Gruppo Sol SPA part 2 – balance sheet, qualitative aspects and weaknesses

After the initial post about Gruppo Sol SpA, let’s look at some other standard issues which are important for a “value investment”:

1. Balance Sheet quality

Gruppo Sol is definitely not an asset play, as the main value lies in at least some local competitive advantages, mostly in it’s homecare business. However it makes nevertheless sense to check the quality of the balance sheet, as a solid balance sheet significantly decreases the downside in those cases where the investment thesis doesn’t play out.

a) Goodwill

Good news here: Gruppo Sol has only a very small amount of goodwill (22mn EUR out of 375 mn EUR equity). In comparison to AIr Liquide or Linde, this looks quite good. Air Liquide has only half of its book value in tangible assets, whereas Linde has negative tangible book value due to its past acquisition. Tangible book value in itself is definitely not a guarantee for success, but it limits the downside to a certain extent.

b) Debt

Debt is unfortunately not insiginifcant. With around 170 mn net debt as of 31.12.2011, debt to equity is around 50%. Although this is exactly the same ratio as Linde and slightly better than Air Liquide, for an Italian based company with most likely Italian bank as creditors, this is something to monitor closely.

Interestingly, they provide a very detailed overview of financial liabilites in the 2010 report on page 54. The good news is that very few loans contain covenants and there are no critical maturities, the “roll down” seems to be very conservatively structured, the bad news is that some of the loans are quite expensive. In total I would judge this as a rather well managed conservative financing structure.

c) Extra assets, Pensions, operating leases, depreciation etc.

There are basically no other assets on the balance sheet than those required for running the business, so no big minority stakes etc. On the one hand, this doesn’t leave any potential for “extra” assets like Autostarada, howver on the other side its a good sign as the comnpany seems to be focused on its core business and not trying to play the typical Italian pyramide structure games.

The company doesn’t seem to have off-balance sheet operational leases. A smaller amount of the assets are financed through financial leases which are included in the nebt debt

They don’t really show pension liabilites which is due to the fact that defined benefit plans are unusual in Italy anyway. However the show a 10 mn EUR reserve for “employee severance and other benefits”. Interestingly they seem to discount this with 1.30% p.a. which is a very very conservative assumption.

A quick view into fixed assets shows that plant and machinery of Sol SpA show a cummulated depreciation of ~2/3 of historical values. Land and building values are only a small amount of fixed assets, so I would not expect any “hidden reserves” there.

So overall, I would consider the balance sheet of Sol SpA as conservative but without significant hidden value.

2. Shareholders & Management

Large shareholders are:

59.98% are held by a Dutch entity called “Gas and Technolgies world” whcih is the vehicel of the founding Fumagali family. The CEO of SoL SpA, Aldo Fumagalli Romario is currently CEO of Sol SpA, so SOl is both, family owned and also actively managed by a family member.

7.35% are held by Tweedy Browne
5.05% are held by Bestinver
4.50% by Stefano Bruscagli, a board member of Sol SpA
3.00% are held by Alberto Tronconi, a former Sol SpA director.
1.13% owned by Leonardo Alberti, a current director of Sol Spa

So in total, 60% are held by the family and further 8.6% by active board members which in my opnion is a good sign.

Board compensation

For some reason I didn’t find director’s comp in the report, so I rely on the FT information. However 500 k compensation for the top officers seem to be OK.

Corporate Governance

The only thing I can say about this is that I am not aware of anything yet. So no dealings between main shareholder and company or directors and company whcih is very good for an Italian company.

Weaknesses and known problems

At some point in time one should also consider the main weaknesses as you rarely find the “perfect” company at hte perfect price.

Capital intensity

As mentioned in the first post, especially the industrial gas business is very capital intensive. So no nice free cashflow franchise busienss but “real investment” business. If Sol was an Anglo Saxon company, they would have spun off Vivisol a long time ago and milking the cash from the gas business without reinvesting.

I am not sure if Vivisol relies to a certain extent on facilities from the industrial gas segment, this is something to explore further. Also, in the Vivisol segement, receivables started to grow. At some point, manngement mentioned that public health insurers, which usually pay for the home care services are paying slower espacially in Italy.

Italian exposure

This brings us to the next obvious point: Especially the industriel gas division is naturally exposed to Italy and a possible further detoriation of economical activity. As of 2010, Sol made 60% of sales within Italy and 40% outside, with outside sales growing by double digits. Although the business should be more stable than other businesses, this risk is definitely there.

2011 preliminary results and intra year reporting

During the year, Sol is only reporting EBIT. For Q3 for example, Sol reported 13.3% increase in YOY EBIT increase, a really strong double digit growth number.

So it came as a surprise that in the preliminary 2011 full year numbers, 12 M EBIT suddenly wnt flat agains the year before and EPS actuall decreased slightly.

As there is no segemnt reporting in the preliminary release, we cannot see if this is an issue for both segments. My assumption is thta the bad Q4 comes from the Italian industrial gas side but it is not really explained and one has to wait for the full annual report.

Investor relation / reporting

This brings us directly to another weak point. Quarterly reports do not include EPS and explanations are short. The last inevstor presentation is from 2003, so they seem to save a lot of money on investor relations if we look at the bright side. Tehy don’t even show up at the “Star” conferences.

Research Coverage & Index

For Sol SpA, analyst coverage is very low. Only one small shop covers them (“EVA dimensions”, whoever that is) with an overweight rating but noprice target. They are also not included in any index, and trading volume with around 200 k paer day is too low for many funds.

For larger institutionals with shorter time horizon, the stock is most likely not interesting.

So lets stop here and summarize part 2:

+ on the plus side, Sol seems to have a relatively conservative balance sheet
+ company is family owned and family run
+ management compensation is OK, managers have relevant stakes in the company
+/- corporate governance is good for Italian standards, however neutral for objective standards
– business is capital intensive
– significant exposure to Italy
– reporting during the year only on EBIT basis, very limited information

So far no “deal breakers” but also some significant general issues. I will have a final post up if to invest and at what price.

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