value and opportunity

I don’t want to transform this blog into a macro blog, as I do not have the competence to really talk about macro events. However I wanted to follow up on the Bull case for Europe post to quickly look at the results of last week’s EU summit

As it is always best to ignore most of the press stuff, let’s look at the original statement:

In my opinion, the 120 bn “growth budget” is less important, as well as the intention to move to a fiscal union. The most important part in my opinion is this one:

Euro area summit statement

Eurozone heads of state or government decided:
to establish a single banking supervisory mechanism run the by the ECB, and, once this mechanism has been created, to provide the European Stability Mechanism (ESM) with the possibility to inject funds into banks directly.

Spain’s bank recapitalisation will begin under current rules, i.e. with assistance provided by the European Financial Stability Facility (EFSF) until the ESM becomes available. The funds will then be transferred to the ESM without gaining seniority status.

It was also agreed that EFSF/ESM funds can be used flexibly to buy bonds for member states that comply with common rules, recommendations and timetables.

The Eurogroup has been asked to implement these decisions by 9 July 2012.

I would call this decision the “Spanish bank circuit breaker”. Up to now, everyone was aware of the potential death spiral, if the ESM gives money to Spanish banks only via the government because this further incrases the debt load.

Interestingly, they did not specifiy what instruments should be used, My assumpton would be someform of “Contingent Convertible” which would provide much needed Tier 1 capital to Spanish banks. The ESM original document speaks of “lending”, but CoCo loans or bond would not violate this.

So in theory, we now have the “full package” for any Eurozone bank:

1) unlimited liquidity from the ECB plus
2) a big pot of potential bank equity from the ESM.

Draghi’s bazooka from last year was only a small bonfire without the possibility to inject capital.

For those who still remember the beginning of the crisis, this was exactly how the US TARP developed. The 700 bn USD fund was initially planned to buy mortgages etc. but was then used to inject money directly into banks. The “vicious circuit” was only broken, when Bazooka Paulson forced his Tarp funds into any large US banks.

So does this end the crisis ? Are banks stocks now good investments ?

I don’t think so, but this feature definitely reduces both, the probability and severity of a tail risk event.

As expected, the usual suspects again come out and say: This is not enough.

Like Nobel laureate Paul krugman, who of course demands a complete solution to any problem being implemented right now.

However, for me it looks like a necessary and logical next step. No solution but risk mitigation. And therefore important and good. I hope it leads to ample supply of loans for PIIGS companies in order to have time to implement necessary other reforms.

At some point in time one might want to start to look into PIIGS bank subordinated securities…….

Always worth to spare some minutes: Jim Chanos Interview on short selling

Final post of Damodaran’s series about value investing

Royce funds on diversification and valuation levels

A couple of more or less interesting presentation from a US value conference

Even the razor blade business model seems to get into some trouble

Avenue capital on the opportunities in Europe

Mark Cuban on High Frequency Trading and the purpose of stock makets

Ruechzugsgut has 2 good posts about Megacycles and the Ennismore value fund

Wexboy on Alternative Asset Managers

Oddball analyses French stock HF Company

China: Chovanec with two scary posts about the detoriating situation in China: Real estate and Guarantee companies. Fortunatly, German investors still like Chinese IPOs.

The fine wine bubble seems to pop any minute

David Einhorn with a new idea: “Go Ups”

After my first French stock analysis Installux, let’s have a look at another of my favourite French small caps, Poujoulat SA

As this is a pretty long post, I will introduce a kind of “management summary” in the beginning:

SUMMARY:

– Poujoulat is a small family owned chimney producer in France

– company is not an asset play (P/E ~ 8, P/B 0.9) but a cheap stock which showed consistent profit growth of 15% CAGR since 1999 with little impact from business cycles

– Poujoulat has profited and profits from the secular trend to energy-efficient heating and is investing into renewable energy (wood pellets)

– if the new “renewable energy” segment really takes of, the company could be worth multiples of the current stock price, if not, the downside is relatively limited as the stock is cheap without any growth

Introduction

Bloomberg describes the company as follows:

Poujoulat is involved in the building supply and heating industries, and specializes in manufacturing chimneys. The Company, through its subsidiaries, supplies construction companies and individuals in France, the United Kingdom, Italy and Belgium.

If we look at “traditional value metrics, the stock is cheap but not spectacularly so (all information from the 2011 annual report)

MArket Cap: 62 mn EUR
P/E 2011 8,0
P/B 2011 ~0.95
P/S 0.4
EV/EBITDA ~5
Div. Yield 2.7%

So nothing special which would show up on one of the various screeners. So what’s interesting about this company ? That becomes clear if we look at the recent history since 1999:

	TRAIL_12M_EPS	NI Margin	ROE	ROIC
1999	2.61	2.9%	8.3%	5.6%
2000	3.39	3.4%	10.0%	6.1%
2001	5.85	4.9%	15.8%	8.6%
2002	3.81	2.9%	9.3%	5.3%
2003	5.41	3.9%	12.2%	6.7%
2004	5.10	3.4%	10.5%	6.3%
2005	7.56	4.3%	13.6%	9.9%
2006	9.76	4.7%	15.2%	15.7%
2007	11.62	4.8%	15.8%	10.6%
2008	14.19	5.0%	16.8%	10.3%
2009	16.73	5.9%	17.0%	9.9%
2010	18.15	5.8%	15.8%	9.8%
2011	16.62	4.6%	na	na

Poujoulat managed to grow its earnings relatively steady by 15% CAGR from 1999 to 2011.

NI margin have almost doubled, however with a small set back in 2011. ROE has increased to a nice 15-17%, ROIC is slightly lower because Poujoulat has some debt on its balance sheet.

So this stock looks like some nice “Growth at reasonable price” stock or GARP. GARP investing was the “Mantra” of Peter Lynch, the legendary Fidelity Portfolio manager.

The most important ratio for “GARP ers” is the PEG (or Price Earnings Growth ratio). The PEG ratio is calculated relatively easy by P/E divided through the growth rate in absolute terms.

For Poujoulat this would be

P/E = 8 , Growth 15%, PEG = 8/15 = 0.53. Everything under 1 is normally considered good, a value like here at 0.53 is even considered very good.

I have no statistical evidence if GARP really works, but all things equal, I always prefer a cheap growing stock to a super cheap no growth stock.

Business model / reason for past growth

Before we go into the valuation exercise, let’s have a look at the business itself. Chimney manufacturing is a highly localised and fragmented industry. Poujoulat calls itself “market leader in Europe” however 85-90% of their business is located in France.

As chimneys are an important part in Fire prevention, chimneys have to be certified by the respective authorities in most countries. So we have certain local barriers of entry because you cannot just import stuff from China and sell it, but I wouldn’t consider this as a really high moat.

Most chimneys are sold through the respective construction companies, so the sales organisation is more business to business than business to consumers. So we should not expect too many branding effects etc. However I could imagine that a good established b2b sales force (plus service and infrastructure) might be a competitive advantage.

Chimneys themselves are not only simple tubes to lead exhausts outside the house, but there seems to be a fair amount of technical knowledge involved.

In summary I would assume that there is no real moat in this business but maybe some regional competitive advantages like sales force etc.. So where did the strong growth in the last 10-12 years come from ?

The answer is relatively easy: usually you need a new chimney if you build a new house or if you change the heating system. As everyone knows, building activity itself is somehow subdued, but due to high oil prices and government incentives, heating systems are being exchanged in an ever-increasing pace.

What seems to be especially interesting is the fact that you seem to get nice tax credits in France especially for wood pellet stoves. According to this article, tax credits have evolved as follows:

In France, 30 – 40% of the population in most areas uses wood as a primary or secondary heat source. However, there was not the explosion of low efficiency polluting devices that occurred in the US in the 1970s and 1980s. As a result, the average French person does not regard wood heating as a pollution problem as many Americans are likely to.

France has had tax credits for stoves at 15% starting since at least 2001. In 2005, they rose to 40% and were as much as 50% in 2008 and 2009. In 2010 they went down to 40%, and in 2011 they were further reduced to 36%. Due to budget cuts, tax credits are likely to be reduced again in 2012 or end altogether.

Also many of the other energy-saving heating systems usually require new chimneys as exhaust fumes are colder and more humid.

So one could compare this a little bit with the German company STo AG, which produces insulation material and profited as well from the energy-saving boom.

If we compare the charts, we can see that at least to a certain extent the stocks performed similar to each other:

So to summarize the business case: We do not have a moat company but a company which has profited and might profit from a secular trend, in this case energy-saving.

Valuation

Even if we don’t account for growth, the company seems to be really cheap. We can buy a company below book value with an ROE of 15%. Even if we assume no growth and 10% CoC, Poujoulat should still be worth something like 160-170 EUR.

If we assume only half of the growth from the past (~7%) then the stock would could be worth 300-400 EUR.

So from a valuation point of view, I think one gets a free option on the further growth of energy-saving solutions which is not a bad deal.

Management / Shareholders / etc.

The company is led by Frederic Coirier, the son of Yves Coirier who bought the majority of the company in 1975 and is still President of the supervisory board.

Son:

Father:

The family holds around 73% of the shares, another 11% are held by three French funds according to Bloomberg. In the annual report they mention a forth fund (“Ocean”). So free float is really small, below 10 mn EUR.

Balance Sheet quality seems to be relatively good. Only small amounts of goodwill, no big acquisitions in the past. The company uses debt. Debt to capital ratios improved until 2010, but debt increased due to relatively large investments in 2011. I did not find anything with regard to hidden assets.

Unlike Installux, there is a link to the annual report on the homepage, even English annual reports are available, unfortunately only until 2009. On a quarterly basis, the company only issues sales updates.

Issues / Problems

For a “perfect” stock, Poujoulat does not generate enough free cashflow. Total Free Cashflow since 1999 is negative. This means that they actually had to invest to grow. Which is normal for a company but some investors do not seem to like companies who invest in fixed assets.

Especially in 2011, Poujoulat invested 25 mn EUR or almost a third of the market cap into fixed assets. On the other hand, if a company manages to earn 10% on invested capital and 15% ROE relatively stable across business cycles one could argue that this is actually a good sign if a company has such reinvestment opportunities.

Another issue to be aware of is of course the impact of tax credits and regulations. This is an issue all the renewable energy stocks share, the impact of the Government is huge and regulations could change quickly.

Finally trading for the stock is really illiquid and prices jump around like crazy. It is nor unlikely that from session to session, prices move by 10% without any news up or down.

New business segment

One interesting aspect is that they are actually diversifying away from producing chimneys. Starting only in 2011 they show now a separate segment “Bois energy” which I would translate as “wood based energy”. Almost 50% of new investments in 2011 went into this area, however with a negative result of -600 K EUR in 2011.

If I understood this article correctly (and Google translated well), they are actually moving into manufacturing wood pellets and logs to be used in wood heating. The new production site also seems to include a biomass electricity generation.

Normally I would see this kind of activity as “diworsification” but with Poujoulat this might be a little bit different. Due to their know how with wood heating and chimneys, they might have a relatively good inside view into this market.

So this could even be the start of a new fast growing segment for the company. As far as I know, the wood pellet market is currently quickly growing and to my knowledge, Poujoulat is the only listed company with exposure to this segment of renewable energy. I have some friends who work in Private Equity who consider this area as quite interesting.

The business segment showed a loss in 2011 although this seems to be normal if you start something like this from scratch. In another article, they say that the new processing plant went live only in Novmeber 2011. Here is a picture:

Accoring to the articel, the dried wood logs and pellets are sold through 1.400 point of sales. So this is something to watch closely, although due to the reporting of Poujoulat we will see the next results only in next year’s annual report.

If we assume a 15% growth rate for this business and a 10% ROA based on the current 25 mn EUR investment, this segment alone could be worth an additional 50-100 EUR per Poujoulat share.

Current quarter

In the first quarter 2012. as usual they only report sales divided into France and “export”. On a group level, they increased sales by a whopping 14.5%, with France actually growing 17%.I assume that this includes the wood energy segment has contributed significantly to this growth.

If the Wood energy business returns the same ROA as the other businesses, we should see some extra 3-4 EUR earnings per share pretty soon.

Summary:

As a pure building material stock, Poujoulat would not be interesting. However due to the fact that they profit over proportionally from the secular trend to energy-saving, the stock becomes more interesting. The final argument for me was the “free option” included for the new segment “wood energy” which looks promising and is not priced in my opinion.

So for the portfolio I will start accumulating Poujoulat from today with a limit of EUR 140, although due to the low trading volume it might take a while before a reach even 1% of the portfolio.

Installux is a small French Company which according to Bloomberg:

manufactures and distributes aluminum and steel components used in carpentry, locksmithing and building. The Company also refurbishes office buildings and factories.

Traditional valuation numbers show that the stock is relatively cheap and conservatively financed:

Market Cap 44 mn EUR
P/B 0.81
P/S 0.4
P/E 7.8 (Trailing 2011)
Div. Yield 5.5%

So far so gut, however, EV/EBITDA is at a sensational 2x EV/EBITDA

This is due to the fact that the company has around 46 EUR per share in net liquidity. Unfortunately, the 2011 report is not yet available, but some preliminary figures can already be accessed for instance here.

If we adjust the P/E for cash we would get a corresponding lower PE of around 5.2 for 2011.

A company with a valuation at 2 x EV/EBITDA and a P/E of 5 needs to have some kind of serious problem. However if you look at Installux, it is hard to find problems. Let’s look at historical numbers:

	EPS	NI Margin	ROE	ROIC
1999	10.2	5.5%	16.7%	15.9%
2000	13.4	6.2%	19.1%	18.7%
2001	14.1	6.3%	18.4%	15.5%
2002	10.4	4.6%	12.7%	13.0%
2003	12.4	4.7%	13.8%	14.9%
2004	17.5	5.6%	17.7%	15.5%
2005	18.5	6.6%	16.6%	15.0%
2006	19.8	6.4%	15.4%	14.6%
2007	18.8	5.6%	13.3%	13.2%
2008	17.9	5.4%	11.9%	11.8%
2009	15.1	4.7%	9.5%	10.2%
2010	21.8	6.4%	12.6%	19.6%
2011	17.9	4.9%	#DIV/0!

What we can see here is a generally growing profit (with some minor hiccups), an unspectacular but very stable Net margin between 4.7% and 6.4% and Mid teen ROEs and ROICs.

The business is highly cash generative. Despite the growth achieved, over the last 13 years, on average 12-13 EUR free cashflow per share have been generated. Around half of that has been paid out as dividends, the other half has accumulated on the balance sheet (in 1999 Installux still had a tiny amount of net debt).

Also the balance sheet is cleaner as clean, no goodwill, no pension liabilities and no operating leases as far as I could see.

So let’s stop here and summarize:
We have a consistently growing and profitable business with very low volatility, attractive ROE and ROIC and a valuation of 2x EV/EBITDA and 5x P/E adjusted for cash (7.8 unadjusted) which produces a large amount of free cashflow despite growing nicely over the years.

Let’s have a quick look at the business:

Installux is processing aluminium, i.e. shaping and forming and coloring it to be used in shops, for windows etc. Interestingly, despite the fluctuation in aluminium prices, they seem to be able to pass on price changes relatively quickly.

Their clients are mostly “corporates” like building contractors etc., they run a small retail segment which however doesn’t seem to be very profitable at the moment (Roche Habitat).

A Net margin of 4-6% is Ok, but does not indicate a big moat. The relatively high returns on equity and invested capital seem to be the result of a relatively low fixed asset base required to run the business.

So the business seems to be nothing special, but produces double digit returns on invested capital which is quite good and is not really cyclical.

In the last 13 years, Installux roughly doubled its sales and profits, so one could not say that this is a shrinking or dying business either.

Management

The current CEO Christian Canty seems to be in charge since 1987 and has bought the company according to the company history website in 1991. They made small acquisitions along the way but nothing spectacular. He is 65 years old and might not continue forever. However his son, Christophe age 38 seems to be already working in the company as a director.

He holds 50% plus some shares and has been buying smaller amounts of shares for instance in 2010 (1500 shares according to the annual report).

I haven’t found a disclosure how much he pays himself, but with a total of +12 mn salaries for all 450 employees, there is not a lot of space for a large CEO salary. Additionally they don’t issue any options or new shares to directors.

It is interesting to read Canty’s “press communication” which seems to be issued in irregular intervals. Another one can be found here.

It becomes clear how cautious he approaches exports and how hands-on he comments on the loss of his smallest division, Roch Habitats. One gets the impression that the “boss” is in control of things.

I also didn’t find any hint that any improper transactions etc. have been made between the CEO as majority owner and the company.

So why is the stock so cheap ?

Some possible reasons are:

– no investor relations at all, on their homepage you neither find a share price nor a link to the annual reports or quarterly news. This is the first time that I see a company homepage of a listed stock which basically denies the existence of its share….

– no trading volume. On a “good” day, 100 shares are being traded. prices jump around a lot between auctions.

– small free float: The CEO Christian Canty owns 50% of the shares and three 5% packages of French institutions are disclosed in the 2010 annual report. No international shareholders as far as I could see.

– even on Bloomberg, you cannot find links to recent news, reports etc. Also the historical numbers are screwed up. In their historical earnings database they show a profit per share of 175 EUR in 2004 per share instead of 17,50 EUR.

– Installux generates more than 95% of sales in France. if France goes into deep recession, it will be hard to compensate for Installux

Valuation

With a stock like Installux, one can take a rather simple approach. As we have seen, the business is cash generative. So if we assume that they just continue to produce around 5.5 mn profit a year and discount this with 10%, we would get a valuation of 55 mn EUR. Plus the 14 mn cash on hand would make a conservative “no growth” valuation of around 230 EUR per share.

Of course we do not have something like a “catalyst” here, on the other hand at least based on historical volatility, a 10% discount rate might even be too high.

Another way to look at this would be: At the moment one can buy Installux at ~80% of book value. The earn 15% on Assets ex cash so one is buying at close to 20% effective ROE (ex cash) which is really really good !!!!

Share price

The stock price looks pretty boring:

Nevertheless, Installux has easily outperformed the CAC 40 even before dividends.
So let’s stop here and summarize:

+ Installux is a very conservatively financed company with a profitable growing business which doesn’t need a lot of assets to run

+ current valuation seems very cheap and neither takes into account the cash on hand nor the relatively high ROCEs and low volatility

+ a very conservative valuation approach would imply at least 50% upside in a no growth scenario

+ if Installux would continue growing at approx. historical growth rates, the stock should be much more expensive.

– however no catalyst in sight other than a slowly growing dividend which might help in the long run. So this is for the patient investor.

For the portfolio will start to accumulate shares at my usual rules (max 25% of daily volume).

Appendix: Others sources from the web for Installux:

– relatively good blog post 2 years ago on a French value blog which doesn’t seem to be active any more. He concludes that the stock is very solid and extremely cheap.

– from time to time there are posts in the boursorama forum. Th few people who discuss the stock seem to come to the same conclusion

– “Worlreginfo” seems to be the best source for Installux company filings