Monthly Archives: July 2013

Short cuts: IVG, CIR SpA, Osram

IVG

After a few days of calm, it seems to get interesting again. A few days ago, an American hedge fund, claiming to own 30% of the convertible, came out with an interesting statement.

It seems to be that IVG treated the on-loan from its Dutch issuing vehicle as structurally subordinated in the calculations issued a few weeks ago. In my opinion this would be a clear mistake.

Yesterday evening, IVG increased the pressure as it declared that no agreed restructuring plan has been achieved yet. I assume that this is not the end of the story yet, but it clealry shows that this will not be an easy walk in the park.

Edit: The subordinated bond lost further and is trading at 5%. As I have repeatedly mentioned, this will most likely result in zero recovery both, for the stock and the hybrid.

CIR SpA

CIR SpA reported results yesterday. Operating results were mediocre, the “Highlight” was a 160 mn EUR write down at Sorgenia. So using 0.5 as P/B multiplier for Sorgenia was the right thing to do in my valuation exercise.

Interestingly, the market seems to have anticipated this already. There also doesn’t seem to be any decision about “lodo Mondadori”. The current trial is only about tax evasion at Mediaset. I didn’t find anything about the Mondadori settlement.

Osram

Osram shares jumped 4% today after the quarterly earnings release.

“The market” seemed to have expected worse numbers. To a certain extent, i find the press release irritating.

The headline reads:

Osram records profitable growth in the 3rd quarter

However, in the real world:

– Sales dropped by 2% (in EUR)
– the positive net income of 14 mn EUR was the result of a one time gain due to a disposal

In the press release, you see a lot of adjusted numbers. Free cashflow looked strong but I guess at the moment they do not invest a lot. Overall a mixed bag. But I do not like the communication style.

Strange stocks part 2: East Asiatic Co. Ltd. – Australian miners meet inflated Venezuelan pigs in Copenhagen

Summertime is always a good time to look at stocks which are to a certain amount “strange”. I started this mini series last year with the two listed National banks of Switzerland and Belgium.

In this second part, I want to look at the Company called “East Asiatic Co Ltd.”, incorporated and listed in Denmark.

Why is this stock strange ? Well, first, for a company called “East Asiatic”, Denmark is not the most natural site to be located. Secondly, the description in Bloomberg is the following:

East Asiatic Company Ltd. A/S processes food and offers moving services. The Company raises and slaughters animals and processes meat in Venezuela; and provides relocation and records management services to corporate and individual clients in Asia.

So Venezuela is not directly in East Asia. According to this website, the name is only related to the historic business of the company:

East Asiatic Company (Ostasiatiske Kompagni, Aktieselskabet Det.), Copenhagen, Denmark. Formed 1897 by Capt. H. N. Andersen and associates. Operated between Denmark and the Far East, trading in rice, oilseed, timber and spices. Operated first commercial ocean-going diesel ship (Selandia (1912)) after which routes expanded to include South Africa, the West Indies, North America and Australia. Survived WWII with a depleted fleet but retained their rank amongst the worlds leading ship operators. Largely divested itself of shipping interests between 1994 and 1997 and diversified into other areas.

So let’s directly look on EACs website to find out what exactly they are doing today.

Subsidiary Santa Fa

If one looks up Santa Fe’s website, this looks like a potentially interesting global business services company. They seem to offer everything, from Visa, moving furniture and finding real estate.

According to EAC’s 2012 annual report, two subsidiaries of Santa Fe (Wridgways, Interdean) were bought in 2010/2011. Overall, Santa Fe made up 31% of EAC’s total sales.

EAC’s annual report by the way is very good. On page 19, they explain Santa Fe’s business model clearly, which looks attractive in a globalized world.

Business is growing strongly, but margins have been reduced, specifically as they feel already the slump in Australian mining activity.

Simple valuation of Santa Fe:

Plan: 5% CAGR until 2016, 300 mn EBITDA. EV/EBITDA of 6-8x realistic ?

Current borrowings 500 mn, growth by 5% in line with sales –> 600 mn debt in 2016

EV of 1.800 -2.400 –> equity value of 1.200 -1.800 in 2016. Discount by 15% for 3 years: NPV of Santa Fee according to this: 790 – 1.180 mn DKK

just for comparison reasons: Current market Cap EAC in total: 1.120 mn DKK

Plumrose:

No comes the fun part. Subsidiary Plumrose ist he leading pork producer in Venezuela, Cranswick of Venezuela so to say. However, other than Cranswick, Plumrose owns the complete vertical value chain. They are growing their animal feed, raising pigs, slaughtering, processing and distribution incl. branded food items.

As we all know, Venezuela has problems and doing business there is at least “challenging”. Among the problems specifically concerning Plumrose are restrictions of money transfers outside Venezuela and Hyperinflation.

Restriction on money transfers

According to the annual report, Venezuelan authorities did not allow to transfer dividends to EAc since 2007. Only one special dividend of 68 mn DNK was allowed in 2012. In parallel, EAC seems also to charge royalties to Plumrose, but again those royalties cannot be paid out.

The theoretical amount of those outstanding amount would be around 60 mn USD at current Bolivar exchange rates.

Inflation /Hyperinflation

Reading the annual report is also an interesting lesson in inflation and IFRS Inflation Accounting I didn’t know for instance that there is a separate IFRS article (IFRS 29) dealing with hyperinflation.

The big issue here in my opinion is the following: In a Hyperinflationary context, one usually is confronted with “official” fixed exchange rate which are subject to transfer restrictions and a black market rate which is usually a lot lower.

In Venezuela, the government devalued th Bolivar in February this year significantly by almost 50% from 4.3 USD/Bolivar to 6.3. Nevertheless, this is far away from the “black market” rate. currently, according to some sources, the “black” rate is around 32 Bolivar per USD, only a fraction of the official price.

Often, the black market rates are maybe too cheap because of the risk involved with “semi legal” transactions, but clearly, the official rate is far off the mark.

So if we look into the 2012 annual report of EAC, we can see that Plumrose is responsible for almost 80% of EAC’s profit as reported with an exchange rate of 4.3. If we look into Q3, we can see that Plumrose at 6.3 Bolivars er USD is responsible for almost all of EACs profits.

No, using the black market exchange rate, one should actually divided those numbers by 4 or 5 to come to a realistic representation. If one does so, then the currently cheap valuation of EAc (P/B 0.46, P/E 7 for 2012) suddenly look at lot different. Calculation with 30 Bolivar per USD, EAc would not have made a profit in 2012 and P/B would be around 1.

So this is an important lesson here: For any company having significant exposures in a hyperinflationary environment, one should not look at the “officially translated” earnings but recalculate at more realistic black market rates.

Other observations:

The company itself seems to be very shareholder friendly. Clearly, many investors would like the Santa Fe business but less the Venezuelan operations. On their website they state the following:

EAC strategy towards 2016

The overriding aim of the EAC Group is in the course of the coming years to develop its two businesses, Santa Fe Group and Plumrose in Venezuela, into strong and independent businesses; each with a size and scale sufficient to attract international investors and to become independent, listed companies.

So this is quite unusual. Many companies just want to become as big as possible. Here, it looks like that they really want to maximise value. This could also be a spin off opportunity at some point in time

Stock price:

The stock price has seen better days:

So it looks like that there is not too much optimism priced in at the moment (or too much optimism in the past). The stock price most likely also reflects that Santa Fe is currently struggling due to the BRIC slow down.

Summary:

All in all, EAC is not only a “strange” stock but also an interesting stock. Although both subsidiaries are struggling, I see some “real option” value here. The Santa Fe business, if the execute as planned, is worth more or less the whole market cap at the moment. Therefore, Plumrose, the Venezuelan pork producer is like a “free” option betting on a better future for Venezuela. This future is highly uncertain, but some positive signs are also visible.

I do not know any other way to invest in Venezuela apart from Government bonds which have their own issues if one wants to bet on some kind of recovery like we have seen in neighbouring Colombia.

On the other hand, Santa Fe is definitely negatively impacted by the slow down in the BRIC and commodities world. So it will need sometime until this potential value could be unlocked.

For the time being, I will however NOT buy the stock but watch developments closely.If Santa Fe really recovers I will establish a position.

Nevertheles, keep in mind that this is not a typical “margin of safety” kind of stock. This is more like “ray Delio style risky but cheap “real option” investment with relatively uncorelated specific risks.

Short cuts: Praktiker/Hornbach, Thermador, Portfolio transactions

Praktiker/Hornbach:

Yesterday, Praktiker gave notice that also the “healthy” subsidiary Max Bahr is insolvent and will seek creditor protection. In my opinion this coul simply the following:

1. an even lower recovery for the Praktiker Bonds. I had read a couple of analysis where people thought that Max Bahr could be sold for hundreds of millions with the proceeds covering the bond partly. Under current circumstances, Praktiker Bond holders in my opinion would be lucky if they get even 5% of nominal back. There will be nothing left.

2. It will be much harder to keep Max Bahr as a fully functional competitive entity. So this improves the outlook a lot for the other DIY chains. If for instance Hornbach could get 10-20% of Praktikers business, this might turn into nice growth. I am therefore quite surprised that the Hornbach shares didn’t react on this news. I personally think that there is a good chance to see a “Schlecker” effect. Schlecker had a higher market share compared to Praktiker, but according to this article, competitors DM and Rossmann saw sales jumping +14 to +16%. A lot of this increase is sales per existing square meter, so I assume with a nice profitability.

I think Hornbach at the moment provides a good risk/return relationship. The had a rather bad last quarter due to the ugly weather. Based on personal observations, I assume that the made up for that in the current quarter plus tailwinds from the Praktiker bancruptcy make me positive about the shares.

Thermador

Thermador issued half year numbers a few days ago, here and here.

Clearly, 2013 will be a difficult year for them. But as the already mentioned after Q1, Q2 was already relatively seen much better than Q1 (sales down -5.2% against 2012 vs. -8.7% in Q1). Profitability is clearly lower, but all in all I think they are still doing quite well. I would have hoped that the stock price might go down a little bit in order to add to my half position, but it seems not to be the case right now.

Portfolio transactions

I sold the second half of the Dart position today at ~2.45 GBP. On the other side, I am adding to Hornbach Baumarkt as I think there is a very good chance for a positive medium term surprise despite all the issues. I will increase from currently 3.7% of the portfolio to a “full” 5%.

Quick check: Astaldi SpA (ISIN IT0003261069)

Astaldi SPA was now mentioned by at least 2 commentators as an interesting stock, so let’s look at this Italian stock.

Looking at the “Normal” fundamentals, it seems clear why:

P/E 7.1 (2012)
P/B 1.0
P/S 0.2
EV/EBITDA 6.2
dvd. yield 3.1%

So at the first look, a single digit P/E and P/B of 1.0 look attractive.

On top of that, Astaldi has increased earnings each year in the last 10 years at an impressive rate:

EPS DIV ROE
31.12.2003 0.23 0.05 10.0%
31.12.2004 0.27 0.07 12.1%
30.12.2005 0.28 0.08 13.1%
29.12.2006 0.31 0.09 11.2%
31.12.2007 0.39 0.09 12.9%
31.12.2008 0.43 0.10 13.2%
31.12.2009 0.57 0.10 16.0%
31.12.2010 0.64 0.13 15.8%
30.12.2011 0.73 0.15 16.0%
31.12.2012 0.76 0.17 15.2%

Well, what is not to like ? Even my Boss Score says that they are attractive, indicating ~100% upside.

First, Astaldi is primarily a construction company. As a construction company, a large part of the balance sheet is either “work in progress” or “receivables”. The problem with that is that you never really know how at what stage profit will booked and if this is really earned or if there is some nasty surprise at the end. To illustrate this point, look at this table from page 179 of the 2012 annual report:

2012 2011 Change 2012 2011 2011+2012 In % of sales
– Revenue from sales and services 879,025.00 292,875.00 1,171,900.00 26%
– Plant maintenance services 12,544.00   12,544.00 0%
– Concessions construction and management phase 95,740.00 91,186.00 186,926.00 4%
– Changes in contract work in progress 1,330,781.00 1,881,223.00 3,212,004.00 70%
– Final inventories of assets and plant under construction 7,209.00 0.00 7,209.00 0%
Total 2,325,299.00 2,265,284.00 4,590,583.00

So this table shows that around 70% of Astaldi’s sales were unfinished projects accounted for as “percentage of completion”. This is the respective passage of their accounting principles (page 285):

Long-term contracts
Contract work in progress is recognised in accordance with the percentage of completion method, calculated by applying the cost to cost criterion.
285. This measurement reflects the best estimate of works performed at the reporting date. Assumptions, underlying measurements, are periodically updated. Any income statement effects deriving therefrom are accounted for in the year in which such update is made.

This is a big problem for me. I don’t know if their “best estimate” is cautious or aggressive. I have no evidence that they are doing anything wrong, but for my personal investment style, I do not like companies with a large share of “percentage of completion” business because that introduces a lot of uncertainty into the stated results.

The second problem I see here is the high amount of (gross) debt funding. Astaldi had around 1.25 bn EUR gross financial debt at the end of 2012. For construction companies, a combination of external debt with long term projects can be quite dangerous. Normally, one would expect that most of the projects would be funded via prepayments but Astaldi only manages to get around 400 mn EUR in prepayments.

The big risk here is that one big busted project or problems with one subsidiary can trigger loan covenants and then there is “game over” or at least a large dilutive capital increase.

Loan covenants:

Let’s look shortly at their loan covenants (page 223):

Covenants and negative pledges
The levels of financial covenants operating on all the committed loans the Group has taken out with banks are listed below:
(The present document is a translation from the Italian original, which remains the definitive version)
– Ratio between net financial position and equity attributable to owners of the parent: less than or equal to 1.60x at year end and 1.75x at half year end;
– Ratio between net financial position and gross operating profit: less than or equal to 3.50x at year end and 3.75x at half year end.

Lets do a quick calculation of the ratios in 2012 (based on their own “net financial debt calculations on page 32):

YE 2012: Net financial deb 812 mn, Equity 468 mn –> this would be already 1.73 times, so clearly above the threshold. Only if they include some “non current financial receivables” in an amount of 186 mn, the come down to 622/486 = 1.27 times.

In my opnion, their financial position looks clearly stretched. Maybe this is the reason why they had to issue a quite expensive 100 mn EUR convertible bond early this year. Issuing convertible bonds is ALWAYS a big warning sign that a company cannot fund its operations with “normal” debt.

For me, this is already a BIG RED FLAG. In my opinion, there is no margin of safety in a company with such a high debt load and such tight situation in terms of covenants.

Other more superficial observations after reading thorough the last annual report:

. unfocused concession portfolio (car parks, motorway, airports, hydroelectric plant, hospitals)
– comprehensive income in the last 4 years was always lower than stated eps

SIAS in comparison, my Italian “infrastructure” stock is a much easier story. Less debt, no “percentage of completion”, clear focus on motorway concessions.

Summary:

Despite the nominally cheap valuation, I don’t really like Astaldi. The high amount of “percentage of completion” assets combined with a rather large debt load make the stock quite risky in my eyes. If things work out well, there is clearly upside, however if one project goes wrong, the company will be in big trouble. So no real “Margin of safety” here in my opinion.

And no, I don’t think that concession business has a bright future. As an Italian company one has a clear competitive disadvantage with higher funding costs and in my opinion it is impossible to run so many different types of concessions in different countries really effectively. I am afraid that they will overpay and/or get the stuff the specialists don’t want.

Some links

China:

– Paul Krugman thinks it is game over for China
– China bear Jim Chanos in the meantime is short Caterpillar
– A similar trade from Andreas Halvorsen: Short Kone
– in the meantime China is building the tallest building in the world

Carson Block in the meantime is shorting American Towers

Book review “What’s behind the numbers” from Old School Value

A blogger looks at Kleeman Hellas

Mebane Fabers “shareholder yield” book is currently free on Amazon

Dart Group – When to sell / Skill & Luck in investing

Today, Dart Group issued preliminary 2012/2013 figures which were excellent.

The stock price jumped another 10%, making Dart my first triple in the 2.5 year history of the blog portfolio:

For me, two questions are now interesting:

1) Should I sell ?
2) Was this skill, luck or both ?

Re 1)

The nice thing about the blog is that you can always go back and look what you have written back then.

Dart was actually the first tangible result of my “Boss Score “model back in June last year. Additionally, at that point in time, the stock was very cheap by any standards.

That’s what i wrote about valuation:

Valuation

A few simple thoughts about valuation:

Dart Group will never be a P/E 15 company, but it could easily be a P/B 1 company. At the moment, you get a company which increases shareholder equity by something close to 20% p.a. at 0.6 times equity. If we assume for instance they manage to generate 15% ROE in the next 3 years and the company would trade at book at that time, we would have a fair value of 1.7 GBP per share or an upside of 150% over 3 years. More than enough for me.

Looking back, under my metrics, Dart increased equity by 8% in 2011/12 and 18% for 2012/13, on average 13%. So slightly below my expectations but still very good. However the share price has shot way beyond my expectations.

Compared to back then, Dart now looks quite expensive as this table shows:

at purchase now Easyjet Ryanair Vueling
P/E: 4.7 11.0 24.6 18.3 11
P/B: 0.6 0.6 1.8 3.33 3.2 1.17
P/S: 0.1 0.1 0.4 1.4 2.1 0.2
Div. Yield 2% 0.87% 1.70% n.a. n.a.
Market Cap 97 mn 348 5558 10290 275
Debt/Assets 2% 1.70% 22.30% 39% 4.50%
EV/EBITDA 0.02 1.8 10.2 8.2

I have included some other discount carriers in the table. Compared to Easyjet and Ryanair, Dart looks rather cheap, but honestly I do not really understand why Ryanair and Easyjet trade so high. Vueling from Spain in comparison does look cheaper than Dart on that basis.

All in all, Dart performed according to my expectations, but the multiple expansion was clearly above expectations.

Personally, I don’t believe that a business like Dart will trade at 2 times book in the long run, nevertheless, momentum and comparable valuations could carry the stock even higher.

As a compromise, I will sell half of my position as of today.

2) Skill or luck

A second question one should always ask oneself: Was this just luck or was some skill involved.

With Dart, I actually try to improve my process compared to the past. I looked quite deeply for instance into fuel hedging as well as into the business model.

That is what i wrote in the first post about the business model:

Business model

There is an interesting discussion about the business model to be found here.

In essence within the airline business, their main competitive advantages seem to be

– regional focus (not fighting on the crowded London market)
– buying cheaper used airplanes for cash instead of leasing new ones (used aircraft buying seems to be one of the special abilities of the CEO..)
– higher flexibility due to ownership and contracts with Royal Mail
– differentiation with slightly better services as a “family budget” airline

I am not able to judge how this holds against Ryanair and Easyjet going forward, but so far the strategy seems to have worked OK and better than many of the smaller competitors.

Actually, part of that competitive advantage, the Royal Mail contract got lost earlier that year and they earn lower margins. What I clearly didn’t see was the fact that Dart could compensate this by growing quite significantly with their packaged tours. This was luck.

Secondly, the stock got a lot of tailwind by the very good performance eof Ryanair and Easyjet. Over the last 12 months, Ryanair gained 84% and Easyjet 147%. Compared to that, Dart’s 192% look good but not totally out of line. That was luck too.

So overall I would say my dart investment was maybe 50% skill and 50% luck. Clearly, my boss model and the research helped to identify a stock which was undervalued. However the timing and the extent of the share price increase and multiple expansion are more luck than anything else.

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