Fortnightly Review January 7, 2018

Fornightly Review January 7, 2018

I hope you all had a wonderful holiday season.  Going forward this review will be every two weeks.


Interesting Links & Tweet

In September 2016, Michael Mauboussin and his team at Credit Suisse put out a base rate book with base rates aggregated on a number of levels. The book is a useful tool as the inability to forecast the future means investing is probabilistic. Understanding what the market is pricing in through reverse engineering a DCF with a focus on a key value drivers (sales growth, operating margin, investment requirements) will allow you compare to base rates.  If the market is pricing in high growth rate, persistence of margins, and low capital requirements, the stock is likely to be overvalued.  There are always a few outliers that beat the odds but placing money on a company with the hope it is an outlier is probably more speculation than investing. (link)


Aswath Damodaran released his annual data. A number of variables are aggregated at a number of levels including at the Emerging Market level. (link) The table below illustrates some key metrics for EM.


JAB Holdings recently offered RM3.18 per share. Oldtown (OTB:MK) manufactures and sells coffee in stores and through a 232 strong chain of cafes, mostly based in Malaysia with outlets also in Indonesia and Singapore. The key stats associated with the acquisition are below.


The transaction multiple provides a benchmark for valuation of similar companies. The main assumption is the private market acquirers are knowledgeable industry insiders that have done extensive analysis and wouldn’t have completed the acquisition without the acquirer achieving an acceptable return. What is an acceptable return is another discussion and different for everyone. Private market valuations also take into account a control premium. The table below illustrates the transaction multiples over the past five years for food and beverage mergers and acquisitions from Peakstone Group. (link)


Stout Advisory has an excellent overview of F&B M&A transaction multiples broken down by sector within the industry. (link)


German firm Star Capital produced a very well research article discussing the pitfalls of Short-term forecasts, market timing and EPS estimations often used by investors, particularly institutional investors. (link) H/T Hurricane Capital


In March 2016, Stalwart Advisors provided insight into its 3 Wave Framework to determine long term sales growth potential of a industry/company, which is well worth the time. (link)


“When management owns stock, then rewarding the shareholders becomes a first priority, whereas when management simply collects a paycheck, then increasing salaries becomes a first priority.” Peter Lynch H/T @MikeDDKing
Fritz Capital wrote a blog post discussing what to look for in a CEO and what to avoid. (link) A summary of the blog post is below. Fritz Capital’s twitter handle is @Fritz844 and is well worth a follow.


The best CEOs:

  • Have a strong customer focus
  • Identify strongly with the company they run
  • Are motivated by a deeper meaning rather than making money
  • Are patient
  • Are frugal
  • Think individual responsibility is more important than processes.



The worst CEOs:

  • Trust expert advice rather than think for themselves
  • Focus on size and profitability
  • Want to win against competitors rather than do what’s best for customers
  • Feel appearance is important
  • Impatient
  • Well-connected
  • Feel misunderstood and want to prove sceptics wrong
  • Driven by making money



This analysis is relevant for stock picking. The quality of the CEO can have a huge impact on R&D-intensive businesses such as in the technology and pharmaceutical industries, but also for commoditised businesses that typically operate on razor-thin margins. At any rate, good CEOs tend to have a strong focus on adding value to customers rather than on beating competitors. They also seem to identify strongly with the company – to have an emotional connection to the ups-and-downs of the business. They seem to be driven by a long-term mission rather than just trying to make a quick buck. And lastly, they seem to have patience to invest for long-term results.


Successful CEOs appear to be optimistic and believe that their work can have a major impact on the company and the lives of others. In contrast, worse-quality CEOs appear to feel that they are victims of circumstances out of their control, feel that they are entitled to fame and fortune regardless of their performance and are quick to blame others for outcomes relating to the business.



The short selling checklist of Feshbach brothers circulated around twitter sometime ago. (link) H/T @Wexboy_Value


Wall Street Converstations put together some links on the Feshbach brothers, which provides some background. (link)


The Cut recently profiled Oscar Olsson, an executive at H&M. (link) After a 50% fall, H&M looks interesting. We may do some research and write something on the name even though it is outside our typical universe due to the quality of the company and the general lack of opportunities.


The Intrinsic Investing blog of Ensemble Capital discusses pricing power. (link) The Intrinsic Investing blog is one of the best around and is a must read. I suggest going back through previous posts if you have not followed the blog. My favorite posts include The Death of (Many) Brands and How Moats Make a Difference.


FT wrote an article on the increase in Chinese share pledging. (link)


Columbia Business School put out its quarterly investment newsletter Graham & Doddsville (link).


Stratechery posted an annual review (link). The author Ben Thompson always has interesting ideas on business models and themes in tech and media that often transfers to other industries. wrote a good description of Dairy Farm (link), an Asian Retailer with four divisions:


  • Food (Hypermarkets and Supermarkets, 36% of 2016 net profit),
  • Health and Beauty (27% of 2016 net profit).
  • Home Furnishings (Ikea, 11% of 2016 net profit) and
  • Restaurants (14% of 2016 net profit)
  • The majority of the company’s locations are in Hong Kong and China.


H/T value and opportunity


Michael Mauboussin’s latest on How Well Do You Compare? (link)


Stalwart Advisors shares their insight on the importance of management. (link)


Bill Nygren discusses his investment approach during a recent talk at Google. (link)


The Federal Reserve Bank of San Francisco released a working paper titled The Rate of Return on Everything, 1870–2015. (link) H/T Hurricane Capital


Morningstar provided their best ideas in each sector. The focus is primarily the US. (link)


Todd Wenning joined Ensemble Capital and wrote about his investment process. (link)


Research Affiliates discuss the effectiveness of the CAPE ratio in the US and International markets. (link)


Jim Chanos and Kyle Bass discuss China in October 2016. (link)


JD’s CEO Richard Liu discusses the Chinese consumer and e-commerce. (link) H/T Craig Bujnowski


South Korean cosmetics company Amorepacific aims to expand in Europe. (link)


December 2017 issue of Value Investor Insight includes a few Emerging Market ideas. (link)


Jeremy Grantham of GMO shares his view of the market. (link)


Tom Fahy tweeted an interesting chart of Offshore Drilling Utilization (link).



Weekly Update December 10 2017

Weekly Update December 10 2017

Over the past year, I have been busy with various projects and a move back to the US from India. Starting in the new year, I will have more time to produce weekly updates on a consistent basis. Hopefully, the weekly updates add a bit of value. Feel free to let me know your thoughts.


Johannesburg Stock Exchange Pass


The Johannesburg Stock Exchange (JSE) was reviewed as a potential recommendation but it was a pass. I was attracted to JSE due to potential network effects combined with a business with all fixed costs leading to potential economies of scale and significant operating leverage. The company is currently trading on a FCF yield of 8.0%. A company with a very strong moat in the form of network effects and economies of scale along with top line growth at GDP and profit growth at a higher rate due to operating leverage should be trading at a higher valuation. If the concerns were solely macroeconomic, I would have recommended the company.


In 2017, ZAR X and A2X were awarded licenses to operate equity exchanges. In 2016, equity markets accounted for at least 60% of the company’s revenue. Operating financial exchanges are a technology business. The biggest risk is new entrants can replicate JSE’s technology at a much lower cost, as JSE technology platform has been slowly built over years and therefore is a patchwork legacy system. The ability to operate a technology platform at a much lower cost allows new entrants to undercut JSE’s pricing. In other markets new entrants have been able to gain share in what was once thought to be an almost rock solid competitive position. The BATS platform has achieved a 19% market share in US equities since entering the market in 2005 and 20% market share in European equities since entering the market in 2008. New entrants in South Africa should at the very least force JSE to cut prices and/or to upgrade its technology platform.  Given the fixed nature of the company’s expenses, any loss of revenue will flow directly to a decrease in the company’s operating profit.


Looking at valuation, assuming market share gains by competitors and/or price cuts in the equity division, revenues related to equity markets would decrease by 20% leading to a free cash flow yield and expected return close to 5.0%. Assuming competition has some effect and cancels out any growth, the company’s free cash flow yield and expected return is roughly 8.0%. Assuming competition is unable to enter to gain a foothold in the market and the company is able to continue to grow at 5.0%, the expected return is 13.0% per annum (free cash flow yield + growth).  The potential ranges for expected return are only estimates as it is difficult to forecast with any accuracy. Assuming, the highest return scenario has a 60% probability and the other two scenarios each have a 20% probability then the expected return per year is 10.4%. KfW is a German government owned development has a rand denominated bond expiring in October 2022 with a AAA rating, which offers a 8.272% yield. Given the potential risk a 2.0% additional annual return over a AAA rated bond is probably not sufficient to warrant an investment in JSE.




Given my focus on high quality companies, I often read Morningstar’s research and insights. Morningstar put out an article discussing company profitability and changing nature of moats (link)


Alpha Vulture, another value investing blog posted an investment thesis on Stalexport Autostrady, a company I wrote about earlier this year. My post on Stalexport Autostrady can be read here while Alpha Vulture’s post can be read here.


Francis Richon of Giverny Capital talked at Google. The talk is well worth the hour (link).  Giverny Capital’s letters can be view here. HT Value Investing World


Giverny Capital process is summarized below.


Financial Strength

  • ROE > 15%
  • EPS growth > 10%
  • Debt/profit > 4x


Business Model

  • Market leader
  • Competitive advantages
  • Low cyclicality


Management Team

  • High level of ownership
  • Constructive acquisitions
  • Good capital allocation



  • 5 year valuation model
  • Try to purchase at half of the estimated valuation in 5 years = IRR of 15%



The Council of Institutional Investors discusses variable interest entities (VIE) used by Chinese companies when listing in the US. (link) Chinese companies also use VIEs when listing in Hong Kong. Below is one of the most interest aspects of VIEs.


“The VIE structure could be deemed to contravene Chinese laws that restrict foreign investment in strategically sensitive industries. VIEs operate using contractual arrangements rather than direct ownership, leaving foreign investors without the rights to residual profits or control over the company’s management that they would otherwise enjoy through equity ownership. While VIEs have established themselves as common practice among U.S.-listed Chinese companies and have won some validation from market actors, the structure puts public shareholders in a perilous position. VIEs depend heavily on executives who are Chinese nationals and own the underlying business licenses to operate in China, introducing unusually significant “key person” succession risk. Aside from dual-class structures with limited shareholder rights in the Cayman Islands and other jurisdictions in which these companies are often incorporated, the VIE structures themselves create significant management conflicts of interest, complicating, if not foreclosing, the ability of outside shareholders to challenge executives for poor decision making, weak management, or equity-eroding actions. VIEs lead foreign investors to believe that they can meaningfully participate in China’s emerging companies, but such participation is precarious and may ultimately prove illusory.”


Due to the high frequency of financial statements being completely wrong, I no longer look at Chinese companies. Through the end of Sept 2017, our average recommendation is up 7.9% in relative terms on a USD basis. Taking China out of the picture, our average recommendation is up 30.8% in relative terms on a USD basis. The reliance on financial statements within my research process means it is best just to stay away when financial statements cannot be trusted. When the outcome is poor the result is clear but when the investment goes right, there can never be conviction so the benefit of a good outcome cannot be realized.  The combination means time is better spent elsewhere. If you are looking at China and concerned with fraud, GMT Research ( does a good job discussing Chinese companies and potential concerns. There is a wealth of free information on their site. One particular video Faking Cash Flows and How to Spot It is a must watch. A key point from the video is outside of China only 1% of companies above USD500 million meet GMT’s four indicators for cash flow fraud while in China and Hong Kong that rises above 6%. Another blog discusses the risks of investing in Chinese companies (link).


Peters MacGregor discusses its investment in Fairfax India (link). Peters MacGregor is an Australian investment firm that invests in undervalued portfolio of world-class businesses with dominant market shares and good growth prospects. It looks very interesting at first glance.


Kellogg Insights interviews Lou Simpson (link)


An interesting tweet by @ValueStockGeek illustrating the number of position in a value portfolio and standard deviation of monthly returns (link). As the number of position in a value portfolio passes 10 the benefits of diversification decreases. Joel Greenblatt did a similar study in his book You Can be a Stock Market Genius. Validea discussed his finding here.


Fundsmith Equity Fund published an Owner’s Manual, which is well worth a read (link). HT @ToddWenning


This following link is to Amazon’s Shareholder Letters from 1997 to 2016. Amazon Shareholder Letters Jeff Bezos 1997-2016


Clear Eye Investing put together a list of 15 questions to ask management (link). HT @HurriCap



Turk Tuborg & GMA Holding Position Sizes 11/6/2017

Turk Tuborg & GMA Holding Position Size 11/6/2017


Turk Tuborg’s position decreased 5.1% on May 12, 2017 when there was the first sales with a goal of reaching 2.0%.  The share price has increased and the stock is illiquid. The current position is 3.2%. There will be no further selling.

There is a similar liquidity issue with GMA Holding.  There will be no more buying and the GMA Holding position.  It is a 6.4% position.

Both are high quality companies that can be held for five years regardless of stock market liquidity.

The latest recommendation size of 6.0% was completed over 7 days.

Future recommendations will be in more liquid stocks. The lower limit for 6 month average daily volume will be USD100,000 in the most attractive of situations but more likely it will be above USD250,000 average daily volume.




New Research Report October 19, 2017

I have produced a new research report on a very liquid high quality retailer with seems to have a few competitive advantages and offers a 16.3% expected return using conservative assumptions. It will start with a 6% position size in our model portfolio.  If you are interested in the report please contact me at

GMA Holdings Position Size 10/2/17

GMA Holdings Position Size 10/2/17

GMA Holdings position size is increasing to 10.0% with Reperio Capital’s model portfolio as the company is an industry that has strong barriers to entry in the form of economies of scale from content creation costs. Profit growth and free cash flow growth within the industry should mirror GDP growth due to barriers to entry and a mature industry.  Currently, revenues, operating profit, and free cash flow are showing negative growth year on year due to one-off political advertisements last year.

The market currently values the company on a EBIT yield and FCF yield of 18.4%.  Assuming the company grows below expected GDP growth (6.5%) at 5%, the expected return is over 23%.

PC Jeweller & Anscor Position Size 10/2/17

PC Jeweller & Anscor Position Size 10/2/17

The company continues to execute with strong growth in showrooms leading to good growth in sales and profitability. PC Jeweller’s share price increased by 33% over the past four months leading to an increase in valuations. The company now trades on an NOPAT yield of 4.4%.


The fragmentation in the market points to a lack of barriers to entry. PC Jeweller’s gross margin similar to its competitors indicates its products are undifferentiated and customer are not willing to pay a premium. The company’s capital efficiency is also on par with competitors meaning capital efficiency is not the source of excess returns. Gross margin return on inventory tells a similar story. Meaning, operational efficiencies are the driver of the PC Jeweller’s excess returns. Its operating expenses averaged 4.1% of sales over the last five years lower than any other jewelry company analyzed.


Operational efficiency is replicable but it is very difficult as processes and values within an organization are difficult to change, therefore, PC Jeweller’s excess profitability should persist for some time. This is backed up by the ability of the company to maintain strong profitability during the latest industry downturn. Further, the organized portion of the segment accounts for only 30% of the industry so competition is currently primarily against weaker peers. Despite the likely persistence of excess profitability, a NOPAT yield of 4.4% requires a persistence growth over 10% into perpetuity with no working capital or fixed capital investment for an investment in PC Jeweller to meet the required rate of return of 15%. The PC Jeweller position is being sold.


A Soriano Corporation is also very illiquid. Reperio’s model portfolio has been purchasing shares since inception and it has only reached 0.5% of the portfolio.  There will be no futher purchases or posts until the position size changes. All recommendations will meet minimum liquidity requirements.

PC Jeweller FY2017 Results 6/1/17

PC Jeweller FY2017 Results Review June 1, 2017


PC Jeweller reported FQ4 2017 & FY2017 results. The company continues to perform well in a difficult operating environment due to regulatory measures. FY2017 saw demonetization and a stricter regulatory environment including high value purchases require a pan card, and imposition of an excise duty. The company also issued preferred shares to DVI Mauritus and Fidelity investments with a guaranteed dividend yield of 13.0% along with a conversion option. Despite, the regulatory environment PC Jeweller grew by 15.7%. Gross profit grew by 0.3% while operating profit increased by 12.1%.


The company’s gross margin declined as exports were a larger portion of sales. The table below illustrates management’s estimates of gross margin by geography and product within the domestic market. Based on the midpoint of the assumptions below gross margin should be roughly 13.37%.

The company improved capital efficiency with inventory only growing by 8.3% in the year. The slight decline in the company’s NOPAT margin combined with the improved capital efficiency saw ROIC increase to 24.7% from 20.9%.  A measure used commonly used in the retail industry is gross margin on inventory. Given the biggest investment within the Indian Jewelry industry is inventory, 57% of PC Jeweller’s 2017 assets was inventory. Since 2008, inventory has accounted for 58% of assets. The typical formula is gross profit divided by average inventory. We modify it slightly by subtracting interest expense from gross profit as the company purchases inventory using gold leases that comes with an interest component.


Unfortunately, the GMROI continues to decline. Compared to its peers, PC Jeweller is at the lower end of GMROI. This is particularly concerning when compared to Titan Company, whose GMROI is almost three times higher than PC Jeweller’s as the company generates a higher gross margin and pays less on interest.


The company’s declining and poor gross margin return on inventory points to a lack of pricing power.


PC Jeweller increased its showroom count to 75 from 60 in FY2017, while the square footage grew by 10% from 352,313 square feet to 386,923 square feet. The company’s average store size decreased to 5,159 square feet.


In FY2017, domestic sales per store and square foot decreased by 15.8% and 4.2%, respectively.


Since, the government took drastic measures in 2013 to stunt the growth of the gold industry, the primary growth driver for PC Jeweller is new showrooms.


The company trialed its first franchise operations and will continue to add additional franchises fueling growth with little additional investment requirements.


Overall, PC Jeweller continues to execute and is one of the most profitable and fastest growing companies in the Indian jewelry industry due to the strength of the company’s management and focus on efficiency. Management is one of the most innovative in the industry with many initiatives not seen in the industry. The company is trying to double its showroom footprint over the next five years. Despite the strengths of the company and management, government is continually bringing new regulation to the detriment of the industry. Additionally, the industry is fiercely competitive with evidence pointing to no barriers to entry. As discussed in a weekly commentary, the jewelry industry evolution in more developed countries points to no barriers to entry and a compression of profitability towards the cost of capital.


Given our research on industry evolution, our base case involves elimination of excess profits by the end of the terminal year as competition intensifies. PC Jeweller is able to grow by 10% over the next five years before fading to 0% terminal growth leading to an estimated annualized return of 2.6%.


The optimistic scenario assumes the company to grow its sales by 15.0% over the next five years inline with PC Jeweller’s target of doubling its store count over the same period. In the terminal assumptions, there is assumed to be continued grow of 2.5%. Also, the company is not impacted by competitive forces allowing the company to maintain its profitability leading to an estimated annualized return of 25.4%.


The pessimistic scenario assumes no growth and immediate decline in profitability as well as no excess profits in the terminal assumption as competition impacts the company.  The estimated annualized return under the pessimistic scenario is -4.0%.


At current valuation levels, the risk rewards is no longer drastically in our favor and a sustained continuation of the company’s excess profits is needed to justify much higher valuations. We will cut our position size to 2.0% as long as the share price is above INR450.

Stalexport Autostrady Q1 2017 Results May 14, 2017

Stalexport Autostrady Q1 2017 Results May 14, 2017

Stalexport Autostrady reported Q1 2017 results. Traffic increased by 8.0% with light vehicles increasing by 7.4% and commercial vehicles increasing by 10.9%. Revenue increased by 8.2%, while operating profit declined by 4.8% as Q1 2017 saw an increase of accrued cost of provision for motorway resurfacing.  The company increased toll rates for heavy vehicles category 2 and 3 by 9.1% from PLN 16.50 to PLN 18.00 and heavy vehicles category 4 and 5 by 13.2% from PLN 26.50 to PLN 30.00.


The report does nothing to change our view on the company. Autostrady has a 30 year concession agreement on 60 kilometers of the A4 between Katowice (junction Murckowska, km 340.2) to Krakow (junction Balice I, km 401.1) ending March 2027. Since 2008, traffic grew at an average annual rate of 4.5% with light vehicles growing by 5.7% and heavy goods declining 0.5% per year. In 2012, there was a decline in traffic by 6.5% driven by a 23.2% decline in heavy goods vehicles. Since 2012, both light vehicles and heavy goods vehicles grew by 9.2% per year. Since 2008, the toll rates have increased by 6.8% per year with the toll rate for light goods vehicles increasing by 5.4% and the toll rate for heavy goods vehicles increasing by 12.5%. The increase in traffic and toll rates has lead to an average annual increase in revenue of 11.6% per year. Additionally, honest and competent management run the company.


Despite the continued growth, the company trades at a 37.4% discount to a DCF value that assumes no growth in revenue and 4% increase in administrative expenses. We will increase our target position size to 3.0% at share price below PLN4.00. Assuming a 6% growth rate, the company’s fair value is PLN7.19, 90.6% above the company’s current share price.

Turk Tuborg 2016 Full Year Results May 11, 2017

Turk Tuborg 2016 Full Year Results May 11, 2017

Turk Tuborg reported 2016 results. The company’s consolidated net sales increased by 29.6% from TRY742.68 million in 2015 to TRY962.7 million in 2016. ASP increases were the main driver of revenue growth as ASP per hectoliter (hl) increased by 30.9% from TRY245.12 in 2015 to TRY320.92 in 2016, while volume decreased by 1.0% from 3.03 million hectoliters (mhl) in 2015 to 3.00 million hectoliters in 2016. Despite the ASP increase and the volume decrease, Turk Tuborg still gained share from Anadolu Efes. Its volume share increased from 31.4% to 33.3% and its market share increased from 33.3% to 40.1%. Turk Tuborg and Anadolu control over 99% of the market so any share gain by one is at the expense of the other.


The table illustrates volume, volume share within Turkey, ASP, and market share within Turkey from 2008 to 2016. Since 2008, Turk Tuborg’s volume grew by 13.2% per annum, Anadolu’s volume decreased by 4.3% per annum, and the overall industry volume decline by -0.9% per annum. Since 2008, Turk Tuborg’s ASP increased by 9.9% per annum, Anadolu’s ASP increased by 7.0% per annum, and the overall industry ASP increased by 8.4% per annum.


In our initiation report, we believed Turk Tuborg’s product innovation and focused operations along with Anadolu Efes debt load is driving Turk Tuborg’s share gains.


In 2016, Turk Tuborg launched Tuborg Amber, the first and only beer in amber category of Turkey illustrating the company’s continued focus on product innovation. Anadolu continues to have operations all over Europe while Turk Tuborg remains focused on Turkey. Anadolu’s extended operations decrease the importance of Turkey on overall operations leading to less management attention. It also adds diseconomies of scale associated with administrating all the different entities. Anadolu improved its financial position to 3.6 times operating profit but capex is lower than depreciation meaning the company is unable to even maintain its current asset base, never mind spending on growth, while, Turk Tuborg grew and modernized its facilities.


Since 2011, Turk Tuborg’s average capex to depreciation ratio is 185% compared to Anadolu Efes’s average capex to depreciation ratio of 114%. The capex allowed it to modernize its facilities decreasing the average age of assets from 18.8 years in 2011 to 7.4 years almost on par with Anadolu Efes.


Despite Anadolu’s debt load, economies of scale persist. Distribution is crucial as over 50% of Turkish beer sales are through a two-way distribution system where bottles and kegs are returned. Advertising is another important fixed cost that benefits the largest players. These costs are included in the selling expense line on both companies’ income statements. Anadolu does not report Turkish beer expenses but assuming a similar split in operating expenses between administrative and selling expenses, the company’s selling expense can be determined.


Despite Anadolu spending almost three times as much on distribution and marketing, Turk Tuborg has made significant share gains. The company seems to be much more efficient with a much better feel for the desires of Turkish customers. Turk Tuborg’s superior management will be very difficult for Anadolu to overcome. Can Anadolu increase its marketing and distribution expense to win back share? The recent past would suggest increasing spending would not do much good. It is also particularly difficult when the company’s debt load is on the higher side. The restrictions on alcohol promotions and advertisements as well as the restrictions on alcohol producers sponsoring events greatly reduces the ability of increased marketing expenses.


Turk Tuborg’s saw its gross profit increase by 34.3% and its gross margin expand by 197 bps. Despite, the company increasing its ASP at an average annual rate of 9.9% since 2008, its gross margin has expanded by over 2675 basis points pointing to pricing power. Over the same period, industry volume declined by 0.9% strengthening the case of pricing power.


Administrative expenses increased in line with revenue 27.7% at remaining at roughly 5.0% of sales, while selling expenses increased by 26.0% decreasing slightly as a percentage of sales from 25.5% of sales to 24.7% of sales.


Operating profit increased by 44.3% from TRY180.78 million in 2015 to TRY260.85 million in 2016. The company’s working capital is negative at –TRY64 million and fixed capital turnover remained roughly the same at 2.82 times. The company’s capital efficiency declined slightly to 3.47 times. Overall, ROIC decreased slightly from 76.1% to 75.2%.


Turk Tuborg continues to perform extremely well growing at a fast pace, taking a significant amount of share, and remaining very profitable with an ROIC of 75.2%.  Given the poor liquidity in the company’s stock and political concerns, Turk Tuborg trades on a NOPAT yield of 7.4% with the potential for continued ASP increases of at least 5% per year leading to expected return of at least 12.5% and potentially more. Our weekly commentary dated 12/13/16-12/19/16, looked at acquisition multiples in the beer industry since 1999 and over the last twelve months. The average transaction multiple was 11.7 times EV/EBITDA and 11.5 times EV/EBITDA, respectively.  Assuming a multiple of 12 times EV/EBITDA, Turk Tuborg has 43% upside.


The barriers to entry within the Turkish beer industry are extremely strong, with Turk Tuborg and Anadolu maintaining over 99% of the market for over a decade, eliminating any concerns over competitive risks. Additionally, restrictions on alcohol promotions and advertising reduces the risk of increased competitive rivalry. The company has a net cash position at 1.2 times the company’s 2016 operating profit eliminating potential financial risk. The biggest risk is political as Erdogan consolidates his power in Turkey. The consolidation of power eliminates checks and balances typically seen in democracy and Erdogan’s conservative nature may lead to continued attempt to stifle the industry. The government continues to increase excise taxes in attempt to stamp out drinking. The current consumption tax rate on beer is 63%. In 2013, the Turkish government imposing a series of new alcohol restrictions including banning shops from selling alcohol from 10 p.m. to 6 a.m. and prohibited all forms of advertising and promotion of alcohol. Alcohol producers are also barred from sponsoring events, and television broadcasters were required to blur images of alcohol in movies, soap operas and music videos. In a 2010 survey commissioned by the Health Ministry, Ankara’s Hacettepe University found that only 23% of Turkish men and 4% of Turkish women drank alcohol so there may be a tolerance for prohibition. Turkish annual alcohol consumption is the lowest in Europe at 1.55 liters per capita compared to over 10 liters in most European countries.


Despite the company’s strong operating performance, strong competitive position, net cash position, and slightly cheap valuation, growth is bound to slow as ASP increase are the driver of growth with industry volumes declining at 1.0% per year. The increasing consolidation of power by Erdogan is worrisome for the industry leading us to decrease our position size to 2.0% as long as the price is above TRY9.00.



Grendene Q1 2017 Results Review May 8 2017

Grendene Q1 2017 Results Review May 8 2017

Grendene recently reported its Q1 2017 results.  Net revenue grew by 7.2% as domestic revenue grew 23.6%, export revenue declined by 19.1%, and sales taxes and deductions increased by 22%. With regard to pricing, net ASP fell by 1.1% and volume increased by 8.5%. Within Brazil, domestic ASP increased by 7.0% and volume increased by 13.0%. In export markets, ASP declined by 19.8% in BRL terms and 0.3% in USD.  In Q1 2017 Brazil was clearly much stronger than export markets.


The table above illustrates total volume, ASP, domestic market volume, domestic ASP, export volume, export ASP in BRL, and export ASP in USD. The company seems to have significant seasonality.


In volume terms, Q1 is typically an average quarter overall but it is a weak quarter in the domestic market and a stronger quarter in the export markets. Q1 2017 volume was weak overall relative to the average Q1 volume with domestic volume slightly above the average Q1 volume and export volume well below the typical Q1 volume.


The chart above illustrates volume over the trailing twelve months (TTM) for the domestic, export, and a combination of the two (overall). TTM volumes peaked for Grendene in Q4 2013 and fell by 7.7% per annum overall with both domestic and export markets declining by the roughly the same amount.


In ASP terms, there is a lot less seasonality with prices consistently increasing in both domestic and export markets at a rate of 2.9% in the domestic market and 3.8% in USD terms in export markets. The ability to raise prices in both domestic and export markets despite a falling volumes and a weak overall macro environment may be a good sign of the company’s pricing power. The company may also be stretching its ability to raise prices as the company sells lower cost shoes that may not provide as much value to customers at higher prices.


Grendene’s gross profit grew by 11.0% in Q1 2017 with its gross margin expanding by 59 basis points (bps) over Q1 2016 and 37 bps over Q4 2016. The gross margin expansion over Q1 2016 was driven primarily by a decrease in cost of goods sold per pair as the ASP decreased from BRL13.63 to BRL13.47. Cost of goods sold per pair decreased from BRL7.25 in Q1 2016 to BRL6.95 in Q1 2017. The driver was a decrease in personnel expense.



Along with higher prices during periods of weak demand, the company’s ability to increase consistently its gross margin points to pricing power.


Selling expenses increased by 2.2% year on year, while administrative expenses decreased by 11.7% leading to an increase in operating profit by 28.9%. The company’s continues to maintain a focus on operational efficiency.


The company’s increased volume and decreased costs led to a 28.9% increase in operating profit. Grendene’s working capital increased by 2.9% year on year, while PP&E increased by 4.3%.


Our initial investment thesis for Grendene was a company that built multiple competitive advantages in the domestic market. Within the domestic market, it is a low cost operator with scale advantage due to heavy investments in advertising, product development, automation, and process improvements. It produces a low priced experienced good and has built a strong brand allowing for pricing power. Grendene’s exports are at the low end of the cost curve ensuring the company stays competitive in export markets. The company is run by owner operators with strong operational skills and an understanding of its competitive position who treat all stakeholders with respect. It also has consistently generated stable, excess profit even during periods of industry stress and has a net cash balance sheet.
We believe the quality of the business remains but the valuation is no longer as cheap as it once was. At the time of our initial recommendation, valuations were attractive with the company trading on a NOPAT yield of 10.1%, a FCF yield of 8.5%, an EV/IC of 1.6 times. Grendene is now trading at a NOPAT yield of 6.7%, a FCF yield of 6.7% and an EV/IC of 5.0 times at a time of elevated profitability.  If we were to normalize margins, Grendene would be trading at a NOPAT yield of 5.3% and a FCF yield of 5.5% making a 5% growth rate into perpetuity necessary for a double-digit return.


The company‘s margin of safety has been eliminated leading us to sell our position and no longer cover Grendene. We will continue to follow its developments, in case valuation become more attractive.