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

Summary
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.


Intro
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...
Possible.
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.