mercredi 2 septembre 2015

CNIM (ticker: COM): too good to be true ?

CNIM has released yestersday its HY2015 results (in French only, for the moment, but CNIM has an english version of its website).

HY results are good and valuation is rather attractive on the basis of trailing earnings (EV/2014 EBIT ~ 4).
Stock is up 5% in 2 days, notwithstanding Monday declining overall market.
However I'm not convinced that the valuation is so attractive, considering the outlook, and would prefer a larger margin of safety.

CNIM is an industrial company operating in 3 sectors:
- environment: mainly construction of waste to energy plants (WTE), operation of WTE plants, some moves towards solar energy (thermal conversion, not photovoltaic)
- "systems": defense (missile launch, sea landing,..), nuclear components, engineering (Bertin subsidiary)
- energy: industrial boilers (maintenance,..)
~ 2800 employees, 2014 sales ~ 800 m€. Market cap ~ 220 m€

A good overall presentation of CNIM has been made here (Value uncovered 2012 post, in English)
See also fininfohub 2014 post on the annual results analyst presentation (in English)

The stock currently trades at a low valuation (76€ when article was written, EV/2014 EBIT ~ 4, ~7% dividend yield) and shows a good historic record of profitability. Strong balance sheet (excess cash 46 m€).
FCF varies a lot because of the changes in working capital requirements linked to the construction contracts payment terms.

Why is it cheap ? Is it a real undervaluation ? Link to value and opportunity recent post on the exact same topic : "Cheap for a reason".

Several possible answers :
1. Forgotten sector/company, etc...
CNIM is not followed by any analyst , as far as I know.
However, liquidity is reasonnable. CNIM is not a "micro-cap" at least on French market standards, and I think that some small cap/value funds are certainly well aware of CNIM.

2. Bad outlook
"Systems" activity suffers from governement budget cuts. Among other things, CNIM makes landing barges for Mistral-class military ships. I'm not sure if the cancellation of the Russian purchase has not affected indirectly CNIM.
Business journal "Les Echos" made this summer an article (in French) on technical unemployment for 510 people (2/3 of the total) in some CNIM plants (mainly in the "systems" division)  due to reduced activity. Translation of the title: "CNIM group suffers from an unprecedented reduced backlog in defense and environment".

Sales and backlog (data from annual reports) illustrate this:

What bothers me is the environment sector, the only one making serious money currently.
I've made some (not enough) research on the WTE market.
Some articles of interest :
An article from Johannes Martin of Martin GmbH which supplies key components (moving grates on which the waste is burned) and a long-time (50 years) industrial partner of CNIM. We'll get back to Herr Martin later.
Summary: saturated market. British market was strong recently.

Another article from "Waste management world"
Explains that EU law on landfills (higher standard for landfill sites) is the driving force behind the construction of WTE plants. Overcapacity in Germany and Northern Europe (some countries import waste to be burned!), dynamic UK market, some distant prospects in South/Eastern Europe. Some perspectives on modernization of old units.
I've noted that recent CNIM contracts for WTE plants are in the UK so it is consistent with this article.
The article also states that southern Europe (including France) "have not yet involved into major markets for WTE" but this is inconsistent (at least for France) with this 2012 map of european WTE plants.

This presentation from J. Martin is also intersesting and gives a worldwide perspective (warning: 8 Mo pdf file).

Scuttlebutt: I currently live not far from Marseilles. The implantation of a much-needed waste incinerator has been met with a fierce opposition from local associations and associated legal battles (NIMBY syndrome). In the above article of "Les Echos", it is also noted that CNIM had been awarded the contract for the modernization of a 40 year-old WTE plant in France, but the contract has been suspended after locals have opposed it.

So to sum it up my interpretation is that the recent good results for CNIM are mainly linked to the UK WTE market, and that it is not reasonnable to extrapolate these recent results.

3. 2014 Buyout
In 2014 CNIM made a tender offer :
- 30 € special dividend
- 75 € tender offer (after the special dividend)
Some major shareholders sold their share, including Martin GmbH (10% of capital) and CNN, a shipowner company (20%) previously associated with CNIM.
So CNIM is now fully controlled by the Dmitirieff family.
I've found no explanation why Martin GmbH or CNN sold their shares. So I must conclude that the price offered was judged fair by these sophisticated investors, and the current price offers no discount.

The tender offer documentation is available here (in French).
I found the following information interesting in the independant auditor report:
- according to the business plan, for the environnemnt division, weaker sales are expected (end of UK orders), with a rebound later (hypothesis of sales in the middle-east), EBITDA margin higher in 2014, lower in 2015 and 2016
- innovation and systems division: better margins are expected, tax rebates (CIR) for R&D expenses is a key point for this division (but will this tax rebate be maintained ?)
- "fair value" (DCF, comparables) : around 125 € (before 30 € special dividend), so around 95€. This figure means little by itself, but I guess it offers some kind of "protection" against a lowball buyout.

Recent information
CNIM has released its HY 2015 figures yesterday.
Backlog is somewhat better compared to end 2014.
Sales are down compared to HY 2014 but operational margin is suprisingly good (8%).
CNIM offers no guidance, other than "orders will be in progress in 2015".
CNIM stock went up ~5% as a result.

Putting it all together
What kind of earnings can we expect.
CNIM is not selling coke bottles or candies, but is mainly a contract-based business so predicting future activity is fraught with uncertainty, and as we've seen the outlook is not so rosy.

Based on baklog orders and HY figures, I think it is reasonnable to expect around 720-730 m€ sales.
I'll use a relatively conservative hypothesis of 5% operational margin instead of the 8% operational margin of the 1st HY 2015 which I don't really understand (the full HY report is not yet available).

I get a "normalized" EBIT of around 37 m€, and a EV/EBIT~ 6 (EV taking into account net cash 46 m€ from the 2015 HY report and 27 m€ retirement liabilities, no correction for negative working capital*).

Not expensive, but not dirt cheap either.
I'll wait for a bigger margin of Safety (if it comes !) before adding to my existing position. Anyway I hate chasing stocks when they go up and prefer to buy on dips.

Disclosure: long CNIM

*One point that bothered me is that CNIM benefits from pre-payments from the client on its contracts and shows a significant negative working capital (for instance almost ~100 m€ negative working capital in 2012). I was unsure about how to account for this excess cash in the EV calculation . However this negative working capital is only 7 m€ in 2014, so I neglect it.

mardi 26 mai 2015

Gevelot (ALGEV)

- Gevelot (ALGEV) makes auto parts and pumps
-  illiquid stock, trades 1 time/day (fixing) 
-  97 m€ net cash on the balance sheet vs 131 m€ market cap (at 145 €/share). EV/2014 EBIT~5
- Management shows no sign of  returning this excess cash to shareholders, a situation quite similar to GEA ; cash will be used for investment
- low valuation but the easy money has been made ?

1) The company
The company has 2 main activities :
- parts manufacturer for the automotive industry (Gevelot extrusion and Dold GmbH)
- pumps for industry, oil/gas, food processing (PCM pumps)

They have posted several videos on youtube about the production sites (plants in France and Germany). So it's industry, presses, cold forming, heat treatment, machining and lots of CAPEX.

Pumps (PCM)
Apparently their technological specialty is PCP pumps, used for instance in oil and gas. PCM was founded in the 1930's by the inventor of PCP pumps.

Carburators (Gurtner)
Division sold at a loss in 2014.

2) Why is it cheap ?
Gevelot owned a 45% stake in Kudu, a canadian pump supplier using this same PCP technology.
Gevelot bought the remaining 55 % from its main shareholder, and sold it right back in 2013 to Schlumberger. Kudu (45%) was valued at 10 m€ in 2012 Gevelot books and Kudu (100 %) was sold for 168 m€ to Schlumberger. Nate at oddball stocks made an article about it in 2014.

3) Where will the cash go ?
Not in the minority shareholders pocket for sure. No special dividend, no announcement for a major buyback program. There's not even an increase in the usual dividend. The company has a modest share buyback program running though.
The last annual report gives an indication about how the cash has/will be used :
- sale of Gurtner division (at a loss), which seems a good move to me (loss making division, not a great outlook on carburators...)
- investment (CAPEX) in Extrusion (13 m€), I'm not sure the return on this invested capital will be great given the historic profitability of this branch (see below)
- acquisition of AMIK Oilfield Equipement and Rentals (Canada). I'm not sure it's the best timing given the evolution in oil/gas prices but I'm not an expert and I don't know if the price paid is right.

The capital is entirely controlled by the family.
A notable shareholder is the fund "Stock picking France", with a deep-value style.
Another fund present at the capital is William Higgon's Independance et Expansion fund, that I've mentioned in some previous article.
However these funds  have bought a long time ago and at a much lower price (years ago for the 1st one).

4) Financials
CA (Chiffre d'Affaires) = Sales
ROP/CA = EBIT margin

Breakdown between Extrusion and Pumps sectors
ROC = current operational result. MOP = current operational margin. Invest= investment
All figures (sales, results) are excluding intra-company transactions (more on that below).

The extrusion division is certainly not a "great" business: no competitive advantage, cyclical, heavy CAPEX, about 4-5% average (median value in the above table to be precise) operational margins. The outlook for the car industry seems recently better than the very difficult post 2008 years though.

The pump division has better margins (~10 %), less CAPEX requirements, but I've been unable to find the contribution of the oil/gas sector. Given the recent slump in oil prices, I wonder how to normalize earnings to account for the oil investment cycle.

5) Valuation
I've tried a sum of parts valuation, but one point that beats me is intra-company transactions (see table below). Just adding the estimated value of the extrusion and pumps branches without taking into accoung this internal transactions (-3 m€ in 2014) would lead to an overvaluation.

To get some idea, here's a very simplified  DCF calculation, with conservative assumptions (no growth, average 4% margin, 12% cost of capital).

6) Conclusion
So yes Gevelot is cheap, but operates in a difficult business with no competitive advantage.
The lack of liquidity, and indifference to minority shareholders probably explains some part of the discount.
In any case it will take patience to see if the excess cash is used wisely and will produce results. Given the recent historical performance I doubt the return on this capital will equal its cost for a company like Gevelot.
Link to a very recent relevant article (Investing in bad businesses Damodaran).

Disclosure : long ALGEV

mardi 27 janvier 2015

GEA 2014 results (short article)

GEA presented today its 2014 annual results.
Sorry for the telegraphic style.
See Fininfohub article here (analyst presentation in English, with lots of interesting information from management).

Compared to my HY2014 worst-case scenario (9 to 10 m€ op result), the 2014 results (EBIT = 12 m€, net result 8 m€) are better than I expected.

GEA apparently cut its costs (outside purchases, interim jobs) quickly, without reducing its permanent workforce.
Backlog seems stabilized, good news.

Dividend cut (constant 33% distribution ratio), rather stingy given the huge cash position.

Tecsidel deal is not finalized. No info on the purchase price.
Net cash is down 57 m€ 2014 vs 60 m€ end 2013, compared to 8 m€ net profit. Why is net cash down ? Some increase of working capital requirement ? Strange because I would expect working capital to decrease when sales are down. Or maybe some investment that's not mentioned in the news release.

Stock closed down 8% today @ 77 €, which surprises me.
Let's assume that GEA pays 1x sales for Tecsidel (about 14 m€ ?)
EV = 92 (market cap) - 57 (cash) +14 (tecsidel ?) = 49 m€
EV/2014 EBIT = 4

Anyway today's drop leaves me rather cold, because I halved my position this summer/fall after :
- Amiral Gestion announced (this summer I think) that they had sold their position at a loss because they had underestimated the decrease in the toll equipment market in France
- Kapsch relased earlier a rather bleak outlook "no invitations to tender...are in the near vicinity" "strategic adjustments to changed market conditions"
- liquidity was super low
- I was getting scared and unable to remain rational because the position was too big in my portfolio.

I'm prepared to start buying again if price drops to silly levels.

lundi 12 janvier 2015

2014 review

Given how this new year has started in France, I guess it can only get better. Best wishes to everybody anyway.
I will refrain from making comments on the recent events, as this is an investing blog.

My portfolio is up 11% in 2014 vs 35 % in 2013.
I have no real benchmark, but I invest primarily in French small caps, so it makes sense to compare with the following benchmarks :
- the mid&small caps index (MS190) is up 8.4%
- investment funds with the same universe (value, small caps)
- Amiral Gestion Sextant PEA up ~12-13 %
- HMG Decouvertes up ~12 %
- Moneta micro entreprises up ~8 %
- Independance et expansion up ~16%
So my performance is more or less in line, but certainly not spectacular.

I do track my operations/porfolio on Excel but one issue I have is that I'm not able to quantify which positions/decisions have contributed the most to a given year performance (if I understand correctly this is called performance attribution).
I think the most positive contributions went from my biggest existing lines (Precia and Installux), but certainly not from the stocks I talked about in 2014, namely GEA and SII. I'll do an update on those later.

The place to be in 2014 for French small caps was biotech (Cellectis +430 %, Genfit +322 %, Adocia +709 %, Innate Pharma +60 %, DBV Technologies +305%...), way outside my (admittedly narrow) circle of competence anyway.
On the other side, some companies in the oil service sector (Technip, CGG, Vallourec,...) have been trashed. I have the feeling that all this is a little silly and temporary, but will not venture further.

I've spent most of the year with a quite important cash position ~20%, because of insufficient opportunities. A short window opened mid oct when the market went down but I still have a large cash position.

The creation of the PEA-PME seems to be rather unsuccessful, which is fine for me (less money inflow, so less competition).

I'm heavily invested in French stocks for good reasons (tax deferred account, less broker fees, probably much less domestic/foreign competition than, say, the US market, less efficient market) and bad (domestic bias, lack of time,...) reasons.
One of my new year resolutions is to diversify more, which means investing in an area relatively decoupled from the Eurozone. 

mardi 28 octobre 2014

IT and engineering consulting services companies AKA, SII

1) Intro
The blog as remained silent for a few months, reflecting what I viewed as a relative lack of opportunities.
However small/mid caps have gone down recently.

I want to make an article on IT service companies (acronym: SSII in French).
As usual, I suppose that many readers will think that the article is too long.
However I'm not in a position where I need to pitch my ideas to a time-pressed fund manager.
I'm just running down my checklist.

See wikipedia article on SSII here (in French).

I'll focus this article on SII (SII: the company, not to be confused with SSII), because I have the impression that it's currently one of the cheapest (EV/2014 EBIT~6 for a quote of 7 €, well actually less since I started writing this article, it's now around EV/2014 EBIT ~5)
Is it a real opportunity or a value trap ?

2) Business model
Nate from Oddball stocks has nicely summarized it in a previous article:
"Technical consulting is a very straight-forward business model. A consulting company places a consultant at a client and bills them out at an hourly rate. The consulting company takes a large cut and pays the remainder to the consultant. As long as a consultant is billing a client both the employee and consulting company are earning money. If a client cancels a contract often a consulting company will let the employee go saving the ongoing expense."

Also the Value and Opportunity blog published a few months ago an interesting article on AKKA (AKA), a direct competitor of SII.
These companies are asset-light, so a potentially interesting return on capital.
They directly benefit from the heavy regulations on the French labor market ; it's long to fire someone, so client companies don't hire and prefer to outsource to these service companies, especially for relatively quick changing technologies such as IT.

On the other hand, they are directly exposed to business cycles; the client company can and will quickly cut the contract, especially new projects or if the service company provides a "commodity"-type service, as pointed out on the Value and Opp blog.

I don't work in this sector, so to get an idea I've spent some time exploring French blogs of people working for such companies (not specifically SII) to get an idea. Of course the more vocal are the displeased ones (a common derogatory nickname is 'meat sellers'), so all this needs to be taken with a grain of salt.

Common complaints:

- hiring mainly young engineers, they indirectly benefit form a relatively bad job market for some young graduates (translation: low pay, around 30-35 k€ starting salary)

- no investment (training) in their consultants. Turnover is high. No capitalization of knowledge or know-how
- consultant is left to himself (no or low follow-up) when working at the client site 
- when a consultant has no contract, company loses money. So the temptation is high to push this consultant on an available project even if he's not really qualified. Some reports of companies reverting to dirty tricks to pressure consultants to resign to avoid the costs of firing (i.e. repeated missions far from home or much under qualification, pressure to take unpaid vacations between contracts,...).

On the other hand these companies hire a lot, and can offer a variety of professional experiences in different sectors to a young graduate.

Competition and comparables
SII lists itself is main competitors in the annual report:
- divisions of big generalist IT companies (Steria, Sopra,...)
- "big" actors: Akka (AKA), Alten (ATE), Altran (ALT), Assystem (ASY)
- mid size actors: Alyotech, Astek, Ausy (OSI), Segula, SII itself
- small actors: hundreds on local markets or specialized applications.
The global market in France is estimated around 8.8 MM€, very fragmented.
SII estimates its market share around 1%.
I don't think that SII possesses any competitive advantage over its peers.

SII clients are mainly in Aerospace, Telecoms and banking+insurance.

SII hired 1400 people last year, on a total of 4400. Mean age is 34 years, almost nobody over 50. Around 200 job offers on their site when I looked.
Pretty high turnover, see above discussion on business model. Also points out on the vital importance of correctly anticipating new staff requirements in function the business outlook.

3) Financials
Balance sheet
SII finishes it year on 31 march.

LT debt 6 m€; short term debt 10 m€, around 28 m€ cash => 12 m€ net cash

Asset light (only 7 m€ fixed tangible assets vs 81 m€ equity ; 17 m€ of fixed intangible assets -mainly goodwill  and capitalized R&D costs).

Working capital
114 m€ receivables + 14 m€ other receivables - 62 m€ operating debt (suppliers, social security,...) = 66 m€ working capital, quite significant (66 m€ /294 m€ annual sales => 80 days).
Consultants are paid monthly but I guess that clients are much slower to pay.
SII operates not only on hourly rate contracts (technical assistance) but also on fixed price projects ("forfait", around 22% of 2014 sales). These projects carry an additional execution risk.
For instance working capital requirement has increased in 2014 even though sales are almost flat. SII explains that they haven't billed yet 5.4 m€ on a project in Spain.

2014 return on capital = 21 m€ operating result (after non recurrent items) x (1-34% tax rate, more on that later)/ (66 working capital + 7 m€ fixed tangible assets) ~around 20 %.
Pretty good, especially if trading at ~6 times trailing EBIT.
(Market cap 135 m€, using 18.5 m shares)

But why is it cheap ?

Income statement
Sales and EBIT (after depreciation) margins.

Operational margins went down in 2009-2010, just after the crisis. SII attributes this to the price pressure on technical assistance contracts, and the time needed to adjust its hiring to new conditions.
Since 2010, SII faces a slow business environment in France (pressure on prices in telecoms, reduced defense spending, end of Airbus A350/A380 program development,...), but operational margins seem to be stabilized.

Around 12%-13% annual growth over the last years, and going back to SII IPO in 1999, growth is pretty impressive.

What is the source of this growth ? Organic or based on acquisitions ?
Unfortunately SII does not provide this information in its annual report (or I've missed it) so I've used what I've found in the analyst presentations.

A recent external acquisition is Rücker Aerospace in Germany. AKKA is also investing in Germany, I wonder if it's a coincidence or if there's some underlying common reason.

SII has a opened a number of branches and international growth seems impressive (double digit).

To sum it up, it does not seem to me that SII is a "serial acquirer" with the associated risks. There's about 11m€ goodwill, compared to 183 m€ total assets.

Taxes and CVAE
I've learned my lesson with my Group Crit failure on this one.

Here is a graph giving the "apparent" tax rate (income taxes/EBIT).

The CVAE tax was deducted from the operational result before 2012. Recently the CICE has made its apparition. Messy. I'll take an average tax rate of 34%.

Where goes the cash ?
CAF = capacite d'autofinancement = cash flow
BFR = variation du besoin en fonds de roulement = change in working capital
flux exploit = cash flow from operations, taken from statement from cash flow
CAPEX = investment in fixed assets
FCF = cash flow from operations - CAPEX

The big drop in 2012 is linked to taxes.
What to make of this ?
Well my interpretation is that these companies are maybe asset and CAPEX-light, but need a large (and growing) working capital. So SII growth is not accompanied by a very large FCF generation.

Capitalized R&D costs
Apparently there's 7 m€ capitalized R&D costs on the balance sheet, mainly linked to software developped by a subsidiary named Concatel in Spain. I'm unsure and wary about the effect of capitalized R&D costs on the operational result, but in SII case it seems relatively secondary.

4) Shareholder structure and management

Who owns the capital
The founder family (Bernard Huvé) owns 55%, Fidelity 8%, Oddo Asset Management 5 %. Only 16% float. Fidelity had previously declared to have crossed the 10 % treshold in september 2013, so they've apparently sold some shares ?
Bernard Huvé stepped down from its operational functions in 2007; the current manager is Eric Matteucci, an internal promotion.
Theoretically, as a minority investor my interests are aligned with the founding family (no excessive risk taking, no major dilution, no excessive stock options for managers), except for the risk of squeeze-out at a low price. The presence of Fidelity and Oddo is quite reassuring on this point.
Another potential issue is when the main shareholder manages to catch a good part of profits before it gets to the bottom line. The founder salary is around 70 k€ in 2014, quite low. No other indirect compensation found in the "conventions reglementees" (regulated agreements and comitments) section.

Is the management renumeration aligned with the shareholders interests ?
The 3 top managers earned around 400 k€ each last year. No golden parachute or retirement package. No "special conventions". The determination of the variable part is not disclosed for "confidentiality reasons".

Dilution due to stock options
20 m shares, around 300 k shares in stock options and free shares for managers, minus 1.8 m shares owned by the company itself.
If I understand correctly, around 150 k free shares + 150 k performance related shares have been issued this year => 300 k shares => around 1.5% annual dilution.
However looking into the past dilution was more significant (up to 800 k potential shares in 2010...).

There is no apparent dilution, because SII buys back and cancels shares to offset stock options and  free shares.  If I understand correctly the annual report, 700 k€ have been charged in 2013-2014 to shareholders to offset this dilution, which is not unsignificant relative to FCF.

5) Valuation
Relative valuation
Comparison table (I'm not sure about my Assystem numbers because of the recent financial operations, convertible bonds and the associated potential dilution)

 At the beginning of this year, Assystem offered a buyout to minority shareholders.
The following table is extracted from the independent expert report.

So SII appears to be somewhat cheaper than its competitors.
This discount can maybe explained by some size effect, maybe in combination with the relatively low liquidity of the stock.

Also SII sales/people ratio is the lower of this sample. I have no explanation for his and wonder how they manage to have an operating margin in the mean.

Historical valuation
I've used approx high/low prices for each year. Looks that SII valuation has always been quite low.

6) Tying it up all together

I don't think that SII has any competitive advantage over its peers.
Likewise, we're not talking about a high-quality or a "moat" business situation. I don't think that SII clients can incur high switching costs.

On the other hand, SII valuation appears quite low in absolute terms, given the respectable return and growth, the robust balance sheet, and an apparent resilience in the crisis years.

SII is also somewhat cheaper than its comparables (especially around 5x EBIT).

Historically, SII valuation has always been quite low.

So maybe SII is doomed to remain eternally cheap, for some reason that escapes me but not Mr Market (maybe I'm underestimating the cyclicality of the business, or the liquidity/size effect).

I bought my 1st shares around 4 € in feb 2013 and some more during the recent downturn.
Maybe it's yet another value trap I've fallen in, however I'm willing to take this risk, which seems moderate to me.

As usual , feedback welcome.

vendredi 30 mai 2014

GEA HY14 results

1) Intro

Note that the article is not self-supporting and will not make sense to a new reader (see my previous articles here 2012 , 2013).

GEA has published it's 2013 annual report and its 1stHY report:
- in the annual report the CEO warns clearly about a marked slowdown of sales in France, the need to focus on export markets, albeit at the cost of significant commercial investments and financial risks
- the CEO warns that it may impact profit margins
- 1stHY sales are down 25% compared to last year; down 50% in France, exports up 38%
- order book sharply down

I want to build a "worst case" scenario to decide what to do.
Besides, I previously compared GEA to Kapsch but Q-Free is maybe a better match (same size; Kapsch is much bigger, and builds but also operates whole/nationwide toll collection systems, a different business).
Q-Free 2013 revenue is the same as GEA.

2) What are GEA fixed costs ?

My current understanding of GEA business and financial situation is as follows:
- GEA designs the toll system (~100 engineers)
- I think it uses largely standard, off-the-shelf components (PLC, printers, card readers, audio and video systems, network components; fabrication of toll steel boxes is subcontracted, maybe they direcly manufacture some dedicated electronic cards) ; it's mainly integration and assembly, so no heavy equipment is needed (see below fixed assets). I wish I had the time to visit their plant near Grenoble.
 - ~100 people directly involved in production
- factory tests
- on-site installation
- maintenance and services

I think that if a downturn comes, GEA will be reluctant to significantly downsize its personnel (temporary staff aside) because:
- it would jeopardize future growth; GEA says in its annual report that the competence and stability of its people is important
- (supposition) not the style of this family-owned small company that thinks long term and not next year stock-options
- anyway long and costly (France labor market).

My main hypothesis is therefore that GEA has mainly variable costs, but that personnel expenses can be regarded as fixed costs, and it's a big part of expenses.

3) 2014 estimates

I've built the estimates with the preceding paragraph in mind and the following hypothesis:

- salaries: fixed cost
- all the rest: variable cost (not true of course)

- 1st hypothesis of 2014 sales~59 m€ (roughly double HY sales)
- 2nd hypothesis of 2014 sales~47 m€ (current order backlog)
- hypothesis that they will not needlessly build up their inventory and other costs
- I neglected amortization+depreciation in this simplified table, it's acceptable because it's generally low (see below)

Here is a table with data taken from the annual reports with my estimates.
Mat1ere = shorthand for "raw materials" expenses (in this case rather parts, components,...)
Autres achats = other expenses (go figure....)
Salaires = salaries
ROP = Operational result

I get a 2014 EBIT ~9-10 m€ in the (worst-case ?) scenario, a spectacular decrease compared to 2013.

But it would then trade at ~4 to 5x EBIT (for a quote of 87€), still a compelling valuation (because of the large net cash 60m€ for a 100 m€ market cap).

3) GEA competitive advantage
I've recently read this book The Little Book That Builds Wealth: The Knockout Formula for Finding Great Investments and liked it a lot; I will try to apply its concepts/ideas to the current situation.

GEA fixed assets are only ~ 1.2 m€ almost fully depreciated.
Much lower than Q-Free fixed assets though (see below). I have no explication for this.

It rents its buildings to another company...that belongs to the founding family/main shareholder, for what seems to me a reasonable price (see annual report).

Working capital is also very low; GEA pays its suppliers 30/60 days and negotiates payment terms with the customer (highway companies).

I've kept the actual denominations of the annual report (French version) for easy later reference.
Mat. 1ere = raw materials
en cours = inventory
creances clients = accounts receivable
dettes fournisseurs = accounts payable
dettes fiscales = fiscal debt
produits constates d'avance = prepaid income
BFR = working capital requirement

The capital employed (fixed assets + working capital) is thus very low.
About 5% of salaries can be considered as R&D costs, but are fully expended (R&D is not capitalized).
If I take assets at acquisition cost, add  5 years of R&D costs (arbritrary), ROCE is still very high.
Why is it not competed away ?

My understanding is that "local" actors (GEA in France, Q-Free in Norway, Kapsch in Austria,...) started early and small and ended dominating their national market (niche market).
I suspect that some kind of switching cost effect is at work there; for the highway company these actors provide a vital service, strongly integrated in the highway company process.
(Imagine the toll collection system down during summer vacations in southern France when half of Europe is en route from Netherlands/Germany/... to Italy/Spain/France...)

Besides from what I've read electronic toll collection investment pays for itself in less than 1 year.

So it makes probably little sense for a highway company to switch its ETC system from one to supplier to a cheaper competitor, unless there's a large price difference. Given the (small) size of the market, it's not just worth it for a competitor (again, a supposition). Additionally there is maybe (supposition) some notion of staff training (highway employees trained to do some basic maintenance on the toll machines) that reinforces this.

GEA benefited from this competitive advantage and an expanding market in France for structural reasons (highways companies going private investment cycle, see my previous article) but it is now apparently nearing saturation.

On the export markets, for new highways, I think that GEA has no clear competitive advantage (GEA "moat" is not scalable, lots of buzzwords here). Their strategy seems to accompany French construction companies (Bouygues, Vinci,...) on export contracts for new highways (see annual reports and also the red corner blog comments on GEA), but its unclear to me if it gives them some kind of commercial advantage on these markets.

5) Conclusion
I don't want to fool myself, and I'm the easiest person to fool.
I like GEA and I have invested some time (and  money) in this investment, but I want to remain cold and rational about this.
I'm certaintly not selling GEA at the current price.
I think a downturn is possible, but I think GEA is still an interesting investment with good long term prospects and favorable economics.
The stock is quite illiquid, and we may (or not) witness a spectular plunge if there's a knee-jerk reaction to weak HY results, maybe a buying opportunity.
I'd appreciate a reality check from outside investors.

vendredi 24 janvier 2014

GEA 2013 annual results

GEA published yesterday evening its annual results : link (in French only).
The presentation slides are interesting to get an idea of GEA business.
Previous posts on GEA: here and here.
The stock went up sharply today (+15%, 88.4 €).

A few comments
Sales are flat ; EBIT margin (operational margin to be precise) is up but GEA warns that it is exceptional and linked to the end of several contracts.

 The drop in backlog orders has -so far- not materialized itself. There's nothing in the press release or in the slides hinting at a future drop in sales ; the management insists on its export recent contracts. GEA does not seem to be much affected by the Ecotaxe Snafu.

The cash is boosted by a reduction of the working capital that was already apparent in the 2013HY accounts ; so again a one-off effect.

True to itself the management has decided to keep the cash to "stay independent" and "finance its investments and exports". However the dividend is up 40% (3.35 €/share).

The family owns 38 % of the capital. Michel Baule, an entrepreneur in polymers turned small caps investor, owns 15%. I see his presence (strong minority investor) as a positive development.

With 60 m€ net cash for a 106 m€ market cap, EV/2013 EBIT ~ 2 !
I see no excuse not to buy some more (and I did at the opening this morning).

A look at competitor Kapsch :

I did not spent enough time on this, but from what I understand the project-related part of the business can be quite volatile (problems in Poland and South Africa legal issues). So a good reminder that a mindless extrapolation of the past performance is dangerous...I guess it applies to GEA also.