Buzzi revisited – time to SELL

Buzzi was part of our initial portfolio. In our initial investment thesis (German), the main reason was simple:

The stock, especially the Pref shares were significantly below book value, Buzzi had never made a loss in the past, “normalized” earnings and p/E ratios were low and it had a nice dividend yield.

We bought into the pref shares share at around 5,50 EUR

Additionally, the fact that Buzzi was only to a small extent an Italian company but rather a very international company due to the Dyckerhoff take over with large exposures in the US and Germany was maybe underappreciated.

Since then, a view things happened:

– Buzzi showed a loss twice, for 2010 and 2012 with only a mini profit in 2011
– when the price of the shares dropped in autumn 2011, I increased the position at 3.28 EUR per share
– the share price of the more expensive common shares performed a lot better than the cheap “Risparmo” shares. The difference since 01.01.2011 is a staggering 28% including dividends
– howver, both, the pref shares and the common shares outperformed the Italian stock index FTSEMIB by 17% resp. 45%

The more interesting question is: How did Buzzi perform against our initial expectations ?

In different posts I came up with different “reversion” to the mean approaches, among others

Reversion to the mean net income/PE
Initially: average P/E for the pref shares of 6. net margin of 9.6% (12 year average)
Now: After 15 years, average net margin decreased to 7.11%. Based on current sales of ~14 EUR per share results in 1 EUR per share normalized profit, so with an average PE of 6, the pref shares are fairly valued. I would argue to common shares are even overvalued.

Reversion to the mean EV/EBITDA
Initially: Assumption EV/EBITDA of 5.5 and EBITDA Margin of 26% (12 year average)
Now: 14 year EBITDA Margin is 24.8%. With current debt, the fair value of a Buzzi share would be around 13 EUR. This means the common shares are fairly valued, the upside in the pref shares without any other catalyst would be that the relative underperformance would be compensated at some point in time.

Free cash flow:
I had assumed free cash flow to equity of 200 mn EUR as “normal” level based on a 7 year history. “Adjusted” free cashflow both in 2011 and 2012 are more like 100 mn EUR, bringing down the average to 175 mn EUR. If I use this as a basis and the same discount rates I used back then (12-18% for a cyclical pref share), I end up with a fair value range of something like 4.75 EUR – 7.11 EUR per share. So the current share price would be rather in the higher part of the range.

Overall issues with mean reversion

Those three examples show a problem with “Mean” reversion plays: What is the mean ? In the Buzzi case, the mean now goes down every year, reducing the fair value for the mean reversion valuation.

Clearly, the current down cycle is a very severe one, but maybe the previous up cycles used for the mean were above the mean ?

What to do now ?

For me this is a typical situation where one should sell. Initial expectations have not been met, fair value has gone down and share price has gone up. Of course one could argue that the “mean” will go up and the sentiment is getting better with recent buy ratings among others from Deutsche bank.

In recent times, some US funds actually built up meaningful positions like Marketfield Asset Mgt. with ~2.9% of the common shares, and another, Mackay Shields with around 2.1%.

Nevertheless, I don’t think that at current levels and based on the current situation that there is a lot of “margin of safety” left in Buzzi. I will therefore sell the complete position at today’s VWAP. At the time of wirting, this would be a total gain of ~36%, mainly attributed to the second purchase at 3.28 EUR in late 2011.

8 comments

  • I am long the telecom italia saving shares: Holders of savings shares do not have the right to vote either in ordinary and in extraordinary Shareholders’ Meetings, but they benefit from the distribution of the net income for the year in the proportion of 5% of the nominal value of the share (0.55 euro) and, in any case, they have the right to receive a greater dividend than holders of ordinary shares in the proportion of 2% of the nominal value of the share. Q: http://www.telecomitalia.com/tit/en/investors/faq-investors.faq-tigroup-shares.html
    Additionally the source tax is lower which means I don’t have to apply for a refund from Italy.

    Do you have any general information about Italian saving shares? Imho the TI saving shares should trade higher than common but it is the opposite.

    • no, i never really looked systematically into italian savings shares.

      However, I am not really a fan of “dividend” investing. So I would never buy shares of a bad comapny only because they pay a good divdend. I would consider TI as a “Bad company” because it is destroying capial and has a lot of leverage. Not my cup of tea.

  • Hi,

    why not selling the common shares instead, in order to prevent down side risk? I have been in an equally long pref / short common position for one year now and I currently dont see a lot of alternatives to invest in.

    Kind regards and thanks for your insights.
    Leon

  • Meines Erachtens ist Mean Reversion selten ein gutes Argument für eine Investition. Ein Durchschnitt ist nur dann aussagekräftig, wenn er sehr viele Datenpunkte umfasst, was in diesem Zusammenhang auf Investitionsperioden hinausläuft, für die kaum ein Investor genug Geduld aufbringt. Wer von Mean Reversion als Kaufargument spricht, vergisst zu oft den Zeitfaktor. Wer sich eine Art normale Marge vorstellt, bei der z.B. Buzzi über kurz oder lang wieder landen sollte, vergisst oft genug sich Gedanken darüber zu machen, WARUM die Margen früher höher waren und WARUM sie jetzt niedriger sind und WARUM sie erträglich bald wiederum steigen sollten. Ein Blick auf die Dynamiken der Bauindustrie, ihre Fundamentaldaten, die Demographie, vorhersehbare Aufträge der öffentlichen Hand in Buzzis Märkten usw. hätte gereicht, um zumindest die hohe Wahrscheinlichkeit einer mittelfristig weiter sinkenden Marge zu erkennen. Aber gerade diese Recherchen spart man sich eben gerne dank der Pseudogewissheit der Mean Reversion.

    • otto,
      schön dass Du die Margen im Zementereich inkl. Eurokrise so gut prognostizieren kannst. Könntest Du mir bitte die Werte für die nächsten 10 Jahre noch schicken ?

      Mean reversion ist keine Pseudegewissheit sondern m.E. eine ganz nützliche Sache bei Zyklikern. Funktioniert wie so vieles halt nicht immer.

      mmi

  • Thanks MMI, interesting to hear your rationale behind selling..I wonder what value investors do when all stocks become over-valued? Go on a well-planned yet thrifty holiday I assume..

    • well, my goal for this summer is to play more golf 😉

      No seriously, as Peter Cundhill said: “There is always soemthing to do”. One should never stop looking at companies. Additionally, there will be always interesting special situations (IVG, etc.).

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