012) against the value of the current report. And surprise surprise:
In the annual report 2012 (which was only issued a few weeks ago), equity for 31.12.2012 was stated at 8.2 bn EUR. In the quarterly report issued now, equity for 31.12.2012 now suddenly has shrinked by 3.4 bn to 4.8 bn.
So just to summarize this:
Between issuing the annual report 2012 in Mid mArch and the quarterly report which was issued in the beginning of May, Lufthansa decided to change their accounts retroactively for a fact which was already well known since quite a long time.
This is not illegal,but in my opinion they could have explained that better that they used a restatement to book this retroactively.
Why did they do it ?
The reason is relatively clear in my opinion: In order to not put a spotlight on the fact that now almost 50% of the equity have disappeared. The strategy so far looks quite succesful:
The stock even outperformed the DAX.
What to do ?
One interpretation of this is that the capital market is so efficient and this has all been priced in already. The other interpretation would be that Lufthansa is trying to bury bad news into past results and this opens up a nice short selling opportunity if reality finally catches up with investors.
I tend two favour the second interpretation.
For a cpaital intensive busienss like airlines with no real moats, the book value (or replacement value) is not a bad proxy for the value of an airline. Lufthansa now “jumped” from around 0.8 times book to 1.6 times book.
|GARUDA INDONESIA PERSERO TBK||1.31|
|INTL CONSOLIDATED AIRLINE-DI||1.31|
|MALAYSIAN AIRLINE SYSTEM BHD||1.25|
|SINGAPORE AIRLINES LTD||1.01|
|THAI AIRWAYS INTERNATIONAL||0.97|
|CATHAY PACIFIC AIRWAYS||0.96|
|AIR NEW ZEALAND LTD||0.93|
|AER LINGUS GROUP PLC||0.89|
|QANTAS AIRWAYS LTD||0.68|
|DELTA AIR LINES INC||na|
Funny enough, the average of those 13 airline companies for P/B is exactly 1.0 but that is a coincidence. On the other hand, I don’t see a compelling reason why Lufthansa should trade signifcantly above book value.
Going forward, Lufthansa will be on my “short watch list”. I am tempted to bet that most analysts didn’t really understand what Lufthansa has done and P/B will most likely go towards the industry average.
Performance April 2013:
Performance for the month April was +0.5% against +2.1%, an underperformance of -1.6% vs. the Benchmark (50% Eurostoxx, 30% Dax, 20% Dax). YTD, the portfolio is up 14.0% against 4.9% for the Benchmark.
For some reason, the underperformance in April reassures me that my strategy is working. I would assume in “up months” a weaker performance than the benchmark, in down months a significant better relative performance. However, in the first 3 months of 2013, the portfolio strongly outperformed although we had seen 3 “up months” in a row and I ran at ~15% net cash in the portfolio. Despite the nice developement, one has to ask if there isn’t a lot of “hidden beta” in the portfolio.
However the current month shows that the stocks do have “their own life” versus the benchmark. For instance Tonnellerie, which acted like a high beta stock in the beginning of the year came down to earth with a -17,7% performance in April. As a reader asked me for it, here is the graphical performance since Inception:
Portfolio as of 30.04.2013:
|Name||Weight||Perf. Incl. Div|
|AS Creation Tapeten||4.7%||55.2%|
|Tonnellerie Frere Paris||5.3%||62.2%|
|KAS Bank NV||4.7%||23.0%|
|BUZZI UNICEM SPA-RSP||5.2%||24.8%|
|Drägerwerk Genüsse D||10.1%||193.0%|
|DEPFA LT2 2015||2.7%||58.8%|
|Short: Focus Media Group||-0.9%||-8.5%|
|Short Kabel Deutschland||-1.0%||-5.0%|
|Short Lyxor Cac40||-1.2%||-11.7%|
|Short Ishares FTSE MIB||-2.0%||-10.3%|
|Terminverkauf CHF EUR||0.2%||6.4%|
Major changes were: Increase in Perrier to now 3%, sale of Total Produce and WMF pref shares, increase in IVG convertible plus 1% KPN as a new share. For my portfolio, this was a very active month.
Comment: All time highs
A lot of newspaper articles are concerned with the current “all time highs”, both in the DAX and the S&P 500 as well as the Dow Jones. Many people argue that level is of very high significance, either as an upper boundary or support.
In my opinion this is one of the most prominent cases of “Anchoring”, a well documented behavioural finance bias. Yes, the Dax already 2 times bounced back from the 8000 point level, in 2000 and 2007 as this chart clearly shows:
However if you look at the composition of the DAX in those years one can quickly see that the Dax is a very different animal now than in the past.
Those are the Top 5 stocks now:
Compare this to the top 5 a mere 5 years ago on December 2007:
Yes, 3 stocks are still in the Top 5 (Allianz, BASF and Siemens) but 2 out of 5 are new and the weights are significantly different.
Even if we compare the top 5 based on their P/Es, we can see that even those shares which remained in the top 5 trade at quite different P/Es:
|PE 2007||PE 2013|
|E.ON SE||15.6||BASF SE||14.6|
|Siemens AG||26.3||Bayer AG||26.3|
|Allianz SE||7.5||Siemens AG||14.1|
|Daimler AG||23.3||SAP AG||25.4|
|BASF SE||12.4||Allianz SE||10.4|
So what does that mean ?
In my opinion, the current absolute level of the DAX compared to the past is totally irrelevant. Any investment decision on such an arbitrary basis is a clear “anchoring bias”. Investment decisions should be made irrespective of index levels. If you find a cheap stock buy it, when a stock is too expensive, sell it. It doesn’t matter where the Index is compared to its past.