value and opportunity

Grupo Sol SpA is an Italian company, which accoding to its homepage is active in

the production, applied research and marketing of industrial, pure and medicinal gases as well as being involved in the home care and in the welding markets. Today, SOL is an Italian based multinational company present in 20 European countries and in India and it has over 2,100 people employed. The annual revenue is 518 million Euro (2010 consolidated figures).

At a first view,the company doesn’t look that exciting and will most likely not show up on any screener with multiples like this:

Market Cap ~380 mn EUR
P/E 12.0
P/B 1.1
P/S 0.7
Div. Yield 2.4%
EV/EBITDA 5.7
P/E (10) 12.5

So neither expensive nor cheap and why bother ?

A quick view to the stock chart doesn’t look that convincing either:

After almost regaining the ATH in 2011, the stock dropped significantly and only regained a little since then.

The reason I got interested was the fact, that Sol SPA is one of the biggest Italian positions of Tweedy Browne’s international value fund. They hold around 7.4% of all shares. Additionally Bestinver, a Spanish value shop which portfolio I track is also invested with a 5% position.

Tweedy normally prefers companies which have almost no debt and relatively large free cashflows. However if we look at historical numbers, both, Sol’s debt position which is constantly increasing and its patchy free cash flow generation are not overly convincing.

	debt/assets	fcf per share
31.12.1999	17.4012	-0.05
12/29/00	18.5842	0.08
12/31/01	18.5484	-0.06
12/31/02	24.0896	-0.22
12/31/03	22.0988	0.12
12/31/04	22.8246	-0.05
12/30/05	23.4384	-0.08
12/29/06	24.0223	-0.15
12/31/07	25.8941	0.03
12/31/08	28.702	-0.09
12/31/09	29.0258	0.19
12/31/10	29.5759	0.0041

However some other historical stats are more interesting:

GJ	EPS	Net Margin	Op Margin	ROE
1999	0.12	5.6%	11.6%	6.6%
2000	0.14	6.1%	10.9%	7.4%
2001	0.15	5.5%	9.6%	7.2%
2002	0.17	5.8%	10.6%	8.1%
2003	0.17	5.1%	11.1%	7.4%
2004	0.20	5.5%	11.4%	8.1%
2005	0.19	5.0%	10.5%	7.4%
2006	0.19	4.2%	10.7%	6.7%
2007	0.30	6.3%	10.8%	10.1%
2008	0.38	7.6%	9.7%	12.0%
2009	0.28	5.4%	10.8%	8.1%
2010	0.35	6.1%	11.5%	9.6%

Although the business seems not not to be extremely profitable, Net Income margins and returns are very stable and EPS grows along increasing sales nicely over the 12 years from 1999-2010. Interesting so far, but what else ?

If one looks in to the (english) annual report 2010, the really interesting stuff is hidden in the notes on page 58 which shows the break down of the 2 main segments, industrial gases and “home care”.

It’s relatively easy to see that home care shows ~50% higher margins than industrial gases.

The differences between the two segments become even clearer if on looks at the history of the two segements. I have compiled some ratios for both segments from past annual reports:

	2010	2009	2008	2007	2006	2005
Homecare
Sales	222	191.2	167.1	150.1	121.9	106.5
Operating profit	31	27.7	24.8	22.8	21.5	14.6
in %	14.0%	14.5%	14.8%	15.2%	17.6%	13.7%
Net assets	157	145	134	118	84	53
Net income	18.3	17.4	17.1	14.4	12.9	6.6
NI margin	8.2%	9.1%	10.2%	9.6%	10.6%	6.2%
ROA	11.7%	12.0%	12.8%	12.2%	15.4%	12.5%
Gas
Sales	331	304	319.5	304	286.7	257.2
operating profit	28.6	22.1	26.7	23.1	13.7	21.5
in %	8.6%	7.3%	8.4%	7.6%	4.8%	8.4%
Net assets	301	289	276	256	269	225
Net Income	20.3	13.8	21.7	12.4	3.6	10.6
NI margin	6.1%	4.5%	6.8%	4.1%	1.3%	4.1%
ROA	6.7%	4.8%	7.9%	4.8%	1.3%	4.7%

Business model:

Industrial gases is a relatively simply business model. One can think of it as a kind of unregulated local utility business model. Technical gases are usually difficult and expensice to transport over longer distances, so competitive advantages exist to a certain extent at a local level. If one operates a industrial gas plant in an indusstrial zone, barriers to entry are one one hand relatively high, as competition has to built a gas plant first. Transport over a longer distance from a gas plant in another country are very difficult to achieve.

On the other hand, pricing power is not unlimited, because if prices get too high in a region, competitors might just built a new gas plant if the margins are high enough. Technologically this is not so difficult, o its mostly a matter of capital and return on capital

Sol SPA seems to have a nice market share (~15%) in the Italian technical gas market. Sol’s profitablity ratios compares pretty well for instance with European market leader Lide AG, which also shows NI margins of between 5-8% and ROCE or ROA of around 6-8%. So a smaller regional player seems to be able to earn similar returns in this business like the undisputed market leader, which is a sign for at least some local competitive advantages in this field.

The much more profitable Home Care business is very interesting in itself. Sol SpA is running this through its subsidiary called “Vivisol“.

They offer different services for home care patients, however the “core service” seems to be the delivery of liquified oxygen to patients who are at home and need respiratory assistance. So this is basically a nice “repeat” business as the liquid oxygen has to be replaced on a weekly or daily basis.

In general, patients with a oxygen deficency need additional oxygen for the rest of their life. For stationary patients, a kind of “oxygen compressor” can be used, however for “mobile” patients, liquid oxygen is the only practicable way of carrying enough oxygen around.

As one can imagine, it is not really an option to order liquid oxygen online at Amazon or Ebay, as on the one hand, certain medical standards have to be fullfilled (inc. licences) and on the other hand liquid oxygen has to be kept at temperatures of -190 degrees celsius. So “disintermediation” through the internet seems to be not a danger.

Vivisol seems to have expanded above the pure liquid oxygen delivery into similar areas like sleep therapy, wound care etc.

As with technical gases, competitive advantages seem to exist on local levels. As it doesn’t make sense to ship around liquid oxygen thousands of kilometers, on a daily or weekly basis to hospitals or home care patients, once a local production capacity and a local distribution system is intstalled, it will be quite difficult for any competitor to enter into this local market.

One could also argue that in contrast to technical gases this creates a sort of network effect if further patients are added within a distribution area.

Competition

Major competitors in both areas are mostly the large Industrial gas players, especially Linde, Air Liquide and Air Products. Howver as discussed before, a dominant position in one market does not automatically generate a big competitive advantage in another area, as the business seems to be highly localized.

I didn’t really find market share data for home care. However in the wake of the recent acquisition of the Air Porducts homecare business by Linde, the following was stated:
e

An industry observer who declined to be named said the acquisition — one of Linde’s biggest since it bought UK-based BOC for 12 billion euros ($15.3 billion) five years ago — would make Linde a strong No. 2 in the homecare business after French group Air Liquide SA (AIRP.PA).

In this German article they say that Linde had 280 mn EUR in home care sales in 2010.

So we don’t know how mach sales Air Liquide has in home care, but I assume that SOL SpA will be either number 3 or 4 on Europe with its ~240 mn EUR home care sales in 2011. So in this niche market they seem to have a quite nice market share which they have built more or less organically.

We have therefore a limited amount of competitors, however the more important point seems to be that it is not so easy to simply enter the market from scratch.

Valuation: Sum of parts

Normally, I could start now with a bottom up DCF analysis. Howver in this case we have a very nice public transaction and we can do a quick (and dirty) sum of parts valuation.

As quoted before, the Air Products business had almost identical size than the Vivisol business (210 mn Sales against 240 mn) and was valued at 590 mn EUR, a whopping 2.8 multiple on sales. Although I have no further info on profitability, this multiple would represent a 2.8*2.40 mn = 672 mn EUR valuation for Vivisol alone. If we deduct a 20% control premium from the purchase, this would give us a non-control value of around 540 mn EUR for Vivisol assuming profitability is close to the Air Products division.

For technical gases, competitors Linde, Air Liquide and Air Products trade at ~9 x EV/EBITDA, so if we apply a 20% discount, a multiple of 7 seems to be reasonable. Based on available 2010 EBITDA for the industrial gases of 70 mn EUR, we would get a EV of 490 mn EUR for the technical gases.

Added together, we would get a theoretical EV of (540+490) = 1.030 mn EV for Sol, compared to actual EV of around 550 mn EUR as of today, which would leave a lot of upside for the company at current valuation levels.

So lets summarize at this point:

+ the business model of Sol SpA looks interesting. Local competitive advantages seem to exist and one part of the busienss seems to be very profitable and growing nicely based on a “repeat business model” including some networ effectss

+ a quick and dirty “sum of part” valuation based on a recent competitor deal shows a significant potential upside

Enough to look further into the company in a follow up post including a more detailed DCF computation and a review of qualitative factors.