value and opportunity

Total Produce is one of the core holdings since the beginnings of this blog. In the beginning, we analysed the stock mostly in German, nevertheless, we finally settled after some back and forth on a fair value range of 0.69-0.83 EUR per share based on a free cash flow analysis, assuming ~8 cent of “adjusted” free cash flow per share (adjusting esp. for minorities.

One of the issues with Total Produce were back then Balance sheet quality (lots of goodwill, leverage) and only average return on equity, which however was set off by a very cheap price, significantly below book value

In between 2 things happened:

1. The price of the stock increased nicely to around 0.61 EUR. resulting in an overall performance of +55% incl. Dividends.
2. The quality of earnings however deteriorated in my opinion.

I think I have to explain point 2 a little bit in more detail. If you read the 2012 premliminary results, everything looks great:

Revenue (1) up 11.2% to €2.8 billion
•
Adjusted EBITDA(1) up 17.8% to €70.4m
•
Adjusted EBITA (1) up 21.4% to €54.6m
•
Adjusted profit before tax (1) up 19.1% to €47.3m
•
Adjusted EPS (1) up 12.0% to 8.11 cent
•
Final dividend up 12.0% to 1.512 cent; total 2012 dividend up 10.0% to 2.079 cent
(1)
Key performance indicators are defined overleaf

So everything is up double digits, where is the problem ? Well, the problem could be the use of the word “adjusted” in most of the items presented.

If one flips to the next page of the report, we can already see that “unadjusted” EPS declined by -7.5% from 7.11 pence to 6.58 pence per share.

Where does that come from ?

The “explanation” reads as follows:

Adjusted earnings per share excludes acquisition related intangible asset amortization charges, acquisition related costs, exceptional items and related tax on such items.

On the one hand, one could say OK, acquisitions are not part of the operating business, let’s ignore that. However, Total produce does a lot of acquisitions, year after year. Most of their growth actually comes from acquisitions, organic growth seems to be quite limited.

Total Produce, year after year reports those “adjusted” earnings, whereas the “regular earnings” are always lower. Let’s look at the past 4 years:

	2012	2011	2010	2009	Avg
“adjusted ” EPS	8.11	7.24	6.84	6.47
EPS	6.58	7.11	5.25	3.7
EPS/Adj. EPS	81.1%	98.2%	76.8%	57.2%	78.3%

So not surprisingly, we only see “upside” adjustments, on average the “real” EPS is only ~78% of the adjusted EPS.

But it gets worse. In my opinion, one of the most “underused” pieces of information about the quality of a companies’ accounts is the Comprehensive Income statment.

“Modern” IFRS accounting allows quite a lot of items to be booked directly into equity as those items are considered sort of non-operating as well. Usual suspects in this category are:

– pension revaluation
– fx effects of foreign subsidiaries
– revaluation of fixed assets

In my opinion, one has to look at all those items because all of them influence the value of the equity position. Let’s look again at the last 4 years:

	2012	2011	2010	2009
EPS	6.58	7.11	5.25	3.7
EPS “Comprehensive”	5.15	4.21	5.39	7.34

2009 looks better based on comprehensive income, however especially 2011 and 2012 look bad from that perspective. This is mostly the result of pension charges. interestingly, in 2009, they booked a 3 mn EUR pension gain into comprehensive income, since then, Total Produce however had to book in total 30 mn EUR negative charge through comprehensive income.^The discount rates used to discount the liabilities at the end of 2012 are still relatively high at ~4.2% both for EUR and UK. So there will be more charges coming.

Many analysts will tell you that comprehensive income doesn’t matter, because it is not operational, but I have a different view. With regard to pension for instance, an increase in pension liabilities means that you will have higher cash outflows in the future and the shareholder will get less.

Free Cashflow

For 2012, Total Produce reports ~41 mn EUR Free cashflow. That’s about 12.5 pence per share or ~50% higher than in our base case scenario. Again, this has to be taken with a “grain of salt”.

Again, as in the first post about Total Produce, I would eliminate the working capital movement, especially as the improvement only came from higher payables and not a reduction of inventory or receivables.

If we do a quick “proxy” calc I would calculate the following Free Cash flow:

+ 38 mn EUR OpCF
– 13.5 maintanance capex (depreciation)
– 1.1 “net minority dividends
= 23.4 mn EUR or ~7.8 cents per share.

This is only slightly below the initial assumption of 8 cents per share but does not include the various payments for the acquisitions.

The problem I do have is that most of the free cash flow is now used for acquisitions, where I am not sure how “value added” that part is.

Summary:

In my opinion, Total Produce’s earnings quality deteriorated significantly. The “adjusted” numbers should be ignored, based on comprehensive income the company only earned ~5.15 pence for the shareholder and this is based on quite optimistic assumptions for the pension liabilities.

The company is using the majority of its free cash flow for acquisitions, where due to all those special effects, it is not clear to me if they earn really enough return. The priority seems to be to increase the size of the company. In my initial thesis, I was giving them extra credit for buying back shares but this seems to be no priority any more. Total value creation suffers quite significantly because of all the related expenses etd.

So I do not see much upside from here as the stock is now already close to my (slightly reduced) value range.

As a result, I will in a first step reduce my Total Produce position by 50%. I assume to have executed this end of last week at an average price of 0.61 EUR per share.

The other 50% are “on probation” so to say, I will look at the annual report and maybe 6M numbers in order to decide finally (or something better comes up).