value and opportunity

Vetropack is one of the “Core Value” shares of my portfolio which I haven’t covered in detail yet.

Vetropack describes itself on its homepage as follows:

Vetropack is one of Europe’s leading manufacturers of packaging glass. With a rich variety of glass packaging products to offer the beverages and food industry, as well as a broad spectrum of services, Vetropack truly delivers “tailor-made glass”.

and:

This end-to-end service is the fundamental reason for Vetropack’s position as market leader in its six home markets, namely Switzerland, Austria, the Czech Republic, Slovakia, Croatia and Ukraine.

Based on “traditional” metrics, the stock looks OK but not “super cheap”:

P/B 1.25
P/E 2010 17.6
P/E 12M Trailing 10.4
P/E Graham (10 years): 13.5
EV/EBITDA 12M Trailing 5.1
Div. Yield 2%
FCF Yield (2010) 9%

No debt (95 CHF net Cash per share)
no intangibles

A quick view on historical earnings shows quite an impressive picture:

	EPS	BV/share	FCF Share
1999	10.96	497.29	25.21
2000	36.58	510.66	92.28
2001	27.22	534.51	30.76
2002	59.78	578.15	-29.87
2003	91.03	681.03	120.04
2004	97.74	768.46	19.42
2005	119.10	909.37	85.48
2006	101.20	933.70	-22.48
2007	236.30	1,180.99	138.17
2008	182.55	1,243.69	105.58
2009	184.84	1,371.71	207.95
2010	91.24	1,283.77	155.84

We can clearly see the incredible rise in Earnings and Book value since 1999 until 2007, however in the last few years the picture has changed to a certain extent.

Looking at the Earnings developement in Swiss franks only shows part of the picture. Only 17% of Vetropacks sales are generated in Switzerland by the Swiss operations, 83% is outside Switzerland. Important: Vetropack does not export anything from Switzerland.

So if we look at peak Earnings in 2007 and compare them to the 2010 earnings, we should take into account that the 87% of Euro denominated Earnings have been reduced by a significant reduction in the value of the EUR against the CHF. Even more interesting is the effect on Free Cashflows:

	FCF CHF	FCF EUR	FX Rate CHF/EUR
2007	138.17	83.56	1.65
2008	105.58	70.69	1.49
2009	207.95	140.16	1.48
2010	155.84	124.51	1.25
CAGR	3.2%	12.3%

Over the last 4 years, Cashflos in CHF have increased by 3%, the underlying EUR Cashflows by 12%, quite a difference. The currency movement also explains the lower book value in 2010 against 2009 despite the profit made.

So how can we value Vetropack ? If we look at the last 5 year free cashflows, we can see that the 2006 number looks quite odd, being negative. A quick glance into the 2006 annual report shows, that actually operating cashflow was strong but the company invested some extra amount in acquisitions and starting productions in contries like Slovakia.

So if we just take the average Free Cash flow of the last 4 years (which would be 150 CHF per share) and capitalise them at 10% we would end up with an intrinsic value of 1.500 or roughly 5% less than the current market price of 1.600 ChF.

Now we enter a difficult area for a contrarian investor: lower discount rates and growth.

If we just look at the following table where I simply discount the avg. Free Cash flow with various growth and discount rates (Discount rate X axis, growth : y axis)

	7%	8%	9%	10%
1%	2,516.67	2,157.14	1,887.50	1,677.78
2%	3,020.00	2,516.67	2,157.14	1,887.50
3%	3,775.00	3,020.00	2,516.67	2,157.14
4%	5,033.33	3,775.00	3,020.00	2,516.67
5%	7,550.00	5,033.33	3,775.00	3,020.00

We can clearly see that for a margin of safety of 50% I would need to assume for instance a discount rate of 8% and a growth rate of 3%.

If history is any guide, Vetropack should be easily able to grow by 3%, having achieved much much mor in the past. Additionally, a 8% discount rate for a non-cyclical consumer product related company with net cash and an extreme conservative balance sheet should be reasonable.

Finally a quick check of the stock chart:

In 2008 the stock went down to almost 1.100 CHF, slightly below book value. Currentbook Value is around 1.300 CHF, so in a 2008 scenario we look at a 20% downside from here.

Summary: Vetropack is a stock with extremely strong historical growth, strong free cash flow generation and a rock solid balance sheet. Based on relatively conservative assumptions (3% growth, 8% Cost of capital), the current price would imply amargin of safety of almost 50%. If the stock should show some weekness in the next few days, I would actually be tempted to increase the allocation from the current 2.8% to 5% on acurrency hedged basis.