Aer Lingus Group, Anton Bilton, distressed investing, equine DNA, Greencore Group, IMC Exploration Group, Irish shares, Irish value investing, ISEQ 20 ETF, iShares MSCI Ireland ETF, New Ireland Fund, Orogen Gold, Pension Deficit, Ryanair Holdings, Smurfit Kappa Group, TGISVP, The Great Irish Share Valuation Project, Uniq plc
Continued from here.
Company: Greencore Group
Prior Post: Here (valuation, see here & here for commentary!)
Price: GBP 95.75p
Well, I guess my perspective on Greencore last year was horribly wrong..! I’ve long considered GNC a distressed company, but the market clearly disagrees. So much so, the share price rallied almost 70% in the past year – my price target (of GBP 32.5p) was certainly left choking in the dust! But if my distressed premise is correct – and, objectively, I can’t see how you’d disagree with me – this rally isn’t so surprising. What..?! But companies like this are always a binary proposition – they simply die, or they survive & maybe even thrive eventually. And if everybody still feels blithely happy about them, they present a temptingly cheap buy. Greencore’s also a
nice scary reminder of how dangerous shorting can be – poor underlying fundamentals are often ignored far longer than you can take the pain…
But it’s 2013, let’s try a fresh slate! I mean, what a stock – look at the price chart, even finding equine DNA in their bolognese sauce doesn’t appear to have scared the…er, horses too much!? And they qualified for FTSE inclusion in Mar-2012, significantly broadening their potential shareholder base. Perhaps their Sep-2011 acquisition of Uniq plc is nicely bedded down now? And finally, there’s perennial speculation GNC may be taken over by a private equity bidder, or a larger industry player. Fairly recent FY results look good: Revenues of GBP 1,162 mio were up +44% (reflecting the Uniq acquisition), but underlying growth was still up a decent +10%. This produced adjusted operating profit of GBP 71 mio, a 6.1% margin. Which led to a 71% jump in adjusted net earnings to GBP 49 mio, plus a 22% increase in adj. EPS to GBP 12.8p (a rights issue funded the Uniq deal). Net Debt of GBP 258 mio resulted in net debt:EBITDA leverage of less than 2.5 times.
All sounds great, but this completely ignores the (totally un-) exceptional charges being expensed every single year, the increasing levels of capex, the continuing & quixotic acquisition spree in the US (believe me, $200 mio of pro-forma US revenues does not make you a player there), and let’s not forget the whopping GBP 116 mio net pension deficit. Again, this is a great reminder to focus on the cashflow statement, not the P&L, and certainly not the management commentary. Op FCF (operating free cashflow, inc. the usual un-exceptional charges) amounted to GBP 55 mio, an underlying margin of 4.8%. That’s an improvement on last year, when I assumed a 4.3% margin, so I’ll now bump my fair value Price/Sales multiple up to 0.4375.
But that’s appropriate for a financially clean company, which GNC most definitely isn’t..! Net interest expense was GBP 15.6 mio, which implies a rather alarming 3.5 times interest coverage (and net debt’s increasing!). I look for 6.7 times coverage at a bare minimum (i.e. net interest’s limited to 15% of Op FCF), so I need to impose a debt haircut of, say, GBP 149 mio (to reduce debt to an acceptable/sustainable level) on my valuation. I’ll also deduct the pension deficit – no acquirer would volunteer to take it on, unless they severely adjusted their acquisition price. After all that, somewhat astonishingly, I come up with a new valuation that’s almost double last year’s! But small changes in (larger) gross figures are often amplified in the resulting (smaller) net figure (take a look at GNC’s pension on a gross basis – bloody scary!). Which, of course, means GNC remains significantly over-valued.
The outcome here, as I’ve mentioned, will be binary. Things might just chug along – if only management laid off the capex & acquisitions, they’d manage a decent debt pay-down schedule & steadily grow into their current valuation & prospects. Unfortunately, they probably won’t – a diet of acquisitions & rationalization (i.e. more exceptional charges) are a tempting way to keep the headline figures trotting along nicely. [And how many investors read past the results headlines anyway..?!] On the other hand, if things start to slip (or another nasty surprise rears up), sentiment & fundamentals could start to fall apart v quickly – in which case, my target would likely prove hopelessly optimistic! [Another nasty reminder: Trade payables exceed receivables by GBP 176 mio! If GNC’s suppliers ever get nervous, this might present another huge funding issue].
Yes, I’m the Greencore mule again…just beat me!
Price Target: GBP 61.9p
Company: ISEQ 20 ETF
Prior Post: Here
Price: EUR 7.65
IETF aims to track the ISEQ 20 (basically, the Top 20 Irish stocks) – so it’s more concentrated, with its top 4 holdings amounting to almost 60% of the portfolio. Once again, I won’t project any specific upside/downside here – after all, I’m focused on trying to assess fair value, not taking a guess on where the Irish market’s headed (OK, yeah…I’m bullish!).
If you’d prefer to gain some Irish exposure via a fund, this ETF could be ideal – but obviously a peer comparison with New Ireland Fund (IRL:US) & iShares MSCI Ireland ETF (EIRL:US) would be a worthwhile exercise. I must admit I’ve a general preference for IRL, since it’s an actively managed closed-end fund at a decent discount.
Price Target: EUR 7.65
Company: Smurfit Kappa Group
Prior Post: Here
Price: EUR 12.42
On the other hand, I did a pretty good job with SKG – another distressed company. I forecast it had over 75% of upside potential, with a EUR 13.51 target. I recall, at the time, some readers were quite shocked at this call – but one year later we’re just about there! Now, I must confess:
i) I feel a little guilty calling SKG a distressed company. Well, actually, it is…but the company was deliberately leveraged up, and management’s been admirably up-front with shareholders about the debt & their subsequent progress. They’ve mostly stuck to their knitting, with a strong focus on cashflow & gradual debt pay-down (although discipline slipped a little with this surprise acquisition last September). I assure you, I certainly don’t mean to suggest they’re another Greencore..!
ii) SKG’s the one Irish share I really feel I missed out on last year! I was enormously tempted, especially when it dropped over 30% to EUR 5 last June. But I already owned enough Irish stocks at the time, and I didn’t have cash specifically earmarked for new purchases either. Anyway, why complain? We all do that far too much…we forget our own success, and enviously eye up the market’s shooting stars instead. A rather pointless (& frustrating) exercise – why on earth do we think we could have picked the market’s top stocks, when we can’t even reliably predict the winners in our own portfolio?!
Things don’t look much different today for my Smurfit valuation. Annualized revenues are about the same & the operating free cashflow margin’s at 7.5%, so my 0.67 Price/Sales multiple still looks about right. Cash has piled up, but their pension deficit’s significantly higher too (as with most companies). Finally, the negative debt adjustment required here (to adjust debt down to sustainable levels) is substantial – in fact, looking at the numbers, it’s a little higher than last year. Plug all this in, and my price target drops about 6% – which leaves SKG trading ’round fair value right now.
Price Target: EUR 12.64
Company: Orogen Gold
Prior Post: Here
Price: GBP 0.4p
I tagged ORE as near worthless last year, and its share price has been duly sliced in half since. This little shit-biscuit has all the hallmarks of your classic junior resource stock: Serial placings for an ever-larger number of shares at ever-lower prices (they’ve got a rather amazing 2.2 bio shares outstanding now!), cavalier re-pricing of options (as the share price drops), serial Irish resource directors, a bare 1 year’s worth of cash on hand, and nothing much to show for it all… Oh, and let’s not forget the inevitable announcement of a new deal/exploration project in a completely different country/continent – in Armenia, for God’s sake, well over a thousand miles away (not that Serbia’s close to the UK/Ireland either)!
[And no, I don’t think those exciting gold exploration grades of 15-63 g/per ton necessarily amount to much… There’s a hell of a lot of time & money to be expended before there’s any hope of seeing an upgrade into something viable. Anyway, those grades are mere chicken-feed compared to the amazing grade IMC Exploration Group (IMCP:G4) came up with recently! And since I’m highly confident IMC’s incredible discovery will come to naught, should I be more hopeful for Orogen?!]
I’m perplexed to see Anton Bilton, of Raven Russia (RUS:LN) fame, still involved here with a 7.4% stake – his colleague, Glyn Hirsch, has bailed though. Orogen’s current cash level is less than a year’s cash-burn, so ORE’s basically worthless. Yes, they might be able to access an equity facility for more cash, but that just accelerates the relentless dilution process for existing shareholders.
Price Target: Zero
Company: Aer Lingus Group
Prior Post: Here
Price: EUR 1.275
Last year, as wary as I am of airlines, I was ultimately looking for well over a triple on AERL! It actually managed a double since – not a bad bloody result in the space of a year, and totally unexpected for a lot of investors. [And what the hell’s wrong with me? I can pick ’em, but I can’t seem to buy ’em too..?!] I also made the following predictions (on more than one occasion):
a) Ryanair Holdings’ (RYA:ID) EUR 1.30 bid for Aer Lingus never had a hope in hell… This now appears confirmed by their most recent announcement, but Ryanair look set to fight on regardless. It’s amazing how often governments end up viscerally opposed to ‘disrupters‘ – despite the fact they inevitably improve the price/service proposition for their citizens! It’s just another reminder 95% of government lobbying is aimed at preserving the status-quo, usually to the detriment of citizens/consumers. I guess a friendly white knight will be needed here…when Ryanair finally ‘decides‘ to sell off its stake.
b) Looks like Aer Lingus is getting ready to bend over for the unions again. I’m bemused to hear them regularly insist (from one side of their mouth), they’ve no legal responsibility for the IASS pension deficit, while they detail their progress on actual pension discussions (from the other)! I’ve also noticed an interesting new fact (perhaps I just missed it before?) – the company has highlighted only 65% of the deficit’s actually related to current/former AERL employees (the airport authorities & their employees are also in the fund). Presumably, this is a coded message the other 35% of the deficit’s not their f**king problem..?!
I’d expect AERL to eventually cough up, say, 50% of the Aer Lingus portion of the deficit (amounting to EUR 253 mio) – and gleefully inform shareholders what a good deal they’ve sealed with the union(s) re employee pay/relations. Yeah, right… Until the unions get restless again, that is – after all, their fat little bottoms will eventually go numb, even if they’re sitting on velvet cushions. But why don’t we assume Aer Lingus carves out a year or two of peace…for a cool quarter of a billion (of shareholders’ money)! Jesus, where’s Willie Walsh when you bleedin’ need him?
So, let’s factor that in. Otherwise, my valuation approach is similar to last year: Op FCF (operating cashflow less capex, but adding back aircraft lease charges) continues to improve – now reaching 8.9% (of revenues). Building on operational performance in the past couple of years, AERL deserves a bump-up to a fair value 0.8 Price/Sales multiple. [This also acknowledges the underlying intrinsic value of the business – if AERL threatens to become a perennial loss-maker, shareholders and/or acquirers can look to the ever-increasing value of its two dozen odd landing slots at Heathrow. They’re worth 10s of millions each!]
Cash has also improved, to over EUR 0.9 bio. Against this, however, we need to haircut AERL’s debt/leases to a more sustainable level – I reckon a 65% debt reduction is needed here. This still bumps up my price target nearly 30%, and offers potential for another double on the share price.
Price Target: EUR 2.69
2013 The Great Irish Share Valuation Project VIII (xlsx file)
2013 The Great Irish Share Valuation Project VIII (xls file)
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Charles – I think you’re proving my point! I believe distressed consumers are defined more by financial stupidity, than poverty, so I’d say there’s a lot more ‘middle class’ usage of ‘alternative’ financial services than any of us might suspect…
Yes, I check QCCO’s share price every day – still pondering if I find the company compelling at all, but it’s certainly cheap. On an absolute basis, and a relative basis – I’ve bunched it with a group of similar/peer companies, which have definitely been outperforming it recently/medium-term.
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Charles Hang said:
What exactly do you mean by “haircutting” a company’s debt? Do you mean a debt paydown or some sort of actual default?
Valuing an over-indebted company can be extremely difficult. Focusing on Enterprise Value & EV/EBITDA multiples is one way to go about it (as the large amt of debt will squeeze the value of equity), but I find most investors don’t use, or are uncomfortable with, that kind of analysis (how many of us actually use DCF?!). And I think it can be downright misleading sometimes – don’t forget, I’m firmly convinced the whole methodology was invented by investment bankers, just to make acquisition targets look that much cheaper on a multiple basis.
The outcome is so binary, in hindsight an equity valuation will be far too low, or high… I often notice that the market/investors can ignore debt for long periods of time – i.e. they value a company almost exactly like its debt free peer. Sometimes the co grows its way out of the debt, and into that valuation – other times, things get worse or investors wake up to the risks, and the valuation collapses.
My rough & ready approximation of the expected value of these outcomes is a debt haircut – note I should more correctly say (as I do sometimes) ‘a haircut to equity, imposed by debt’. At most, I think a company can operate comfortably with net interest at 15% or less of EBIT (operating profit), which is equiv. to 6.7 interest coverage. Companies with debt/interest in excess of that risk suffering: i) a significantly adjusted price for their equity in the event of a takeover – acquirer will refuse to take on debt, or will take on debt but haircut equity to compensate, ii) an eventual rights issue/placing to pay-down debt – this will probably hurt the share price and/or dilute intrinsic value per share significantly, or iii) investors will mark down company severely at some point. Of course, the other alternative (as you mention), a debt default might actually occur eventually…
I find that if I haircut my (relatively debt-free) equity valuation by the value of excess debt, on average it tends to capture an appropriate value for the company. Calculating in this fashion also is a good insight into what a company might be worth on a non-distressed basis, if they can pay-down debt, sell assets, eliminate losses etc. I also do something similar for low-debt/cash-rich companies – i.e. I adjust the value of equity higher (but not according to the same scale), which I think captures their ability to potentially enhance earnings/shareholder value overnight with investment, share buybacks, acquisitions etc.
Charles Hang said:
I put your response off to read more carefully once I had more time, and it was definitely worth it! This is a great way of evaluation highly indebted companies that I’d never considered before–thanks for introducing it to me!
Incidentally, I think the phrase “‘a haircut to equity, imposed by debt” captures it quite nicely.
Charles Hang said:
By the way, I was walking past the Rent-A-Center location near my home and my first thought to myself, no joke, was: “Hmm, I hope Wexboy comes out with that promised follow up on distressed asset investing soon.” I eagerly anticipate your post!
I can’t resist a joke: In most parts of America, if you were walking past a Rent-A-Center, that would surely imply you are/should be a Rent-A-Center customer..! 😉 In fact, in some parts, if you’re a walker there’s almost a presumption of criminal intent (unless you’re a zombie, of course…though some would consider them criminals also).
Thanks, Charles – yes, it’s on the to-do list, and RCII & a bunch of other stocks will be in there – I won’t be doing any individual valuations/write-ups (that’s not the purpose of that series), but hopefully I’ll provide some decent running commentary & list a good few interesting names a lot of readers may not have come across before (like I said, this seems a fairly neglected/obscure sector for most people).
Thanks – glad it makes sense to you, Charles – I think the approach is useful in a number of different ways, and it certainly took me some painful time, effort & losses to arrive at..!
Charles Hang said:
(Responding to your other post, which for some reason doesn’t have a respond button)
Hah, well, I suppose I should have mentioned that I was walking the sixty meters from my car to the big box store in the same plaza. I’d definitely agree with your overall point, though–walking anywhere outside one’s immediate neighborhood definitely marks you as somewhat odd in my corner of the US.
That said, you’d be (or maybe not–I figure you might already know this) amazed at how prevalent these stores (plus title/payday loan and similar) locations are in middle class America. After reading a book about them, I’ve gotten into the hobby of counting them as I drive, and you can easy count five of those places in that many minutes going down a major commercial street in a comfortably middle class area. It’s not as bad as the seven such locations I see literally within sight of one another on my daily commute, but it’s pretty astounding.
Anyway, I wanted to mention QC Holdings (QCCO:US), a payday lender, as an interesting company in addition to Rent-a-Center, and not just because I see them every day. I’ve been skimming their reports–they’re suffering a downturn in margins over the past couple of years, which they blame on regulation (unsurprisingly) and the costs of offering some new products (longer duration term loans, among others). If the latter is true and margins can revert, the company would be trading at low single digit P/Es, with almost 100% cash earnings.
Charles Hang said:
Anyway, I look forward to your next post!
sean carne said:
greencores earnings are very dependent on the large multiples in the uk and their daily fresh made sandwich demands . in my opinion this is a very poor basis for producing quality earnings .greencore has been badly managed for the past 20 years . they failed to capitalise on their large property portfolio when they stood to make several hundred million on property sales.the recent horse meat scandle demonstates how vulnerable their profits to relatively minor events.not a share for the pension fund.
My reply seems to have disappeared!? Thks, Sean – yes, yes, YES! 😉