Category Archives: Anlage Philosophie

Deeply discounted rights issue watch: KPN NV (NL0000009082)

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I had briefly covered deeply discounted rights issue as a potential “special situation” opportunity a couple of weeks ago.

Now, with KPN, we have an interesting non-financial candidate. This is what KPN issued today:

Dutch telecoms group KPN confirmed a €4bn rights issue to shore up its capital position after heavy expenses on bandwidth that have led to dividend cuts and lower profit margins.

The company announced the move along with its 2012 annual results, which showed a 3.5 per cent drop in revenues and a 12 per cent fall in earnings from the year before.

As one might expect, the stock tanked some 16% or so. Currently, at around 3.45 EUR per share, KPN has a market Cap of only 5 bn EUR, so raising 4 bn via a rights issue might require a large discount on potential new shares.

The “wild card” in this game will be Mexican Billionaire Carlos Slim who owns currently 27.5% of the company. If he fully participates as lead investor and even taking up more than his share, then the “forced selling” aspect might not be too relevant.

If for some reason, he would refuse to participate, the situation will become very interesting.

Just for fun, let’s look how the performance was for Unicredit. I would distinguish the following events / time periods:

– 4 weeks before announcement
– announcement day
– period between announcement and price setting (for new shares)
– price setting day
– period between price setting and start trading of subscription rights
– trading period
– 4 weeks after end of trading period

First the relevant dates:

Unicredit
Announcement first trade date 14.11.2011
Price setting of rights issue 04.01.2012
First trade date subscr. rights 09.01.2012
Subscription trading until 01.02.2012
 
Discount 43%
New share 2 new for 1 old

Now the relative performance:

Performance UCG MIB Relative
– 4 weeks before announcement -18.35% -4.98% -13.37%
– Date of announcement -6.18% -1.99% -4.19%
– announcement until price setting -14.40% 2.95% -17.35%
– day of price setting -17.27% -3.65% -13.62%
– price setting to start trading -26.46% -4.45% -22.01%
– trading period 73.75% 12.94% 60.81%
– 4 weeks after trading period 0.05% 2.82% -2.77%
– 6 months after trading period -32.25% -11.39% -20.86%
– 12 months after trading period 12.53% 9.53% 3.00%

In the Unicredit example, clearly the period where the subscription rights were traded showed the best relative performance of the shares. Interestingly, on the announcement day, the price drop was much less in percentage points than KPN. This might have to do with the short selling ban which was in place (at least to my knowledge) when Unicredit announced the rights issue.

Again for fun, a quick look at Banco Popular’s rights issue from the end of last year.

Again the dates first:

POP
Announcement first trade date 01.10.2012
Price setting of rights issue 10.11.2012
First trade date subscr. rights 14.11.2012
Subscription trading until 28.11.2012
 
   
New share 3 new for 1 old

and then relative performance to the IBEX:

Performance POP IBEX Relative
– 4 weeks before announcement -3.95% 5.11% -9.06%
– Date of announcement -6.17% 0.98% -7.15%
– announcement until price setting -29.95% -1.71% -28.24%
– day of price setting 4.56% -0.90% 5.46%
– price setting to start trading -8.86% 1.39% -10.25%
– trading period 8.12% 2.16% 5.96%
– 4 weeks after trading period -6.71% 3.74% -10.45%

One can see a similar pattern first, with the stock losing 4 weeks before announcement, as well as on the announcement date until the final price setting. However of the date of price setting, the stock jumped, until loosing only a little bit until starting of the trading period.

Then however, the gains within this period were relatively low compared to Unicredit. Overall it looks a lot less volatile than Unicredit, so maybe less forced selling here.

Back to KPN:

Other than Unicredit and Banco Popular, KPN had outperformed the AEX almost +11% in the last 4 weeks, so today’s large drop might compensate for this (unjustified) outperformance.

If the other two stocks are any guide, one could still expect lower prices until the price for the new shares will be set.

The stock price of KPN look really really ugly long term:

But make no mistake, any company which needs to go into deeply discounted rights issues is in trouble. This is “distressed” territory.

(…to be continued….)

Performance January 2013 – The importance of being patient

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Performance
In December I said the following:

To be honest, I don’t think that the current portfolio has an equal upside potential like in the beginning of last year, mostly due to the lack of really interesting special situation investments. For instance, the upside of athe Draeger Genußschein was much higher when it trades at~2.5 times the pref shares than the current 4.5 times.

Well, I was obviously very wrong on that one. The portfolio gained gained 8.6% in January, the largest single month gain in the 25 months of the portfolio’s history. The Draegerwerke Genußschein alone gained 25%, other top performers were Tonnelerie (+19%), KAS Bank (+17%) and Dart & Cranswick 15% despite the strong Euro.

The outperformance again the Benchmark (4.9% outperformance) can be almost fully explained by the typical January small cap effect which has been covered quite well by Mebane Faber. The German small cap index SDAX for example gained 10% in January.

Portfolio as of January 31st

Name Weight Perf. Incl. Div
Hornbach Baumarkt 4.3% 9.5%
AS Creation Tapeten 4.0% 29.0%
WMF VZ 3.5% 57.0%
Tonnellerie Frere Paris 5.4% 56.2%
Vetropack 4.4% 4.6%
Total Produce 5.8% 55.9%
Installux 2.9% 6.7%
Poujoulat 0.9% 6.4%
Dart Group 3.8% 100.7%
Cranswick 5.1% 12.9%
April SA 3.4% 39.0%
SOL Spa 2.4% 6.8%
Gronlandsbanken 1.1% 24.4%
     
KAS Bank NV 5.1% 27.5%
BUZZI UNICEM SPA-RSP 5.2% 18.9%
SIAS 6.1% 59.5%
Bouygues 2.7% 8.7%
Drägerwerk Genüsse D 10.6% 142.9%
IVG Wandler 4.5% 13.7%
DEPFA LT2 2015 2.8% 56.6%
HT1 Funding 4.6% 44.9%
EMAK SPA 4.2% 23.1%
Rhoen Klinikum 2.2% 3.0%
     
     
     
Short: Focus Media Group -0.9% -2.7%
Short: Prada -1.0% -10.8%
     
Short Lyxor Cac40 -1.2% -8.5%
Short Ishares FTSE MIB -2.2% -13.7%
     
Terminverkauf CHF EUR 0.3% 7.4%
     
Tagesgeldkonto 2% 10.0%  
     
     
     
Value 47.0%  
Opportunity 48.1%  
Short+ Hedges -5.1%  
Cash 10.0%  
  100.0%

The only change to year-end is Sol Spa which was bought in the beginning of January. Cash is now exactly at my target level of 10%. that means any addition will trigger automatically a sale of another position.

Comment: The importance of being patient

A few days ago, the longterm value blog had a great post about patience in investing.

He mentions one of the cardinal sins in current markets:

I’m writing this, of course, to focus myself. One of the hardest things to do is…. to do nothing. The instinctive reaction to a rising market is to pile on, add shares, up your leverage. But really that’s the absolute worst thing you can do. Don’t kid yourself.

Clearly, jumping into the market because you missed out the rally, especially in risky “high beta” stocks will most likely end in tears.

However another potentially big mistake should also not be underestimated: Taking profits too early. Most investors (including myself) get nervous if their stocks climb quickly 20-30%. What you then often hear is something like “It never hurts taking a profit” or “No one ever got bankrupt by taking a profit” or something similar.

The truth is: In order to generate above average returns, taking profits too early hurts badly. Statistically, the vast majority of investment ideas will be rather average, some will be bad, but some of them and usually only a small amount will be really really succesful.

If I look at my portfolio, most the outperfomance of ~23% over the last 25 months can be attributed to only a few positions especially Draegerwerk, Aire KgAa, Dart Group which have all doubled.

In all cases, it was and is always tempting to sell out and “take the profit” quickly. For Draegerwerk and Aire, I started selling too early, however I was lucky to start only with small amounts. Looking back over my 25 year investment “carreer”, I made many mistakes. However the most costly ones in the end were selling companies like Fuchs, Rational or Fielmann much to early.

Fuchs AG Vz. for example was one of the stocks I bought during the 2008/2009 around 12 EUR (adjusted for the split) and happily took the profit end of 2009 at 20 EUR, feeling like an investment genius. However, with the stock now at 58 EUR (plus a few Euros dividends in between), it looks pretty stupid. I knew that Fuchs was an outstanding company. Even worse, if I would have kept those shares the gains would have been tax free as they would have not been subject to the “Abgeltungssteuer” introduced in January 2009.

So looking back, “taking the profit” on a share like Fuchs (much) too early was maybe one of the biggest and most expensive mistakes in my investment career.

Following up an Maisons France Confort (ISIN FR0004159473) – Business model & Capital management

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Last week, I ran Maisons France Confort through my checklist and found it quite interesting.

If we simply look at very basic profitability numbers, we can see that the numbers look almost too good to be true:

ROE NI margin Net debt per share
31.12.2002 27.1% 2.8% -1.46
31.12.2003 28.5% 3.1% -2.28
31.12.2004 34.5% 4.0% -4.74
30.12.2005 38.0% 4.6% -5.92
29.12.2006 39.1% 4.8% -7.33
31.12.2007 35.3% 4.8% -4.09
31.12.2008 24.3% 3.8% -4.44
31.12.2009 13.3% 2.9% -5.15
31.12.2010 16.7% 3.6% -6.98
30.12.2011 21.2% 3.9% -10.39
       
avg 27.8% 3.8%

The 10 years from 2002-2011 is a full cycle with boom and bust years, so achieving on average an ROE of 28% with a financially unlevered balance sheet is outstanding.

How do they do it ? The answer is (of course) effective capital management. I have used Bloomberg data for this but if we look at the last 6 years we can see that their capital management is really outstanding:

FY 2011 FY 2010 FY 2009 FY 2008 FY 2007 FY 2006
Goodwill 45.34 40.75 36.6 37.11 33.64 17.31
PPE 17.8 16.39 13.96 14.39 12.02 9.59
 
Inventory 21.74 20.8 24.23 24.14 21.17 7.95
Receivables 82.11 74.41 57 80.9 91.2 82.5
Prepayed expense 27.06 25.37 23.36 24.85 23.24 44.49
 
Accounts payable 96.9 81.88 70.95 93.26 92.58 80.06
Net Working capital 34.01 38.7 33.64 36.63 43.03 54.88
 
Revenue 583.91 443.06 395.84 499.62 482.97 424.98
Net income 22.68 15.83 11.51 18.9 23.19 20.2
 
PPE in % of sales 3.0% 3.7% 3.5% 2.9% 2.5% 2.3%
Net Working capital in % of sales 5.8% 8.7% 8.5% 7.3% 8.9% 12.9%
PPE+Net WC in % of sales 8.9% 12.4% 12.0% 10.2% 11.4% 15.2%

Running a business with only ~9% of “operating” net assets compared to sales is something you don’t see very often.

Let’s have a quick look at Kaufman & Broad, another French listed home and appartment builder:

FY 2011 FY 2010 FY 2009 FY 2008 FY 2007 FY 2006
Goodwill + int 151.52 150.82 150.5 149.71 149.81 69.96
PPE 5.88 5.99 5.93 7.27 9.47 8.87
 
Inventory 235.56 246.15 295.74 519.52 595.46 513.2
Receivables 305.67 203.33 203.77 296.26 405.7 309.13
Prepayed expense 141.26 159.48 139.43 158.64 147.39 122.14
 
Accounts payable 409.67 377.29 398.79 552.65 620.98 535.91
Net Working capital 272.82 231.67 240.15 421.77 527.57 408.56
 
Revenue 1,044.26 935.70 934.91 1,165.11 1,382.57 1,282.83
Net income 0 0 0 0 0 0
 
PPE in % of sales 0.6% 0.6% 0.6% 0.6% 0.7% 0.7%
Net Working capital in % of sales 26.1% 24.8% 25.7% 36.2% 38.2% 31.8%
PPE+Net WC in % of sales 26.7% 25.4% 26.3% 36.8% 38.8% 32.5%

Interestingly, Kaufman & Broad improved their capital management as well but they still need 3 times the operating net assets to generate roughly the same returns.

This of course shows in Profitability:

ROE NI margin Net debt per share
31.12.2002 21.4% 4.4% 5.90
31.12.2003 20.8% 4.5% 2.55
31.12.2004 20.1% 4.7% 3.46
30.12.2005 28.7% 5.9% 3.79
29.12.2006 33.5% 6.6% 4.64
31.12.2007 31.8% 6.1% 16.74
31.12.2008 4.6% 0.7% 19.90
31.12.2009 -31.1% -3.2% 12.46
31.12.2010 19.4% 1.9% 9.92
30.12.2011 37.7% 4.5% 7.69
       
avg 18.7% 3.6%

Despite a significant leverage, ROE are lower on average and due to the leverage much more volatile.

Maybe this is one of the reasons why Maisons has outperformed larger Kaufman by a wide margin over the last 10 years.

Just for fun, let’s also look at Helma AG, a small homebuilder in the currently booming German market:

FY 2011 FY 2010 FY 2009 FY 2008 FY 2007
Goodwill + int 2.21 2.19 1.85 1.63 1.51
PPE 16.31 14.57 14.89 15.48 13.79
           
Inventory 19.83 8.63 5.61 5.8 6.67
Receivables 10.59 6.33 4.27 3.47 2.92
Prepayed expense 8.85 5.76 3.11 2.98 2.72
           
Accounts payable 5.85 5.02 0.76 0.79 4.72
Net Working capital 33.42 15.7 12.23 11.46 7.59
           
Revenue 139.50 118.50 106.68 103.59 74.54
Net income 5.2 3.4 2.36 2.31 1.3
           
PPE in % of sales 11.7% 12.3% 14.0% 14.9% 18.5%
Net Working capital in % of sales 24.0% 13.2% 11.5% 11.1% 10.2%
PPE+Net WC in % of sales 35.6% 25.5% 25.4% 26.0% 28.7%

Interestingly, the operate roughly at the level at Kaufmann & Broad but nowhere near MFC’s level. Helma by the way actually seems to have jumped into property developement which might explain the increase in operating assets.

So compared to two other homebuilders, the business model of Maisons France looks extremely “lean” from a capital management point of view. The big question of course is why are they so much better ?

I think the big “trick” was already mentioned in the Ennismore summary from last week’s post:

Unlike many other markets, in France there is virtually no development risk for the company because land is purchased separately by the customer and the house will only be built once it is fully financed.

In their annual report, there is a hint how they operate:

Under Note 4.8 (receivables) we find the interesting information, that the receivables amount on their balance sheet is a net amount. So the roughly 80 mn receivables translate into 320 mn gross receivables against which they show something like 250 mn prepayments.

Those prepayments, which they seem able to get are basically an interest free float which explains in my opinion the superior ROE and ROIC metrics compared to the other builders.

Summary:

From a pure capital management perspective, Maisons France Confort seems to have a very good business model. they seem to generate a lot of interest rate free “float” which greatly reduces the required amount of net operating assets.

I am not sure if currently is the right time to invest as the stock has run up quite fast and french housing might be slow this year, but is definitely a very interesting company.

The big quesiton is: Is such a business sustainable without an obvious “moat” ? In my opinon yes, because creating such a business model is not something you can do from scratch. 3-5% margins are not overly attractive for many competitors. Howevr, in any case some deeper research into to this will be necessary anyway before a final investment.

Rallye SA (ISIN FR0000060618) – another Holding company at a discount ?

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Rallye SA, France is the holding company for 49.97% of Casino Guichard, one of the big French retail chains.

In their annual report they present the company as follows:

Their major assets are:

– 49.93% of Casino Guichard Perrachon SA (ISIN FR0000125585)shares (61.24% of voting rights)
– 72.86% of Groupe Go Sport SA (ISIN FR0000072456)(78.73% of voting rights), another small listed French company
– “investment portfolio”.

There is some qualitative description of the “investment portfolio” on page 19 of the report, it seems to be a quite divers collection of participations and real estate.

Rallye’s investment portfolio was valued at €365 million as of December 31, 2011, compared to €435 million as of December 31,
2010. At the end of 2011, the portfolio consisted of financial investments with a market value(1) of €272 million (vs. €295 million
at end-2010) and real estate developments measured at historical cost(2) of €93 million (vs. €140 million at the end of 2010).

Net external debt stands at 3 bn as of year end 2011. Other than that i did not see major positions.

The trickiest part of Rallye’s balance sheet is the 2.5 bn EUR receivables position the show in their single entity balance sheet.^2.3 bn of that seem to be receivables against Group companies:

The current account advances made by Rallye to its subsidiaries are part of the Group’s centralized cash management system. They are
due within one year.

The point I am struggling with most is the following:

If those receivables are against Casino, then one would add those assets for the Rallye evaluation. If those receivables are against their various subholdings which also hold Casino shares, then one would need to fully eliminate them.

I have quickly checked the 2011 Casino annual report, but didn’t find any liability against Rally SA. So we should assume that those internal Rallye receivables are a technical position which is financing the Casino stack and should therefore not be counted extra. Only the “external” part (~200 mn) should be used).

So with that assumption we can now calculate the “sum of part” or intrinsic value of the Rallye SA share:

EUR mn
Casino Guichard (50%) 4,112.3
Group Go 34.8
Investment Portfolio 365.0
Receivables, other assets 220.0
Sum assets 4,732.1
   
Debt -3,000.0
Other liabilites -110.0
Net Assets at market 1,622.1
   
 
Number of shares 47.2
Value per share 34.37
 
Current market price: 25.80
“Discount” 24.9%

Overall, a 25% “discount” seems to be quite normal for such a slightly in transparent structure including extra financial debt. However if one thinks Casino is a great investment, then investing through Rallye might be a good idea:

Casino Guichard itself is not uninteresting. Although it is not cheap, they are growing pretty strongly. Especially interesting is the fact that 60% or more of their sales are now in LatAm (Brazil and Colombia), two markets which seem to be the most interesting retail markets at the moment.

On the other hand, I am not a big expert on retail chains, so from that point of view I will not analyze Rally/Casino further.

Summary:

If my assumptions are correct, the current “discount” of Rallye vs. its sum-of-parts as a holding of 50% Casino Guichard is only 25%. Considering the extra leverage and the lack of visibility, it does not look greatly undervalued.

TNT Express (NL0009739424) – “post mortem”

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As it is commonly known, free lunches are few and rare in the stock market.

Another proof for this was last week’s termination of the TNT Express takeover by UPS.

I was quite lucky that I didn’t join in the “trade“, despite considering it quite seriously. My final decision was based on the believe that in such a “crowded” market like merger arbitrage, if a situation looks too good to be true, most likely it isn’t true.

Interestingly enough, a lot of “players” must still have believed in the deal. Looking at the chart, we can see that TNT is now trading relatively close to the lower bound of the “undisturbed” price before UPS came up with the bid:

As discussed in the previous post, at the current level, TNT Express is still not cheap, for instance compared to FedEx.

On the other hand, UPS seems to have been better off without TNT Express if we believe in “Mr. Market” as they have outperfomed the Dow Jones by almost 10%:

To me, this looks like that the offered price of 9,50 EUR was way too high and UPS realized this at some point in time and did not really try hard to get the deal through. For a company like UPS, blaming it to the EC is always a “face-saving” possibility.

However that also means that the price tag of UPS might never be reached again, even if FedEx would show up as potential buyer. On the other hand, TNT Express might still benefit by being spun off from POstNL which is crippled by pension liabilities and the terminally declining mail business.

PostNL Was even hit harder, dropping to a new all time low:

This might have to do also with Moody’s recent downgrade.

At the moment, both, PostNl and TNT Express are too much “hot potato” type investments, but it is definitely something for my “special situation” watch list. I think it will be especially interesting to see if TNT Express is able to turn around the business on a standalone basis.

Alsi for the future, I think it is the safest to keep away from Merger Arbitrage situations for my special situation “bucket”, as this requires very special skills which I do not have.

Edit:
It seems that French activist investor Lutetia is trying to start a campaign for PostNL. This could bcaome interesting at some point. Lutetia also showed up (quite succesful so far) in the SIAS Spa case.

The Herbalife “Slugfest”

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In my opinion, the most interesting (and entertaining) story in equity markets is the current Herbalife story.

Herbalife is a US based producer and distributor of diet shakes, vitamin pills etc.

Looking at the chart, one can see that until early 2012, Herbalife was one of the “hottest” stocks out there:

Herbalife went public in December 2004 at a price of 14 USD per share. Including a stock split, the stock returned a phenomenal return of ~ 30% p.a. until the end of 2011.

Earnings per share rose more than 10-fold from 0.47 USD per share to more than 4.80 USD in 2011. During the “financial crisis”, the stock suffered but then quickly went back into outperformance mode.

The first “crack” in the success story appeared, when David Einhorn personally dialed into the conference call on May 1st 2012 for the first quarter and started to ask some weird questions.

Two weeks later, when Einhorn spoke at the annual Ira Son conference, the stock bounced back 20% because Einhorn didn’t mention Herbalife. So far I didn’t find out if Einhorn is still short.

The next step in the story is well known, the epic presentation of Bill Ackman why Herbalife is a Pyramid scheme. To reinforce his point, he even set up a dedicated website about his Herbalife short thesis. For Ackman, this is not his first short battle. There is even a book (by the way highly recommended) about his several year long fight against the US mortgage insurers, called “The confidence game”:

However, pretty soon after his presentation, some quite savvy investors and bloggers pointed out some weaknesses in Ackman’s presentation, especially the claim that the Herbalife “scheme” is illegal and the US regulators will have to shut the company down.

One of the first was blogger Kid Dynamite and one of my personal favouritesm, blogger and hedge fund manager John Hempton.

Like sharks smelling blood, some other “famous” hedgefund managers joined the party, most notably Dan Loeb’s Third point which actually took a massive 8% long position in the company. Yesterday, even “activist” legend Carl Icahn came out swinging against Ackman, disclosing a long position in Herbalife.

So this is quite an interesting situation:

On the one side, we have some of the brightest “new generation” HF managers David Einhorn and Bill Ackman against well respected “activists” like Dan Loeb and Carl Icahn as well as extremely clever bloggers like Kid Dynamite and John Hempton.

Last Thursday, Herbalife held an investor day, trying to take on Ackman’s acusations. I found the Herbalife presentation rather unconvincing.

My advice on this:

If you are not a famous investor who can move markets with a presentation, STAY OUT OF THIS !!!!!

Otherwise you will end up like this poor guy, who “joined” Bill Ackman just at the wrong point in time:

The Herbalife story is the proverbial “hot potato” investment one should just enjoy and watch (and learn) instead of joining.

Personally, I think that Loeb and Icahn are only in for the quick rebound and long term Ackman will most likely come out with a nice profit, but I wouldn’t really bet on this, as you might be killed (or squeezed) in the meantime.

So get your popcorn, lean back and enjoy !!!

P.S.: For anyone more deeply interested in “multilevel marketingg companies”, there is a very good detailed post at Seeking Alpha.

Investment checklist v 0.1 (beta)

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One of my “secondary” goals for 2013 is trying to develop a more “formal” checklist especially for my “boring stock” strategy. As the “Boss Score” is only ment to be a starting point, I usually try to “quick check” certain points in order to find out if a deeper analysis makes sense.

One of the first thing one has to decide is: “what kind of stocks am I looking for” ? I don’t believe that a single check list for all kind of different stocks exists. So please keep in mind, the purpose of this checklist wil be to find stocks that:

– perform consistently well over time but not spectacularily so (no “wide moat” companies)
– have little fundamental downside (low debt, “hard” assets, stable sector)
– can be “left alone” if necessary for a long time because management is trustworthy (“low maintenance”)
– are nevertheless “mispriced” by the market

So far I have come up with the following list and the first 27 items (beta version):

1 . Market cap between 25-250 mn
“sweet spot”, large enough to invest, small enough to deter “large professional” investors

2. Less than 3 analysts following on Bloomberg or very bad sentiment
Unfollowed or “hated” stocks have larger potential to be mispriced

3. “low key” IR. E.g. no English annual reports, short quarterly updates etc., no share price on company homepage
Many investors skip such stocks

4. Potential special circumstances like Euro crisis, very diverse business activities, complex structure, Spin off etc.
increases chance of mispricing

5. Low historical beta /volatility
Good for my nerves, bad for any index oriented investors

6. Dividend yield > 3%
subjective criteria based on experience

7. P/E < 10
For some reasons I prefer “single digits” P/E

8. P/B < 1.2
Maybe anchoring effect, but in my opinion limtis downside risk

9. EV/EBITDA <= 6
in order to detect “special effects”

10. 10 Year mean reversion potential > 50%
Mean reversion potential based on P/E- net margin & EV/EBITDA, EBITDA margin

11. Positive 10 year FCF yield
no FCF generation normally indicates issues with capital allocation efficiency

12. Large acquisitions in the past or serial “acquirer” ?
might severly impact quality of reported numbers

13. Large share of intangible assets ?
again, quality of reported numbers

14. Significant pension liabilities, operating leases ?
Adjust for them accordingly to see if total leverage still acceptable

15. Low financial debt (net debt/equity <0.5)
again to minimize downside risk

16. Family owned / run
better chance for long term strategic management, best with founder still in charge and not too old

17. Treatment of shareholders in the past ?
Any indications of screwing shareholders in the past ?

18. Sharecount stable or decreasing ?
Does company dilute shareholders e.g. via options to management ?

19. Alignment of management and shareholders ?
Does management earn comparably much more than their shareholdings ? Outsized & unwarranted bonuses ?

20. Subjective impression of company management (pictures, speeches, comments)
Might sound stupid, but sometimes a picture says more than 500 pages …. Avoid jet set, sleazy looking guys

21. 10 Years of comparable history available ?
preferably companies with a long term track record as listed companies without major restructurings etc.

22. Industry in general decline
avoid value traps or make sure to understand whats going on

23. Positive/neutral short term (6m-1 year) price momentum ?
only catch the falling knife if you are very very sure

24. high quality investors as share holders ?
Preferable less known but good investors

25. Do I understand the business model ?
Why is the company succesful over the long run ?

26. Potential short/medium catalyst ?
i.e. sale of loss making division, change in shareholder structure etc.

27. 10 year sales growth above inflation
Don’t pay for growth, but if you get it cheap…also trade off with FCF

For each item I will give a score which is either:

+1 for a very positive answer
0 for a neutral position
-1 for a negative aspect

I will then add all the scores, the maximum is then logically the total number of checklist items. Anything which scores above 50% or more will be analysed deeper. In order to “callibrate” the list, I will also calculate scores for all my current holdings.

For a first test I calculated the “sores” for the following positions:

Installux: 18
Total Produce: 16
Hornbach: 16
Tonnelerie: 22
AS Creation: 20
Vetropack: 18
Buzzi: 10

As with any checklist or other “Model”, I don’t think one should follow this like a slave. Rather it should help to look more structured at a stock and also being able to review such a stock periodically on a structured basis.

I would be highly interested if any of the readers has comparable checklists and suggestions for the list.

Listed German utility companies – part 1: Overview and E.on (ISIN DE000ENAG999)

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In my small series about utility companies, it might make sense to start with those companies which are at least geographically in my “circle of competence”, Germany.

There are currently 8 listed companies which qualifiy one way or the other as “utilities” which are:

Ticker Name Mkt Cap EV/EBITDA T12M P/B P/E Dvd Yld
 
EOAN GR Equity E.ON SE 28,194 7.5 0.7   7.8
RWE GR Equity RWE AG 19,099 4.7 1.2 8.3 6.3
EBK GR Equity ENBW ENERGIE BADEN-WUERTTEMB 8,340 5.6 1.4 31.0 2.7
MVV1 GR Equity MVV ENERGIE AG 1,549 8.3 1.4 25.3 3.8
FHW GR Equity FERNHEIZWERK NEUKOELLN AG 72 6.8 2.1 15.6 4.5
MNV6 GR Equity MAINOVA AG 2,031 22.9 2.2 20.8 2.5
WWG GR Equity GELSENWASSER AG 1,887 17.8 2.3 19.3 3.2
LEC GR Equity LECHWERKE AG 2,198 20.0 2.7 22.6 3.2

Obviously, the large companies look the cheapest. Most of the smaller companies are in fact subsidiaries of the large players or owned by the Government such as:

– Lechwerke is owned ~90% by RWE
– Mainova is part of EON (91.3%)
– Gelsenwasser is owned by the government (92%)
– MVV is majority owned by the city of Mannheim (50.1%)
– EnbW is majority owned by the Government (85-90%)
– Fernheizwerk Neukölln is owned by Sweidish Vattenfall (80.1%)

RWE is de facto controlled by the regional government as well, only E.On to my knowledge does not have a controlling shareholder or significant Government influence.
A
s one could read in the press, the regulatory environment in Germany is supposed to be quite ugly, among others, the major issues are:

– unpredictable politics (close down of Nuclear power plants following Fukushima), the utilities are actually trying to sue the Governemnt for this
– heavily subsidized renewable energy (costs are added to the electricity bill for retail customers)
– relative low allowed yields on infrastructure which led the major players to shed electricity grids and gas pipelines
– heavy competition for instance for electricity. I just checked, where I am living (Munich), I got ~44 different offers for electricity

Going back to the “Buffet on utilities” approach, especially suing the Government (i.e. regulator) is maybe not a ver good long-term strategy if you then want to negotiate your next investment.

Another interesting aspect in my opinion is the fact, that especially the subsidiaries with purely local (regulated) focus show quite satisfying longterm ROEs.

10Y ROE 5Y ROE Debt/Equity
FERNHEIZWERK NEUKOELLN AG 18.6% 19.6% 0.0%
LECHWERKE AG 24.5% 13.9% 0.2%
GELSENWASSER AG 17.7% 12.5% 2.1%
MAINOVA AG 17.1% 9.1% 70.3%
ENBW ENERGIE BADEN-WUERTTEMB 21.0% 12.8% 94.1%
MVV ENERGIE AG 10.3% 11.3% 107.6%
       
 
RWE AG 17.4% 15.4% 122.4%
E.ON AG 10.2% 1.8% 79.2%

I find especially Lechwerke, Fernheizwerk and Gelsenwasser fascinating. Without any leverage they manage to produce solid double-digit ROE’s over long periods of time. So looking at this one might think that both, for RWE and EON, the German regulator is maybe not the real reason for their current problems.

Rather bad management and failed international expansion are the drivers between the rather bad performance in the last few years. Eon for instance lost lot of money with gas contracts outside Germany.

This is also the major issue I have with E.on. For some reason, they believe that they must grow outside Germany, just recently they swapped German Hydro plants with Austrian Verbund against a 50% stake in a Turkish utility group. Earlier in 2012 they teamed up with Brazil’s Eike Batista to invest in Brazil. Some people might like this exposure to “growth markets”, but personally I think this is a quite risky strategy.

Again, if we look at the comparable performance between E.on and its listed German subsidiary Mainova, we can see that at least this German business performs quite well and consistent despite E.on’s claims of bad German regulation:

Some additional thoughts about E.on based on the 2011 annual report:

– Nuclear is not coming back, that was more than 1 bn of EBIT which is missing going forward
– 60% of sales are actually energy trading revenues. The results of this “sector” look quite volatile
– they show huge swings in the net results of financial derivatives. In 2010 for instance, E.on showed a net gain of 2.5 bn against a 2011 loss of -1 bn .
– E.on has around 17 bn liabilities for nuclear waste etc. This liability is hard to analyse and could be grossly over-/understated. In the notes they state that the discount rate they use is 5.2%. I think this is a rather high rate. Combined with the long duration of those liabilities, there could lurk a potential multi billion hole there as well as in the 14 bn pension liabilities
– another “whopper” are the 325 bn EUR (yes that’s three hundred twenty five billion) of outstanding fossil fuel purchase commitments. Disclosure is rather limited here but I guess this is one of the big problem areas where they have locked in Russian NatGas purchases at too high rates
–

On the plus side we could add:

+ maybe earnings were understated to put pressure on regulators and trade unions
+ positive effect from future reduction in interest rates

All in all, EON in the current form looks like a big black box to me. mostly due to the large trading activities which are not transparent at all. I would be not able to value the company. I also don’t think it is particularly well-managed. As there is no dominant shareholder, the major “upside catalyst” could come from an activist investor. In contrast, I think current management will most likely waste the cash flow in stupid “growth investments”.

Another issue, and that goes for most of the German utilities is the fact, that the combination of Nuclear exit and strongly subsidised local renewal energy production might have altered the business model going forward. So betting on a “reversion to the mean” might not necessarily work here, at least not in the short run.

Last but not least, I don’t see how I could have any “edge” in valueing E.on. It is a liquid large cap stock, with plenty of analyst coverage. True, sentiment is quite bad which is maybe a chance at some point in time but as a private investor with a small portfolio, this is not the first place to look for “value”.

Yes I know, for many “value investors”, a P/B of 0.77 and dividend yield of 7.6% would already be enough and maybe yield starved investors will bid up E.On stocks for the dividend, but looking 3.5 years ahead, I don’t see a real “Margin of safety” at current prices with the current management and strategy plus taking into account the fundamental issues mentioned above.

2012 Performance review and comments

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Performance

2012 was a very good year for the blog portfolio. Overall performance 2012 including dividends and interest) was 37,4% vs 26.6 % for the Benchmark (50% Eurostoxx, 30% DAX, 20% MDAX), resulting in a relative outperformance of 10.4% for the year 2012.

Further details can be found in the following table:

Bench Portfolio Perf BM Perf. Portf. Portf-BM
2010 6,394 100      
2011 5,510 95.95 -13.8% -4.1% 9.8%
           
Jan 12 5,972 99.27 8.4% 3.5% -4.9%
Feb 12 6,275 105.90 5.1% 6.7% 1.6%
Mrz 12 6,330 107.22 0.9% 1.2% 0.4%
Apr 12 6,168 108.02 0.8% -2.6% -3.3%
Mai 12 5,750 108.90 -6.8% 0.8% 7.5%
Jun 12 5,969 110.17 3.8% 1.2% -2.6%
Jul 12 6,229 112.15 4.4% 1.8% -2.6%
Aug 12 6,428 119.48 3.2% 6.5% 3.3%
Sep 12 6,510 123.48 1.3% 3.3% 2.1%
Okt 12 6,672 125.32 2.5% 1.5% -1.0%
Nov 12 6,804 127.04 2.0% 1.4% -0.6%
Dez 12 6,973 131.81 2.5% 3.8% 1.3%
           
           
YTD 12 6,973 131.81 26.6% 37.4% 10.8%
           
Since inception 6,973 131.81 9.1% 31.8% 22.7%

The December 2012 outperformance is mainly a result of some significant year-end effects in some of the stocks like Total Produce, SIAS and Buzzi to name a few.

Also many of the stocks are rather “boring” low beta stocks. Therefore the 2012 outperformance should be viewed more as lucky timing of special situations than anything else. In a normal “bull year” like 2012 the portfolio should significantly underperform. In 2012 however, some of the special situations (esp. AIRE KgAA and Draegerwerke) catalysed unexpectedly early and let to this outperformance. From an overall strategy point of view, i would assume that my portfolio outperforms in bad years and underperforms in bull years.

To be honest, I don’t think that the current portfolio has an equal upside potential like in the beginning of last year, mostly due to the lack of really interesting special situation investments. For instance, the upside of athe Draeger Genußschein was much higher when it trades at ~2.5 times the pref shares than the current 4.5 times. On the other hand, I think the portfolio is well protected to the downside which should be the major concern of any (real) value investor.

Portfolio:

The only change in the portfolio in December was the purchase of some Sol Spa shares in the last few days, taking advantage of the significantly dropping share price.

Name Weight Perf. Incl. Div
Hornbach Baumarkt 4.5% 6.9%
AS Creation Tapeten 4.1% 22.2%
BUZZI UNICEM SPA-RSP 5.5% 16.0%
WMF VZ 3.4% 42.6%
Tonnellerie Frere Paris 4.9% 31.5%
Vetropack 4.5% -2.3%
Total Produce 6.2% 53.3%
SIAS 6.3% 52.6%
Installux 2.9% -1.6%
Poujoulat 0.9% -2.8%
Dart Group 3.8% 83.7%
Cranswick 5.0% 2.7%
April SA 3.5% 33.0%
Bouygues 3.1% 15.2%
KAS Bank NV 4.7% 9.6%
Gronlandsbanken 1.2% 19.5%
SOL Spa 1.7% -0.7%
     
Drägerwerk Genüsse D 9.2% 96.5%
IVG Wandler 4.9% 11.6%
DEPFA LT2 2015 3.0% 52.6%
HT1 Funding 4.7% 38.4%
EMAK SPA 4.4% 17.6%
Rhoen Klinikum 2.4% 2.4%
     
Short: Focus Media Group -1.0% -3.7%
Short: Prada -1.2% -17.3%
     
Short Lyxor Cac40 -1.3% -5.7%
Short Ishares FTSE MIB -2.2% -7.5%
     
Terminverkauf CHF EUR 0.2% 5.0%
     
Tagesgeldkonto 2% 10.7%  
     
     
     
Value 63.4%  
Opportunity 28.6%  
Short+ Hedges -5.5%  
Cash 10.7%  
  97.2%

The cash quota of ~10% is within my usual target range.

Outlook and comments:

If I would be in the “tactical” Asset allocation business, I would expect a rather strong start into the new year.(Edit: Is started writing this 2 days ago…) So many investors have watched the stock market from the outside and momentum looks quite strong. It looks like the fear of missing out another strong year is overcoming the fear of Euro crisis, fiscal cliff etc. or to quote Howard Marks: “when greed is stronger than fear”.

On the other hand, as a bottom up value investor one should be more cautious than ever. When greed is trumping fear, naturally for a value investor times get harder as under valuations are fewer and harder to find. The temptation rises to invest in “weak” stocks or turnarounds without much downside protection.

This goes together with the behavioural bias of “overconfidence” which usually is getting stronger after good years.

So the main focus for value investors will be to “stay the course” and not get lured into more risky and only superficially “cheap” stocks despite another period of potential underperformance against major stock indices.

The “harvest” will come when everyone is “on board” in the stock market and the next (inevitable) correction or contraction will come.

Utility companies – The Warren Buffet perspective

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In 2012, I sold my two utility stocks EVN and Fortum because I realised that I didn’t really understand the business model. I looked a little bit more general into utilities here, but with no real results. However,at least in Europe, the utility sector looks like one of the few remaining “cheap” sector.

If you don’t know a lot about a sector but need to start somewhere,it is always a good idea to look ifWarren Buffet has something to say about it

Although mostly his well-known consumer good investments like Coca Cola and Gilette are mentioned, Buffet runs a quite sizable utility operation called MidAmerican Energy.

Starting with the Berkshire 2011 annual report, let us look how the “sage” describes the business:

We have two very large businesses, BNSF and MidAmerican Energy, that have important common characteristics distinguishing them from our many other businesses. Consequently, we assign them their own sector in this letter and also split out their combined financial statistics in our GAAP balance sheet and income statement.
A key characteristic of both companies is the huge investment they have in very long-lived, regulated assets, with these partially funded by large amounts of long-term debt that is not guaranteed by Berkshire. Our credit is not needed: Both businesses have earning power that even under terrible business conditions amply covers their interest requirements.

So let’s note here first: Buffet uses “large amounts” of debt for his utility company.

Just below we find the following statement:

At MidAmerican, meanwhile, two key factors ensure its ability to service debt under all circumstances: The stability of earnings that is inherent in our exclusively offering an essential service and a diversity of earnings streams, which shield it from the actions of any single regulatory body.

I would argue he second point is interesting: Diversification in utilities works across regulators, not necessarily geographic location.

What I found extremely interesting is that Buffet is allocating a lot of capital to the utility sector. Out of the 19 bn USD Capex in Berkies operating businesses from 2009-2011, MidAmerican Capex summed up to ~9 bn USD, so almost half of Berkies total Capex.

One can assume that Buffet is not making all share investment decisions nowadays, but I think capital allocation to operating companies will be still made by him personally.

Buffet seems also quite interested in renewable energy, as the following comment from the annual report shows:

MidAmerican will have 3,316 megawatts of wind generation in operation by the end of 2012, far more than any other regulated electric utility in the country. The total amount that we have invested or committed to wind is a staggering $6 billion. We can make this sort of investment because MidAmerican retains all of its earnings, unlike other utilities that generally pay out most of what they earn. In addition, late last year we took on two solar projects – one 100%-owned in California and the other 49%-owned in Arizona – that will cost about $3 billion to construct. Many more wind and solar projects will almost certainly follow.

Here, he also mentions that he doesn’t extract any dividends out of his utility group. He considers it a growth opportunity rather than a cash cow. I think this is also worth keeping in mind, as many investors would judge utility stocks mainly by dividend yield.

From the 2009 report we learn the following:

Our regulated electric utilities, offering monopoly service in most cases, operate in a symbiotic manner with the customers in their service areas, with those users depending on us to provide first-class service and invest for their future needs. Permitting and construction periods for generation and major transmission facilities stretch way out, so it is incumbent on us to be far-sighted. We, in turn, look to our utilities’ regulators (acting on behalf of our customers) to allow us an appropriate return on the huge amounts of capital we must deploy to meet future needs. We shouldn’t expect our regulators to live up to their end of the bargain unless we live up to ours.

This is as clear as it gets. Utilities are a “natural” monopoly. If you play by the rules (at least in the US), you are guaranteed a decent return.

In the same report Buffet once more explains why he is suddenly more interested in utilities:

In earlier days, Charlie and I shunned capital-intensive businesses such as public utilities. Indeed, the best businesses by far for owners continue to be those that have high returns on capital and that require little incremental investment to grow. We are fortunate to own a number of such businesses, and we would love to buy more. Anticipating, however, that Berkshire will generate ever-increasing amounts of cash, we are today quite
willing to enter businesses that regularly require large capital expenditures.

From the 2008 report, this sentence is reinforcing Buffets strategy:

Indeed, MidAmerican has not paid a dividend since Berkshire bought into the company in early 2000. Its earnings have instead been reinvested to develop the utility systems our customers require and deserve. In exchange, we have been allowed to earn a fair return on the huge sums we have invested. It’s a great partnership for all concerned.

On acquisition of utilities, we can also find his thoughts in that report:

In the regulated utility field there are no large family owned businesses. Here, Berkshire hopes to be the “buyer of choice” of regulators. It is they, rather than selling shareholders, who judge the fitness of purchasers when transactions are proposed.

There is no hiding your history when you stand before these regulators. They can – and do – call their counterparts in other states where you operate and ask how you have behaved in respect to all aspects of the business, including a willingness to commit adequate equity capital.

When MidAmerican proposed its purchase of PacifiCorp in 2005, regulators in the six new states we would be serving immediately checked our record in Iowa. They also carefully evaluated our financing plans and capabilities. We passed this examination, just as we expect to pass future ones.

So being nice and trustworthy to the regulator is what counts in this business.

Finally let’s look at some “hard numbers” from MidAmerican, in order to be able to compare this to other utilities. I will use the MidAmerican 2011 annual report for this.

  2011 2010 2009 2008
Total Assets   47.7 45.7 44.7 41.4
Shareholders Equity   14.1 13.2 12.6 10.2
total financial debt   17.8 18.2 19.3 18.2
Sales   11.2 11.1 11.2 12.7
EBIT   2.684 2.502 2.465 2.828
Net Income   1.331 1.238 1.157 1.85
Int. Exp   1.196 1.225 1.257 1.333
Op. CF   3.220 2.759 3.572 2.587
Capex   2.684 2.593 3.413 3.937
 
ROE   9.8% 9.6% 10.2%  
NI margin   11.9% 11.2% 10.3% 14.6%
EBIT Margin   24.0% 22.5% 22.0% 22.3%
Debt/equity   126.2% 137.9% 153.5% 178.4%
EBIT/Int exp   2.24 2.04 1.96 2.12
ROA   2.9% 2.7% 2.7%

We can clearly see that this is low ROA business. Only the significant leverage allows Buffet to have ~10% ROE on average. Additionally, he seems to provide some “contingent” capital to MidAmercian, i.e. to promise a capital contribution of 2 bn USD if required. I think this keeps down the cost of debt without explicitly guaranteeing it. MidAmerican has a credit rating of “only” A- against Berkshire’s AA+. Also one can see that he reduced leverage over the last few years since taking over MidAmerican.

Nevertheless he seems to prefer this vs. returning cash to shareholders. Interesting.

So let’s quickly summarize Warren Buffet’s perspective on utilities as far as I understood it:

– he only started to invest into utilities relatively lately because he needs something where to invest his growing cashflows from the other operations
– he prefers regulated utility business, diversified over different regulators
– he invests a lot of money into renewable energy
– he uses significant leverage to achieve 10% ROE
– he is not looking at the busienss as a cash cow but a long term growth business and therefore does not extract any dividends

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