Category Archives: Portfolio Construction

GMA Network Q1 2017 Results 6/1/17

GMA Network Q1 2017 Results 6/1/17

 

GMA Network reported Q1 2017 results recently. Revenue decreased by 4% due to PHP40 million in political advertising in Q1 2016. Without the gains associated with last year’s elections, revenue grew by 15%.

 

Operating expenses grew by 5% due to a 12% increase in production costs. Production costs are a fixed costs that allows the company to take advantage of its size so the company should spend as much as it efficiently can to stop smaller peers from being able to compete. The increase in production costs came with a 4% decrease in other general and administrative expenses. The decrease in revenue from political advertisements led to a decrease in EBITDA and net income.

 

Q1 2017 brought no surprises. The company’s competitive position is very strong as it is one of the largest firms in an industry with economies of scale and customer captivity. Despite the strength GMA’s competitive position, the company is trading on an NOPAT yield of 13.0% providing a sufficient margin of safety. We are increasing our position size to 6.0%.

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.

 

Stalexport Autostrady SA 3/11/2017

Stalexport Autostrady SA 

Bloomberg Ticker:                               STX:PW

Closing Price (3/10/17):                       PLN4.30

6 Month Avg. Daily Vol. (USD mn):    0.13

Market Cap (USD mn):                        262

Estimated Annualized Return:           10.5%

March 11, 2017

Stalexport_Autostrady_Final_March_11_2017

 

INVESTMENT THESIS

 

Stalexport Autostrady holds a concession on a 61-kilometer stretch of the A4 in Poland between Katowice and Kraków. The concession ends in 2027. The company’s management has done an excellent job of improving operations since taking over in 2006 growing toll revenue at 11.8% over the past ten years. Despite the growth in the business, and inherent operating leverage in running a toll motorway, the current market valuation is 19% below a zero growth intrinsic value making Stalexport an attractive investment opportunity. If the company is able to grow revenues at half of its historic rate, there is 67% upside to its intrinsic value. If the company is able to continue to grow its revenues at its historic rate, there is 131% upside. Given the stability of the company’s revenue and the expected return of 10.5%, we recommend a starting position of 2.0%.

 

 

COMPANY DESCRIPTION

 

 

History

 

Stalexport Autostrady started operations on January 1, 1963 as Przedsiębiorstwo Handlu Zagranicznego “Stalexport”. It specialized in exporting and importing steel products as well as importing raw materials for the Polish steel industry. In 1993, the Polish government privatized the company with shares listing on the Warsaw Stock Exchange in October 26, 1994. In 1997, Stalexport won a 30-year concession to construct, adapt, and operate a 61 km toll road on the A4 motorway between Katowice and Kraków.

 

The motorway was secondary to the steel business until 2006, when the Atlantia Group, then Autostrade S.p.A., an Italian infrastructure company, acquired 50%+1 share of Stalexport for €67 million or PLN200 million. By Polish regulation, Atlantia was forced to launch a public tender offer for up to 66% of Stalexport’s share capital. It increased its share to 56.24% at the time of the acquisition. To complete the acquisition, Atlantia required Stalexport to increase its share capital with all new shares going directly to Atlantia. It also mandated the sale of the steel business. Prior to obtaining Atlantia as a strategic investor, Stalexport was dealing with potential bankruptcy for a number of years with its auditor, BDO, issuing a statement of the going concern nature of the company in its opinion statement. Atlantia manages a network of 5,000 km of toll motorways in Italy, Brazil, Chile, India, and Poland. It is a leader with respect to automatic motorway toll collections systems.

 

In 2011, Stalexport reduced its share capital to PLN185.45 million to reflect the change of the of the organization and capital requirements as the company was solely an operator of a toll road.

 

Since the acquisition, Atlantia increased its shareholding to 61.20%. Post-acquisition, its first increase came in to 2011 with a purchase of 10.86 million shares increasing its stake to 60.63%. In 2016, the company purchased another 1.4 million shares increasing its stake to 61.20%. Management has an insignificant shareholding with Emil Wasacz, President of the Management Board, holding 59,000 shares.

 

 

Organizational Structure

 

Stalexport Autostrady S.A. focuses on the upgrade and expansion of motorway infrastructure. In 1997, it was the first Polish company to be granted a concession to operation, upgrade, and maintain a toll motorway wining the concession on the A4 motorway between Katowice and Kraków section. In 2004, the concession was transferred to Stalexport Autostrada Małopolska S.A.

 

Stalexport Autoroute S.à r.l. was establish on December 30, 2005. The entity does not conduct any operational activities apart from holding shares in SAM as well as in VIA4. The entity was established as a prerequisite to obtain a loan for a consortium of banks.

 

Stalexport Autostrada Małopolska S.A. (SAM) SAM was established on December 19, 1997 as a special purpose vehicle to manage the A4 motorway between Katowice and Kraków. The motorway concession was transferred to from the group to SAM on July 28, 2004. After the transfer, SAM was authorized to collect lease fees and tolls for using the above-mentioned motorway section. As stated by the concession agreement, the entity is obliged to provide ongoing maintenance of the motorway and continue other necessary investment tasks.

 

VIA4 (formerly Stalexport Transroute Autostrada S.A.) was established on 14 May 1998. VIA4’s only customer is SAM. Its main tasks are ongoing operation and maintenance of the A4 toll motorway section, which includes operation of the toll collection system, management of motorway traffic, and comprehensive renovation and maintenance of the motorway. VIA4 also carries out tasks related to safety and road traffic. VIA4 is 55% owned by Stalexport and 45% owned by Egis Road Operation S.A., a French company with expertise in all of aspects of motorway management.

 

Biuro Centrum was established on June 9, 1994. The main business of Biuro Centrum consists in management and maintenance of the office and conference building in Katowice at ul. Mickiewicza 29 co-owned by Stalexport Autostrady (40.47%) and Węglokoks S.A. (59.53%).

 

98% of the consolidated company’s revenues and 96% of EBIT are from SAM, the entity that collects the lease fees and tolls from the motorway.

 

Given the importance of the toll road, we focus our attention on this business. The A4 toll motorway between Katowice and Kraków is 61-kilometer toll road. It is part of the A4, which is one of the major motorways in Poland and one of the two motorways planned to stretch from the eastern border Poland to the western border of Poland by 2022 along with the A2 in central Poland.

 

The A4 from Katowice to Kraków is an open system, where money is paid at tollbooths stretching across the road based on the vehicle type. The open system is relative cheap but forces commuters to stop at each tollbooth decreasing the capacity of the motorway. The other system is a closed system where there are tolls at each interchange when entering and exiting the motorway the toll is paid based on the vehicle and the distance traveled.

 

According to Google Map driving directions, the A4 is the quickest way from Katowice to Kraków beating the 94 by 28 minutes. As mentioned, the only major competition to cross Poland is the A2 in central Poland. The decision is based on your starting and ending point and the quickest route of travel so in many instances there is no competition. The A4 is a fastest way to travel particularly if you are driving across southern Poland from east to west or west to east and there are very few alternatives. It would be very difficult for a competing toll road to be built over the next 10 years allowing the A4 to generate steady revenue with very little investment requirements. Additionally, if another road were to be built to compete with the A4, it would cannibalize government revenue, as the A4 from Katowice to Kraków will be handed over to the government at the end of the concession in 2027. Toll roads also have barriers to entry in the form of habitual behavior. When commuters have a road travelled on a daily basis a habit is formed as the road is travelled without any thought creating a habit that is difficult to break.

 

For the consolidated entity, since 2008, toll revenue increased by 11.6% per year with passenger vehicle toll revenue increasing by 11.4% per year and heavy goods vehicle toll revenue increasing by 11.9% per year. Average daily traffic increased by 4.5% per year with passenger vehicle traffic increasing by 5.7% per year and heavy goods traffic decreasing by 0.6% per year. The average toll increased by 6.8% per year with the average toll for passenger vehicles increasing at 5.4% per and heavy goods vehicles increasing by 12.5% per year.

 

Despite the growth in revenues, Stalexport’s cost of goods sold have decreased from PLN85 million in 2006 to PLN37 million in 2016. 2006 and 2012 were the two years with the highest cost of goods sold at PLN85 million. Cost of goods sold is very dependent on road works during the year, which creates a bit of lumpiness and no correlation with revenues. 2016 saw lower road works leading to much lower cost of goods sold. Since 2006, cost of goods sold averaged PLN66 million.

 

Administrative expenses increased steadily from PLN21 million in 2016 to PLN30 million in 2016, equal to a 3.8% annual increase, well below the rate of change in toll revenue.

 

Atlantia has done a good job of growing revenues while decreasing expenses as a percentage of revenues. The biggest driver of decreasing costs relative to expenses was eliminating inefficiencies from having too many subsidiaries.

 

The A4 concession expires in 2027. Upon expiry, the A4 will be transferred to Poland’s Treasury. If Stalexport is to grow, it will come from the existing asset. There are other potential PPP projects but it would be speculative to assume any growth from these projects as the company has not indicated there are any potential projects in the pipeline. The company has also been selective in the past and passed on projects where prospective returns were not attractive enough.

 

Internal growth will come from traffic growth and growth in the average toll. In 2016, Stalexport implemented its own A4Go on-board units after not being able to coordinate with the viaToll system used elsewhere in Poland. The A4Go unit allows for electronic payment at the tolls decrease traffic at tollbooths. The A4Go was implemented in only 6 months and went online in July 2016. By the end of the year, roughly 10% of morning traffic used the A4Go system. The decrease in traffic at tollbooths decreases the travel time for commuters making the A4 a more attractive route for existing and potential users.

 

 

VALUATION

 

Given the barriers to entry and the predictability of revenue, we value Stalexport using a DCF until 2026 the year before the company has to hand operations back to the treasury. We assume no cash flows in 2027 for conservatism.

 

We vary sales growth to get an estimated intrinsic value under different scenarios. Under the most conservative scenario, we assume no growth in sales. Sales growth is then assumed to increase by 3% as scenarios become more aggressive and we reach the most aggressive scenario of 12%, which assumes sales growth will continue at roughly the pace it has over the past ten years (11.8%).

 

The last ten years saw significant variability in the cost of goods sold but the variability was within a well-defined range. We assume an average of the last ten years with no inflation.

 

Administrative expenses have increased steadily over the past 10 years at a rate of 3.8% per year. We assume administrative expenses continue increasing at 4.0% per year. We also assume a tax rate of 20% roughly in-line with the effective tax rate of 19.8% over the past ten years.

 

Since 2008, the company’s average change in working capital to revenue rate is 6.3% meaning every zloty of revenue generates 6.3 grosz of positive free cash flow due to negative working capital requirements. Despite the negative working capital generating free cash flow, we assume there is no cash flow generated from working capital and there are no investments in working capital.

 

Also since 2008, the company has spent 26.1 grosz on capital expenditures for every 1 zloty of revenue just above the depreciation rate of 19.1 grosz for every 1 zloty of revenue. Over the past four years, the capex to depreciation rate averaged 0.8 meaning the company is spending less on capex than depreciation. The recent trend of capex below depreciation leads us to assume capex equals depreciation therefore there are no additional fixed capital requirements other than the maintenance capex.

 

The company has a net cash position just over PLN315 million and a share in property investments with an estimated value of PLN10 million.

 

We place a probability on each of the 5 revenue growth scenarios to a get a blended intrinsic value of PLN7.21 per share, which has 67.6% upside from the current price.

 

 

Under the most conservative scenario of zero revenue growth still leads to an upside of 19% illustrating the downside protection at current prices.

 

 

RISKS

 

Stalexport’s biggest risk is regulatory risk. While a toll motorway concession is a contract, the authorities are most likely least concerned with the owner of the toll motorway and more concerned with other stakeholders such as commuters. In Poland, Stalexport was sued by the Polish government for anti-competitive practices due to high toll rates. In 2008, the company had to pay a PLN1.5 million fine. In India, populism led to abolition of tolls for an extended period. Countries may also change their previous position to void contracts.

 

Any new motorway running parallel to the A4 would create additional supply impacting Stalexport’s ability to attract traffic and raise toll rates.

 

Traffic particularly heavy goods vehicles is dependent on economic growth. Slowing macroeconomic growth could hurt traffic growth.

 

The company has more related party transactions than what we would like and there is potential for some corporate governance risks. The main related party transactions are with companies owned by Atlantia, which complete roadworks on the motorway.

 

Management remuneration has decreased substantially as a percentage of operating income. Management may increase its salaries and extract greater value in the future.

 

There is a risk of the company tendering for new concession and overpaying hurting returns on future projects. The company was disciplined enough to pass on past projects that did not meet the parameters needed for attractive returns.

WEEKLY COMMENTARY 2/27/17 – 3/5/17

WEEKLY COMMENTARY               2/27/17 – 3/5/17

 

 

CURRENT POSITIONS

 

 

 

COMPANY NEWS

 

There was no company news this week.

 

 

INTERESTING LINKS

 

 

The Fervent Loyalty of a Costco Member (Scuttlebutt Investor)

 

The Scuttlebutt Investor does an excellent job writing about Costco. The company is not an Emerging Market company, but it is always interesting to see business models that work, particularly in the retail industry. The first quote by Peter Lynch is an excellent way to look at industries with no barriers to entry. (link)

 

 

Why Facts Don’t Change Our Mind (New Yorker)

 

The New Yorker discusses research and reasoning for flaws in our ability to change our minds or think critically about our own ideas. (link)

 

 

How Indian families took over the Antwerp diamond trade from orthodox Jews (Quatrz)

 

Quartz takes a look at how Indians took over the Antwerp diamond trade from Hasidic Jews. The success story sounds like many new entrants within a market by starting at the parts of the industry that are overlooked by competitors, typically due to lower margins. Added to the successful strategy were cheap labor in India, large families, and a strong work ethic. (link)

 

 

3G Purchases and Their Profit Margins (Economist)

 

The Economist writes a short article discussing 3G, their history, and operating model.  The most interesting takeaway is the improvement in profit margins post acquisition. (link)

 

 

Notes from Howard Marks’ Lecture: 48 Most Important Things I Learned on Investing (Safal Niveshak)

 

Vishal Khandelwal talks about the 48 most important take aways from Howard Marks lecture in Mumbai. (link)

 

 

How Signet Jewelers Puts Extra Sparkle on Its Balance Sheet (New York Times)

 

The New York Times provides some insight on Signet’s business model and use of in-house credit. (link)

 

 

Tools We Use to Forecast the Future Prospects of a Business (Latticework)

 

Michael Shearn, author of the great book The Investment Checklist, contributes to Latticework by discussing what he looks for in businesses to increase the odds of correctly forecasting the future. (link)

 

 

Can YouTube TV Get You to Cut the Cord for $35 a Month? (Bloomberg)

 

Bloomberg looks at Youtube’s new service of providing a cable television product for $35 per month. The internet continues to disrupt traditional media. (link)

 

 

India’s Battle With Booze Isn’t Stopping Johnnie Walker (Bloomberg)

 

Bloomberg wrote an good article looking at India’s Spirits Market and recent regulation. (link)

 

WEEKLY COMMENTARY 2/20/17 – 2/26/17

WEEKLY COMMENTARY               2/20/17 – 2/26/17

 

CURRENT POSITIONS

 

 

 

COMPANY NEWS

 

There was no company news.

 

 

INTERESTING LINKS

 

 

Founder-Led Companies Return Three Times S&P 500 Average (Mason Myer)

 

Mason Myer discusses how owner operators outperform the S&P 500. (link)

An HBR article from the Bain Consultant mentioned in the previous article. (link)

The original research paper by Purdue professors used in both articles. (link)

 

 

The $143bn flop: How Warren Buffett and 3G lost Unilever (CNBC)

 

FT looks at 3G’s failed bid of Unilever. (link) In the article, sources state Unilever thought the bid had no merit and thought a 3G takeover was the worst-case scenario as illustrated by following statement.

 

Another insider said: “When they put something on the table, Paul was just utterly categorical that there was no merit. He gave a number of reasons why there was no interest in such an offer.” The offer was rejected immediately.

 

Completely dismissing the bid without analyzing the proposal feels as if shareholders are irrelevant and an entrenched management team is worrying about their own positions. A FT article from 2010 echo’s this. (link)

 

Mr. Polman said: “I do not work for the shareholder, to be honest; I work for the consumer, the customer . . . I’m not driven and I don’t drive this business model by driving shareholder value.”

 

In 2016, FT published another interview with Mr. Polman. (link) If the link is behind a pay wall google “FT interview with Unilever.” The narrative is Mr. Polman is concerned about all stakeholders including shareholders. He has no concern for short-term oriented shareholders but long-term investors as his focus is the next 100 years.  There are a number of other interviews with Mr. Polman essentially saying the same thing. This is another interview with The Guardian where  he says shareholder value is not the most important focus. (link) Here is another recent interview with Fortune. (link) Unilever’s focus is the customer not the shareholder. The customer should be the focus when making products, but the company is owned by shareholders and management has a fiduciary duty to them.

 

Illustrated above is Unilever’s relative performance over the past five years. Unilever has the fourth lowest operating margin with the second highest capital efficiency leading to the third highest ROIC. Growth has slowed among all peers. Over the last five years, Unilever’s sales grew by 0.7%, its operating profit grew by 2.8%, and invested capital grew by 2.7%. The focus on the customers has not lead to drastic underperformance or outperformance.

 

Kraft Heinz bid $50 per share or €47.30 for all Unilever shares. The company has a strong competitive position with economies of scale being the biggest competitive driver along with customer captivity in the form of habit. ROIC also has very little dispersion making so it is a safe assumption that its average ROIC over the past five years will persist. The €47.30 bid placed Unilever’s market cap at €134.32 billion and an enterprise value at €146.26 billion. In 2016, the company generated €5.17 billion leading to a cash flow yield of 3.5%. Since 2012, the company grew its free cash flow at 3.8% per year creating a total return of 7.3%.  Using a residual income model, a ROIC of 127% with a growth of 2.5%, similar to operating profit growth and invested capital growth over the past four years, and a discount rate of 10% into perpetuity, Unilever’s fair value is 26% below the offer price. Using a lower discount rate of 7.5% and the same profitability and growth assumptions, Unilever’s fair value is 10% above the offer price.

 

Kraft Heinz’s bid did not undervalue Unilever given its recent growth. Rejecting Kraft Heinz’s bid without analysis along with numerous management statements points to a management team at Unilever that are more concerned with the benefits of their position over focusing on shareholder value.

 

 

Shareowner’s Rights Across the Markets (CFA Institute)

 

A 2013 CFA Institute report on shareowner’s rights across markets (link)

A. Soriano Corporation Shareholder Structure Correction 2/24/2017

A. Soriano Corporation Shareholder Structure Correction 2/24/2017

There was an error in the shareholder structure table in Anscor initiation.  The total outstanding shares was incorrect.  The corrected table is below.  We also corrected the table in the initial post.

A. Soriano Corporation 2/23/17

A. Soriano Corporation

Bloomberg Ticker:                              ANS:PM

Closing Price (2/23/17):          PHP6.34

6 Month Avg. Daily Vol. (USD mn):    0.017

Market Cap (USD mn):           156

Estimated Annualized Return:            18.0%

February 23, 2017

 

A_Soriano_Corp_Feb_23_2017_Final

 

INVESTMENT THESIS

A. Soriano Corporation (Anscor) is a Filipino investment holding company with investments in many different industries. The company has a healthy balance sheet and consistently generates a return on equity around its discount rate. Despite the healthy balance sheet and the consistency of the company’s ROE, Anscor trades well below its book value currently at 0.56 times book and at 5.46 times cyclically adjusted earnings. There is significant upside to the company’s earnings valuation (110% upside) and asset valuation (77% upside). We are taking a 2.0% starting position as the stock is very illiquid.

 

 

COMPANY DESCRIPTION

 

Anscor was incorporated on February 13, 1930. It is an investment holding company located in the Philippines. Anscor’s largest investments are Phelps Dodge International Philippines, Inc. and Seven Seas Resorts and Leisure, Inc. Other investments include Cirrus Medical Staffing, KSA Realty, Prople Limited, and Enderun College among others.

 

 

Phelps Dodge International Philippines

 

Phelps Dodge International Philippines, Inc. (PDIPI) was incorporated in 1955 and started production in 1957. Its products are primarily copper-based wires and cables including building wires, telecommunication cables, power cables, automotive wires and magnet wires. PDIPI has a technical assistance contract with General Cable Company (GCC), the second largest cable company in the world. GCC was also a shareholder in PDIPI until December 2014 when Anscor acquired GCC’s 60% shareholding for PHP3.0 billion. The Philippine wire and cable industry is comprised of both imported and domestically manufactured products. The four largest manufacturers are Phelps Dodge, American Wire and Cable Co., Inc., Columbia Wire and Cable Corp., and Philflex Cable Corp.

 

Over the past three years, PDIPI’s average return on assets of 16% is well above its discount rate pointing to potential barriers to entry within the industry. Despite the strong returns, the industry is fragmented. There are no supply side barriers to entry as copper cables are a relatively simple product to manufacture and there is no favorable access to raw materials as raw materials are commodities that can be purchased from many suppliers. There are no demand side barriers to entry as purchasing copper cables does not create habit and there are no switching costs, search costs, or network effects.  There may be some economies of scale but with gross margin at only 14%, it seems the cost structure of the business is primarily variable eliminating any real barriers to entry from economies of scale.

 

 

Seven Seas Resorts and Leisure

 

Seven Seas Resorts and Leisure, Inc. (SSRL) was incorporated on August 28, to plan, develop, operate and promote Pamalican Island as a world-class resort. The resort is named Amanpulo and started commercial operations on January 1, 1994. SSRL inventory is 103 rooms with 40 original casitas and 63 rooms in villas. SSRL is a joint venture between Anscor, Palawan Holdings, Inc., and Aboitiz & Co with Anscor owning 62% of the resort.

 

The resort’s services are offered through the worldwide Amanresort marketing group based in Singapore, accredited travel agents, reservation sources/systems, and direct selling. Amanpulo is in competition with all other small 5 star resort companies in other destinations that are generally better known than the Philippines, such as Indonesia, Thailand, and Malaysia.

 

According to reviews on Tripadvisors.com, 90% of Amanpulo’s reviews were excellent, the highest rating. It is rated as the #1 hotel in Palawan Province.

 

Until 2015, SSRL failed to earn a reasonable return on assets. The company also failed to generate any meaningful growth with revenue increasing from PHP517 million in 2011 to PHP645 million in 2016. Similar to PDIPI, there does not seem to be any barriers to entry. There are thousands of luxury resorts around the world illustrating the lack of barriers to entry within the industry. There are no supply side advantages in owning a luxury resort. There are no demand side advantages. If there are economies of scale within the industry, SSRL is a smaller resort, which would be disadvantaged.

 

 

Cirrus Medical Staffing, Inc.

 

Cirrus Medical Staffing (Cirrus) is a US-based nurse and physical therapist staffing business. It places registered nurses on contracts of twelve weeks or longer. In January 2008, Anscor acquired Cirrus. Cirrus has a preferred vendor relationship with the US’s largest home health company. Anscor owns 94% of Cirrus.

 

Similar to SSRL, Cirrus did not generate an acceptable on assets until 2015. Unlike SSRL, Cirrus has been growing its business at a rapid pace. Since 2011, service income growing by 16.7% per annum, gross profit grew by 21.3% per year, and EBITDA grew by 90% per year.

 

The nurse and physical staffing business is very fragmented and there are no supply side advantages. Potentially, there are demand side advantages in the form of switching costs. When using a staffing agency for a large number of employees as long as the staffing agent is doing a good job, the client should continue to use the agent and the agent has a bit of pricing power due to the cost of switching providers. The client can easily offset the staffing agent’s bargaining power by using multiple providers. For small clients, it seems like the potential for a demand side advantage is much smaller as it is easier to find the necessary supply of labor.  Economies of scale do not exist in the industry.

 

 

KSA Realty Corporation

 

Anscor exchanged its old building located at acquired a 11.42% stake in KSA Realty Corporation (KSA) 1990 in exchange for Paseo de Roxas in Makati. KSA develop The Enterprise Center, a two tower, grade A office building located in Makati.

 

In 2015, KSA had an occupancy rate of 96%, generating PHP992 million in revenue, and PHP1,300 million in net income including a PHP517 million revaluation gain. Despite a decrease in the occupancy rate from 2013, KSA was able to increase revenue by 20% over the past two years. KSA’s assets have been revalued twice in the past three years. There are no competitive advantages in the property business.

 

 

Enderun Colleges, Inc.

 

In October 2008, Anscor acquired 20% equity stake in Enderun Colleges, Inc. Enderun was established in 2005 by a group of business leaders, including senior executives from Hyatt Corporation in the U.S., Enderun offers a full range of bachelor’s degree and non-degree courses in hospitality management, culinary arts, and business. Enderun has close to 1,200 full time and certificate students spread almost evenly across the school’s three main degree offerings.

 

Enderun recently launched Enderun Extension, a continuing education unit that is the college’s language training and tutorial business. In 2014, Enderun launched a hotel and management consultancy unit. Several hotels and resorts are under Enderun’s management.

 

Management expects Enderun to deliver double-digit growth in the coming years.

 

Within education, there is a brand advantage at the very elite schools but Enderun does not have that advantages.

 

 

Prople Limited

 

In December 2007, Anscor acquired 20% of Prople for US$800,000. In November 2013 acquired 100% of the non-audit business of US-based Kellogg and Andelson Accountancy Corporation (K&A). Founded in 1939, K&A is a well- established accounting firm that provides tax, general accounting, and consulting services to thousands of small to medium sized companies in California and the Midwest. It operates out of five locations in Los Angeles, Woodland Hills, San Diego, Kansas City and Chennai (India). Following its acquisition of K&A, Prople now employs 373 people serving over 5,500 clients from operations located in six cities worldwide. In 2015, Prople closed K&A’s San Diego office and client attrition in the Midwest. Prior to the acquisition of K&A, Prople’s services included business process outsourcing, knowledge process outsourcing, and content services. K&A tripled the company’s revenue.

 

With the acquisition of K&A, Prople is primarily a tax, accounting, and consulting provider. Professional services, like tax and accounting, have some switching costs as the provider is embedded in the company’s operations becoming an integral part of the team. Despite the switching costs, the industry is fragmented and bargaining power of the provider can be decreased by using multiple suppliers.

 

 

AGP International Holdings Ltd.

 

AGP International (AG&P) is Southeast Asia’s leading modular fabricator of refinery and petrochemical plants, power plants, liquid natural gas facilities, mining processing, offshore platforms, and other infrastructure. AG&P has 110 years of experience serving clients like British Petroleum, Shell and Total.

 

Anscor made its first investment in AG&P in December 2011. In June 2013, Anscor subscribed to 83.9 million series C, voting preferred shares in AG&P. Series B and Series C preferred shares are convertible at the option of the holder, into class A common shares. The subscription increased Anscor’s holdings to 27%.

 

Similar to cable manufacturing there are no barriers to entry within the modular fabrication.

 

Anscor’s businesses do not appear to be competitively advantaged. The lack of barriers to entry makes industry analysis irrelevant.

 

Listed above is the company’s shareholder structure. 50.7% of the shares issued are held by a 100% owned subsidiary. Insiders own another 27.1% of shares issued, affiliates own 3.2% of shares issued, and the public own 19.0% of shares issued.

 

 

VALUATION

 

The lack of barriers to entry within Anscor’s businesses and the management team is deeply entrenched the company’s earnings power is the best method of measuring the company’s value as the earnings generated are likely to continue. Assuming average management and a lack of barriers to entry means the value of the company’s assets should be close to the company’s earnings valuation as excess returns are unlikely and cyclical adjusted earnings should be close to the company’s discount rate.

 

Given the company’s large investments in securities and associates, we use net income as the best measure of the company’s earnings and equity as the best measure of investment capital. Since 2010, Anscor has generated an average net income of PHP1,423 on an average tangible equity of PHP12,106 equating to a roughly 11.8% return on equity.

 

Given the lack of barriers to entry in Anscor’s businesses, growth does not create value and therefore is irrelevant; therefore, assuming a 10% discount rate Anscor should be trading at roughly 1.18 times tangible book value representing a 110% upside.

 

Anscor is trading on a cyclically adjusted PE of 5.46 times meaning in the absence of growth, the company’s expected annualized return in 18.3%.

 

Given the company’s ability to generate a consistent return on equity equal to the company’s discount rate, the reproduction value of the company’s assets should equal the company’s tangible book value. It is difficult to say a collection of assets are impaired if they generate a return equal to the discount rate.

 

Anscor’s fair value is between tangible book (77% upside) and 1.18 times tangible book (110% upside).

 

 

RISKS

 

A company with a dominant shareholder (A. Soriano III) brings potential corporate governance issues. Anscor only material related party transactions are key management remuneration, which averaged 8.8% of net income over the past five years. Key management remuneration is a little high but the absence of any other related party transactions and the cheap valuations means it can be overlooked.

 

Our goal with assessing macro risk is not to forecast the path of macroeconomic indicators but to eliminate risks from a poor macroeconomic position. Anscor’s business is primarily in the Philippines, a country that seems to be in very good financial health. In 2015, the country’s current account was 2.6% of GDP and its structural balance was 0.18% of GDP allowing the country to self-finance all the domestic initiatives as well as decrease the country’s debt load. The country does not have too much credit in the system with domestic credit provided by the financial sector at 59.1% at the end of 2015, which is well below the Emerging Markets average of 97.5% and the High Income countries average of 205%. Gross government debt as a percentage of GDP stood just under 35% with External Debt to GDP at 36%. The one concerning macroeconomic indicator is the level of growth in credit in the Philippines. Over the past five years, the amount of domestic credit provided by the financial sector has increased at a rate 12% per annum. When a country is growing its banking assets at this pace, there is a high probability of an increase in non-performing loans. The country’s banking system has a healthy capital balance with capital to assets at 10.6%.

 

The investment is based on Anscor’s strong financially health. If the company were to leverage its balance sheet, the attractiveness of the investment opportunity would decline.

 

The investment is also based on Anscor’s consistently generating net income around its cost of capital. If earnings in the business were to permanently decline, the investment would become much less attractive.

 

If earnings were to decline making a liquidation value a more appropriate valuation methodology, there is still 30% upside meaning there is significant downside protection.

 

If Anscor were to make expensive acquisitions, it would decrease the returns in the business through the write down of income and equity.

 

Given the nature of Anscor’s businesses, they all lack barriers to entry and therefore are at risk of increased supply depressing profitability.

 

Most of Anscor’s businesses are cyclical in nature and subject to macroeconomic risks.

 

At the end of Q3 2016, 47% of Anscor’s assets were in available for sale securities or fair value through the profit and loss investments making the company exposed to the fluctuations of the Philippines Stock Exchange.