Update: Is Value Dead?

For many investors, the current investment climate is bizarre and new lockdown rules are not well received for investments as well as consumption. For this reason, ‘online’ companies are still in high favour (although stagnated a bit recently) and many other firms, for instance, that need factories to actually manufacture a physical product, are out of favour.

Since the dawn of this blog, focus has always been on value; speculation or lofty promises have been tried to be avoided. So far, the results have been mediocre at best and at the beginning of this year, it was rather difficult to find attractively valued shares – a situation that has changed completely with lots of long-term opportunities available now. Some of the investments discussed on this blog have performed rather well, while others have gotten much cheaper and most of them show a better risk/reward situation than at initiation.

It is imperative to think about current macrotrends; however not to get too much drifted away by it but rather look at each company individually and assess its future earnings potential. Most of the companies discussed in this blog have a history dating back decades and so far always found a way to weather challenging storms.

 

Let’s look at some current announcements:

-Alaris Debenture: At the beginning of October, Alaris said that despite the difficult environment the majority of its partner’s results have been better than expected. The stock price has been stable over the last months, which is a good sign for the debenture holders, that enjoyed a small increase in the price of the debentures. Next week, Alaris will provide its Q3 results for more details.

-Altria: Altria reported its Q3 numbers with an increase in the smokeable and oral tobacco segment of 9.1% versus last year’s quarter. Furthermore, actual EPS for the quarter and full year EPS are showing positive trends. The company depicts a current dividend yield of more than 9% which is fully covered by free cash flow. Where else can such yields be obtained?

-Fresenius: Fresenius’ quarterly update demonstrated its resilient business model and sales grew by 1% (5% in constant currencies). Guidance was confirmed and the company’s valuation remains cheap.

-Hunting: The firm’s cash position increased to £69 million, whereas inventories are down. All in all, the asset play case is still in place with the current share price trading lower than its cash plus inventory position.

-BIC Group: BIC reported strong operating cash flow generation resulting in a net cash position of €128 million. A good recovery was visible especially in the lighters business. And btw, BIC also has online shops leading to an increase in e-commerce sales of 15% ytd.

 

While the last decade was pretty much a lost decade for value investors and was very favourable to technology or growth companies, the economics for value investors for the next decade show tremendous possibilities. Stay tuned and don’t lose patience – good things come to those who wait.

Fresenius SE & Co (ETR: FRE)

Intro

Fresenius is a global healthcare group offering products and services for dialysis, hospitals and outpatient treatment. Fresenius is split into four different segments: 1) Fresenius Medical Care is the world leader in treating people with chronic kidney failure; 2) Fresenius Helios is the largest private hospital operator in Europe; 3) Fresenius Kabi is a supplier of essential drugs, clinical nutrition products and medical devices; and 4) Fresenius Vamed plans, develops and manages healthcare facilities. A lot of segments, but it is crucial for the reader to understand at least to a certain their business.

Since its beginning in 1912, Fresenius has grown in each of its business units to a leader and generated revenues of more than €35 billion in more than 100 countries.

The largest shareholder is the Else Kröner Foundation with 26.6% of the shares and guarantees a long-term, sustainable vision.

 

Valuation

Fresenius was able to steadily increase its EPS from €2.64 in 2015 to €3.44 in 2019. In the first half year of 2020, EPS amounted to €1.56 so an EPS >€3 should be reasonable under conservative assumptions, which translates into a P/E of approx. 9.5-11x, which looks rather cheap for such a quality and growing business.

Further, under EV/EBITDA ratio, the economics look rather cheap as well: Historical EBITDA was around €6 billion and this in relation with an EV of approx. €43 billion (market capitalisation €19 billion plus net debt €24 billion) equals a low ratio of around 7x.

The strong and robust business model puts Fresenius also in the dividend champion category with this year’s raise being the 27^th consecutive dividend increase. The current dividend per share of €0.84 yields 2.4% with a rather low pay-out ratio.

 

What’s next?

Fresenius lowered its guidance for 2020 due to COVID-19 slightly, yet should still be around 2019 levels, which is proof of the resilient business model. Fresenius hasn’t been that cheap in the last six years and should under normal conditions trade above €50 per share!

 

Current Price

€34.06 per share

Walgreens Boot Alliance (NASDAQ: WBA)

Intro

Walgreens is a global leader in retail and wholesale pharmacy with a history going back to 1849. The company is present in more than 25 countries delivering to more than 250,000 pharmacies, doctors, health centers and hospitals.

Besides an impairment for its assets in the UK by approx. $2 billion, the firm has ‘survived’ COVID-19 rather well with 2% higher sales for the full year ending in August and growth of 2.3% in the last quarter compared to last year.

While it might be that the retail segment will decline over time due to online sales, Walgreens has partnered with Microsoft and Adobe on the digital front and its e-commerce business has shown strong sales growth, especially this year.

 

Valuation

Mainly as a result of the UK impairment, EPS for the last 12 months has been under pressure albeit still being decently positive. Adjusted for these negative events, the company’s adjusted EPS would have been $4.74. However, a real figure might be more in the area of $4 due to some adjustments that don’t seem to be one-off adjustments but rather recurring such as acquisition-related amortization and costs. In 2018 and 2019, EPS was $5.05 and $4.31, respectively. Walgreens is guiding for a small increase in its adjusted EPS so it is fair to say that the P/E is around 8-9.5x, which seems rather cheap for such a track record and prospects ahead.

Recently, it also raised its annual dividend rate to $1.87 per share, resulting in a dividend yield of almost 5%. This marked the 45^th consecutive year of a dividend raise and the 87^th year a dividend has been paid! It seems the dividend is fairly supported by a free cash flow generation of more than $4 a share.

 

What’s next?

Walgreens has completed more than 1 million COVID-19 tests and also launched a program for businesses, so short-term we likely hear more about this. Priority will be placed on a successful turnaround of its UK business and the implementation of a large cost management program to save annual costs in excess of $2 billion by 2022. All in all, a nice long-term story at a very decent price coupled with a more than solid dividend yield.

 

Current Price

$38.04 per share

Hunting plc (LON: HTG)

Intro

Today, I’ll write about a special situation, which is not aimed for all investors – a good old net-net stock as defined by Benjamin Graham. Hunting plc is a British supplier to the oil and gas industry and hence has a highly cyclical business: Revenues more than doubled from 2016 to 2019 while EPS grew to almost £0.44 in 2019. After the sharp decline of the oil price at the beginning of 2020, revenue declined significantly and the stock price is down from more than £9 in May 2018 to approx. £1.4 at the moment.

Although the outlook is not rosy for the industry, it might still be worth to have a look at this company from a contrarian perspective, especially taking into consideration its solid balance sheet and its ability to weather also wild storms.

 

Valuation

A net-net stock is a company whose cash plus accounts receivable plus inventories minus all liabilities is higher than its market capitalisation. So let’s look at the H1 2020 figures (all numbers in £ million):

Cash: 50

Accounts receivables (current): 174

Inventories: 331

Total Liabilities: 139

=Net: £416 million

 

This amount divided by the total number of shares results in a net-net value (or liquidation value) of £2.5 per share. Comparing this value with the current share price, a discount of 45% can be calculated. Not including other assets on the balance sheets, such as property, plant or equipment, investments or tax assets, there should be a wide enough margin of safety.

In the first half of 2020, Hunting recorded a huge impairment of more than £170 million, of which £33 million was a mark down of its inventory. While additional impairments cannot be ruled out, companies typically try to avoid to have another impairment in the near future again and hence tend to be generous with the recorded impairment.

 

What’s next?

At the end of this month, Hunting will provide a trading update, where it will be crucial to see if Hunting’s sector has recovered at least to a certain degree. With current valuation though, this is a clear ‘balance sheet’ investment and prices above £2 should be reachable again as soon as the segment’s outlook will be improving.

 

Current Price

£1.4 per share

Update Massimo Zanetti Beverage Group (BIT: MZB)

Roughly three weeks ago, the chairman and CEO, Massimo Zanetti, who indirectly holds ~68% of the company made a voluntary offer to acquire all outstanding shares for a price of €5.00 per share. While this lifted the share price from below €4 to now €5, this still doesn’t come close to the fair value we assigned to the shares. However, since the offering party already owns the majority of the shares, it seems rather unlikely that either the deal falls through or that there will be an adjustment in the offering price.

When the first blog entry was made this January, it was expected that the opposite will happen: a further sell down of the majority stake to third party investors to turn this into a ‘real’, stock market listed company. Now they will become a fully private entity again.

On the bright side, there are still many great value plays in Europe where the sale proceeds can be allocated to. New stock ideas will follow in due course.

 

Current Price

€5.00 per share

BIC Group (EPA: BB)

Intro
Probably most people have used a product of this company, which produces ballpoint pens, lighters and razors. In 2019, BIC sold 31 million products every day and is either number one (for lighters) or number two (for shavers and stationery) in terms of market share. Total revenue was hovering around €2 billion p.a. with a free cash flow generation of approx. €200 million per year – as can be expected from a mature, solid firm with a long history.

The founder’s family still holds 45% of the shares (voting rights 61%) which guarantees a long-term vision and strategy.

Valuation
BIC has withdrawn its guidance for 2020, as many other companies as well, where it was initially guiding for a flat year. Historically, BIC earned around €5 per share and we may expect similar numbers after the current crisis will be over, which would result in a P/E of approx. 10x. Besides the attractive dividend (was set at €3.45 per share in the last years and reduced to €2.45 due to COVID-19), the company actively buys back shares for significant amounts in normal times. Cash flow will primarily be invested in either CAPEX or acquisitions, followed by paying dividends and share buy-backs.

The company shows a solid balance sheet (equity ratio above 60%) with a net cash position at the end of June.

What’s next?
Similar to other companies, a recovery should also be underway for BIC. With ongoing free cash flow generation, growth coming mainly from smaller acquisitions and fair shareholder remuneration, BIC’s current valuation seems to be attractive – a steady and “boring” company coupled with a strong market share and a long-term oriented owner structure, right up our alley!

Current Price
€50.30 per share

Altria Group (NYSE: MO)

Intro
Cigarettes? Who and why would anybody invest in cigarettes nowadays since everybody is aware of its possible health issues it can cause and hence the declining client base? Well, the tobacco industry has done an excellent job to more than compensate the declining customer base with price increases or substitutes. Altria, probably best known for its Marlboro cigarettes, has a very long history and is seeking to invest its high cash flows from the tobacco portfolio into other related trends such as the stakes in IQOS or JUUL. Besides, the company owns shares in ABInbev, the drink and brewing company, as well as a wine producer and cannabis firm.

Valuation
Altria’s share price dropped around 50% from almost $80 just three years ago. Does this make the company a bargain? Of course not, but let’s look at the earnings and balance sheet: The company has been generating consistent revenues of around $25 billion in the last years and, what’s more impressive, has been able to raise its operating income almost every year. COVID-19 only has had a minor effect on Altria whose net revenue in the first half year increased by 3.9% and adjusted EPS by 8.5% – very resilient numbers which show the low cyclicality of its underlying business.

If we do a quick and dirty valuation, taking an EBITDA of $10 billion, a multiple of 12x and add the equity investments of $22 billion (as shown on the balance sheet at the end of June), enterprise value stands at $154 billion. From this, we subtract net debt of $24 billion to derive an equity value of $130 billion which we divide by the number of shares outstanding of approx. 1.86 billion and calculate a value per share of almost $70. This is just a back of the envelope calculation but may indicate the attractiveness of the current share price.

Adjusted EPS has been hovering above $4 and therefore shares are trading at an attractive ~10x P/E ratio. Due to the low amount of capital investments, free cash flow generation is huge and decent dividends of currently annualized $3.44 are being paid (more than 8% dividend yield!).

What's next?
Many institutional investors and funds have reassessed its investment criteria and a large part of these investors are much more cautious in what businesses they invest in – needless to say that the highly addictive tobacco business does not check their boxes. Some of them may have been forced to sell shares in this industry and thus created an opportunity for investors not adhering to these strict guidelines.

With an unbelievable track record of 55 dividend increases in the last 51 years, Altria should also be able to produce solid results for its shareholders in the next years be this from the tobacco business and its complementary assets.

Current Price
$42.17 per share

The Swatch Group Ltd (SWX: UHRN)

Intro

Having written about a few smaller companies recently, this blog entry talks about a major firm – a Swiss blue chip. Swatch is the number one producer of watches in the world and produces nearly all of the components for its 18 watch brands in house. The brands include names in different price segments such as Harry Winston, Swatch, Breguet, Omega, Longines and Rado.

Some uncertainty in Hong Kong (political turmoil, protests), the spreading of a new virus (COVID-19), provisional measures adopted by the Competition Commission and possible risk of smartwatches have weighted heavily on the stock price, which trades on the lowest levels since 2009 – albeit the operational performance has been very acceptable.

Valuation

In the last four years, Swatch was able to increase its sales from CHF 7.5 billion to more than CHF 8.2 billion; operating profit (margins between 10.7-13.6%) and net income have seen even bigger boosts. For 2019, net income is around CHF 750 million, which reflects a currently depressed P/E of approx. 14x.

The balance sheet is just pristine: as of 2019, Swatch shows financial debt of only CHF 120 million, while total assets are worth more than CHF 13.6 billion. It is fair to say that this company would be in a position to absorb a potential market downturn easily, even for an extended time horizon. Buying a pretty much debt free company like Swatch at a P/B of 0.93x with a long term track record is rather cheap and provides a fair margin of safety.

What’s next?

For 2020, Swatch initially expected healthy growth in all markets in local currency, except in Hong Kong – we’ll see if that is still possible after COVID-19. Many things are quite negative when looking at Swatch at the moment – as always, times will change and Swatch will still be around to hopefully receive the full valuation as it deserves.

Current Price

CHF 40.16 per registered share

Alaris Royalty Corp. (Debenture Symbol: AD.DB)

Intro

This entry constitutes a novelty – so far, all entries have been about a specific stock, while this post is about an attractively priced bond with an excellent risk reward situation (and why not profit from it?). The Canadian company that issued this bond is Alaris Royalty, a highly diversified royalty firm with the majority of its assets in the US. Alaris’ business model is to advance money to companies and in return receives a percentage of the investees revenues – in other words, Alaris sits in the capital structure between the equity holders and banks, a form of hybrid capital. Hence, companies requiring money usually have one of the following needs: growth capital, partial liquidity, recapitalisation or for a management buyout (MBO). Alaris has been public since 2008 and currently holds royalty interests in 16 partners.

 

Valuation

Alaris is only as strong as the weakest link in the chain, its royalty partners – if they are able to make their royalty payments to Alaris then Alaris will do fine and generates a significant amount of cash flow. However, by having a meaningful portfolio, sooner or later some of the investees will face difficulties; the crucial thing is to make sure the losses and gains will balance out within the broad portfolio. Looking at the balance sheet as of end of March, Alaris has total investments (its royalty investments) of approx. C$740 million and cash as well as promissory notes of around C$50 million. On the other side of the balance sheet, the liabilities, loans amount to roughly C$150 million and the aforementioned bond is with C$92 million in the books. As a result, assets are close to C$800 million while interest-bearing liabilities amount to C$242 million – at least as of March a wide margin of safety.

By now, you may ask yourself: what is this bond exactly? The Alaris bond is actually a subordinated convertible debenture that pays annual interest at 5.50%, can currently be bought at 85% and will be repaid at 100% in June 2024. This translates into a yield of approx. 10.1% p.a. – not too shabby in the current interest rate environment. As always though, the devil is in the detail: The bond is subordinated, meaning if Alaris goes belly up, proceeds will be received ahead of the shareholders but after other loans and borrowings are fully paid back. Furthermore, according to its prospectus, Alaris can choose to repay the bond with its own shares, at the then prevailing price and a discount of 5%. In short, if worst comes to worst, bondholders might end up as shareholders – a scenario the company and the bondholders want to avoid under any circumstances and as of now only has a low probability.

What’s next?

Luckily, Alaris sold its biggest investment ‘Sales Benchmark Index SBI’ in February 2020 for roughly US$91 million and its proceeds were used to repay its credit line. It is evident that the timing was superb, and a potential later sale would have resulted in lower proceeds. From a total portfolio point of view, Q1 2020 was still alright and most partners showed sufficient coverage ratios. It won’t come as a surprise though, that Q2 will look much worse and that Alaris might have to either postpone or even waive some of the royalty payments from its partners, followed by potential write offs of some of its investments. However, this shouldn’t worry bondholders yet and Alaris still has a lot of wiggle room in case it needs to preserve liquidity, be this either through the complete suspension of the dividend or making use of further drawings of its credit line.

Current Price

C$85.00 (i.e. 85%), listed on the Toronto Stock Exchange under symbol ‘AD.DB’