Category Archives: Quick Check

Travel Series 8: GDS (Sabre, Amadeus, Travelport) – Ultimate travel platforms or Dinosaurs waiting for extinction ?

Time to do another “travel series” post after the last Tripadvisor post a few months ago.

GDS – The business

The so-called “GDS” (short form of Global Distribution System) is one of the oldest “platform business” I know about.

Basically (and as far as I understand it), it is a real-time repository of available airplane seats, hotel rooms and rental cars from different suppliers (airlines, Hotels etc.). This repository can then be accessed by travel agents, OTAs etc. in order to book these offers for their ultimate clients. The GDS charge money both for access to the system and transactions.  The added value comes clearly from the fact that they act as a single interface to many different back-end systems on the supplier side.

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Gaztransport (GTT), Cheniere (LNG), Swatch

Gaztransport – Dodged the bullet..

Well, that was quick. 2 weeks after I reviewed Gaztransport, they have dislosed the following:

2016-01-29

Paris, 29 January 2016 – GTT (Gaztransport & Technigaz) announces that it received today a notification from the Korea Fair Trade Commission informing the company that an inquiry has been opened into its commercial practices with regard to its Korean shipyard clients.

The result: The stock price dropped  ~20% in two days:

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Quick update Bilfinger

I looked at Bilfinger for the first time in August 2014, after the price dropped almost 50% from its peak some months before. I resisted again in November 2014.

Again as a reminder my comment from the first post:

– some of the many acquisitions could lead to further write downs, especially if a new CEO comes in and goes for the “kitchen sink” approach
– especially the energy business has some structural problems
– fundamentally the company is cheap but not super cheap
– often, when the bad news start to hit, the really bad news only comes out later like for instance Royal Imtech, which was in a very similar business. I don’t think that we will see actual fraud issues at Bilfinger, but who knows ?

So now the new CEO came in on June 1st. And surprise surprise, the 6th profit warning within a year if I have counted correctly.
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Quick check: John Deere (DE) – Great “cannibal” or cyclical trap ?

Looking at Berkshire’s portfolio is clealry a “must” for any value investor. Whenever they disclose a new stake it makes clearly a lot of sense to look at least briefly at what they are buying. Berkshire disclosed the John Deere position in late February this year. I assume this is a “Ted & Todd” stock. Looking at the track record of Berkshire’s public holdings, this is actually a good sign as Ted&Todd have beaten the “master” now several years in a row.

Looking quickly at Deere, it is not difficult to see some of the attractions:

+ relatively cheap (trailing P/E of 12,6, Stated EV/EBITDA of 5,5, EV EBIT 7)
+ organic growth, low Goodwill, good profitability in the past
+ good strategy /incentives in place
+ solid business model, significance of dealer network (quick repairs during harvest season…)
+ “Cannibal”, is massively buying back stocks

Especially the massive share buy backs are clearly a common theme for “Ted&Todd stocks”. Starting in 2014, Deer has reduced the sharecount constantly from around 495 mn shares to now ~344 mn shares.

However we can also see quickly a few “not so nice” things at Deere:

– pension /health liabilities (health – how to value ? 6bn uncovered. Very critical, healthcare sunk GM, not pension (EV multiples need to be adjusted for this)
– they do not cancel shares, held as “treasury”, why ?
– Financing business –> receivables & ROA most likely not “true”..
– lower sales but higher financing receivables ? Channel stuffing ?
– comprehensive income to net income volatility
– cyclical business. current profit margins still above historical average

Financing business

One of the most interesting aspects of John Deere is clearly the financing business. As other companies they offer financing, here mostly to dealers and not to the ultimate clients. A financing business is nothing else than an “in-house bank”, sharing much more characteristics with a financial than a corporate business, for instance requirement of continuous capital market access, default risk etc.

What I found especially interesting is the following: looking at Bloomberg, they already strip out automatically all the debt from the financing business when they show EV multiples. This could be OK if the debt is fully non-recourse however I am not so sure with Deere. Although they not explicitly guarantee the debt, there seems to be some “net worth maintenance” agreement in place which acts as a defacto guarantee for the debt.

An additional important point is the following: Deere shows very good profitability on capital in its “core” business. However, this is partly due to the fact that they show almost no receivables in the core segment. the receivables are indirectly shown in the financing business. To have the “true” ROIC or ROCE, one would need to add back several months of receivables to the core segment in my opinion.

Cyclical aspect: Corn prices

This is a 35 year chart of annual corn prices:

corn annual

We can clearly see that corn prices went up dramatically in around 2006 but are dropping since 2013 back to their historical levels. Demand for farm equipment is pretty easy to explain: If you make a lot of money on your harvest, you have money to spent for a new tractor (with a small time lag).

This is the 17 year history of Deere’s net margins:

Net margin
31.12.1998 7,52%
31.12.1999 2,08%
29.12.2000 3,76%
31.12.2001 -0,49%
31.12.2002 2,32%
31.12.2003 4,17%
31.12.2004 7,04%
30.12.2005 6,89%
29.12.2006 7,82%
31.12.2007 7,68%
31.12.2008 7,32%
31.12.2009 3,78%
31.12.2010 7,17%
30.12.2011 8,75%
31.12.2012 8,48%
31.12.2013 9,36%
31.12.2014 8,77%
Avg total 6,02%
Avg 2006-2014 7,68%
Avg. 1998-2005 4,16%

So it is quite interesting to see, that in the 7 years before the “price explosion” of corn, margins were quite volatile and around 4,2% on average. In the last 9 years however, the average jumped to 7,7% with 2014 being still above that “high price period” average.

Clearly, Deere doesn’t only sell to corn farmers, but many other agricultural prices have faced similar declines.

To be honest: I do not know enough if Deer can maybe keep the high margins they are enjoying currently, but to me at least the risk of margin mean reversion is pretty high for such a cyclical business.
Even if we assume mean reversion only to the overall average of ~6%, this would mean around 6 USD profit per share which seems to be currently also the analyst consensus.

Summary:

For me, despite a lot of positive aspects, John Deere is not an attractive investment at the moment. Despite being well run, the business is cyclical and has profited from high crop prices in the past. The balance sheet is not as clean as I like it and the valuation is not that cheap if we factor in pensions and the financing arm. Clearly the stock looks relatively cheap to other US stocks but the risks are significant. Maybe there is more if one diggs deeper (network moats via dealers etc.) but for the time being I will look at other stuff. At an estimated 2015 P/E of 16-17, there are many opportunities which look relatively speaking more attractive and where I can maybe gain a better “informational advantage” than for such a widely researched stock.

Edit: By the way, if someone has a view on the moat / brand value of John Deere I would be highly interested……

Updates: Admiral CEO, Lloyds Banking, Cranswick + Editorial (Comments)

Editorial stuff:

While I was away (without access to my account) some people complained that their comments were not shown while other comments went through. The reason is the WordPress commenting system. If you comment for the first time, I need to manually approve this first comment. Once you are approved, further comments appear automatically if you login and comment the same way than you had done for the first time. So for anyone who commented for the fist time in the last 2 weeks, the comments were still in the “to be approved queue”.
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Short cuts: Admiral, KAS Bank, NN Group

Some quick updates on preliminary numbers form 3 of my financial stocks:

Admiral

Admiral released “preliminary annual” numbers yesterday. EPS declined slightly which was not a big surprise. My take aways at a first glance:

Negative:
– UK car still tough, UK comparison some issues due to competition, however cycle might turn in 2015
– slowing growth in Italy

Positive:
+ Italy at break even, break even in Spain expected for 2015
+ US growing strongly
+ Intenational comparison sites profitable

The CEO letter is again a must-read for anyone who is interested in Admiral and/or insurance. These guys are really different.

KAS Bank

Kas Bank came out already a few days ago with a press release on preliminary 2014 numbers. EPS almost doubled to 1,65 EUR due to the already mentioned one time effect. “Normal” earnings would have been around 0,74 EUR per share.

On the negative side, KAS Bank’s equity has been siginficantly reduced by an increase in the pension liability due to lower discount rates. Additionally they announced that they will expense 5 mn or so p.a. of the one-time gain as “investments”. Top line income acually fell but they were able to cut costs quicker. Overall, if low or negative rates will remain for a lnger time, the upside potential of KAS Bank now seems to be limited.

NN Group

Finally, NN Group came out with their 2014 results already 4 weeks ago. As with any life insurance company, they are quite difficult to interpret. What I found quite intereting is the fact that they said that their Solvency II ratio under the Standard model is 200%. Normally, most internal models show much higher solvency ratios than the standard model. In my opinion. NN Group remains the best (and only !!!) European Life insurance company to invest in despite the overall extremely difficult environment.

In any case, I will need to analyse all cases in more detail once the annual reports come out, especially with regard to KAS Bank and the pension issue.

Quick check: Adidas AG (ISIN DE000A1EWWW0) – will this fallen angel rise again ?

Adidas, the iconic German sportswear company, seems to be a big topic for value investors these days. A couple of my readers mentioned Adidas in the comments and also Geoff Gannon thinks it is cheap at least compared to Nike and Under Armour.

Over the past decade or so, Adidas was a great performer, riding mostly on the “Emerging Markets consumer” megatrend. This year however the share price is down ~-37% at the time of writing,:

Nevertheless, the Stock is still not really cheap on an individual basis:

P/E 19
P/B 2,2
P/S 0,9
EV/EBITDA ~10
Dividend yield 2,6%

Since a couple of weeks, there are constant rumours that some activist hedge fund will sooner or later appear and press for changes how the company is run.

Maybe in order to make it harder for activists or other potential “predators”, Adidas just announced a 1,5 bn share buy back over 3 years. According to the Reuters article this seems to be a rather quick change of mind:

Chief Executive Herbert Hainer said in August that Adidas had no plans for a share buyback.

Adidas also just launched a 1 bn EUR bond issue, most likely to fund some of the share repurchases. The bond issue however doesn’t seem to have been a smashing success.

Why did the share price go down so much ?

They had to issue a couple of profit warnings in the last few months. According to Adidas, two reasons are to blame: The issues in Russia, a core market for Adidas and the problems with the Golf business (Taylormade).

With the football World cup in Brazil, everyone thought that Adidas will have a record year, but as of 6m 2014, Profit declined by ~.27%. Adidas is the German company with the largest share of Russian sales in the DAX 30 index with around 7,5% of total sales. Doing badly in a year with a football Worldcup is not a good omen for the eventless next year.

What I don’t like at Adidas:

When I look at an expensive company like Adidas, I always look out for things I don’t like. After reading the 2012 & 2013 annual report, here are my “don’t like” point:

– management targets do not include capital profitability
– growth in recent years mostly from retail business
– Sales decreased already in 2013, 2014 just extends the negative trend
– they blame FX for most of their problems but that is part of the normal risk of doing business in Emerging Markets
– Adidas is doing Ok, but both Reebock and Taylormade are shrinking
– as with EVS, 2014 should have been a fantastic year (Brazil, Socchi). 2015, without any big events will most likely be even worse
– US as a strategic growth market does not make that much sense to me
– comprehensive income is lacking net income by a wide margin
– reporting overall is not very good, lots of “Marketing stuff”, critical figures like profitability per region are missing

What I like

– clearly iconic brand with growth potential especially in EM
– relatively conservative balance sheet
– management salaries are relatively low compared to total profit

Let’s look at some issues in more detail:

Retail business

If you look at their historical numbers, a large part of the recent growth comes from their “retail segment”. They started opening own stores some years ago and have expanded them fast. In 2013, the traditional business which they call “whole sale” already shrunk and only retail had some growth. However retail is lower margin business (Operating margins ~20% against 30+%). They expanded their stores much more aggresively than Nike, especially in Emerging Markets.

Also, retail business in my opinion is riskier than their core business. If you are in retail, you are also in Real Estate. With the threat of the internet (Zalando, Amazon), they are walking on a thin line.

Interestingly, despite paying ~600-700 mn rents p.a. they are only disclosing 1,7 bn of operating lease liabilities. I am not sure what to make of this, it looks like they are only renting short-term which might be OK if EM continue to be weak.

Currency Management:

According to the CEO’s letter in the 2013 annual report, Adidas doesn’t hedge FX risk in Emerging Markets as it is “too expensive”. Well, that’s complete nonsense in my opinion. Of course it is expensive, but for an EM based retail business, not hedging FX is almost suicide. A retailer in Russia is short the USD vs. Rubles twice: First, all the merchandise will be imported from China on a Dollar basis. Secondly, most of the rental contracts will be in USD as well. Sales will be made however in Rubles, so if the Ruble declines against the Dollar, all the nice margins just disappear.

Instead of hedging, the report “currency neutral” sales growth etc. In my opinion this is definitely a weakness especially if you compare Adidas to their major rival Nike. If you look into the annual report of Nike, you can see on page 77 & 78 that they have a pretty sophisticated hedging program in place, which creates a lot less volatility in stated net income AND comprehensive income.

Comprehensive income

As this is often the case, the Comprehensive Income of Adidas is hidden deep within the annual report, in this case it is mentioned the first time on page 189. And, as it is not surprising, Comprehensive income is a lot lower than Net income as the table shows and also much more volatile compared to competitor Nike:

Adidas     Nike    
  EPS CI in % EPS CI in%
30.12.2009 1,25 -0,4 -33,0% 1,99 1,81 90,8%
30.12.2010 2,71 4,4 161,9% 2,22 2,12 95,6%
30.12.2011 2,93 4,0 137,2% 2,48 2,48 99,7%
28.12.2012 2,52 1,5 60,9% 2,65 2,81 106,2%
30.12.2013 3,76 2,2 59,4% 3,02 2,83 93,6%
Total 13,17 11,8 89,3% 12,36 12,04 97,4%

Most analysts would ignore this, as they would call this a “non cash” accounting effect. But especially currency movements in the comprehensive income in my opinion have enormous predictive value. Although its true that the initial currency movement (i.e. the decline of the NAV of foreign subsidiaries) does not impact the cashflow, a permanently lower value of the foreign currency will clearly lower the future profits of the company, especially if they don’t hedge.

Ignoring this effect is like looking at your stock portfolio and ignoring the currency movements if you calculate performance. You can do this, but it does not reflect the underlying value.

Strategy & Capital allocation

Adidas’ strategy to focus on Emerging markets has paid of, despite set backs like currently in Russia. What I don’t understand why the want to target the US. In the US, they have no advantage against Nike, rather the opposite. Nike is much bigger in the Us and clearly has economies of scale against Adidas in advertising expenses.

In my opinion, this is mostly due to the fact, that return on capital is not part of the targets for Adidas management. They have target like sales growth, operating margins and some nonsense stuff like EUR amounts for investments, but no return on investment or return on invested capital targets. Nike, th main competitor, reports ROIC

This leads more often than not to chasing growth for growth sake and not creating value. In my opinion, Adidas clearly has a strategy & incentive issue here.

Brand & Moat

There are different opinions on this topic, but for me , a brand is not a moat. It is a competitive advantage, especially as we have seen in “new markets” like the EM, but on the other hand, brands can easily loose their power if they are not well managed. A sports brand like Adidas in my opinion is even more difficult than a “luxury brand”. Sports brands define themselves via sports stars. Signing sports stars or teams gets more and more expensive and when you are unlucky, your expensive star turns out to be a sex maniac or drug abuser and all the money is for nothing.

A real strong brand allows you to make above average margins and returns on capital, which somehow Adidas fails to deliver compared to some of its competitors.

Valuation

At a 2014 PE of 19, Adidas is clearly not in value territory, based on Comprehensive income, the stock looks even more expensive. In order to justify an investment, one would either need to assume EPS growth or multiple expansion. Yes, Nike trades at a lot higher multiple, but it is also a lot better company than Adidas with much better earnings quality. I also have doubts, that Adidas will increase stated EPS in 2015. Without a major sports event and with Russia still critical, they should rather be happy to maintain current profits.

The share repurchase will maybe add to EPS, but overall, for me Adidas is not a buy at the moment. If you are an event-driven investor wanting to bet on a short-term bump by someone like Icahn, Loeb etc. it could be interesting.

Summary:

Adidas is a company with an iconic brand, however stand-alone it is already quite expensive and the company has at best average management. Earnings quality in my opinion is clearly lower than for competitor Nike. Some activist investors might indeed shake up things a little bit and bump up the share price in the short-term, but the company is clearly facing a very difficult year in 2015. “Turning around” Adidas and bring them to Nike’s level in my opinion is not just spinning off Reebock and Taylermade, but a real change in startegy and incentives.

Adidas is clearly a bet on the Emerging Market consumer, which might work out over the long-term but is somehow maybe difficult in the short and mid-term. There are also cheaper stocks available if one wants to bet on an EM revival. On top of that, I am clearly no expert on branded sports good so for me, this would only a buy if it would look cheap from an absolute point of view, which it doesn’t.

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