Tags
Aryzta, blind stock challenge, Glanbia, Greencore Group, intrinsic value, investor bias, Kerry Group, mystery stock challenge, stock picking, stock selection, stock valuation
Continued from here. A week ago, I set readers a mystery/blind stock challenge – to estimate an intrinsic/fair value for four mystery companies: Conquest, War, Famine & Death. Here’s the data table I provided:
First, let me thank all the readers who participated (by blog comment & email): Congrats, you took the time to stick your neck out & provided me with what I consider a meaningful set of fair value estimates. Second, without further ado, here’s a table of the 4 companies & their actual underlying data:
[NB: For the challenge, remember I normalised to 1 billion of revenue – i.e. applied factors of 20.8%, 39.4%, 78.5% & 17.4%, respectively, to each company’s revenue & additional data points (except CAGRs).]
Yes, the mystery companies are the original Four Horsemen of the Irish food industry (though each has focused more & more on its ex-Ireland business):
Aryzta (YZA:ID, ARYN:VX) Mkt Cap: EUR 6.5 Billion
Glanbia (GLB:ID, GLB:LN) Mkt Cap: EUR 4.9 Billion
Greencore Group (GNC:LN) Mkt Cap: GBP 1.4 Billion
Kerry Group (KYG:ID, KYGA:LN) Mkt Cap: EUR 11.1 Billion
Wow, these charts show quite an astonishing sector rally:
Aryzta & Kerry have basically tripled in just under 5 years, while Glanbia blows ’em away with a share price that’s multiplied almost seven times over. And even that pales in comparison with Greencore…which managed the same feat in just 3.5 years!
Now here’s my readers’ Fair Value Estimates & Long/Short Picks:
[Modified Mean: Mean of readers’ FV estimates, excluding highest & lowest outliers. Long/Short: Readers’ Long/Short picks are aggregated to arrive at a net Long/Short for each company – most popular Long & Short are bolded.]
[Note: Readers’ responses were based on my normalised data, so I’ve grossed up their FV estimates accordingly here. For example, submitted mean was 917 million for Aryzta – applying the same 20.8% factor, that’s equiv. to an actual mean FV estimate of 4,411 million.]
Which is also astonishing…
Right across the board, readers’ FV estimates are consistently & substantially lower than current market caps. To put it another way, what I consider a representative sample of pretty well-informed investors tags these companies as over-valued by a significant 47-63% (Aryzta & Kerry) to a colossal 112-136% (Glanbia & Greencore). But they’re invariably touted as reliable/defensive/steady growth food stocks – how hard can it be for investors in the market to broadly agree on fair value here?! We’re not exactly talking about buggy-whip companies heading over a cliff, or new-tech/media enterprises accelerating into the stratosphere…
Somewhere, a devoted company shareholder is choking on his protein drink right now…I mean, this was only a mystery stock challenge, aren’t huge valuation discrepancies the intended result?! And I suppose I’m the evil puppet-master controlling the entire exercise? Yeah sorry, I’m just not buying it… I didn’t cherry-pick the data I provided, and I fail to understand what missing data here would have somehow magically doubled readers’ FV estimates. And lest anyone think this is some value investing conspiracy, I’ll repeat a version of my last table, now with current market multiples:
Ouch, those multiples are really extraordinary..!?
On average, does the sector really deserve a 22.2 P/E now, considering its long-term growth history? The numbers don’t lie… And that P/E’s based on gussied-up earnings from management – which often bear little resemblance to the net earnings figure you’ll actually find at the bottom of the P&L Statement. Or the free cash flow figure found in the Cash Flow Statement…on average, the sector’s now trading on a dizzying 52.1 P/FCF multiple!
And why bother highlighting potentially stretched balance sheets, in terms of debt & pension liabilities? [I mean, how many investors in the market really care about debt (or cash flow)?] Yes, food companies can arguably support higher levels of debt, but current debt/interest expense vs. cash flow multiples could potentially cause difficulties, given unforeseen developments. [Shareholders might argue the current capex binge could always be drastically reduced. Um, sure, but wouldn’t that undermine the (investment &) growth story?!]
Now, I wasn’t actually planning to pick apart each company individually – in fact, I tagged all of them as over-valued last year in The Great Irish Share Valuation Project. But I can’t resist picking on Greencore for a sec…after all, despite having no market caps to reference, readers overwhelmingly (& quite rightly!) designated it as their favourite Short candidate. Who in their right mind* would seriously justify Greencore’s 21.6 P/E & a 40.8 P/FCF multiples, when its adj diluted EPS growth was actually zero & negative (respectively) for the past 5 & 10 years?!
[*Er, maybe Patrick Coveney? He’s been at the helm of Greencore for almost 10 years now – first as CFO in 2005, and then as CEO since early-2008. [Bizarrely, he’s also a director of Glanbia!?] Despite the company’s abysmal medium/long-term financial performance & over-stretched balance sheet, Coveney’s annual compensation has quintupled since he arrived – I calculate he’s collected over GBP 10 million in total comp. as CEO! The board should be ashamed of themselves… What really takes the biscuit cake sandwich here though, is that shareholders have lavished even greater undeserved riches on Coveney, via Greencore’s perplexing share price rally: His vested/unvested shares are now worth over GBP 15 million, while his options are worth another million!]
Personally, I find cash flow shortfalls in well-established companies particularly troubling. Are the growth opportunities really so attractive & compelling that actual capex (& intangibles) spend continues to far outpace depreciation & amortisation? Well, that’s what management will invariably claim…but if that’s true, shouldn’t this compelling growth already be blindingly obvious from a company’s last 5 & 10 years of financials? In reality, as I noted in my last post, a company’s future reflects its past more often than not, and companies ‘generally don’t experience hockey stick growth out of the blue (nor do they suddenly fall off a cliff…)’
But go ask their shareholders, that’s exactly their argument! I can now repeat it in my sleep: Each of these companies has been continually restructuring and/or shedding non-core/low-growth businesses, and is now spending hand over fist to capture & exploit the multitude of high growth opportunities just ahead of them. Fair enough, who am I to doubt this wonderful future…except that’s the very same investment thesis management & shareholders were pitching 5 & even 10 years ago! [And management, in most instances, has changed very little]. Don’t believe me – just go back & read the annual reports, go back & read the bulletin boards. So…shouldn’t this wonderful future be here by now?!
But look, crazy investors & share prices are no real surprise to any of us. And despite the share price rallies these companies have enjoyed to date, a further ‘cross the board rally wouldn’t necessarily come as a huge surprise either. [In fact, since October, all four shares have actually taken off afresh]. Of course, this is a classic example of reflexivity at work:
Initially, management’s cautious in its strategy & investors buy mostly for the defensive qualities & dividends that food stocks usually offer. As share prices rise, management grows more confident & investors grow more wedded to their stock(s). Eventually, as share prices surpass what might reasonably be considered fair value, the story really starts to evolve… Management pitches an ever more ambitious acquisition & investment strategy (debt & pension liabilities are no longer perceived to be a potential risk), and most shareholders are inevitably forced to buy into it…simply to justify the fact they continue holding their shares, despite the escalation in valuations. Which is how they end up arguing food companies are, quite obviously, both safe/defensive & high-growth/high-multiple stocks! And every fresh share price rally is therefore hailed as divine proof of this new paradigm & their own investment genius, rather than a welcome & obvious chance to sell…
Unfortunately, when you hear investors talking out of both sides of their mouth like this, you know you’re getting into bubble stock territory – not the easiest thing to bet against though…
I think the real lesson of this challenge/post is to realise how many investors in the market pretty much ignore the reality of the numbers…they prefer to simply buy the story instead, at any price. More insidiously (and this happens to all of us), investors regularly confuse & conflate stock selection (story) with stock valuation (price), when picking stocks. Consciously or unconsciously, we seem to inevitably massage & cherry-pick the good data & trends, to arrive at a substantially higher intrinsic/fair value that correlates more closely to the story of the company/stock, as we perceive it…and yes, first impressions really do count! [The inverse is true too – we don’t like a story, we mark down the stock accordingly. And as Buffett reminds us, our errors of omission are often just as painful & expensive as our sins of commission].
No matter how experienced an investor you are, a blind/mystery stock challenge is a useful demonstration that a simple unbiased analysis of the numbers can present a very different story (vs. the one you hear presented by management & shareholders). It’s also a great warning of how easily management, the market, the media, message boarders and/or shareholders can seduce you into believing a higher (or lower) valuation is warranted & justified for a stock, regardless of the numbers & despite the current market valuation. And for some, maybe it reminds you that your valuation process might actually be more conservative the less you know about a company…if so, is that such a bad thing?!
I’ve written about this before (see Cheap & Interesting!) – I think there’s huge value & advantage in treating every stock you encounter, first & foremost, as a mystery stock challenge. Before you even consider thinking about reading/learning about a company, before you read any of the message boards, before you absorb management’s investor pitch, before you react to some talking head’s sound-bite or some hack’s regurgitation, why not dive immediately into the historic financials & take a first crack at a valuation? I think you’ll find it can be a far more honest & revealing way to start what might ultimately prove a long & valuable relationship with a company/stock.
Like I said, the numbers don’t lie…
Wexboy 
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Nice post but I’d like to see the examples of the calculations used to get to the fair value figures.
Hi Jells3,
The comments on the original challenge post are representative:
https://wexboy.wordpress.com/2015/02/26/the-four-mystery-horsemen/
Unfortunately, not everybody explained the math behind their valuations… If you’re intrigued by/have questions about any specific valuations, feel free to reply to their comment(s) & hopefully they’ll reply. I’m also happy to pass along an email from you to a specific reader/commenter, if you wish.
Thks,
Wexboy
I dont see how any of those examples would have been shorts. At the right price they all seem attractive.
On related note, what do you think about Macau wexboy? The whole sector looks cheap right now, and it seems some stocks way overshot on the way down. Plus it is a really nice way to profit from fast growing discretionary Income of southeast chinese middle class at a cheap price.
Hi brmah – except they don’t seem to be at the right price, eh? See my short/$KO comments below.
Yes, I’m a fan of anything that offers exposure to Chinese wealth & its burgeoning middle class. However, the casino stocks are in the middle of a perfect storm right now it appears, and most have new capacity coming online, which exacerbates the situation & potentially weakens them financially. As I tweeted in past day or two, they all appear to now be breaking/have already broken 2 year lows/support, so I think we may be looking at another painful leg down here…
Technical analysis will probably prove relevant & useful here – I’d prefer to be a buyer on the way back up, rather than attempt some falling knife trick! Committing to an averaging-in strategy takes some of the emotion/fear & greed out of the equation also. Ultimately, I think the long-term story is still pretty much as bullish as ever – best to focus on casino stock(s) which: i) have strong balance sheets & cash flow, ii) are focused on/transitioning to mass market, and iii) aren’t ultimately US-owned companies.
Good luck,
Wexboy
“Like I said, the numbers don’t lie”
No they don’t but neither do the charts.
Thanks Michael,
Well, I knew that was coming… 😉 But I’m reminded of the joke:
Investors in over-valued bubble stocks are like turkeys…the closer it gets to Xmas Day, the happier they are!
Identifying an over-valued stock isn’t necessarily about finding short selling candidates – mostly it’s just about avoiding them & opting for something better/more certain. Because over-valued stocks don’t always collapse, most just end up going down/sideways/nowhere for years afterward…which might actually be even worse for investors. I’m reminded of Coke here – investors couldn’t love it more in 1998, no price was too high to pay…yet here we are 17 years later, and $KO is still down!
http://finance.yahoo.com/echarts?s=KO+Interactive#symbol=KO;range=my
Regards,
Wexboy
Thanks Wexboy.
I want to be humble here on this board. I have never come across a board that is written so intelligently with so much insight nor so prolifically.
In terms of knowledge and skill if the blog is 100% I am about 5%.
I put up this post for a reason which I am hoping you and the other people can consider because it is causing me no end of consternation and it’s the whole deflation/inflation conundrum. I know some really smart value investors and their view is that the world is going to see deflation.
These charts however are indicating to me Hyperinflation. It is possible for inflation and deflation to occur simultaneously. It’s called Biflation.;
http://en.wikipedia.org/wiki/Biflation
Canadian ETF’s investing in farmland are up 40% in 12 months. The Chinese are buying land all over Europe as are many hedge funds because Land has not futures market I know of and it has 0% increase in supply (except for land reclamation).
This allows them to preserve wealth and in the Chinese case they are converting the land to produce fodder for cattle raised in China taking land in Europe out of food production for humans. This is because of the increase in consumption of meat in China.
I was raised on a small farm in the west of Ireland and historically land sells for 1000% over commercial value. At currently about 10k per acre its commercial value is around 1k per acre.
I cant see how if I remain in cash for example looking at charts like this that my value is enhanced with the Euro collapsing. Surely with the enormous reset in the world’s financial system that is coming the best value I can find is to buy an asset with no counter party risk, which can’t be manipulated in the futures markets and which will always have a demand like food or land ?
I am really curious and respectful.
Thanks for letting me post on your blog.
Michael.
Thanks Michael,
Sorry, this comment slipped away from me for a while…
Here’s a post of mine from 2012: https://wexboy.wordpress.com/2012/09/04/so-wheres-the-bloody-inflation/ You might find it useful/interesting – it still seems to be fairly on-point.
We may well be experiencing the building of the mother of all bubbles in the equity markets (particularly in the developed markets), so there’s where inflation went…it became asset inflation! I suspect agri & natural resource commodities will actually be the last to join in the boom.
Investing in real assets isn’t a bad strategy – but investors often get in trouble when they focus exclusively on one asset class/sector, far better to be sensibly diversified. My series on Portfolio Allocation might be useful: https://wexboy.wordpress.com/2012/06/20/hitting-the-century-its-pretty-panties-time-i/ Inc. the posts on real assets, like Agri: https://wexboy.wordpress.com/2012/12/05/hitting-the-century-viii-agriculture/ Bear in mind though, with agri stocks, there are plenty of promotional/cash flow negative companies out there to be avoided. In regard to ETFs, note this post: https://wexboy.wordpress.com/2012/10/12/agriculture-etfs-can-you-smell-em/
And I’m not generally in favour of physical assets vs. paper assets (unless you’re planning to hide gold coins in your shoes & head for the border!). In my mind, their specific disadvantages usually outweigh their supposed advantages – and ultimately they won’t necessarily protect you (any better than paper assets) when it comes to extreme forms of risk (like political risk).
btw What Canadian farmland ETFs are you referring to? ETFs aren’t a suitable vehicle for an illiquid asset like farmland – are you talking about farmland REITs (I know of a couple of unattractive US farmland REITs), or perhaps agri-stocks ETFs? [But I would note, if you can find a suitable (i.e. non-promotional/over-valued) investment vehicle, Canadian farmland may just be the best farmland in the world – in terms of price vs. fertility vs. political stability. And Europe, of course, is probably the most over-priced!].
Hope this all provides some food for thought,
Cheers,
Wexboy
Thanks Wexboy. I made a mistake on the canadian farmland etf and thanks for pointing it out. The following etf was the one I was looking at;
iShares Global Agriculture Comm (COW.TO)
Thanks again,
Michael.
Thanks Michael – not bad – though remember Agriculture ETFs tend to inevitably provide exposure to the ‘picks & shovels’ providers, rather than direct exposure to crops/livestock & farmland itself. Cheers, Wexboy
Just stumbled across this fantastic article and blog. This simple intuitive test is as insightful as any super investor market commentary.
With some juicy valuations floating around there are a lot of comments about “quality” stocks, as though the discounted future cash flows of one business are worth exponentially more than the same comparable discounted future cash flows of an alternative company that isn’t a consumer staple or discretionary.
Couldn’t agree more with your statement about having a look at the financials before allowing the story to muddy your thinking.
Hi Max Alpha,
Yeah, you nailed it, it’s extraordinary how much more highly investors will value one set of numbers vs. another, simply because they’ve already put the stock in a ‘story bucket’ they like.
I’m also reminded of Buffett here – sometimes I think he’s done more harm than good: Too many investors have listened to his advice over the years, and somehow think it’s licence to buy familiar household names at any price…
Wexboy
Great post – more of these exercises should be done across the board! FCF is largely overlooked by many investors. Follow the cash! Cash is king!!
PJF – yeah, exactly!
Read any book/profile of the great investors, and invariably they prioritise a company’s cash flow & balance sheet far more than its P&L, esp. when management starts touting adjusted/bullshit earnings. Which also reflects the fact most great investors put far more emphasis on avoiding mistakes/losses rather than worrying about your gains (they’ll take care of themselves!) – most investors who focus on cash flow/balance sheets generally end up owning a far safer portfolio, in terms of valuation & financial strength/stability.
Cheers,
Wexboy