4 years of Value and Opportunity and still having fun (plus some advice on that)

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Exactly 4 years ago the very first post appeared on the blog, outlining the rules and philosophy of the “virtual portfolio”.

The top 10 posts in 2014

1. How to correctly calculate Enterprise Value
2. P/E, EV/EBITDA, EV/EBIT, P/FCF – WHEN TO USE WHAT ?
3. OPERATING CASH FLOW AND INTEREST EXPENSES – (THYSSENKRUPP VS. KABEL DEUTSCHLAND, IFRS VS. US GAAP)
4. “RISK FREE” RATES AND DISCOUNT RATES FOR DCF MODELS
5. ADMIRAL PLC (ISIN GB00B02J6398) – SHORT CANDIDATE OR “OUTSIDER” COMPANY WITH A MOAT ?
6. MY 24 (BORING) INVESTMENTS FOR 2014
7. Emerging Markets: Sberbank ADRs (ISIN US80585Y3080)- Buying Russia in one stock
8. Banca Monte dei Paschi Siena (BMPS)- Another deeply discounted rights issue “Italo style”
9. The Dutch Job: Royal Imtech (NL0006055329) Deeply discounted rights issue – The “short opportunity of the century”
10. TGS Nopec ( ISIN NO0003078800) – an “Outsider” Company Buffet would buy if he could ?

The most interesting aspect of the Top 10 list is that 5 out of the 6 most popular posts are old, “general investing” posts. Especially the “Enterprise Value” post is attracting many many hits each day.

Personal blogging highlights 2014

First, I am quite happy with the new design of the blog. Although it actually did cost money (those WordPress guys are pretty smart…), I think it was well worth the “investment”.

The highlight of the year was clearly my journey into Emerging Markets. Although not all investments were succesful (Sistema, Sberbank ughhh…), it was a lot of fun (more on that later) and should be seen as an intellectual investment into the future. One thing that annoys me is that I started to look into China & Hongkong quite early but did not follow up.

Another highlight was the MIFA story. Although I didn’t make any money on this, it was still interesting to see that a look into the accounts can reveal so much. Yes, having winners in a portfolio is important, but avoiding losers is even better !!!

A final highlight just occurred yesterday. My E.ON Management disconnect post was explicitly mentioned in the print version if Germany’s most read weekly business paper, Wirtschaftswoche. Many thanks to the readers who told me about this.

And still having fun !!

1 year ago I had already written why and how I write the blog.

Personally, one of my fundamental beliefs is that one can only be succesful if one is enjoying (to a certain extent) what one is doing. This goes for work, personal life etc. Clearly some things have to be done and hard work is almost always necessary, but without having some fun it is very hard to keep something up until success kicks in eventually.

There is an amazing, less than 4 minute “TED talk” on what makes success to be found here and having fun is clearly one of the most important aspects:

One of the great things about investing is the fact that there is not a single way to success but many ways can lead to success. Value investing works, momentum works, activist investing, quant strategies etc. etc. So everyone should be able to find his own way of investing which is fun and still have good chances for long term succss. There is no need to do it exactly one way or the other.

So how can you make sure that you have fun in investing ?

The following points reflect both, my personal experience and observations I made over the years within the financial industry.

1. Make yourself independent of short-term returns.

One of the most gruesome things in investing is the fact that especially as an institutional fund manager you can have the best strategy but if you underperform over 3,6, or 12 months you will begin to lose money. Another bad year or 2 and your job is in danger. The impact on many fund managers is that at some point they lose all the fun they had in the beginning and just try to play it safe. This then leads to bad mid- and longterm performance and often is a kind of vicious circle. Many fund managers I know are actually not very happy in their job. And yes, that is one of the reasons why i never went “professional”.

Focusing on short-term returns often kills both, your long-term returns as well as the fun of doing it. The best and only way for institutional investors is in my opinion to continuously educate clients

As a private investor, I think the key is to invest only an amount which you can easily lose. If you need the money in 3 years to buy a house or you don’t have a buffer to pay for your broken down car DO NOT INVEST IN STOCKS. Get your personal finances in order, determine what you can have available long-term and then start to invest. I cannot guarantee you success that way but I guarantee this way you will feel much more relaxed about it. People often ask me if why I am not afraid to lose money in the stock market. The answer is: I only care long-term ,because short-term I don’t need the money. Oh yes, I forgot: DO NOT LEVERAGE UP STOCKS, because at some point in time your fun will be gone very quickly.

Another thing which helps me a lot is keeping a long-term performance record. Especially for a long-term strategy like value investing, where you easily can underperform several years, at least for me it is a great comfort to look at my now 15 year-long personal track record. A 15 year record does not change much if you underperform in a single year.

2. Establish a routine but be flexile within

success requires a couple of inputs. Work is one of them. This applies for investing too. Yes, there are stories about the guy who got rich by investing 10 thousand in a great startup but most of those stories are wrong and this is much more about playing the lottery than investing. If you want to become good and successful in investing you need to invest money and time.

For me the first trick to do this regularly and still having fun, is to have a daily routine. I usually work on my private investments first thing in the morning. I get up, have a quick (N)espresso and then start. The second trick is that within this routine I then do whatever I want. Although I have a long list of companies I want to research, I still keep for myself the possibility to do something completely different. When one morning I read for instance about the German candidate winning the Romanian election, I decided to ignore my to do list and look into Romanian stocks for the next couple of days.

Even within your normal job there is often some flexibility to do different things. Some very succesful companies allow employees to pursue “own”projects like Google and 3M but in my experience even in other companies it is both fun and potentially good for a career if you sometimes do things “outside the box”. You don’t have time for something like this ? Than just skip a few useless meetings, stay at your desk and think about something different.

3. Keep it simple

Both in private investments and work, just increasing complexity rarely adds value to the outcome. In private investing, adding to much stuff into ones “process” makes things difficult. Yes, checklists are great, quant models can help and understanding macro is important as well as managing the risk of the portfolio. But I found it easier (and much more fun) to look at investments one by one.

In a professional environment I often have the impression that complexity is used to justify fat management fees which for simpler models would be much harder to justify.

If you have to many inputs into the process, the actual decision-making becomes harder. Although simple doesn’t equal easy, it is clearly more fun in the long run.

4. Communicate with other investors regularily

Not everyone can call a genius like Charly Munger to test the newest investment idea, but in general it is not that hard to find like-minded investors and meet them for regular opinion exchanges or just a couple of beers. Communication via the web is great, but at least for me, sitting together with some investors, talking stocks and drinking a few beers is even better. You usually learn a lot and, the most important: it is fun. I do meet for instance with some local guys every 1-2 months and I am always looking forward to it. Often, after those meetings I am motivated to look things up that have been discussed which then leads to new idea etc.

So to summarize this shortly:

In order to have long-term fun in investing, those 4 point might help you:

1. Only invest money you can afford to lose
2. Establish a routine but within that do whatever you feel like doing
3. keep it simple
4. Socialise with other investors

Some links

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Don’s miss: 122 things you should know about investing from Morgan Housel

A great list of business/investment books from Farnam Street blog

Must Read: James Montier explaining why Shareholder Value is “The World’s dumbest idea”

Interesting panel discussion on Bershire Hathaway inculding Tom Russo and the CEO of See’s candy.

Review of an interesting book called “The Frackers”

A great TED Talk on “Leading like a great conductor” (by the way: There are a lot of great talks on the TED homepage, check it out)

Special situation “Quickie”: Flughafen Wien AG (ISIN AT0000911805) partial Tender offer

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Just by chance I looked at Flughafen Wien these days where since a few weeks an interesting situation is playing out.

Although Flughafen Wien is owned 50% by the Government and cannot be taken over, an Australian based Infrastructure fund called IFM made a partial tender offer for up to 29,9% of the shares.

Initially, IFM offered 80 EUR per share with a minimum threshold of 20% acceptance.

A few days ago, after pressure from soem shareholders, IFM increased the offer to 82 EUR and waived the 20% minimum threshold.

If I understood correctly, the new final date to tender the shares is December 18th. The money then is being paid within 3 working days, so before year end according to the official offer.

IFM seems to have secured around 12% from 2 funds already (Silchester, Kairos).

IFM seems to be a “reputable” investor, there seems to be no relevant operational risks for the offer from a technical point of view as far as I can tell.

However, the stock doesn’t trade at 82 EUR but rather at around 79,20 EUR per share:

This implies that investors expect 2 things

a) that more than 29,9% will be offered
b) and that the share price will fall after the offer below the offer price

Now we can play around a little bit to see if this is something worth betting on. We could start for instance assuming that the stock directly drops to 70 EUR after the offer expires.

Then we can calculate at the current price of 79,2 EUR an implicit or “break even” acceptance ratio:

79,20 = X*82 + (1-x)*70 = 76,67%.

So if 76,67% of the offers get accepted, the remaining not accepted stocks can drop to 70 EUR before one is making a loss on the transaction.

If all tendered shares are accepted, the max. profit would be 2,8 EUR per share or +3,54% for a period of 2 weeks.

Worst case: All minority shareholders tender (The Austrian government will definitely not tender…), then the lowest possible acceptance rate is 29,9/50 = 59,8% and the price falls directly to the value before the ofer (~61,50 EUR). Then the maximum loss per share would be -5,44 EUR or -7,4%.. At a more realistic drop to 70 EUR, the downside would be 2,02 EUR or -2,6%. This would be a positive expected value if the assumption of 70 EUR as a post tender price is correct.

I do think that this is a nice liltle side bet, so I will invest 2,5% of the portfolio at 79,25% into this little “special situation” with a time horizon of 2 weeks

One important note here: There is clearly a downside here and I would not recommend this to anyone who doesn’t regularily do such things, as the “single bet” might be not super attractive. However if one runs such bets on a continous basis (as I do, like MAN, Sky etc.), over time one will make money even with a few loosing trades.

Electrica S.A. (ISIN US83367Y2072) – A deeply discounted infrastructure stock from Romania ?

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Again, this has turned out to be a long post. So a quick “executive summary” upfront:

Electrica S.A. looks like an interesting play on infrastructure in Romania. The stock is attractive as
– the current valuation is cheap compared to grid companies in Spain, Portugal and Italy
– the underlying business (electrical grid monopoly) looks structurally attractive due to high guaranteed returns on investment
– there is good visibility on growth for the next 5 years
Overall, based on relatively conservative assumptions, an investor could expect to earn 17-21% p.a. in local currency over the next 5 years.

There are clearly lots of risks (regulatory, politically) but overall the risk/return profile looks good and the risks are less correlated to overall market risks.

DISCLOSURE: This is not an investment advice. Do your own research !!! The author may have already invested in the stock prior to publsihing the post.

When analyzing Romgaz I said this:

Why Romgaz ? Well that one is easy: This is the only Romanian stock you are able to invest if you don’t have access to the Bukarest Stock Exchange. There are no ETFs on Romania either.

Well, that was wrong, because another formerly Government owned Romanian company IPOed in June this year on the LSE, the grid operator Electrica.

Electrica – the business

Electrica’s main business is owning and running the electrical grid in an area covering ~40% of Romania. Additionally, they are also an electricity supplier, however they do not generate any power. This graphic from the recent 9 month presentation shows how this looks on the map:

Electrica small

Similar to Romgaz, the IPO prospectus is a pretty interesting read, covering many aspects of the Romanian electricity market. Those were the major points that I extracted from reading the prospectus:

+ IPO proceeds went 100% to the company to fund future growth
+ significant potential for additional guaranteed investments
+ conservative balance sheet
+ efficiency gains possible (10% grid loss)
+ underlying growth potential
+ valuation ex cash VERY cheap for a grid company
+ potential M&A opportunities (ENEL assets)
+ EBRD as shareholder actively protecting minority rights
+ local regulation creates attractive “float”

– guaranteed return on regulated assets has been just lowered from 2014 peak (7,45% vs. 8,35% in 2014)
– business is partly electricity distribution, no pure “grid” play (no guarantees for distribution)
– limited experience with regulator (previous head of regulator convicted for bribery)
– some distressed subsidiaries (external grid maintenance)
– 22% minorities in all major subsidiaries

Electrical grid as a business

Building and maintaining an electrical grid is a very capital-intensive business. The electric grid is one of the most dominant monopolies available. There is competition on the generation and supply side, but there is always only one electric grid as this represents the archetypical network effect.

There is just no reason to build a second electrical grid and unlike as for instance telephone landlines, there is a pretty low risk that electricity could be distributed via an alternative way. This is one of the reasons that grids are almost always heavily regulated as the potential power to abuse this monopoly would be pretty high.

One additional features is the fact in many countries the grid was not designed to cope with locally generated renewable energy, so there is clearly a need for massive additional investments. Normally, a sector with large investment requirements is not that attractive, but if you combine this with stable yields and leverage potential, things can suddenly become very interesting in a low growth environment.

I had written 2 years ago that even Warren Buffett thinks utilities can be attractive, if the earnings are stable or even guaranteed, especially if you then can leverage up accordingly. Also the announced E.On spin-off ties to move grid and end-user supply into the good ship

Although there is always a risk that regulators run amok, at least for electrical grids the seem to be on the soft side as they know that a lot of capital is required to cope with the renewable energy revolution. As a consequence, the valuation of listed grid operators are the highest among the overall utility sector.

Let’s look at the valuations of 4 listed electric grid companies in Europe:

Name Mkt Cap (EUR) BEst P/E:2FY P/B ROE ROA Debt/capital
             
REDES ENERGETICAS NACIONAIS 1.352 12,2 1,2 11% 2,4% 70%
RED ELECTRICA CORPORACION SA 9.922 16,5 4,2 24% 5,8% 60%
TERNA SPA 7.811 14,6 2,5 17% 3,7% 71%
ELIA SYSTEM OPERATOR SA/NV 2.442 16,1 1,1 9% 3,3% 55%

It is interesting to see that despite being located in the more critical countries of the Eurozone (Portugal, Spain, Italy and Belgium) those companies enjoy quite rich valuations. ROAs are low single digits but due to the monopoly character of the business, it can easily be leveraged up between 50-70% of the total capital (and several times equity).

Romanian electricity market

This is an interesting quote from the IPO prospectus:

The average electricity consumption per capita in Romania is still significantly lower than the average electricity consumption in the 28 EU member states. In 2012, Romanian electricity consumption per capita was 2.3 MWh, whilst the average electricity consumption per capita in all the EU countries was 6.0 MWh and in the selected Central and Eastern European countries (excluding Romania) in the table above it was 4.3 MWh.
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So assuming that Romania will catch up to a certain extent with the Eurozone, underlying growth in the electricity market should be strong. Romania has separated grid and power generation, however, at least in the case of Electrica, supply to end users is still part of the package.

The power market for end users is still highly regulated to a large degree but will be liberalized going forward. For Electrica’s grid business, this is irrelevant, but the supply business could be affected.

Electrica has a 25 year concession to operate the grid with an option to extend another 25 year. They can charge a fee to customers which guarantees them a certain pretax rate of return on assets if the meet minimum requirements set by the regulator. The base rate which they can charge is currently 7,45% for the next 4 years, higher rates seem to apply for “smart grid” investments.

One interesting specialty of the Romanian market is the existence of the “connection fee”. This is what they say in the IPO prospectus:

According to the law, the value of new connections to the electricity network is charged to the final users as a connection fee. The new connections to the electricity network are the property of the Group. The Group recognises the connection fee received as deferred revenue in the consolidated statement of financial position and subsequently records it as revenues on a systematic basis over the useful life of the asset.

The total amount they show as deferred revenue is 1,4 bn RON which is quite significant. For them, this is a very attractive “float” as it doesn’t carry interest and no covenants are attached. I assume that this also explains why they don’t use external debt as the investments are basically financed by the clients.

Valuation – simple version

Electrica has a market cap of 4 bn RON. Including IPO proceeds, the sit on 2,8 bn liquid assets, so the core business is valued at 1,2bn RON. With a run rate of 250 mn Earnings, this equals P/E of 4,8 ex cash. Assuming that a unlevered grid company in Romania could be worth 10 times earnings (still cheap compared to a highly levered Portuguese grid company at 11x earnings), the upside for the stock would be at least 30% based on current earnings.

Valuation including growth

Now comes the interesting part. Normally as a value investor I would assume zero growth. But in Electra’s case I would make a difference. Why ? Well, because:

1. They can invest (“compound”) at a guaranteed rate
2. The have already raised the money
3. The guaranteed rate can be charged irrespective of power prices or volume
4. There is no competition

The “only” risk that remains is the regulator. In order to model the profit growth, I have built a very simple model for the next 5 years using the information form the IPO prospectus:

I made the following (conservative) assumptions:

– supply business remains more or less constant despite significant growth yoy 2014
– I assume the losses from the “distressed” service subs will be phased out over 3 years
– they will distribute 85% of earnings as dividends
– they will invest according to plan at a blended guaranteed rate of 7,7%

Based on those assumptions, the profit after tax and minorities should double within 5 years. Assuming 8%% dividend payout (all of which can be funded by existing cash on operating cashflow), one can expect a return of 17-21% p.a. assuming an exit P/E multiple of 11-15.

Assuming exit multiples is of course already quite aggressive, on the other hand, if the price wouldn’t move, the assumed dividend yield of Electrica would be more than 10% in 2019. So some multiple expansion would not be unrealistic.

Addtitional (significant) upside could come via profit increases in the supply sector or opportunistic M&A as the ENEL grid seems to be for sale. My required rate for such an investment would be 10-15%, so at the current price Electrica looks attractive.

Other considerations

Stock price: In local currency, the stock price is only slightly above the IPO price of 11 RON:

Analysts: According to Bloomberg, a surprising number (8!) of analysts cover the stock. Their price target on average is around 14,6 RON, a potential upside of 30%.

Shareholders: During the IPO, the EBRD (European Developement Bank) acquired 8,6% of the shares. According to this article they are actively working to protect/ensure minority shareholder rights:

“Our participation demonstrates the EBRD’s commitment to supporting the government’s plans for increased privatisation of the energy sector,” Nandita Parshad, Power and Energy Director at the EBRD, said in a statement.

Parshad said the EBRD will work with Electrica to align its corporate governance with international standards: “This will provide additional comfort and confidence to potential future investors.”

The Romanian government still owns 49%.

Management: There is unfortunately not a lot of information on management. The CEO is an “Old timer”, joining the company in 1991. there seems to be some variable component in their companesation package but it is not clear how this looks like.

“Frontier” market: Despite being an EU member, Romanian stocks including Electra are considered “Frontier” stocks by MSCI, not even “Emerging”. That might make it more difficult for “established” funds to invest.

Summary:

As I have written in the Romgaz post, I find Romania fan interesting market in general especially with the lection of the new President. Electra is similar to Romgaz a privatization story. What I like about Electra is the fact that there is good visibility on growth.

The major risks are from the regulatory side, although I am quite optimistic that with the new president there will be even more of a “pro business” and “pro growth agenda”. Plus, the risks in this case in my opinion are relatively uncorrelated to other issues within my portfolio, so I think this could be a good diversifier.

With relative conservative assumptions and the guaranteed part of Electrica alone, one should expect between 17-21% return per annum over 5 years. If the non-guaranteed supply business improves or they are able to get other parts of the Romanian grid then the upside could be even higher.

I am pretty sure that not many investors will be interested in the stock as it seems to be both, too exotic and a strange mixture between “deep value” and growth, but for me it is the perfect stock as I don’t have to track any indices.

For the portfolio, I will buy a 2,5% position at current prices. This increases my “Romania bet” to 5% and total EM exposure to 13%. Time horizon is 5 years.

E.ON Spin off plan – The final “Hail Mary” pass ?

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According to Wikipedia, a “Hail Mary pass” is described as following

Originally meaning any sort of desperation play, a “Hail Mary” gradually came to denote a long, low-probability pass attempted at the end of a half when a team is too far from the end zone to execute a more conventional play, and that it took divine intervention for it to happen.

I have covered E.ON already a couple of times in the blog, with a first analysis, followed by a deeper look into their Nuclear decommissioning liabilites.

Finally, just a few weeks ago when the “spun” their Q3 results, I commented that E.ON is one of the prime examples of Management/Shareholder “disconnect”.

Now on Sunday, out of the blue, E.on came forward with an announcement to split themselves up into 2 parts, a “Renewable energy & Grid part” and a “Conventional part” including oil upstream nuclear power etc.

This was big news in Germany with a lot of press coverage and let to a nice “Bounce” in the share price on Monday:

Before I make some comments on the proposal, I found it quite interesting that another part of the press release had been pretty much ignored:

Fourth-quarter impairment charges of about €4.5 billion anticipated due to altered market environment
Outlook for 2014 EBITDA and underlying net income confirmed

Further down the “explain” it the following way:

Altered market environment necessitates in impairment charges

As part of the process of preparing the annual financial statements and the new medium-term plan, the E.ON Board of Management recently tested the Group’s assets for impairment. Beyond the roughly €700 million in impairment charges already disclosed in the first three-quarters, E.ON expects to record additional impairment charges of about €4.5 billion in 2014, primarily on its operations in Southern Europe and on generation assets. Although not cash-effective, the impairment charges will result in E.ON reporting substantial negative net income. However, E.ON expressly reaffirmed its forecast for full-year 2014 EBITDA and underlying net income.

Once again, EBITDA, which is relevant for the CEO bonus looks great, unfortunately shareholder’s equity will be further reduced by a cool 4,5 bn EUR, but the capital market either seemed to have not noticed this “small detail” or they are so enthusiastic about the spin-off.

The “Spin-off”

Spin-offs are generally considered interesting “special situation” investments. The underlying theory is the following: Many times, the capital markets seem not be able to price companies correctly, if the company either runs very different business lines or some of the business lines are performing badly. “Spinning off” underperforming divisions to shareholders then can unlock value because the capital market will value each part correctly and in sum this should be higher than the conglomerate. A secondary effect of spin offs is often that previously underperforming divisions freed from their previous owners often develop a unexpected positive dynamic, especially if the incentives for the management of the spin-off are correctly aligned.

Before moving into more details, let’s look once again in the original press release of EON:

The first step of the spinoff will involve E.ON transferring a majority of New Company’s capital stock to its shareholders, with the result that New Company will be deconsolidated. E.ON intends—over the medium term and in a way that puts minimum pressure on the stock price—to sell the shares of its remaining minority. This will enhance E.ON’s financial flexibility for future growth investments.

Why does EON only spin-off part of the “bad ship” ? Well, I guess the reason is simply that “E.On new” does not have enough capital to grow the renewable business on its own. It need the proceeds from the retained part in order to fund future investment.

In my opinion, this already lowers my enthusiasm for the deal, as the two parts are clearly not able to exist independently without an external capital injection. Economically, the sale of the remaining part is equivalent to a “backdoor capital injection”. This will clearly not be beneficial for the valuation of the “bad ship” part after the spin-off und limit the upside potential for some time.

Let’s look at the proposed structure of the spin-off next:

I didn’t listen to the Concall, but the slides for the new strategy can be found here. Before jumping into the presentation, let’s look what I have written almost 2 years ago:

– 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

This is the plan from page 3 of the presentation:

E.on:
+ Renewables
+ Distribution/grid Germany / EU
+ “customer solutions” (whatever that means)
+ Turkey

NewCo (Bad ship):
– Generation (fossil, Nuclear)
– Hydro (why is this not renewable ?)
– E&P
– Global commodities
– Russia
– Brazil

So comparing my “problem list” from back then clearly shows, that ALL PROBLEMATIC areas would go to New Co.

Does this create value ?

I think some smart investment bankers have compiled valuations of utilities across Europe. This is a quickly compiled list of some utility and “utility like” companies across Western Europe:

Name Mkt Cap (EUR) EV/TTM EBITDA
     
ELIA SYSTEM OPERATOR SA/NV 2.443 12,3
RED ELECTRICA CORPORACION SA 9.973 11,5
NATIONAL GRID PLC 44.385 11,1
EDP RENOVAVEIS SA 4.726 10,7
SNAM SPA 14.196 9,9
EDP-ENERGIAS DE PORTUGAL SA 12.754 9,7
ENEL GREEN POWER SPA 9.135 9,6
A2A SPA 2.672 9,5
RWE AG 17.672 8,3
IREN SPA 1.221 8,0
GAS NATURAL SDG SA 22.771 7,8
E.ON SE 30.405 7,8
ACEA SPA 1.876 7,7
ENDESA SA 16.760 7,6
IBERDROLA SA 37.017 7,0
ENEL SPA 36.372 6,7
ACCIONA SA 3.427 6,3
EDF 45.477 4,9
GDF SUEZ 48.498 4,0

It is pretty easy to see that anything which sounds like “renewable” and/or “grid” trades at double-digit EV/EBITDAs whereas all the “integrated players” trade at medium to low single digit EV/EBITDA multiples.

So the idea behind this the proposed split seems to be clearly driven by the hope that the grid/renewable part will be valued at double-digit EV/EBITDA and the rest remain in the “integrated” valuation range.

The problem is of course, if the “bad ship” will actually trade at an integrated utility” multiple or not. My guess is: In the beginning, it will most likely not. I could also hardly imagine that the government will let the “bad ship” pay high dividends for a longer time because they will know that this is money which should be held for the nuclear liabilities.

Other considerations:

Looking into the past, E.ON has been spectacularly bad at reacting to changes and timing its strategic investment decision. They bought into Brazil right before their partner Batista went bankrupt, they missed the first 10 years of renewables etc etc.

If history is any guide, then the timing of the proposed split could indicate that maybe we have seen the worst and better times for conventional power generation lie ahead

It is also interesting that they said nothing about who will be running the two companies. Will the old guys remain at E.On ? This would be clearly negative

There could be some roadblocks on the way. The current German energy minister Gabriel seems to like the transaction (or doesn’ understand it) but there could be more resistance building up if people understand that the nuclear liabilities are dramatically under reserved. Also the pensioners of the “bad ship” could try to block the deal as having claims against the bad ship is clearly les valuable than for “E.On new”.

Summary & evaluation

The proposed split/spin-off of E.On was clearly a surprise. So far, the spin has worked and the stock market has liked this move. E.ON has outperformed the DAX and RWE by 7% since the announcement, which is a lot considering that they announced an unexpected 4,5 bn loss at the same time.

For me, E.On currently is clearly not a buy. On one hand, there is the risk that the spin-off does not work. Secondly, it is no real spin-off and depends on people actually buying the minority stake. Thirdly, just splitting the company in my opinion will not increase the value. If the same guys remain who made all the past mistakes, why should they suddenly be able to turn things around ?

On the positive side, the grid/renewable part could clearly be a take-over target, the bad ship however looks pretty toxic. For me, E.ON is still too much of a black box and without management change and better incentives, I could not see that much more upside. Still, I will keep them on my watch list as the prospoctus for the “Bad ship” IPO could be really interesting.

Coming back to the beginning of the post: Yes, E.ON has just thrown their final “Hail Mary” pass, but at the moment there is no way to tell if the ball even makes it to the end zone….

Performance review November 2014

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Performance November:

In November, the portfolio gained 1,2% against 5,4% for the benchmark ((Eurostoxx50 (25%), Eurostoxx small 200 (25%), DAX (30%),MDAX (20%)). This is a quite significant underperformance of -4,2%. YTD, the performance is up 5,4% against 4,1% for the BM.

Positive contributors were Koc (10,2%), Hornbach (+9,0%), NN Group (+7,2%) and Cranswick. However, quite a lot of positions had actually negative performance like Admiral (-7,1%), Trilogiq (-6,7%), Ashmore (-3,4%), Thermador (-2,4%), Gronlandsbanken (-1,8%) etc.

On risk management:

With TGS Nopec and Romgaz, I do have two direct oil/commodity positions in my portfolio. However there are also some “indirect” exposures. Gronlandsbanken (my investment case assumes development of natural resources in Greenland) is such an “indirect” exposure as well as Bouvet (biggest client Statoil) and Sberbank. Overall, around 12,5% of the portfolio are oil/commodity “exposed”. There is a kind of off-set from Koc and the TRY Zerobond, as Turkey, a major net oil importer gains from lower oil prices. But overall I will need to make sure that I don’t expose the portfolio too much to commodity price fluctuations unless I would be bullish on that sector.

As I have mentioned in the past, the portfolio will not look good in months with strong benchmark performance. During the 47 months since I run the portfolio, there were 9 months with a performance of 5% or more for the benchmark. This is how the portfolio did perform in those 9 months:

Start Bench Portfolio Perf BM Perf Portf. Delta
Jul 11 6486,69 99,03 14,9% 3,9% -11,0%
Okt 11 5667,92 95,46 10,0% 2,9% -7,0%
Jan 12 5972,48 99,27 8,4% 3,5% -4,9%
Feb 12 6275,00 105,9 5,1% 6,7% 1,6%
Jul 13 7844,96 160,0 5,0% 3,1% -1,9%
Sep 13 8193,80 166,9 5,6% 4,9% -0,7%
Okt 13 8676,38 172,0 5,9% 3,1% -2,8%
Feb 14 9.306,80 186,3 5,2% 2,7% -2,5%
Nov 14 9.389,96 184,5 5,4% 1,2% -4,2%

We can easily see that the portfolio did only beat once, eight times the performance was worse, in some months much worse than the benchmark. The interesting thing is that over the total 47 months, the portfolio has still a lead of +37,7%. I think there are several factors at play here, among other a lower beta, time lags and individual issues. Nevertheless, this gives me confidence that my strategy will work over time although it involves some pain in the short time, mostly in months with big up moves.

Running a portfolio with a lot of individual, uncorrelated risk clearly cannot outperform in any kind of market, especially at the moment when “Beta” is king.

Portfolio transactions:

The only transaction was the 2,5% initial position in Romgaz. The current portfolio can be seen as always on the portfolio page.

Outright cash is now at 10,8% plus ~7,5% of positions which I would consider “cash like” (Depfa LT2, MAN).

SNGR Romgaz (ISIN US83367U2050) – A chance to participate in a Romanian revival at a large discount ?

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As this turned out to be a quite long post, a quick summary upfront:

Romgaz, the recently privatized Romanian Natural gas producer looks like a pretty cheap play on the success of privatisation in Romania. Additional tail winds could come from the recently elected ethnic German President who wants to fight corruption and intends to repeat the business friendly and succesful model of his hometown Sibiu where he was mayor for 14 years.

Depending on the underlying value of the natural gas resources, the stock could have a potential upside between +50% in a pesimistic case and 200% in an otimistic one.

Disclosure & Risk: The stock presented is clearly risky and quite illiquid. The author might have bought shares before publishing this. Please do your own research !!!

On Romania

Romania is part of the European union, however it is the second poorest member, only trailed by neighbouring Bulgaria. The country never really recovered from the financial crisis and many Romanians left the country to work all over Europe.

Last week, something quite interesting happened in Romania: An ethnic German was elected as new President of Romania.

Klaus Johannis became major in Sibiu, a mid size town in Romania in 2000 despite representing only 1% remaining ethnic Germans who live there since the 12th century. He was reelected 3 times and managed to attract a lot of German companies to his hometown Sibiu. As a consequence, Sibiu is the Romanian city with one of the lowest unemployment rates and the highest standards of living. By the way it is a really beautiful city very close to the Carpathian Mountains. In my opinion a very attractive yet undiscovered travel destination:

In Romania, the President has a lot more power and influence than for instance in Germany, I think one can compare it to France. Clearly, this election alone will no be enough, as for instance his opponent for the President’s job is still prime minister. nevertheless the vote should be a huge plus for Romania going forward, both as the new president seems to be trustworthy and anti-corruption as well a pro business and economy.

So how did the Romanian stock market react ? Ummm, if we look at the BET index, it didn’t react at all. Actually Romanian stocks are down since the election, so no “Modi Mania” for Romania it seems. One can speculate why this is the case, but in my opinion the Romanian Stock market is too small and so off-the-beaten-track that just no one bothered with it. And Romanians themselves do not really invest in stocks.

Romgaz

Why Romgaz ? Well that one is easy: This is the only Romanian stock you are able to invest if you don’t have access to the Bukarest Stock Exchange. There are no ETFs on Romania either.

Romgaz is a Natural Gas producer (“upstream”) with around 50% market share in Romania. Romania produces most of its own natural gas. In contrast to OMV-Petrom, its domestic rival, Romgaz only does “on shore” production,.

Romgaz has been IPOed one year ago and placed shares on the Bukarest stock exchange as well as on the LSE in the form of GDRs. Since then when the stock was sold at 30 Lei per share, not much happened with the stock price:

The great thing about a recent IPO is, that one usually gets the best information about the company and the sector through the IPO prospectus, which is normally much more comprehensive than any annual report.

The Romgaz IPO prospectus is actually very good and comprehensive

This is a summary of my pro’s and con’s after reading the prospectus

+ no debt, significant net cash
+ only one share class
+ further scheduled price increases due to deregulation, mostly independent of market prices
+ many additional assets like gas storage (90% of total storage capacity), smaller distribution networks, power plant etc.
+ dividend payout ratio ~90%, resulting in a current dividend yield of ~8% (withholding tax “only” 16%)
+ High quality reporting (English)
+ privatised Government company with modern management -> lots of potential to be more efficient

– windfall tax applied in 2013 & 2014
– “royalty payments” on natural resources to Government which could increase (Nat gas & storage)
– “donations” to Government in the past
– government clients defaulted on receivables (that’s how they became owner of a power plant in 2013)
– government influence remains with 70% share
– proven reserves for only 10 years at current production rate
– reserve replacement rate very weak in the past (better in 2012/2013)

This is on the reserves from the IPO prospectus:

Owing predominantly to the re-evaluation of existing reserves, Romgaz has recorded an increasing replacement ratio, reaching 298% in 2012 (2011: 152%, 2010: 92%, 2009: 49%, 2008: 57%), with proved reserves being 71% of its total reserves. Romgaz believes that further increases of Romgaz’s reserves base can be achieved by improving its recovery rates through utilisation of well-established technologies. Romgaz’s size, longevity and market position has also helped it to enter into partnerships with major international natural gas companies including Lukoil, ExxonMobil and Schlumberger to develop other opportunities to increase reserves both inside Romania and internationally

On the upside, until 2012, Romgaz had to deliver their natural gas at “far below market” prices to their customers. Following the deregulation, prices can be adjusted to reach the market price in some years. Again from the prospectus:

Price Liberalisation
In addition, Romania has undertaken to fully liberalise the gas price for domestic production as well as the end-customer prices. In February 2013, the Romanian government started to implement a plan to deregulate natural gas prices by raising gas prices by 5% for non-household customers. It has planned to achieve the
complete price deregulation by 1 October 2014 for regulated customers and by 1 October 2018 for non-regulated customers. For non-household customers, the price of domestic gas is to increase from 49 RON/MWh, as of 1 February 2013 to 119 RON/MWh, by 1 October 2014, and for household customers, the price is to increase from 45.7 RON/MWh, in 31 December 2012 to 119 RON/MWh, by 1 October 2018.

Despite a windfall tax applied by the government, this development has been clearly positive for Romgaz with a 40% profit increase so far in 2014 against the prior year.

Valuation:

Valuing commodity producers by “standard” metrics like P/E or P/B often misses the point. The main value of a commodity producer is clealy “the stuff in the ground” minus the costs to get it out. However normally it is quite difficult to value the “stuff in the ground”. In the Romgaz case however we are again quite lucky. Part of the IPO information package was an independent “resources report” carried out by a large and well known US specialist company.

In this report, they calculate future “net revenue” including all costs taxes etc. and then come up with an NPV. In the Romgaz case, they actually created 3 scenarios: A base case, a low case and a high case. Addionally they provide NPVs for different discount rates, ranging from 8-15% p.a.

So in order to fully value Romgaz we can do a relatively simple asset-based valuation: Using the value of the reserves from the report plus any “extra assets” like the storage facilities and the power plant.

This is what I came up with for Romgaz:

Some comments:

– for the net cash I used the most recent quarterly report 09/2014
– I assumed a valuation of 6x EBITDA for the gas storage in all cases (one could argue for a much higher valuation as “infrastructure asset”)
– I assumed the original “purchase price” of the power plant form early 2013 as the market price
– for the “resources worst case”, I used the lowest value from the report (low case, only proven reserves, 15% discount)
– for the mid case I used base case, proved plus provable resources discounted at 12%

I think it is important to mention that this valuation does not give any credit to a potential exploration of new reserves, this is pure “run-off” only.

In any case, even in the worst case, the stock would have a 50% upside to “fair” value, although the fair value would still imply that you make ~15% p.a. after this value has been achieved. In the more optimistic cases, the current stock price seems to represent an even higher upside. Clearly, there is no guarantee that this value will be realized within a short time frame, but it clearly should limit the downside and create a relatively attractive risk/return relationship.

Why is the stock cheap ?

To me, this could be the combination of different factors, Mostly in my opinion:

– natural resource companies/commodities are out of favour anyway
– Emerging Markets and especially Eastern Europe are unpopular and Romania is even further away from the “Beaten track”
– there is no local shareholder base for Romanian stocks

A few words on Russian companies (Lukoil, Gazprom)

P/E wise, Russian natural resource companies look a lot cheaper and I expect some readers to comment that I should rather buy Gazprom at a P/E of 2 or so instead of Romgaz at 10. For me, despite the higher multiple, Romgaz looks more attractive to me because:

1. there is less uncertainty with regard to property right etc. in Romania. Despite obvious issues with corruption, Romania has proven that Democracy works and it is full member of the European union. This should significantly lower the risk of any “Sistema scenario”.
2. Due to the privatization story, Romgaz is less exposed in the next years to overall market price fluctuations.
3. Despite the low P/Es shown, you never know what actually happens with all those Russian profits. Dividend payout ratios are very low and the companies issue debt like crazy. Romgaz in comparison pays out a large amount of earnings and runs a big cash surplus

Summary:

In my opinion, Romgaz offers a compelling combination between a recently privatized company at a large discount to its underlying value and a potential “macro trigger” for Romania following the surprise election of an ethnic German as new President.

As Romania is so “off the beaten track” for stocks, it might take some time to realize this value, but in between one is paid quite handsomely with a 7-8% dividend yield.

As a result, I will enter into a 2,5% position as part of my “Emerging Markets” bucket at current prices (34 RON / 7,60 EUR per share).

Overall, I expect to make ~100% over a 3-5 year horizon. 30-40% should come through dividends, the rest with price appreciation, mostly based on increased earnings. Downside factors to watch are clearly any government interventions (additional taxes, royalties), further upside could be realized if reserve replacement ratios develop better than expected.

Some links

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Great article on the problems at Mc Donalds

Joel Greenblatt talks about his “new” strategy

Great analysis (part 1) of German Online tire company Delticom from Frenzel & Herzing

Damodaran looks at Brazilian Vale and Russian Lukoil.

Alphavulture has analyzed Clark Inc. which seems to be the Canadian version of Carl Icahn

Interesting analysis on the US shale oil industry and the 75 USD oil price (spoiler: Capex will go down A LOT)

The performance of companies, whose CEOs play a lot of golf, does not look so good. What about money managers ?

Don’t miss: Blogging luminaries on Charlie Rose (Josh Brown, Joe Weisenthal, Felix Salmon, Megan Murphy)

Harvesting the archives (1): AS Creation, Medtronic, Netflix

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Introduction:

Keeping track of all the companies one has ever looked at is pretty hard. It is pretty easy to update the companies which are in the current portfolio, but in my case, I often forget about the companies which I have looked a couple of years ago but didn’t buy for one reason or another or sold them. One of the great things of blogging is that you can easily look at everything you have ever written. Especially in the current environment, where good value investing ideas are pretty hard to find, it might make sense to look back at companies one has researched sometimes ago and either sold or not bought. Maybe they have become interesting again ? For me it is a lot easier to update myself on a stock I have looked 3-4 years ago compared to looking (and digging) into a completely new stock.

So in this new series, I will look into stocks I have written about and either sold or rejected and try to find out if something has changed or if some lessons could be learned.

AS Creation

AS Creation was the first detailed stock analysis on the blog in December 2010 (in German). The company back then looked cheap: Single Digit P/E, historically a single digit p.a. grower, 30% market share in Germany and the potential upside of a Russian JV (Russia was supposed to be a growth market back then). After some quite significant ups and downs, the stock was sold in August 2013 because the margins didn’t mean revert and the Russian JV was already in some trouble under “non crisis” conditions.

Looking back, the decision to sell in June 2013 at ~34 EUR looks smart if we consider the chart although in between the stock went up to 40 EUR again:

Operationally, AS Creation was hit by several negative events: First, the bankruptcy of Praktiker impacted them in the German core business, secondly, their French subsidiaries suffered and finally, the Russian JV which had to suffer from delays has been clearly hit by by the current crisis. With regard to the German business I have the impression that they never really rebounded to their historical average, maybe they did profit from some kind of anticompetition arrangements, for which they were fined. An interesting detail: They were convicted to pay 10,5 mn EUR in 2014, but they seem to have appealed the decision. To my knowledge, no appeal was ever succesful.

In any case, I don’t think AS Creation is interesting at the current level of 30 EUR. At a 2014 P/E of 15-20 (before any extra write-offs on Russia) there seems to be quite some turn around fantasy being priced in.

From my side there were 2 important lessons:
1. Mean reversion on single stock basis is nit guaranteed
2. If you buy cheap enough, you don’t lose much if things go wrong.

Medtronic

Medtronic was introduced (in German) on December 31st 2010 and then kicked out in August 2011 because I didn’t feel comfortable with a large cap US stock.

Looking back, this clearly doesn’t look like the smartest decision I ever made. Back then, I sold Medtronic at a loss of around -19%. Since then, the stock showed a total return of 167% in EUR. One of the interesting things about Medtronic is that a lot of the performance came from multiple expansion.

When I sold the stock at around 32 USD, the stock was trading around 10 times trailing earnings (3,27 USD per share 2010). 4 years later, reported earnings 2013/2014 have been ~20% higher per share at 3,80 USD, but Medtronic is now trading at around 18,5 times trailing earnings.

What is even more interesting than that is the fact that in absolute terms, 2013/14 earnings are at exactly the same levels as 2010/2011. Profit margins are even lower than back then. What happened ? Well, as in many cases for US stocks, the company bought back shares aggressively. Still, both ROE and ROIC declined but shareholders don’t seem to bother.

So despite the big run up of the share price, I don’t think that selling the shares has been a mistake. From a fundamental view the company looks worse than back then, however investors seem to be so happy about buyback driven EPS gains that they are willing to pay a pretty high valuation for this.

You could have speculated on such an outcome but as a fundamental investor, this would not have been in line with my investment philosophy. And clearly, You cannot increase the value of the company forever just by reducing the share count.

Stand-alone I would argue that Medtronic is clearly overvalued, based on the stagnating profit and deteriorating profitability. However with the current Healthcare “merger mania” I would not want to short the stock either.

Netflix

I briefly considered to skip the whole Netflix episode but then decided against it. Looking back, this clearly shows that one can do stupid things and still make money….

I shorted Netflix in January 2011 after a short thesis from Whitney Tilson. Luckily I was able to cover the short with a gain in September 2011.

Looking at the chart, we can see that despite extreme volatility, Netflix is now trading 3 times higher than when I covered the position:

The lessons here were pretty simple:

1. Don’t short “hot stocks” based on fundamentals. It is too volatile and just not worth it-
2. Stay away from whatever Whitney Tilson is recommending

Fundamentally, Netflix is on my “too hard” pile. I do think streaming is a big thing and will be even bigger in the future. However I have no idea how much money Netflix will actually be able to make.

Book review: “Built to Last: Successful Habits of Visionary Companies” – Jim Collins

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“Built to last” is a managment literature classic, first published in 1994. It has been reviewed and critized many times already,so I just want to provide a very short summary:

The author analyzes 18 companies which were succesfull for a very long time and compares them to less succesful companies in order to find out what set them apart. The most important point seems to be that the company is a “visionary company”, meaning that the company has a clear mission which is not only earning as much money as possible but somthing in the way of “We want to make people happy” (Disney). Combined with “core values” and “really big goals”, this, according to the author is the secret sauce for a long term succesfull organization.

Looking at those 18 companies clearly shows that since the book was written, not all the companies were great successes for their shareholders. Citigroup, Ford, Motorola were clearly not performance stars, on the other hand, a couple of o the companies (AMEX, Wal-Mart, IBM) are long-term successes and core holding of our value investing Hero Warren Buffett.

Is the book relevant for investing and if yes how ?

I think the answer is clearly “YES” and those are the 3 major points in my opinion:

1. Many current CEOs have read this book (and many future CEOs will read it) and try to act accordingly

For instance the “3G story” of the Brazilians who now run Ambev, Heinz and Burger King seem to have clearly taken this book as blueprint for their strategy. “Dream Big”, core values such as meritocracy, honesty etc. were clearly inspired by this. Edit: And yes, Jim Collins has actually written the foreword to “dream Big” and he seems to have worked with “mastermind” Leman for a long time.

Interestingly, in the book it is clearly said that just writing down those statements is clearly not enough, you have to live them every day which is not easy to achieve. So just when you see something like this written on an annual report, you know that they have read the book but you cannot be sure if a company actually follows those vision and values.

2. A strong vision and core values compared with a good alignment of management and investors might result in great shareholder returns

Many critics use the failed companies of the book as a proof, that success is more depending on luck than on any vision and core values. I would argue that they are missing one point: In many of the failed cases, there happened a serious disconnect between shareholders and management. The most obvious case is Citigroup, which at least since the 2000s was run to the benefits of the employees rather than for all stakeholders. The same could be said of Ford, where the Ford family did not really exercise the owner’s influence as it would have been necessary.

I think it is not random, that especially the companies which were held for instance by Berkshire (Amex, Procter) or where the founder / founding family has a strong tie to the business (Wal-Mart) did well. Both, the influence of a significant investor or a founder with a large ownership can ensure that a visionary company can be also a big success for shareholders. It is clearly not a 100% “hit ratio” but I think the chances for long-term success are clearly above 50%.

For me, Google for instance is a fantastic “visionary company”, but in Google’s case I am not fully convinced that their goals are fully aligned with me as potential minority shareholder.

3. Non-visionary companies can be very good investments as well but it might be harder to sustain success in the long run

The prime example for a non-visionary company in my opinion is Berkshire Hathaway. Buffett’s target has always been to compound shareholder’s wealth. That the company did this for so long and so successful in my opinion is clearly the result of Warren’s and Charlie’s genius and their long and healthy lives. Interestingly, now close to the end of their careers, they seem to be on the “Vision” and “core value” track. At least that is how I interpret the rebranding of many subsidiaries as “Berkshire Energy” and Buffett’s speeches about Berkshire core values which at least to my knowledge were not so prominent years ago.

I think it has become clear to Buffett, that a conglomerate formed by two geniuses might be hard to sustain when those two are not around anymore.Additionally it will be interesting to see how the interests of a future Berkshire CEO who will not own half of the company, will be aligned with the shareholders.

Summary:

Despite having some lengths, I think the book is a good and relevant read for investors who want to look a little bit outside typical investment literature. Some people might say that the book is too old to be relevant, but I personally think that the content of the book is pretty timeless.

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