Reply SpA (ISIN IT0001499679) part 2: – Peer Group, Free Cash flow & receivables
First of all thank you for the many helpful comments in part 1 of the Reply post.
I think as a next step, a standard Peer Group comparison might be interesting. I selected a couple of midsize European IT system providers. Lets look how they compare based on some standard ratios:
| Name | Mkt Cap (EUR) | P/E | EV/EBITDA (FY1) | Return on Equity 3 Yr Average |
|---|---|---|---|---|
| REPLY SPA | 159.56M | 5.76 | 3.48 | 15.39% |
| BECHTLE AG | 638.40M | 11.02 | 6.21 | 13.20% |
| TIETO OYJ | 984.66M | 15.91 | 5.42 | 10.28% |
| PRODWARE | 51.15M | 3.51 | 3.06 | 18.47% |
| CANCOM AG | 127.49M | 9.37 | 4.6 | 16.46% |
| SOPRA GROUP | 465.04M | 10.05 | 4.43 | 17.58% |
| ATOS | 3.90B | 20.87 | 4.29 | 5.59% |
| GROUPE STERIA SCA | 335.76M | 5.96 | 3.91 | 7.31% |
| COMPUTACENTER PLC | 750.09M | 9.42 | 4.45 | 13.81% |
| INDRA SISTEMAS SA | 1.30B | 9.34 | 6.77 | 20.07% |
| Avg | 10.12 | 4.66 | 13.82% |
One could say despite good profitability, all of those companies are relatively cheap. Apart from tiny Prodware, Reply is the second cheapest despite above average ROEs.
Interesting are of course also the operating statistics:
| Name | Days Sales Outstanding (A/R Days) | Revenue per Employee | Operating Profit per Employee | Operating Margin |
|---|---|---|---|---|
| REPLY SPA | 169.5 | 128.67k | 14.22k | 11.05% |
| BECHTLE AG | 49.0 | 364.10k | 14.96k | 4.11% |
| TIETO OYJ | 72.1 | 100.87k | 5.64k | 5.60% |
| PRODWARE | 152.8 | 93.23k | 14.82k | 15.90% |
| CANCOM AG | 47.0 | 259.60k | 8.80k | 3.39% |
| SOPRA GROUP | 124.0 | 83.29k | 7.30k | 8.76% |
| ATOS | 84.7 | 92.98k | 5.77k | 6.20% |
| GROUPE STERIA SCA | 59.6 | 87.44k | 6.26k | 7.16% |
| COMPUTACENTER PLC | 64.8 | 298.50k | 7.65k | 2.56% |
| INDRA SISTEMAS SA | 226.5 | 86.47k | 8.67k | 10.03% |
| Avg | 105.0 | 7.48% |
It is obvious, that Reply and Indra (from Spain) do have issues with receivables. Reply Germany only has ~64 days of receivables outstanding. Based on profit per employee Reply looks good as well on par with German Bechtle and French prodware. Operating margins are far above average.
So what not to like ?
The answer is relatively clear if we look at this tabel: Free Cashflow
| Name | FCF Yld | Dvd Yld |
|---|---|---|
| REPLY SPA | -11.99% | 2.92% |
| PRODWARE | 5.87% | 1.08% |
| ATOS | 9.94% | 2.44% |
| CANCOM AG | 10.23% | 2.79% |
| BECHTLE AG | 3.91% | 3.24% |
| GROUPE STERIA SCA | 13.52% | 4.27% |
| COMPUTACENTER PLC | 13.07% | 4.43% |
| SOPRA GROUP | 3.63% | 4.75% |
| TIETO OYJ | 5.17% | 5.45% |
| INDRA SISTEMAS SA | 6.95% | 8.66% |
As we can see, the business is usually quite cash generative, only Reply has negative free cashflow. How comes ?
As some of you might know, I like to structure the cash flow statement a little bit differently to see where the cash goes to:
| 2011 | 2010 | 2009 | 2008 | 2007 | Total | |
|---|---|---|---|---|---|---|
| Op CF | 4.7 | 25.3 | 26.0 | 10.3 | 19.6 | 85.9 |
| Delta WC | -21.8 | -24.6 | -2.5 | -22.9 | -9.9 | -81.7 |
| Free CF adj. | 26.5 | 49.9 | 28.6 | 33.2 | 29.5 | 167.6 |
| Capex | -7.8 | -5.8 | -7.5 | -8.6 | -4.7 | -34.3 |
| acqu | -8.0 | -4.1 | -6.9 | -21.3 | -7.1 | -47.3 |
| Div. | -4.5 | -3.3 | -3.7 | -3.7 | -3.0 | -18.2 |
| other fin cf | -4.6 | -13.9 | -9.9 | 7.0 | 2.2 | -19.2 |
| Depr. | -6.0 | -7.6 | -6.9 | -4.9 | -4.0 | -29.4 |
| Capex-Depr | -1.8 | 1.9 | -0.6 | -3.7 | -0.7 | -4.9 |
| Net income | 24.2 | 20.4 | 16.6 | 18.9 | 15.7 | 95.8 |
| FCF adj/NI | 109.7% | 244.9% | 171.7% | 175.2% | 188.0% |
So over the last 5 years, 50% of the free cashflow had to be invested back into working capital, 25% into acqisitions, the rest into Capex, dividends and financing.
If we look at 2010, we can see that this was a very strange year with a big jump in cashflow whereas 2011 looks rather bad, especially compared to net income.
One of the major factors in 2011 for the low cashflow seems to be an abnormally high tax payment (30 mn va. 13 mn the year before). I have to admit that taxes are my weakest point in my analytic skill set and I don’t really understand this. The 2010 payment seems to have been lower than the tax expense, the 2011 higher, on average they seem to be similar to expenses.
Receivables:
Now to the fun part. Let’s look at he 2011 report and we see something truly worrysome here:
“Overdue” receivables jumped up from ~10% of receivables to almost 20% of receivcables. We can also see that in 2010, almost 100% of the 360 day overdue receivables were written of, wheres only 25% were written of in 2011.
Let’s compare 2010 and 2011:
| 1-90 | 91-180 | 181-360 | > 360 | |
|---|---|---|---|---|
| Overdue 2010 | 15.6 | 2.6 | 0.9 | 1.7 |
| allowance | 0.2 | 0.2 | 0.2 | 1.5 |
| in % | 1.15% | 8.21% | 28.49% | 87.71% |
| 1-90 | 91-180 | 181-360 | > 360 | |
| Overdue 2011 | 28.0 | 8.0 | 3.1 | 4.9 |
| allowance | 0.4 | 0.2 | 0.5 | 1.5 |
| in % | 1.27% | 2.56% | 15.90% | 30.35% |
This is a real issue from my point of view and could mean some “optimistic” accounting on the side of Reply SpA. If we would apply the same percentages as in 2010, we would get the following additional charges:
| 1-90 | 91-180 | 181-360 | > 360 | |
|---|---|---|---|---|
| Overdue 2011 | 28.0 | 8.0 | 3.1 | 4.9 |
| 2010% | 1.15% | 8.21% | 28.49% | 87.71% |
| 2011 allow (2010) | 0.32 | 0.65 | 0.88 | 4.27 |
| Delta | -0.03 | 0.45 | 0.39 | 2.79 |
So this would mean 3.6 mn pre tax charges. One could even argue that based on the recent developements even higher charges would be necessary so for instance a full write off of 360+ receivabels. So we migth want to adjust Reply’s earnings maybe for ~5 mn EUR pre tax or 2.75 mn (~30 cents per share) after tax, which would still give us EPS of ~ 2.60 or a P/E of 6.6.
Summary:
Free cashflow generation at Reply is somehow limited as 50% of FCF go directly into an increase in working capital. Additionally, receivables accounting seems to be optimistic. So we have already 2 reasons why the stock is so cheap. However I will have to dig a little bit deeper to understand if there is still value there.
In general, I do have problems when I discover “optimistic” accounting as I loose confidence in their overall accounts. For a company like Reply with a lot of goodwill and intangibles, the accounting should be more on the conservative side.
value and opportunity 
Concerning Steria I was just curious why it trades at such low multiples (P/B of approx. 0.4, apparently). Since EPS stayed close to the average for the last 4 years, inflated earnings cannot be the reason. So either the market nonetheless expects earnings to fall in the future, or there is fear of further dilution (over the last ten years the share-count doubled!!!) or there is the fear of asset-impairment (goodwill) on the balance-sheet.
I am just curious what it might be, although I think the past dilution certainly did not help. Low end commodity companies do usually not trade at P/Es of 5 to 6 based on average earnings for the last 4 years.
Thanks for the work on comparables. It is always interesting to see the facts on one chart. Surprisingly Steria looks quite interesting. It has been trading at depressed PER-levels for some time. I always thought this was due to a lack of free CF,but apparently this is not the case. They have a number of interesting new products/services (for example “accounting” tools for a clients energy-consumption, in cooperation with Microsoft). There are a number of interviews with the CFO of Steria on the web, he seems quite normal/conservative. Maybe worth looking into (why is it “cheap”?).
Steria shows a ROA of 3.2, ROE of 7.2 and EBIT margin of 4.7 per cent.
Not low end commodity?
It certainly looks like it. But the company offers the following services:
Applications Management
Infrastructure management
IT Service Management
Business Process Outsourcing
Testing and Quality
Cloud – Workplace On command, Infrastructure on Command
Security – Right Security
Some of those (cloud-workplace, outsorcing) are probably a low end commodity. But applications/infrastructure/IT-management and testing and right security would usually be associated with higher profitability (see importance of service revenues for IBM or even Hewlett-Packard). Could it be that large write-offs on goodwill need to be expected?
Goodwill impairment depends on value fair and value fair depends on present value of future cash flow (or what a willing buyer would pay). In the face of 3.2% ROA, I would also look on the cost of capital.
Without Goodwill there would be nearly no equity but liabilities of € 1,060 Million, including debt of € 352 Million. Is that what you mean?
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