IVG – Now what ?

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IVG is one of my special situation investments, I had detailed posts about them here:

Introduction (German)
“Good news” (German)
Capital Increase
Capital Structure considerations
Balance sheet analysis

My overall thesis could be summarised as follows:

IVG is clearly in troubled water, so the shares and the Hybrid bonds are extremely risky, however the senior convertible which has a put in early 2014 has a good chance of being repaid. My main argument was and is that IVG is quite big and an outright default would have too bad consequences for the banks and hedge funds wer not yet involved. Even in the downside case, I would still come up with a recovery for the Hybrid in the 90ties due to the amount of underlying equity and hybrid debt.

Last week however, IVG came out with another worse than expected annual result for 2012.

The “bomb” however was this statement:

As the company would like to explain the financing concept being developed to the shareholders and to allow them to decide on specific measures, where appropriate, the 2013 Annual General Meeting will be postponed from 16 May 2013 to presumably the end of July 2013.

Well, clearly postponing the Annual Meeting is ALWAYS a bad sign. So all the listed IVG securities got of course hammered:

The stock lost around 2/3 of its value:

as well as the Hybrid bond:

The convertible lost almost half of its value before rebounding, resulting in a loss of 1/3:

So to look at the only positive aspect. At least the Senior bond outperformed against the subordinated capital tranches as one would expect in such cases. As reader JM commented, the activity in the convertible prior to the announcement looks very very suspicious and smells of insider trading.

Updated liquidation analysis

First of all, let’s update the liquidation analysis from 2012:

Summary valuation of Assets

In the first step, I think it makes sense to use the same assumptions as last time, to make the numbers comparable. In the following table we see the asset “model” updated based on the 2012 report.

2011 Adj. Val 2012 Adj.Val Comment
Intangibles 251 0 253 0 100% write off
Inv. Property 3,964 3,398 3,654 2,920 scaled to 7% yield
PPE 157 118 190 143 25% discount
Financial Assets 189 142 174 131 25% discount
equity part 95 71 84 63 25% discount
DTA 404 0 336 0 100% write off
Receivables 60 45     25% discount
   
Inventory 1,025 513 996 498 50% discount
Receivables 179 134 190 143 25% discount
Cash 238 238 142 142 0% discount
   
AFS 341 256 58 44 25% discount
Asset Management 275   318 1.5% of AUM
Marekt value caverns 163   140 50% of disclosed adj.
         
Total 6,903 5,351   4,540

In second step we can then determine, how much assets are available for which debtor class. In the case of an insolvency, collateralized lenders get paid first, then senior lenders then hybrid and then equity.

Based on the 2012 numbers, i would calculate the following liquidation values:

  2012
Adjusted NAV   4540
-Bank loans   -3837
Remaining   703
Other senior liabilities    
  -Derivatives -84
  – Tax -77
  – pension -34
  – other financial -17
  – other liabilities -218
  – Convertible -400
  Total senior unsecured -830
     
  Coverage 84.70%

So this means that senior creditors would get under my assumptions still around 85% of nominal. This is slightly worse than last year but still quite positive and should limit the downside.

Of course, I did not consider additional costs of winding such a company up, on the other hand I didn’t put for instance a business value on the cavern business. However it is also clear that in a liquidation, both Hybrid and shareholders get a big fat “donut” as recovery.

What next ?

In such situations, it usually makes sense to listen to the analyst call in order to see what Management is actually saying. Fortunately, the call is easily accessible via their website. By the way: The used app for the audio file is really shitty…..

The most interesting section of the management comments is the fact that the 0.7 bn EUR 2013 maturity doesn’t seem to be a problem at all, as this is a 50% LTV loan.

From the Q&A, I found the following points most interesting:

– Squaire: Relative slow increase in occupancy. They need 90% occupancy to really exit which seems to need time, at least until 2014
– Caverns: Demand from utility side has shrinked, “NAV adjustment” at risk
– IFRS 13: There seem to be some issues in order to reflect transactional costs in the current valuations. They mentioned 100 mn EUR as potential (negative) impact.
– LTV target: They mentioned 55% as a goal, from around 71% today, with the intermediate step of 60-65% (my remark: with ~4 bn Bank, 5% LTV is 200 mn EUR.)
– no plan to sell fund management (would have been one option to generate equity)
– no mention of hedge funds as holders of the bank debt
– the “gherkin fund” has an indirect 44 mn EUR risk for IVG

In general, they were very vague about refinancing. They mentioned Rothshild being an advisor which is not the best news for existing investors. The whole call was with that respect a deja vue similar to the Praktiker call almost 2 years ago.

My expectation is the following:

Current equity holders will suffer one way or the other. My guess is that a new convertible will be part of any refinancing package. I could easily imagine somthing like pledging the fund business to a new investor, similar to the “Max Bahr” pledge at Praktiker.

In the process, they will come up with some “voluntary” contribution of Hybrid and Convertible holders which in my opinion will not work. I still belive that the Convertible will be paid in full in 2014, but the next few months can be very volatile.

Lessons learned:

I think I made one real mistake here: When I researched utilities earlier this year, especially Energiedienst, it should have been clear that the gas cavern business will not be so good going forward as in the past. As my thesis on the IVG bond implied a stable gas cavern business, I should have reviewed the case back then.

On the other hand it is interesting to see that a very broad research focus could yield quite interesting “cross results”.

Summery:

I think there is no urgent need to sell as Convertible holder. The asset base is still high enough to support a relatively high worst case recovery for the senior unsecured creditors.

Nevertheless, one should prepare oneself for a quite bumpy rest of the year with some “Praktiker style” attempts t bail in bond holders. All in all I still expect full repayment in MArch 2014 with a high probability. However, because of the problems in the utility sector, the stabilizing effect of the cavern business has weakened significantly and the investment is riskier than before.

For the portfolio, I will hold the bonds for the time being.

DISCLAIMER: As always, DO YOUR OWN RESEARCH !!!! This is by no means an investment recommendation for anyone. Don’t trust anyone with tipps etc.

Severfield-Rowen – Follow up deeply discounted rights issue

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A few days ago, I mentioned UK based Severfield Rowen as a potential interesting “deeply discounted rights issue” special situation.

Problem is that I don’t know much about the company. So the problem is always: How do you start looking at a new company ?

That’s when I remembered a very good post of Geoff Gannnon a few days ago:

:
I recently mentioned something in an email that I’m not sure I’ve said before on this blog. I always read the newest and oldest 10-K for a company when I start analyzing it. Reading the oldest 10-K gives you perspective.

I have to confess that normally I would start with the latest report and then work my way back, but the approach of Geoff really makes a lot of intuitive sense to me. So why not try with Severfield-Rowen ?.

The oldest annual report to be found on S-R homepage is the one from 2000.

So let’s compare some key figures from 2000 against 2011:

The difference couldn’t be bigger. In 1999/2000 we have a completely unlevered company with OK margins but very nice ROE/ROCE because of a quite efficient capital/sales ratio.

The 2011 company however looks very different. Sales have doubled, but lower margins, significant goodwill and debt including a growing pension liability reduce ROE/ROCE into low single digits.

So what happened in between ? Well of course, acquisitions:

2005: Acquisition of Atlas Ward, however this looked like rather a small fish at a bargain price

But then the big bummer:

2007: Acquisition of Fisher Engineering for a whopping 90 mn GBP

Fisher Engineering seemed to have been a Northern Ireland based company at least, the seemed to have paid partly in new shares according to this article:

Severfield-Rowen has agreed to buy AML for a total consideration of approximately £90m, of which £36.6m will be satisfied by the issue of 1,750,000 new shares at approximately 2,089 pence each with the balance in cash.

The rational given now f course sounds like a big joke, but at that time Ireland was still “hot” (for another 6 months or so:

The Fisher acquisition will extend Severfield-Rowen’s leading market position in the UK and give Severfield-Rowen a stronger presence in the growing Irish steel fabrication market.

In 2010 finally, they started a JV in India, but more on that later.

SO let’s look at 2006 vs. 2007 :

We can see in 2006 a very very healthy company with lots of net cash on the balance sheet, no goodwill nothing. In 2007, profits still went up but didn’t really compensate for the increased invested capital.

Interestingly, 2008 and 2009 were quire ok, however in 2010 S-R was hit by the “Wile E. Coyote” moment:

I spare myself the details, but i think this table is quite telling:

2007 2008 2009 2010
United Kingdom 289.6 314.6 325.4 260.5
Republic of Ireland and mainland Europe 8.9 79.5 23.2 3.6
Other countries 0.9 2 0.8 2.5

The access to the “Fast growing Irish market” for which they paid 90 mn GBP in 2007 had completely “vaporized” in 2010. I have to confess that this seems to be one of the worst timed acquisitions I have seen in my life.

interestingly enough, the still carry proudly the whole acquisition goodwill on their balance sheet. I wonder how the auditors sign this on a subsidiary without sales ?

The rights issue

Propectuses for rights issues are a very good ssource of information, the one from S-r is no exception.

Especially the following paragraph makes clear, how severe the problems are:

Severfield-Rowen will be in breach of one or more covenants under the Existing Facilities on 18 March 2013, being the date of the General Meeting. A breach of any one of such covenants would be an event of default under the Existing Facilities entitling the Group’s lenders to demand immediate repayment of all outstanding amounts and cancel the facilities. As at 14 February 2013 the Group had net financial indebtedness of £44.0 million. In the event that Shareholders’ do not vote in favour of the Resolution and the Group’s lenders demanded repayment of all outstanding amounts and cancelled the Existing Facilities on 18 March 2013, the Group would have insufficient funds to repay the amounts outstanding. The Group would then immediately need to find alternative sources of funds to replace the funds that would have been made available pursuant to the Rights Issue and the Revised Facilities. The actions that the Group would then seek to take to make up the shortfall in its funding requirements (which the Directors believe would need to be pursued simultaneously and immediately), include seeking to negotiate a new facility agreement with its lenders; seeking to obtain a sufficient amount of alternative funding from other sources; seeking to dispose of some or all of its assets or businesses; and/or seeking to find a purchaser of the entire Group. The Directors are not confident that any of the above actions will be achievable. In the event that the alternative courses of action set out above fail, the Group
ultimately may have to cease trading at that time. As a result, Shareholders could lose their investment in the Company.

So it is pretty clear: A failure to get the rights issue approved will lead to a direct insolvency of the company.

Quick valuation exercise

We have seen that the business of S-R is clearly very cyclical. At the moment, the UK and S-R are clearly at a low part of the cycle. Also, years like 2006 and 2007 will not be repeated any time soon.

Over the full 1999-2012 cycle, S-R has an average net margin of 3.7%. The exactly same average is the result of the “Normal” years, taking out 2007-2009 and 2012.

So if S-R gets back to ~300 mn GBP sales, that could result in 11.1 mn GBP normalized earnings. After the capital increase,S-R will have 290 mn shares outstanding. This results ~ 3.7 cents normalized earnings per share or a “fair value per share” after the capital increase of around 37 pence.

In order to make this interesting, the price should be definitely cheaper than that, so I would only buy below 25 pence or so.

Stock price

The rights have been split of on Tue, March 19th. The stocks are trading now around 0,37 GBP

Summary:

Looking at Severfiled-Rowen in 1999 and 2011 is like looking at two different companies. Especially the misguided acquisition in 2007 lead the company in deep trouble. However, despite the very significant decrease in the share price, S-R is still not a real bargain due to the massive dilution of the rights issue.

Only if one believes in a short term recovery of the UK economy, S-R would be a “buy” right now. So for the time being “no action”.

Gerard Perrier – Follow up (Acquisition history)

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In my initial post, I was actually quite sloppy. As reader al sting pointed out in the comments, they actually made a couple of acquisitions over the last years:

– 2005: Ardatem
– 2007: Maditech (?)
– 2007: SEIREL AUTOMATISMES
– 2011: SERA

Let’s look for first at Ardatem,, the service comnpany specialised on nuclear facilities. In their 2005 annual report they mentioned the acquisition as follows:

24.- Evénements postérieurs à la clôture du bilan. Acquisition de la société Ardatem le 4 janvier 2006, par la SAS Soteb : cette société de prestations de services intervient dans le secteur du nucléaire et réalise un chiffre d’affaires de l’ordre de 5 millions d’euros pour une marge nette d’environ 4% en 2005.

So in beginning 0f 2006, when they bought it, Ardatem had sales of 5 mn EUR with a margin of 4%.

In 2007, they bought “Maditech” which complemented the Ardatem acquisition and seems to be now als part of the “Energy” segment. Maditech had sales of 3 mn EUR at the date of the acquisition.

In 2011 then for comparison, the “energy” segment had sales of 28 mn EUR and an operational result (before tax) of ~2 mn EUR. That is quite a good developement 4-6 years. So yes, G. Perrier did acquire companies, but most of the growth happened after the acquisition !

Seirel was acquired in 2007 as well, the following can be found in the 2007 report:

Le chiffre d’affaires de la SAS SEIREL AUTOMATISMES, contrôlée indirectement est de 3 887 367euros (exercice de 6 mois) contre 6 307 313 euros l’an passé (exercice de 12 mois) et le résultat de 134 426 euros contre 285 731 euros l’an passé.

In the 2011 report this looks like this:

Le chiffre d’affaires de la SAS SEIREL AUTOMATISMES, contrôlée indirectement est de 7 551 587 euros contre 6 471 226 euros et le résultat de 491 215 euros contre 229 896 euros l’an passé.

Again, within 4 years, the doubled sales and even managed to increase profit 4 times. Seirel looks like it was a “distressed buy”.

Overall, the recent acqusition startegy looks quite successful. They seem to buy opportunistic and are able to put those companies onto a growth path. This makes me worry less about their cash pile. I think having cash and then being able to move quickly can be a great advantage. Especially now that maybe more companies are struggling in France, G. Perrier could make very interesting deals.

I will use the current weakness of the stock to buy some more below 35 EUR.

Cyprus bank deposit guarantee scheme – fact checking

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Yesterday and today, the press and most of the blogs I follow are full of comments on the Cyprus Deal.

Some examples:

Pragmatic Capitalism, Naked capitalsim, self evident

The summary is clear:

“Insured” bank deposits are going to be confiscated because of the evil (Germans/IMF/ECB). This is a catastrophe because no one will believe in bank deposit insurance any more.

Fact checking:

What I find extremely interesting is the fact that no one actually bothered to really look at the so-called “bank deposit insurance” in Cyprus. The Central Bank of Cyprus has an English language description of the scheme on their homepage.

In the beginning it sounds like a “normal” deposit guarantee:

Deposit Protection Scheme (DPS) was established in September 2000, and operates since then, in accordance with Article 34 of the Banking Law of 1997 as subsequently amended, and the Establishment and Operation of the Deposit Protection Scheme Regulations of 2000 to 2009. In accordance with these Regulations, a Deposit Protection Fund has also been established which operates as a separate legal entity administered by a Management Committee.

The purpose of the DPS is to provide protection to deposits and compensate depositors in the event that a member bank is unable to repay its deposits. The DPS covers deposits denominated in all currencies.

But then this:

The maximum level of compensation, per depositor, per bank, is €100.000. This limit applies to the aggregate deposits held with a particular bank. When calculating the amount of compensation payable to a depositor, any loans or other credit facilities granted by the depositor’s bank are set-off against the deposits. Any counterclaims that the bank concerned may have against the depositor in respect of which a right of set-off exists, can also be set-off.

I have to admit that I didn’t check all European deposit guarantee schemes but setting of loans against your deposit first looks unique to me. So in practice this means if you have a 300 k mortgage from your bank and for some reason a deposit of 100k at the same bank, your guarantee is worth nothing/nada/niente/nichts.

So the proposed deal of getting a 6.75% haircut on deposits irrespective of outstanding loans will be a much better deal for many people than being the “beneficiary” of this so-called “deposit guarantee”. Maybe that is one of the reasons they did this ?

It also seems to be that the word “guarantee” means something different in Cyprus than in the rest of the (finance) world.

Book review: “The success equation – Michael Mauboussin”

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The subtitle of the book claims the following: “Untangling Skill and Luck in Business, Sports, and Investing”

As being able to distinguish between luck and true skill is quite an important issue especially in investing, I was really curious to read the book.

Content:

Mauboussin really does a good job to look at this from several perspective, like sports, business and investing and how to place this activities on what he calls the “luck – skill continuum”.

The relationship between luck and skill then is important for instance if you want to test something statistically. The larger the part of luck, the more observations you should use to make statistical assumptions. So Buffet’s famous “investors of Graham and Doddville” would not qualify as statistically relevant in this regard, because only using a handful of examples for an activity with a lot of luck involved is not significant.

Another implication is that when you try to assess mean reversion, activities with a lot of luck involved will move quicker back to the mean compared to activities with mostly skill.

He mentions also some interesting aspects with regard to strategy. As an underdog you might prefer to complicate a certain competitive situation, as this increases the potential “luck” percentage in outcomes. Very simple games with uneven opponents do not leave a lot of room for luck.

Investing is for the author an activity with a lot of luck involved, at least in the short-term. The best mitigation in his opinion is a coherent investment process.

Summary:

All in all it is a quite interesting read with many interesting stories. However, I have one big “quibble”: The day after reading the book, I did hardly remember any specific details. I had to kind of speed read again to actually being able to write this summary.

So for some reason, the content of the book seems not to stick with me. I had the same problem with “Think twice”. Well written book, but nothing that really sticks. Also, I was a little bit disappointed that as an investor, you don’t gain a lot of insight.

I am not sure why this is the case, maybe Maubousin should have concentrated more on specific areas instead of jumping between sports, management and investing.

So if you want to have a well written book about diverse topic you might consider buying it. If you are looking for a book that might qualify as an investment classic, save your money.

Quick update Gronlandsbanken (DK0010230630) – 9% Dividend yield & elections

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Since the first post about Gronlandsbanken last year, the stock developed quite nicely so far, around +33%.

Part of that positive developement can be clearly attributed to the very positive 2012 annual report.

The first sentence of the report sets the tone:

Record Profits at The BANK of Greenland in 2012 – Return on Equity of 17.9% p.a.
Throughout the years of the financial crisis, The BANK of Greenland has managed a consistent series of fine results. Therefore, the bank is satisfied with the fact that the 2012 result was the best in the bank’s history. The profit on ordinary activities was DKr. 135 million – an increase of 72% as compared with 2011.

Earnings after tax were ~51 Kroner per share, resulting in a Trailing P/E of 12. Surprisingly for me, Gronlandsbanken decided to almost double the dividend from 30 Kroner to 55 Kroner, providing a “juicy” 8.8% dividend yield based on current share prices of 625 Kroners.

The report is again a very good summary of the situation in Greenland. They also mention the potential big projects and as a bank of course the recommend the following:

These major projects are a unique opportunity. It is crucial to take advantage of them.

Now comes the interesting part:

3 days ago, Greenland elected a new Government. And, surprise surprise, the opposition party did win, with Aleqa Hammond becoming the first woman to become prime minister.

In the press, the new Government is often cited as “Anti Mining”, in my opinion however they only difference is that they want to receive higher taxes and make sure local people get work too. For the mining companies, this means of course higher costs, but for local businesses (incl. Gronlandsbanken) this could mean that more money stays in the country which would be very good.

An additional interesting aspect was that the old government was against rare earth mining, because that stuff contains Uranium which was a no go for the old president.

There is also a quite recent article in the Economist which kind of confirms that view.

Summary:
So all in all I think the Bank is on good track and the nice dividend will maybe attract further investors. The change in Government should be good for local businesses going forward. I have therefore increased the stake by 1% of the portfolio (2000 Shares) up to a 2% position at a share price of ~630 Danish Kroners, representing the VWAP from March 8th to March 14th.

Short updates: Rhoen, KPN, HT1 Funding

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A few short updates which i think are worth mentioning in a post:

Rhoen Klinikum

One of my “special situations”. My original thesis behind this was that it is a solid company with a lot of interested suitors. Just today, the Fresenius CEO stated in WSJ Germany that they are still interested.

So this is still a solid, uncorrelated speculation that something could happen any time.

KPN
As one part of their capital raising effort, KPN issued two Hybrid bonds last week, 1.1 bn EUR at 6.125% and 400 mn GBP at 6.875%. According to Bloomberg, both bonds seem to have a “change of control” clause, meaning the bonds have to be paid back if someone becomes majority shareholder of KPN. This is quite uncommon for hybrids and looks a little bit like a “poison pill” against Carlos Slim.

Additionally, I found that rating review from Fitch (via Reuters) quite interesting.

KPN is facing some headwinds in the Netherlands. A fourth entrant plans to set up a 4G network (Tele2) and there seems to be a potential 2 bn liability from a subsidiary called Reggefiber, where KPN currently seems to have a 41% share but will soon have the majority.

Commerzbank HT1 Bond

Commerzbank just released news that they plan to increase share capital by 2.5 bn EUR and paying back their silent participations. This is not so nice for shareholders, but very good for HT1 holders as more equity is now “below” the subordinated capital, reducing downside risk.

So not surprisingly, the price of the HT1 bonds increased significantly.

Total Produce (IE00B1HDWM43) 2012 preliminary results – Disappointing

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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).

Berkshire Hathaway 2012 listed stocks performance

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I hope everyone has now read the 2012 annual Berkshire Letter which came out last week.

Among other stufff, Warren Buffet complained a little bit that he didn’t beat the S&P 500 based on the increase in Book Value at Berkshire.

Just for fun, I hacked in Berkshire portfolio.

In a first step I looked at all the disclosed positions above 1 bn USD.

2012 perfomance P/E P/B EV/EBIT EV/EBITDA Beta Volume
American Express 23.57% 14.7 3.8 16.1 8.9 1.05 8,715
Coca Cola 6.51% 19.6 5.3 16.6 14.0 0.72 14,500
Conoco Philips 9.20% 9.5 1.5 6.5 4.4 0.98 1,399
Direct TV 17.31% 10.8 #N/A N/A 9.0 6.2 0.89 1,154
IBM 4.17% 13.7 12.4 11.6 9.4 0.91 13,048
Moody’s 51.86% 16.6 29.1 10.3 9.5 1.31 1,430
Munich Re 54.71% 8.1 1.0 #N/A N/A #N/A N/A 0.94 3,599
Philips 66 50.41% #N/A N/A 2.0 10.8 8.5 1.16 1,097
POSCO 1.19% 8.3 0.7 9.0 6.4 1.01 1,295
Procter & Gamble 5.18% 19.4 3.2 14.4 11.9 0.64 3,563
Sanofi 34.20% 20.0 1.7 13.2 6.9 0.76 2,438
Tesco -8.20% 10.8 1.7 10.4 7.2 0.72 2,268
US Bancorp 20.96% 11.9 1.9 #N/A N/A #N/A N/A 1.09 2,493
Walmart 16.97% 14.6 3.2 10.3 7.9 0.59 3,741
Wells Fargo 27.37% 10.7 1.3 #N/A N/A #N/A N/A 1.15 15,592
 
Total / Avg 17.56% 14.27 5.0 13.4 10.1 0.92 76,332

To add some value, I have added some valuation metrics and aggregated the performance based on year end values. Although this is not the 100% correct way to do this, we can see that the listed stock portfolio outperformed the S&P Total return index (+14.1%) by a margin of almost 3.5%. A very respectable outperformance for a 75 bn USD portfolio. One can also see that the Beta of the portfolio is clearly below 1, so the outperformance really looks like alpha. (EDIT: I do not know which Index Buffet used for his 16%, I took S&P 500 total return performance from Bloomberg).

From simple valuation metrics, the portfolio of course looks quite expensive. P/E of 14.4 is in line with the S&P 500, but it looks like that Berkshire doesn’t consider P/B as a meaningful metric for listed stocks anymore. Also, the average EV/EBIT of 13 and EV/EBITDA of 10 is far above I would be prepared to pay.

In a second step, I added all the stock positions which were disclosed by Berkshire plus anything available on Bloomberg with a value of more than 200 mn USD.

2012 perfomance P/E P/B EV/EBIT EV/EBITDA Beta Volume
American Express 23.57% 14.7 3.78 16.05 8.88 1.05 8,715
Coca Cola 6.51% 19.6 5.33 16.55 13.98 0.72 14,500
Conoco Philips 9.20% 9.5 1.47 6.54 4.38 0.98 1,399
Direct TV 17.31% 10.8 #N/A N/A 9.03 6.16 0.89 1,154
IBM 4.17% 13.7 12.41 11.56 9.41 0.91 13,048
Moody’s 51.86% 16.6 29.11 10.29 9.48 1.31 1,430
Munich Re 54.71% 8.1 0.96 #N/A N/A #N/A N/A 0.94 3,599
Philips 66 50.41% #N/A N/A 1.98 10.82 8.52 1.16 1,097
POSCO 1.19% 8.3 0.70 8.96 6.36 1.01 1,295
Procter & Gamble 5.18% 19.4 3.21 14.44 11.88 0.64 3,563
Sanofi 34.20% 20.0 1.74 13.22 6.88 0.76 2,438
Tesco -8.20% 10.8 1.74 10.40 7.15 0.72 2,268
US Bancorp 20.96% 11.9 1.86 #N/A N/A #N/A N/A 1.09 2,493
Walmart 16.97% 14.6 3.21 10.27 7.86 0.59 3,741
Wells Fargo 27.37% 10.7 1.33 #N/A N/A #N/A N/A 1.15 15,592
               
Davita 45.80% 19.4 3.33 14.95 11.94 0.80 1,830
Swiss Re 49.31% 6.8 0.92 #N/A N/A #N/A N/A 1.15 909
Washington Post 1.20% 17.6 1.16 9.27 4.52 0.81 704
General Motors 37.40% 9.3 1.47 #N/A N/A 1.31 1.19 697
M&T Bank 31.99% 13.7 1.43 #N/A N/A #N/A N/A 1.07 558
BonY Mellon 30.69% 12.2 0.92 #N/A N/A #N/A N/A 1.28 544
Costco 26.15% 24.8 3.50 13.49 10.21 0.75 444
USG 166.24% #N/A N/A 502.76 48.17 18.47 2.14 472
Viacom 16.92% 14.5 4.21 9.25 8.70 1.16 459
Precision Castparts 12.83% 20.3 2.92 15.23 13.93 0.92 374
Mondelez 6.24% 12.7 1.58 9.46 7.81 0.62 366
National Oilwell -0.76% 11.5 1.43 8.19 6.96 1.51 357
Deere 11.80% 11.2 4.67 8.22 6.75 1.14 355
Wabco 43.46% 14.4 6.48 12.46 10.07 1.72 281
General Dynamics 6.04% 10.6 2.10 30.15 17.28 0.97 262
Visa 47.56% 24.6 4.68 18.01 17.09 0.98 250
Torchmark 18.82% 11.2 1.25 #N/A N/A #N/A N/A 0.97 245
Mastercard 29.89% 23.9 9.38 14.04 13.27 1.00 214
               
               
               
 
Total / Avg 19.57% 14.4 7.6 13.6 10.1 0.94 85,653

A few observations here:

I do not understand, why DaVita was not included in the shareholder’s letter with a market value of 1.8 bn. Maybe they have forgotten this position ?

Secondly, including those additional ~10 bn of stocks increases the total performance of the total portfolio by an incredible 2%.

In a third step, I calculated the performance of what I would call the “Non Buffet” Portfolio, taking Direct TV from the annual letter and eliminating Swiss Re and Washington Post from the < 1bn list.

2012 perfomance P/E P/B EV/EBIT EV/EBITDA Beta Volume
               
Direct TV 17.31% 10.8 #N/A N/A 9.03 6.16 0.89 1,154
Davita 45.80% 19.4 3.33 14.95 11.94 0.80 1,830
General Motors 37.40% 9.3 1.47 #N/A N/A 1.31 1.19 697
M&T Bank 31.99% 13.7 1.43 #N/A N/A #N/A N/A 1.07 558
BonY Mellon 30.69% 12.2 0.92 #N/A N/A #N/A N/A 1.28 544
Costco 26.15% 24.8 3.50 13.49 10.21 0.75 444
USG 166.24% #N/A N/A 502.76 48.17 18.47 2.14 472
Viacom 16.92% 14.5 4.21 9.25 8.70 1.16 459
Precision Castparts 12.83% 20.3 2.92 15.23 13.93 0.92 374
Mondelez 6.24% 12.7 1.58 9.46 7.81 0.62 366
National Oilwell -0.76% 11.5 1.43 8.19 6.96 1.51 357
Deere 11.80% 11.2 4.67 8.22 6.75 1.14 355
Wabco 43.46% 14.4 6.48 12.46 10.07 1.72 281
General Dynamics 6.04% 10.6 2.10 30.15 17.28 0.97 262
Visa 47.56% 24.6 4.68 18.01 17.09 0.98 250
Torchmark 18.82% 11.2 1.25 #N/A N/A #N/A N/A 0.97 245
Mastercard 29.89% 23.9 9.38 14.04 13.27 1.00 214
               
               
Total / Avg 34.97% 15.2 33.6 15.3 9.9 1.07 8,862

And here we can see that Weschler and Combs really “shot out the lights”. 35% performance for 2012 is a fxxxing fantastic result. Ok, Beta is slightly above 1 but at least for 2012 the did a outstanding job. No wonder Buffet said that in his annual letter:

Todd Combs and Ted Weschler, our new investment managers, have proved to be smart, models of integrity, helpful to Berkshire in many ways beyond portfolio management, and a perfect cultural fit. We hit the jackpot with these two. In 2012 each outperformed the S&P 500 by double-digit margins. They left me in the dust as well.

So even if some of the smaller stocks are “Warren & Charlie” stocks as well, Weschler and Combs showed them how its done at least with a smaller portfolio. Maybe the smaller size of the portfolio is the reason ?

Summary:

Once again, the portfolio of listed stocks of Berkshire outperformed the S&P 500 by a nice margin. However it seems to be that Buffet’s “elephants” don’t have a chance against the smaller holdings of Weschler and Combs. Nevertheless, for the “lazy” value investor, copying the Berkshire portfolio looks still like a winning strategy.

Copying the “small” Berkshire stocks however looks like the absolute killer strategy.

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