Category Archives: Strange Stocks

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.

A bond camouflaged as stock: Societé D’Edition de Canal+ (ISIN FR0000125460) – Part 2

Following the first post about Societé D’Edition de Canal+ (“SECP”), let’s look how our “camouflaged” bond trades before we move to the valuation:

It is quite amazing to see this security trading so close to the CAC 40. For me it seems clear that not many are aware of the “special” characteristics of this security. Statistically, this translates “only” into a correlation of 0.48 and a beta of ~0.66 in this period but just from the graph one can see this is a very close relationship.

Compared to “parent” Vivendi, we can clearly see that SECP was the better investment:

Over the past 5 years, SECP and Vivendi moved closer together, but correlation is still much higher with the CAC40.

My valuation approach

So to summarize the results from the first post, for valuing the security, I will:

a) use only 90% of the guaranteed after tax result as coupon (plus the 2.5% growth rate)
b) expect so “sell out” at the end at NAV (incl. the 10% retained guaranteed profits)
c) will use discount rates as mentioned between 4.7% and 5.7% representing long duration hybrid high grade corporates
d) deduct a 0.25% from the discount rate for the “inflation protection”

Results:

Based on a current value of 4.525 EUR per share, my estimated cashflows represent an IRR of 8.2% p.a.

On a discounted basis, we get a fair value range of 6.87 EUR to 8.23 EUR per share, so quite a nice upside to the current share price but lower than the author determined in his analysis. The reason is simply the assumption of only using 90% payout ratio and not counting the cash upfront but the NAV “back ended” in year 2050.

Due to the long duration of the cashflows minor changes in those assumptions change the value significantly.

Opportunity / Special situation: Investor constraints

In principle, SECP would be a highly attractive high yielding long duration corporate investment for any pension fund or life insurance company. Due to the fact that this is officially a stock and it also behaves like a stock, many of those institutions will no be allowed to buy it as listed equity is a quite unpopular asset class these days.

On the other hand, for a typical equity investor, the stock is too boring, as a growth rate of 2.5% is not very sexy.

The characteristic of a long duration corporate exposure itself is relatively attractive as there is only very limited supply in the market. Most of the long dated (hybrid) stuff is financial which no one wants to buy these days. Long dated corporate exposure, especially to high quality corporate is very very scarce.

Catalyst

In the original research from the Value investor Club, the author says the following:

To review the corporate structure, C+ is 49.5% owned by C+ France, which is 80% owned by Vivendi and 20% owned by Lagardere. Lagardere has been trying to simplify its business and raise cash to repay debt over the past few years. It has been trying to sell its 20% interest in C+ France for a while, either as an IPO or to Vivendi, but has not been happy with the available prices. Lagardere has recently re-committed to sell its 20% interest one way or another in 2012. Vivendi has had an active policy of purchasing its French minority interests but has not yet agreed with Lagardere on price. Two weeks ago Bloomberg News reported that Vivendi will consider breaking itself up and will perhaps separate C+ Group from the rest of its businesses.

I am not sure how all this plays out, but I think that within 1-2 years C+’s parent company C+ France will be 100% owned by someone, and that there is a pretty good chance that party will want to acquire the 51.5% public float of C+’s shares. I believe that purchase will make economic sense at prices well above today’s €4.05 since at today’s price C+ is receiving a payment implying a 12.3% FCF yield. At €8/share the implied FCF yield is close to 5% and I think an acquirer would still want to purchase C+ at that level to avoid the cash payment, simplify ownership and eliminate any duplicated costs/public listing costs and tax inefficiencies. Vivendi can borrow short-term money at around 0.5% and long term below 5% so it has leeway to make a purchase at €8 that is EPS-enhancing.

I agree, that it is not totally unlikely that at one point in time Vivendi will repurchase the minorities. However one has to be careful not to overestimate the price they are paying. At the moment, the minority share costs them 6% dividend yield but has the advantage that it does not count as debt.

If Vivendi really would issue debt to repurchase minorities, their debt will increase, even if they could then consolidate the cash in SECP. At S&P, Vivendi has a BBB with negative outlook and more importantly a A-2 Short term rating with negative outlook. So even if its good for EPS, I think Vivendi does not have a lot of leeway to increase debt at the moment, especially if they would buy the Lagardere stake first.

Nevertheless, there is a relatively high probability that something might happen in the next 2-3 years.

How to tackle the stock volatility

So the problem is: SECP has a nice “special situation” angle, but for the time being it behaves like a CAC 40 index tracker without having a fundamental stock upside. It is a bond with an equity volatility. Normally I am rather looking for equity with bond volatility.

There are 2 potential ways to “mitigate” this:

1. Wait for the Stock to follow the CAC down in a correction and buy really really cheap.

2. Try to implement a long/short or hedge strategy in order to take out some volatility

The nice thing about SECP is that the dividend yield with 6% is higher than the CAC 40 yield with 4%, so we do have in principle a “positive carry” against the index (all other things equal).

In theory, one would implement a short position according to the beta of the stock to the CAC 40. Adjusted Beta has been quite stable to the CAC with 0.67, Raw Beta is at around 0.48.

I have run a quick simulation (30.07.2010-31.08.2012, daily basis) with some interesting results:

Standalone, the CAC 40 returned -6.3% against -5.2% for SECP for this period. Volatility was 10.2% for the CAC and 9.7% for SECP.

A static long / short (funding through the effective sale short position as an ETF) with a 0.67 short CAC position returned -2% ROI with a Vol of 10.9%, however a 0.5 CAC 40 short position returned -4% with a Vol of 8%.

A Long stock / short future (Ratio 0.5:1) strategy, despite requiring a higher capital investment shows almost “bond like” characteristics with a vol of 3.6% and a performance (before forward discount) of -1%.

Graphically we can clearly see that the index hedge (purple) creates a much less volatile pattern than the stock alone (green) and the long/short strategy (blue):

So this strategy could basically achieve the following:

– lower volatility to a “bond like” profile
– generating a small positive carry
– “extract” the special situation aspect

The result would be an “ok yielding” position with some small remaining market exposure and the “special situation” upside option.

Summary:

I was rarely so unsure about an investment as in this case.

On the one hand, it is clearly a misunderstood security with a potential catalyst trading at a quite attractive discount. So in the beginning I thought this really will be the next special situation investment.

On the other hand, I am usually looking for stocks which trade like bonds not vice versa. Also for a bond alone, the 8.33% IRR is OK but not spectacular. And for a bond you normally have a “hard” catalyst in form of a maturity or call date.

Also I don’t think we see a “gradual” revaluation, as there are just no natural buyers for this security. Maybe “yield hogs” will warm up to that at some point in time but I am not sure. They will rather buy crappy high yield bonds because this is the “right” asset class.

Combined with a CAC 40 hedge, Canal+ might be an interesting “special situation”. Although I am also not totally convinced that we see a short term buyout offer from Vivendi yet, so for the time being “no action”.

I would go long the security if prices come back to like 4 EUR or we see some action on the Vivendi buyout front.

Edit & lessons learned

This was again a good learning experience. If you invest a lot of time into analysing such a security, one is sometimes tempted to “make it look good” in order to justify the effort. I really felt this effect myself a couple of times. I think this is one of the typical mistakes made by many fundamental investors and something one has to monitor closely.

New Series: Strange stocks – Part 1: Swiss National Bank (SNB) and Banque National de Belgique (BNB)

Before Nate at Oddball “discovers” all the <2off the radar" European stocks I thought that I start a series about stocks which are in my opinion are strange or uncommon. A little competition in this area might not hurt…

IMPORTANT: Most of those stocks will not be really investments. This is “just for fun” mostly. So if you are looking for “actionable ideas with a catalyst” you might consider skipping this series. If you are however more liek a “stock collector” feel free to read and comment.

In the internet there is often a lively debate about the fact that the US Fed is in principle privately owned. I don’t want to touch this now as this pretty quickly goes into the racist or religious direction.

So lets look at two other National banks. Not many people know that both the Swiss National Bank (ISIN CH0001319265) and the Belgium National Bank (BE0003008019) are both listed stock companies.

Swiss National Bank (ISIN CH0001319265)

The SNB has 100 thsd shares outstanding giving it a market cap of ~100 mn “Swissies”. Not a lot for a bank who can print one of the hardest currencies in the world and is holding 400 bn CHF foreign reserves ? To make things more interesting, the SNB had a profit of 6.5 bn CHF (!!!) in the first 6 month of the year. So ist his a P/E 0.01 investment ?

Not so fast there are some details to consider.

1. Shareholders do not really have rights as most of the normal shareholder’s rights are capped through a special Swiss law

2. The same law also fixes the maximum dividend amount at 15 CHF. Any profit above goes to the Government

So effectively we do have a perpetual Swiss Frank Bond with a yield of around ~1.5 % at current prices, which for CHF is not unattractive.

As the stock basically trades in line with interest rates the long decline in rates actually led to a very nice and steady performance over the last 10-15 years:

For some strange reason a German professor is the largest private shareholder of SNB with almost 5.6% which caused some raised eyebrows in Switzerland. According to the Economist only ~53% are held by Swiss Government entities.

Summary: If you are bullish on the Swissie it could be a good hedge to buy SNB shares. additionally it might be just fun to be shareholder of the Swiss Nationalbank. If you have some spare time the annual meeting might be good entertainment. However it clearly does not fit into my portfolio.

Belgium National Bank (BE0003008019)

The Belgium National bank is also a listed company. Interestingly tiny weak Belgium National Bank has a market cap of 900 mn EUR ~8 times that of “Mighty” SNB. How comes ?

This might have something to do with the following developement of dividends since 1998:

Dvd/share
31.12.1998 58.67
31.12.1999 59.16
29.12.2000 59.87
31.12.2001 61.47
31.12.2002 63.00
31.12.2003 64.13
31.12.2004 65.33
30.12.2005 66.67
29.12.2006 68.47
31.12.2007 70.00
31.12.2008 72.00
31.12.2009 75.00
31.12.2010 126.48
30.12.2011 166.12

So clearly the BNB is paying out a lot more than the SNB having a nice yield of around 6.2%. The “Mechanics” of the dividend are published unfortunately only in Dutch or French.

If I understood correctly the dividend is determined the following way:

1. A guarantee dividend of EUR 1.5 per share
2. Additionally the National Bank reserves a part of the profit which prevents that all profit is distributed to the Government. The yield on this reserve is then distributed to the shareholders.

In the latest shareholder presentation there are some slides regarding this reserves and average yields etc.

I didn’t fully understand the mechanism but it looks like that BNB shareholders were one of the beneficiaries of expanding central bank balance sheets.

Summary: Although i don’t fully understand the mechanism the BNB profit distribution mechanism looks quite interesting. I am not sure if this is an investment right now but something to keep on the radar screen maybe as an alternative to long term bonds with in implicit Financial crisis option. The stock actually would qualify for the “Exotic security” category as well.