Tag Archives: ISIN IT0001206769

Gruppo Sol SPA part 2 – balance sheet, qualitative aspects and weaknesses

After the initial post about Gruppo Sol SpA, let’s look at some other standard issues which are important for a “value investment”:

1. Balance Sheet quality

Gruppo Sol is definitely not an asset play, as the main value lies in at least some local competitive advantages, mostly in it’s homecare business. However it makes nevertheless sense to check the quality of the balance sheet, as a solid balance sheet significantly decreases the downside in those cases where the investment thesis doesn’t play out.

a) Goodwill

Good news here: Gruppo Sol has only a very small amount of goodwill (22mn EUR out of 375 mn EUR equity). In comparison to AIr Liquide or Linde, this looks quite good. Air Liquide has only half of its book value in tangible assets, whereas Linde has negative tangible book value due to its past acquisition. Tangible book value in itself is definitely not a guarantee for success, but it limits the downside to a certain extent.

b) Debt

Debt is unfortunately not insiginifcant. With around 170 mn net debt as of 31.12.2011, debt to equity is around 50%. Although this is exactly the same ratio as Linde and slightly better than Air Liquide, for an Italian based company with most likely Italian bank as creditors, this is something to monitor closely.

Interestingly, they provide a very detailed overview of financial liabilites in the 2010 report on page 54. The good news is that very few loans contain covenants and there are no critical maturities, the “roll down” seems to be very conservatively structured, the bad news is that some of the loans are quite expensive. In total I would judge this as a rather well managed conservative financing structure.

c) Extra assets, Pensions, operating leases, depreciation etc.

There are basically no other assets on the balance sheet than those required for running the business, so no big minority stakes etc. On the one hand, this doesn’t leave any potential for “extra” assets like Autostarada, howver on the other side its a good sign as the comnpany seems to be focused on its core business and not trying to play the typical Italian pyramide structure games.

The company doesn’t seem to have off-balance sheet operational leases. A smaller amount of the assets are financed through financial leases which are included in the nebt debt

They don’t really show pension liabilites which is due to the fact that defined benefit plans are unusual in Italy anyway. However the show a 10 mn EUR reserve for “employee severance and other benefits”. Interestingly they seem to discount this with 1.30% p.a. which is a very very conservative assumption.

A quick view into fixed assets shows that plant and machinery of Sol SpA show a cummulated depreciation of ~2/3 of historical values. Land and building values are only a small amount of fixed assets, so I would not expect any “hidden reserves” there.

So overall, I would consider the balance sheet of Sol SpA as conservative but without significant hidden value.

2. Shareholders & Management

Large shareholders are:

59.98% are held by a Dutch entity called “Gas and Technolgies world” whcih is the vehicel of the founding Fumagali family. The CEO of SoL SpA, Aldo Fumagalli Romario is currently CEO of Sol SpA, so SOl is both, family owned and also actively managed by a family member.

7.35% are held by Tweedy Browne
5.05% are held by Bestinver
4.50% by Stefano Bruscagli, a board member of Sol SpA
3.00% are held by Alberto Tronconi, a former Sol SpA director.
1.13% owned by Leonardo Alberti, a current director of Sol Spa

So in total, 60% are held by the family and further 8.6% by active board members which in my opnion is a good sign.

Board compensation

For some reason I didn’t find director’s comp in the report, so I rely on the FT information. However 500 k compensation for the top officers seem to be OK.

Corporate Governance

The only thing I can say about this is that I am not aware of anything yet. So no dealings between main shareholder and company or directors and company whcih is very good for an Italian company.

Weaknesses and known problems

At some point in time one should also consider the main weaknesses as you rarely find the “perfect” company at hte perfect price.

Capital intensity

As mentioned in the first post, especially the industrial gas business is very capital intensive. So no nice free cashflow franchise busienss but “real investment” business. If Sol was an Anglo Saxon company, they would have spun off Vivisol a long time ago and milking the cash from the gas business without reinvesting.

I am not sure if Vivisol relies to a certain extent on facilities from the industrial gas segment, this is something to explore further. Also, in the Vivisol segement, receivables started to grow. At some point, manngement mentioned that public health insurers, which usually pay for the home care services are paying slower espacially in Italy.

Italian exposure

This brings us to the next obvious point: Especially the industriel gas division is naturally exposed to Italy and a possible further detoriation of economical activity. As of 2010, Sol made 60% of sales within Italy and 40% outside, with outside sales growing by double digits. Although the business should be more stable than other businesses, this risk is definitely there.

2011 preliminary results and intra year reporting

During the year, Sol is only reporting EBIT. For Q3 for example, Sol reported 13.3% increase in YOY EBIT increase, a really strong double digit growth number.

So it came as a surprise that in the preliminary 2011 full year numbers, 12 M EBIT suddenly wnt flat agains the year before and EPS actuall decreased slightly.

As there is no segemnt reporting in the preliminary release, we cannot see if this is an issue for both segments. My assumption is thta the bad Q4 comes from the Italian industrial gas side but it is not really explained and one has to wait for the full annual report.

Investor relation / reporting

This brings us directly to another weak point. Quarterly reports do not include EPS and explanations are short. The last inevstor presentation is from 2003, so they seem to save a lot of money on investor relations if we look at the bright side. Tehy don’t even show up at the “Star” conferences.

Research Coverage & Index

For Sol SpA, analyst coverage is very low. Only one small shop covers them (“EVA dimensions”, whoever that is) with an overweight rating but noprice target. They are also not included in any index, and trading volume with around 200 k paer day is too low for many funds.

For larger institutionals with shorter time horizon, the stock is most likely not interesting.

So lets stop here and summarize part 2:

+ on the plus side, Sol seems to have a relatively conservative balance sheet
+ company is family owned and family run
+ management compensation is OK, managers have relevant stakes in the company
+/- corporate governance is good for Italian standards, however neutral for objective standards
– business is capital intensive
– significant exposure to Italy
– reporting during the year only on EBIT basis, very limited information

So far no “deal breakers” but also some significant general issues. I will have a final post up if to invest and at what price.

Gruppo Sol SpA (ISIN IT0001206769) – only hot air or hidden moat company (part 1) ?

Grupo Sol SpA is an Italian company, which accoding to its homepage is active in

the production, applied research and marketing of industrial, pure and medicinal gases as well as being involved in the home care and in the welding markets. Today, SOL is an Italian based multinational company present in 20 European countries and in India and it has over 2,100 people employed. The annual revenue is 518 million Euro (2010 consolidated figures).

At a first view,the company doesn’t look that exciting and will most likely not show up on any screener with multiples like this:

Market Cap ~380 mn EUR
P/E 12.0
P/B 1.1
P/S 0.7
Div. Yield 2.4%
EV/EBITDA 5.7
P/E (10) 12.5

So neither expensive nor cheap and why bother ?

A quick view to the stock chart doesn’t look that convincing either:

After almost regaining the ATH in 2011, the stock dropped significantly and only regained a little since then.

The reason I got interested was the fact, that Sol SPA is one of the biggest Italian positions of Tweedy Browne’s international value fund. They hold around 7.4% of all shares. Additionally Bestinver, a Spanish value shop which portfolio I track is also invested with a 5% position.

Tweedy normally prefers companies which have almost no debt and relatively large free cashflows. However if we look at historical numbers, both, Sol’s debt position which is constantly increasing and its patchy free cash flow generation are not overly convincing.

debt/assets fcf per share
31.12.1999 17.4012 -0.05
12/29/00 18.5842 0.08
12/31/01 18.5484 -0.06
12/31/02 24.0896 -0.22
12/31/03 22.0988 0.12
12/31/04 22.8246 -0.05
12/30/05 23.4384 -0.08
12/29/06 24.0223 -0.15
12/31/07 25.8941 0.03
12/31/08 28.702 -0.09
12/31/09 29.0258 0.19
12/31/10 29.5759 0.0041

However some other historical stats are more interesting:

GJ EPS Net Margin Op Margin ROE
1999 0.12 5.6% 11.6% 6.6%
2000 0.14 6.1% 10.9% 7.4%
2001 0.15 5.5% 9.6% 7.2%
2002 0.17 5.8% 10.6% 8.1%
2003 0.17 5.1% 11.1% 7.4%
2004 0.20 5.5% 11.4% 8.1%
2005 0.19 5.0% 10.5% 7.4%
2006 0.19 4.2% 10.7% 6.7%
2007 0.30 6.3% 10.8% 10.1%
2008 0.38 7.6% 9.7% 12.0%
2009 0.28 5.4% 10.8% 8.1%
2010 0.35 6.1% 11.5% 9.6%

Although the business seems not not to be extremely profitable, Net Income margins and returns are very stable and EPS grows along increasing sales nicely over the 12 years from 1999-2010. Interesting so far, but what else ?

If one looks in to the (english) annual report 2010, the really interesting stuff is hidden in the notes on page 58 which shows the break down of the 2 main segments, industrial gases and “home care”.

It’s relatively easy to see that home care shows ~50% higher margins than industrial gases.

The differences between the two segments become even clearer if on looks at the history of the two segements. I have compiled some ratios for both segments from past annual reports:

2010 2009 2008 2007 2006 2005
Homecare            
Sales 222 191.2 167.1 150.1 121.9 106.5
Operating profit 31 27.7 24.8 22.8 21.5 14.6
in % 14.0% 14.5% 14.8% 15.2% 17.6% 13.7%
Net assets 157 145 134 118 84 53
Net income 18.3 17.4 17.1 14.4 12.9 6.6
NI margin 8.2% 9.1% 10.2% 9.6% 10.6% 6.2%
ROA 11.7% 12.0% 12.8% 12.2% 15.4% 12.5%
             
Gas            
Sales 331 304 319.5 304 286.7 257.2
operating profit 28.6 22.1 26.7 23.1 13.7 21.5
in % 8.6% 7.3% 8.4% 7.6% 4.8% 8.4%
Net assets 301 289 276 256 269 225
Net Income 20.3 13.8 21.7 12.4 3.6 10.6
NI margin 6.1% 4.5% 6.8% 4.1% 1.3% 4.1%
ROA 6.7% 4.8% 7.9% 4.8% 1.3% 4.7%

Business model:

Industrial gases is a relatively simply business model. One can think of it as a kind of unregulated local utility business model. Technical gases are usually difficult and expensice to transport over longer distances, so competitive advantages exist to a certain extent at a local level. If one operates a industrial gas plant in an indusstrial zone, barriers to entry are one one hand relatively high, as competition has to built a gas plant first. Transport over a longer distance from a gas plant in another country are very difficult to achieve.

On the other hand, pricing power is not unlimited, because if prices get too high in a region, competitors might just built a new gas plant if the margins are high enough. Technologically this is not so difficult, o its mostly a matter of capital and return on capital

Sol SPA seems to have a nice market share (~15%) in the Italian technical gas market. Sol’s profitablity ratios compares pretty well for instance with European market leader Lide AG, which also shows NI margins of between 5-8% and ROCE or ROA of around 6-8%. So a smaller regional player seems to be able to earn similar returns in this business like the undisputed market leader, which is a sign for at least some local competitive advantages in this field.

The much more profitable Home Care business is very interesting in itself. Sol SpA is running this through its subsidiary called “Vivisol“.

They offer different services for home care patients, however the “core service” seems to be the delivery of liquified oxygen to patients who are at home and need respiratory assistance. So this is basically a nice “repeat” business as the liquid oxygen has to be replaced on a weekly or daily basis.

In general, patients with a oxygen deficency need additional oxygen for the rest of their life. For stationary patients, a kind of “oxygen compressor” can be used, however for “mobile” patients, liquid oxygen is the only practicable way of carrying enough oxygen around.

As one can imagine, it is not really an option to order liquid oxygen online at Amazon or Ebay, as on the one hand, certain medical standards have to be fullfilled (inc. licences) and on the other hand liquid oxygen has to be kept at temperatures of -190 degrees celsius. So “disintermediation” through the internet seems to be not a danger.

Vivisol seems to have expanded above the pure liquid oxygen delivery into similar areas like sleep therapy, wound care etc.

As with technical gases, competitive advantages seem to exist on local levels. As it doesn’t make sense to ship around liquid oxygen thousands of kilometers, on a daily or weekly basis to hospitals or home care patients, once a local production capacity and a local distribution system is intstalled, it will be quite difficult for any competitor to enter into this local market.

One could also argue that in contrast to technical gases this creates a sort of network effect if further patients are added within a distribution area.

Competition

Major competitors in both areas are mostly the large Industrial gas players, especially Linde, Air Liquide and Air Products. Howver as discussed before, a dominant position in one market does not automatically generate a big competitive advantage in another area, as the business seems to be highly localized.

I didn’t really find market share data for home care. However in the wake of the recent acquisition of the Air Porducts homecare business by Linde, the following was stated:
e

An industry observer who declined to be named said the acquisition — one of Linde’s biggest since it bought UK-based BOC for 12 billion euros ($15.3 billion) five years ago — would make Linde a strong No. 2 in the homecare business after French group Air Liquide SA (AIRP.PA).

In this German article they say that Linde had 280 mn EUR in home care sales in 2010.

So we don’t know how mach sales Air Liquide has in home care, but I assume that SOL SpA will be either number 3 or 4 on Europe with its ~240 mn EUR home care sales in 2011. So in this niche market they seem to have a quite nice market share which they have built more or less organically.

We have therefore a limited amount of competitors, however the more important point seems to be that it is not so easy to simply enter the market from scratch.

Valuation: Sum of parts

Normally, I could start now with a bottom up DCF analysis. Howver in this case we have a very nice public transaction and we can do a quick (and dirty) sum of parts valuation.

As quoted before, the Air Products business had almost identical size than the Vivisol business (210 mn Sales against 240 mn) and was valued at 590 mn EUR, a whopping 2.8 multiple on sales. Although I have no further info on profitability, this multiple would represent a 2.8*2.40 mn = 672 mn EUR valuation for Vivisol alone. If we deduct a 20% control premium from the purchase, this would give us a non-control value of around 540 mn EUR for Vivisol assuming profitability is close to the Air Products division.

For technical gases, competitors Linde, Air Liquide and Air Products trade at ~9 x EV/EBITDA, so if we apply a 20% discount, a multiple of 7 seems to be reasonable. Based on available 2010 EBITDA for the industrial gases of 70 mn EUR, we would get a EV of 490 mn EUR for the technical gases.

Added together, we would get a theoretical EV of (540+490) = 1.030 mn EV for Sol, compared to actual EV of around 550 mn EUR as of today, which would leave a lot of upside for the company at current valuation levels.

So lets summarize at this point:

+ the business model of Sol SpA looks interesting. Local competitive advantages seem to exist and one part of the busienss seems to be very profitable and growing nicely based on a “repeat business model” including some networ effectss

+ a quick and dirty “sum of part” valuation based on a recent competitor deal shows a significant potential upside

Enough to look further into the company in a follow up post including a more detailed DCF computation and a review of qualitative factors.