value and opportunity

As proposed, the follow up to part 1.

Let’s move to the next step in valuation, the EPV:

EPV Valuation WMF

Let’s look at my standard set of CF calculations first:

	2006	2007	2008	2009	2010	Total	Avg
Operating CF	43.84	40.418	35.35	83.01	55.98	258.602
Delta WC	-0.6	-22.4	-7.9	40.6	-11.3	-1.6
Capex	-19.2	-26.4	-27.4	-24.8	-25.8	-123.6
Free CFTF	25.244	36.418	15.85	17.61	41.48	136.602	27.3204
per share	1.80	2.60	1.13	1.26	2.96	9.76	1.95
Uses
Dividends	-9.8	-13.3	-16.8	-14.7	-16.8	-71.4
WC	-0.6	-22.4	-7.9	40.6	-11.3	-1.6
M&A	-8.5	0.8	3.7	8.4	-8.7	-4.3
financing ex div.	-3.4	4.6	4	-13	-17	-24.8
Sum Uses	-22.3	-30.3	-17	21.3	-53.8	-102.1
						0
Depr.	22.7	23.3	22.3	22.8	24.8	115.9
Capex-depr	-3.5	3.1	5.1	2	1	7.7
Free CF addj. (depr.)	21.744	39.518	20.95	19.61	42.48	144.302	28.8604
per share	1.55	2.82	1.50	1.40	3.03	10.31	2.06

A few observation:

1. Free Cashflow, even adjusted for working capital changes has been quite volatile over the past 5 years. Especially 2007 and 2010 stand out as really great years. On average, adjusted for investments above depreciation, WMF managed to generate 2.06 EUR Free cashflow per share to equity.

2. Working capital management looks excellent. Despite an increase in sales of +25% over the 5 year period, working capital remained constant. This is very good

3. More than half of the free cashflow has been distributed to shareholders, which can be explained most likely by the fact that the PE majority sharholder has financed his stake to a large amount with debt. However it is very positive that they did not try to “push down” the debt through a dividend recap like for example Permira did at Hugo Boss.

4. Also the company consistently invested more than they wrote off plus some smaller acquisitions. This is a good sign as well that the PE investor does not “plunder” the substance of the company.

However, if we take the average 2.06 EUR and look at a set of discount rates:

Dicsount rate	5%	6%	7%	8%	9%	10%	11%
	41.2	34.33	29.43	25.75	22.89	20.60	18.73

we can clearly see, that we need to go down to 7% just to break even on the current share price.

But now we come to an interesting question: In the case of WMF we have a company which has clearly improved its profitability over the last decade significantly. Even taking the average of the last 5 years implies roughly a permanent 1/3 reduction of free cashflow compared to the 2010 result going forward.

So without going into the discussion about future growth, one has to ask if one has to “mean revert” past growth as well. A quick sanity check is the current year. WMF doesn’t issue full quarterly reports, howver they give a short summary.

Despite some problems in the smaller divisions, they still expect growing net income (and hopefully increased free cashflows).

What I find most intersting is the fact that since the current year they started to break down the segments much better than in the earlier years, especially they seperated the division of the professional coffee machines.

Q3	Sales	Net Margin
sales outlets	91.9	neg
Table and kitchen	288	7.3%
small appliances	58.3	neg
Hotels	59.7	5.4%
Coffee machines	208.5	17.5%

What we can easily see are two mediocre business lines, two awfull ones and one outstanding business line, the coffee makers.

This is in my opinion also the main explanation for the increased profitablity since 2006. In 2006 WMF additionally purchased the majority of Swiss coffee machine maker Scherer (66%) for 8.7 mn EUR and started to consolidate sales and results from Schaerer. If one estimates the total purchase price at around 12 mn EUR and relates this to Schaerer’s current sales (~80 mn EUR) and the margin of the coffee machine business, WMF purchased them for a current P/E between 1 and 2. So my thesis is: The increase in the profitablity was kick started by the “bargain” purchase of Schaerer and the full consolidation from 2006. WMF then managed to participate in the “mega trend” of high quality or “gourmet” coffee makers for restaurants, company cafeterias and so forth.

If one looks for example to this article from 2002, one can see that total sales for coffee makers at WMF in 2002 were only 90 million, comaperd with 280 mn in the first 9 months of 2011.

So coming back to valuation and the EPV:

I think there is good fundamental evidence that we don’t have to mean revert past growth in the coffee maker division within an EPV analysis, but that we can rather start at 2010 levels. If we look at the range of discount rates again:

Dicsount rate	5%	6%	7%	8%	9%	10%	11%
	60.6	50.5	43.29	37.88	33.67	30.30	27.55

that at 10% discount rate, WMF would be faily valued, at lower discoutn rates (which are not unrealistic in my opinio due to the conservative balance sheet), WMF starts looking attractive.

So lets stop hear and summarize:

The significant improvement in profitablity can most likely be attributed to the strong growth of the coffee maker division. If we use 2010 as a representative year going forward, we could see a certain potential if we accept discoutn rates lower than 10% for this solid company which might not be unrealistic. If one accepts for instance 7-8% as dicount rate, one would get an upside of 28-46% against the current share price for the common shares.