Aggreko Plc (ISIN GB00BK1PTB77) – A great company with only temporary problems ?
Aggreko is a UK based company with a pretty simple business model:
They buy diesel engines, put them into big metal containers, add some basic electricity generating gear and rent them out globally to whoever needs them.
Aggreko’s generators are often used for big events, but also after natural catastrophes (Tsunami, hurricane), military campaigns (Afghanistan) or for mining projects in remote areas. I have been following Aggreko for some time, especially the annual reports are a pleasure to read through.
It’s clearly a niche business but quite simple. The main reason why they are able to earn 20%+ margins and 20%+ ROCE’s seems to be the fact that they are by far the biggest provider with an excellent reputation. So if you need let’s say 50 generators quickly, you can either call 4-5 local competitors to get this amount or you place one call to Aggreko. Via their global distribution net, they can als0 make sure that their generators are not idle for long. This is a very important factor for any company which is renting out equipment as it leads to lower costs. I am not sure if this is a “moat” but certainly a competitive advantage.
Multiple fundamental headwinds
Aggreko is currently hit by an almost “Perfect storm” with regard to their business model:
– there are no large natural disasters (good for the world, not so good for Aggreko)
– the number of large military campaigns has declined
– mining / oil projects get delayed and /or cancelled
– Emerging markets are struggling in general (weak currencies, weak economies)
– no big events in 2015 (Olympics, Football World cup etc)
Looking at this it is almost surprising that Aggreko was able to manage to grow sales at least a little bit but margins have been clearly reduced compared to the boom years 2010-2012. So when we look at historical numbers one has to be aware that especially 2010-2012 were not representative years. With regard to oil prices, Aggreko showed an interesting chart how this affects their business:
On the other hand, this could make investing in Aggreko interesting. A great company with temporary problems due to external factors is basically the definition of a “value investment”. The question is clearly if the problems are indeed temporary.
The big issue: Management change
Aggreko used to have an outstanding management team and culture but CEO & CFO Rupert Soames and Angus Cockburn went to Serco, the new CEO has been hired from British Gas:
One of his first actions was to restructure the company’s division from regional to business line, as a result only 1 person of the old leadership team remains. I am usually sceptical about those restructurings but the new management team is a big unknown. Also changing the reporting segments is often an indicator for worse things to come. On the other hand I would say in Buffett’s words that Aggreko’s business model would almost allow an idiot to run the company, but let’s hope the new guy is not an idiot.
Another aspect with management change is the fact that the new management obviously in the beginning has very little equity interest in the company. We will come to that later, but clearly the link between management and owner is weaker when the management owns very little stock.
The strategic review:
A few days ago, the new CEO presented a strategic review. Investors seemed to have been disappointed by this outlook as it looks pretty sure that 2016 will be a transition year with even lower profit than 2015. I guess many had hoped for a quicker turn around.
I personally found it a quite solid review, nothing fantastic but also nothing stupid, just very realistic. I think one has also to keep in mind that the new CEO doesn’t have a big equity position yet. For him to aggresively promote a quick turn around would be quite counter productive. For him it’s better that he can accumulate equity via share bonuses at lower prices for some time and then deliver great numbers at a later stage.
If you look for instance on page 4 of the 6m presentation, it is quite uncommon to stress that underlying sales our down as actual sales are up. Any other CEO would have disclosed this maybe in the footnote and told a story how sales have increased. I do think that the new management is “low balling” a little bit.
Transition from Growth to Value Stock
Aggreko used to be one of the “hottest growth stocks” over many years. As we can see in the table below, despite a small set back in 2005/2005, Aggreko was able to increase earnings by an astonishing 17,9% p.a. with nice margins and good ROICs. That also explained why Aggreko was granted mostly a P/E above 20, on average 21,8 x earnings over this period:
|P/E||EPS||yoy Growth||Net margin||ROIC|
However those times are gone. From the 2012 peak of 1,04 EPS, Aggreko dropped to 0,92 in 2013 and 0,84 in 2014. The current consensus is 0,79 for 2015, the third consecutive decline, and this was not due to overall crisis but to the quite specific head winds mentioned above. This is one of the interesting things one can see in the stock market: If a former growth stocks stops to grow, it takes some time and pain until the last “Growth investor” has sold the stock and value investors move in.
Falling knife stock chart:
This transition to value can be seen nicely in the stock price which has been hammered down and lost almost -50% since the peak almost exactly 3 year ago in August 2012 when the going was still great.
This is a chart from a typical “momentum” investor, in this case Capital Group:
Buying into momentum, they almost owned 3% of the company in 2012 and then redeuced the position to close to zero. Looking at the shareholder base, one can see some value investors already, like FPA or Woodford, but most of them bought into Aggreko already in 2014 and are sitting on painful losses. Buying into this “falling knife” stock charts is usually a very bad idea, unless you have a very good view on the underlying value of the business.
Not surprisingly, Aggreko went from “Analyst’s darling” to being hated. Wenn you sort the Stoxx 600 by analyst rating consensus from highest to lowest, Aggreko is at number 580. Still slightly better than Admiral and TGS Nopec but pretty bad nevertheless.
As I have mentioned often, I do like very simple valuation models with simple assumptions. For Aggreko I make 3 very simple assumptions as my “base case”:
– a P/E of 15 should be a fair P/E for Aggreko, so in 5 years time (2020) I can sell the stock at 15 times earnings (current trailing P/E is 14)
– Aggreko will reach 2012 earnings again in 2020 (2016 flat, 7% EPS growth thereafter)
– I need to earn 15% p.a. to reflect the uncertainties with regard to EM and new management
Together with assumed dividends I can then calculate what I am prepared to pay now in order to achieve a 15% IRR over the next 5 years:
Now I could make this much more complicated with more cases etc. but overall it clearly shows that for my simple “base case” assumption, Aggreko still looks expensive compared to my return requirements. At the time of writing, at around 10,60 GBP the price would need to drop a further 2 GPB or -19% to make the investment interesting for me. At 10,60 GBP, my assumptions would only generate ~10% IRR which for me would not be enough.
I made the experience that my first valuation attempt was more often than not the best one, so for the time being I would stick with this and wait if Aggreko becomes cheaper. I think I would be tempted to buy below 0 GBP per share.
In an absolute bear case, the lower bound for Aggreko should be the replacemtn value, both of the genrators and the distribution network. I do think that a lot of this cost has been expensed, so I think replacemtn value should be significantly higher than book value, but I can’t value it. An upside case would take into account that Aggreko writes down generators aggresively, so free cash flow and owners eanrings should be higher than stated EPS.
I do think that Aggreko has a good business model. The new management is clearly a question mark, as well as if and when EM turn around. Overall I do like the company a lot but buying atthe current price would not cover all the risks I see at the moment.
I would become highly interested if the price falls below 9 GBP and the new management doesn’t do anything very stupid. So this is my second “watch list” stock after Svenska Handelsbanken which I would buy more or less automatically if my limit would be hit.
My initial Pro/Con list
+ Relatively simple business model
+ size –> moat (fleet size, distribution system). Not so easy to copy
+ no pension deficit, small DBO, reasonable debt levels
+ past growth was organic, much more robust than M&A driven grwoth
+ Transparent reporting, few adjustments
+ management salaries/bonuses based on ROCE & EPS growth
+ flexible Capex
+ “copycat” competitor APR went more or less belly up recently (Praktiker/Hornbach ?)
+ very bad analyst sentiment (bottom 20 of the Stoxx 600, next to TGS Nopec and Admiral)
+ even at a subdued business level still very profitable
+ potential long-term structural growth
– management change (CEO left early 2014)
– business in dangerous parts of the world
– receivables against weak counterparts
– increased debt to return money to shareholders
– stagnation in sales, profit warning
– co-investment plan dropped in 2015
– “lowering the bar” for EPS growth
– not “really” cheap (P/E 14)