value and opportunity

As some might remember, I kind of like the Magic Sixes Screen (P/E < 6, P/B 6%) initially mentioned by Peter Cundill.

Many of the “Magic Sixes” companies are declining and/or cyclical companies which do not score well on my Boss Screen which is looking for stable companies.

The exception at first sight seems to be French DIY chain Mr. Bricolage.

The stock looks quite attractive from a pure valuation point of view:

Market Cap: 95 mn EUR
P/E Trailing: 5.4
P/B: 0.4
P/S 0.2
EV/EBITDA 4.7
Div. Yield ~ 6.45%

However we can spot some “warning signs” as well:

– almost 90% of Book value is intangible
– net debt per share is almost 15 EUR

However other than “problem child” Praktiker AG in Germany, Mr. Bricolage shows remarkable stable earnings and ROE’s since going public in 2000:

	EPS	Dvd. pS	Sales per share	NI Margin	ROE	FCF p.s
2001	0.96	na	25.6698	3.7%	14.2%	1.87
2002	1.36	0.40	33.5204	4.1%	11.9%	0.81
2003	1.64	0.46	45.2729	3.6%	12.6%	-0.45
2004	0.85	0.47	45.7708	1.9%	6.2%	-0.57
2005	0.96	0.47	44.3958	2.2%	6.8%	1.41
2006	1.46	0.47	42.9739	3.4%	9.9%	2.92
2007	1.43	0.50	46.0753	3.4%	10.0%	0.09
2008	1.84	0.53	50.0587	6.5%	18.0%	0.35
2009	2.16	0.55	53.5614	3.9%	10.4%	-1.21
2010	1.75	0.57	55.2493	3.6%	9.2%	0.12
2011	1.76	0.58	55.0272	3.1%	7.7%	2.33
Avg				3.6%	10.6%	0.70

ROE is clearly not overly impressive but one should not forget that the company trades at 0.4x book. A company which generates 10-11 % ROE should not trade at that level.

Free Cash flow generation is very volatile, but 0.70 EUR on average per share looks ok and covers well the dividend paid out over the last 11 years.

For me, those numbers create two questions which i have to answer at some point in time:

a) why is the share of intangible so high and is it valuable ?
b) why is the stock so cheap (if the intangibles have value) ?

Looking into Mr. B’s history, one sees two large acquisitions which led to substantial intangibles:

2002: Group Tabour, for 85 mn EUR, financed by cash and a significant capital increase (share count jumped from 6.9 mn to 10.7 mn)
2009: Briconautes Group, however no prices disclosed.

So at a first view those acquisitions (other French DIY chains) seem to look ok. An interesting bit of the linked article shows that Mr. Bricolage seems to be the 3rd largest French DIY group with ~13% market share at that time.

Competitive Environment

Mr. B’s annual report is a really good source for information about the French DIY market. Especially interesting for me was the chart about the market shares in France:

As far as I know, the barriers to entry in France for DIY stores are relatively high, on the other hand the market is much more concentrated than in Germany, where the largest Group ahs only ~15% market share.

I am not sure but I don’t think that being number 3 by a large distance is a very comfortable competitive position. Of course, retail is very local but as Walmart shows, certain size advantages with regard to advertising etc. exist.

Interestingly, Bricorama, the number 4 is listed as well. However at a first glance it doesn’t look really cheap and/or attractive to me.

Mental note: Check out Kingfisher

Business model

Mr. Bricolage has a very different business model than the two German listed companies, Praktiker and Hornbach. Mr. Bricolage does run its own stores, but the majority of “gross sales” runs through Franchise partners which carry one of the Mr. Bricolage brands. Mr. Bricolage itself shows sales of ~560 mn EUR in 2011, “network sales” have been something like 2.3 bn.

Storewise, 89 stores are directly operated, around 600 mn EUR

if we look at the 2011 numbers, we can clearly see where the “problems” of Mr. B come from. On page 81 of the 2011 report, they break up their operating earnings:

So the own stores produce a (constant) loss and more than 100% of the profit comes from the Franchising segment. This gets even worse when we look at Mr B’s sales split:

So 32% of sales are responsible for > 100% of profits. One might ask the question why they run own stores anyway. Additionally, this gives us a hint about the value of the Goodwill. If we look at page 105, we can see the Goodwill by business line:

If we were to be prudent we would deduct the full Goodwill for the stores (70 mn ) from the Goodwill, which would reduce book value by ~ 7 EUR per share to something like 16 EUR. Still cheap but not so cheap than before.

So to sum up the business model so far: Mr. Bricolage has a loss making chain of own stores and a quite profitable franchise business.

Franchise Business

As discussed above, the Franchise business looks quite attractive. Profitability looks extremely good as this table shows:

	2010	2011
Sales	257.0	263.0
EBITDA	47.4	49.2
EBIT	41.4	43.0

An operating margin of 16.5% is not something you see usually at any retailing company.

A little bit more tricky is the question of how much capital they need to run the franchise business. On page 130 they give us an overview of assets and liabilities by business line:

At first glance it looks like the need 160 mn of Net assets, so return on equity for this segment is not that spectacular. Howver we see that especially two position where the Franchise sectors has big asset positions, “Actifs financiers non courant” and “”Actifs financiers et autre actifs courant” are mostly consolidated out in the group, so this looks like that the Franchise sector is basically funding the own store sector.

This as a consequence means that the franchise sector itself could run with very little capital and producing incredible returns on capital.

Capital structure BSAAR/OBSAAR

A quick check of the capital structure shows us that Mr. B has something special there as well. From what I understand they have issued something like a convertible bond or bond with warrants which converts at 16 EUR per share (ISIN FR0010814178). The bond itself is maturing in 2014 but with amortization starting already in 2012 (1/3) and 2013 (1/3).

There is some more information here. I am not sure if the warrants are still attached but I haven’t seen them trading seperately.

Anyway, so we have around 20% potential dilution at EUR 16 which of cours puts additional limits on the upside.

At this point in time I want to stop in order to determine if a further analysis makes sense. So let’s summarize what we know:

– the company looks potentially quite cheap, however part of the goodwill might not be valuable and the debt load looks quite high
– the competitive position is questionable in such a concentrated market like France, especially if one trails the leaders by such a wide margin
– underneath the topline we have an unprofitable chain of own DIY stores and a very profitable franchise business
– a separation of those two business lines could unlock a lot of value but seems unlikely, there is no indication for that (and this is France, not the US)
– upside potential is kind of limited, both because of a potential rquired write down of intangibles and a dilution through outstanding warrants

So for the time being I will stop here and not further investigate the stock. However if at some point in time a sale of the own stores would be announced or they are able to turn them around, the company might become interesting.

As a side effect and to complete my journey into the Eurpean DIY area, I might look at Kingfisher at some point in time.