FRENZEL & HERZING VALUE INVESTMENT
Elekta AB: Short Company Intro

logoThis weeks post is an introduction of a (well known) Swedish company. After several guidance adjustments, the company has disappointed some investors and the share has dropped significantly; potentially by too far? We will try to give an overview of the business itself.

The Business

Sweden-based Elekta develops, manufactures, and distributes treatment planning systems for neurosurgery and radiotherapy, including stereotactic radiosurgery and brachytherapy. The company’s platforms and software are used in more than 6,000 hospitals globally. Its headquarters are located in Stockholm.

Elekta operates in 4 business areas and the operational segments listed beneath:

 unitsareas

regions

It is easily visible that Elekta operates in the Americas, Eurasia and Asia Pacific in about the same dimension. North and South America are the world’s largest market for radiation therapy: Elekta is the #1 in software and brachytherapy and #2 in the markets for linear accelerators (following Varian, controlling e.g. 70% of the US market). It is the market leader in the EMEA area with potential in the Middle East and some weakness in Russia. Asia Pacific offers the strongest opportunities for the company. Not only is Elekta the market leader, its growth potential in China is still remarkable.

Customers

Elekta’s customers for its oncology and neurosurgery solutions are over 6000 hospitals worldwide, primarily public care providers, but also a growing portion of private care providers specializing in radio therapy. Elekta also trains its customers in using their products and includes their feedback in their R&D process.
The company has recently invested in salesforce.com which is known for its customer relationship management program, providing detailed analysis of the sales force and accomplished deals, thereby curbing up efficiency in the sales process. Elekta sells mainly through its own sales organization which constitutes 17% of overall employees. The sources of revenue are: hardware, software and system sales (hardware + software). Sales often stem from ongoing service contracts. A large and very important part of Elekta’s business model is its services sector (35% of employees). Its primary purpose is to maintain and develop equipment and software installed in clinics. This includes the prevention of downtime and the increase of customer efficiency. The former makes Elekta’s running service especially crucial to customers. Elekta uses these relationships to sell accessories, upgrades, more services and new systems. Services are organized globally (about 700 employees).

 

Competition and Moat

The nature of competition differs in the various operating areas. The most important competitor globally is Varian Medical Systems (NYSE:VAR). It also manufactures medical devices and software for treating cancer and other medical conditions with radiotherapy, radiosurgery, proton therapy and brachytherapy. As mentioned, it is very well established in the US market and takes up 70% of the radio therapy market share (50% of global RT market). For radiosurgery, Accuray (NASDAQ:ARAY) is another notable competitor, that develops, manufactures, sells and supports treatment solutions (radiosurgery, stereotactic body radiation therapy, intensity modulated radiation therapy, image guided radiation therapy and adaptive radiation therapy) and can therefore be considered a niche peer. For brachytherapy, competitors are Phillips (Pinnacle treatment planning tools, integrated photon, electron, stereotactic, brachytherapy, simulation, image fusion, IMRT options and most recently VMAT planning) and Raysearch (STO:RAY-B) (RayStation treatment planning platform). There is a greater variety of Hospital Information System (HIS) companies in the IT business, whereby cancer care is only one of many specialities. The business of radio therapy is highly protected by barriers of entry through intellectual property and technological know-how. As we have shown before, through services area that includes maintenance, switching costs are also massive. As a consequence, we have seen very strong consolidation in the sector. In the US market, Varian and Elekta have formed a stronghold protected by these barriers. When doing further research to compare the individual products (on the basis of personal experience reports given by MDs) it cannot be denied that the portfolios are very similar in nature.

 

Key Industry Drivers

Radiation therapy (RT) still lags behind the attractiveness of cancer drugs. Even though RT offers a cost-efficient way of fighting certain kinds of cancer, its side effects seem rare but consistent. This does not mean that improvements cannot be made in the future. Morningstar estimates that 95% of the world’s RT equipment installations will be provided by Varian and Elekta over the next decade, partly enabled by Siemens’ exit from the industry in 2012.

The company itself lists four levels on which its success will ultimately depend. The first is the research and development level with regard to all products, software and services. Especially on the IT level, solutions such as MOSAIQ have to be developed quickly. The second level is the sales and marketing level which can be argued is not as sophisticated as the R&D and less reliant on special individuals. The third level is the lifecycle management which plays into the services strategy. 45% of sales are made up by software and services and synergies are very valuable to the costumer on an efficiency bases and to Elekta on a recurring sales and growth basis. The fourth level of intrinsic growth is based on the success of the former three but also strategies like evidence-based medicine and training.

 

Economics

The emerging markets, particularly China could be a welcome customer. The Asia/Pacific marketplace could support up to 5’000 new linac (linear accelerator) installations, according to Morningstar.

In the USA, the Centers for Medicare/Medicaid Services (CMS), a federal US agency, control government funds spent on medical equipment. It is their decision which products will be paid for, but as long as Varian and Elekta offer the most suitable options, the situation should not be problematic. The increasing power of large hospital networks will have an impact on the choice of supplier. This could either turn out positively or negatively. Western Europe will depend on government’s decisions to increase RT support.

 

Cyclicality, Exposure to Recession

Obviously, the cancer treatment (and medical overall) appears as a sector that is almost immune to broad economic trends due to its importance to the patients. Cyclicality could merely stem from government decisions on health care spending resulting in periods where more new devices are employed or systems are updated. A change in recognized services on the side of the health insurer seems highly unlikely.

 

Potential Treats

While the US market seems to be a rather safe, and Europe (ex UK) at least stable, a visible threat is the aggressive competition in emerging markets. Customers have been declared to be more cost-conscious and therefore pushing competition and lowering margins. Forex depreciation in these markets is possible due to a strong US Dollar.

 

Management & Governance

Mr. Laurent Leksell is a SSE graduate. He is the founder of Elekta and the board chairman, owning 14,250,000 A-shares, 8,856,624 B-shares, 3,562,500 A-convertibles and 2,500,681 B-convertibles. He is the company’s largest shareholder. It is remarkable how much effort is put into explaining the corporate governance structures in the annual report. It shows a scheme of how the board and the auditor interact and lists the boards most important members with days of attendance in board meetings as well as their total compensation. Overall, the corporate governance report seems to be very transparent, but I do not have any opinions on the management yet.

votes

 

Conventional Valuations

• P/S lies at 1.82 compared to 2.88 for Varian and 1.52 for Accuray.
• P/B is at 3.11 compared to 5.50 for Varian and 5.58 for Accuray.
• Elekta trades at a P/E of 37.40 against P/E of 46.26 for RaySearch and 21.93 for Varian.
Earnings multiples are high due to the earnings decline while when focussing on other fundamentals, the company looks rather undervalued. However, this is of course just a quick glance.

Risks

One risk for Elekta is the change of the competitive landscape. Technical shifts occur as well as continuous improvements of industrial know-how. Constant development is crucial in this industry. In its risk report, it states: “The Company’s continued success is dependent on the ability to establish and maintain successful relationships with customers.” Elekta’s delivery of treatment equipment relies on customers’ readiness to receive the delivery at site. Depending on contractual payment terms a delay can result in postponed invoicing and also affect timing of revenue recognition. The Group’s credit risks are normally limited since customer operations are, to a large extent, financed either directly or indirectly by public funds.

 

Conclusion

Besides recognizing a potential opportunity after the recent downturn, we will restrain from a buying decision and further research because of:
1. The size of the company and strong analyst coverage
2. The complexity of the sector, especially R&D ambitions and needs
3. A competitive disadvantage towards more specialized agents in the market

 

We will have to learn much more about the sector and the industry in general to make better judgements. Also, this is not as easy to comprehend as Coca Cola, to be fair. The next two posts are going to make more precise conclusions; we have full valuations coming up, stay tuned.

 

Questions to the audience: What are your future expectations for Elekta? What is your guess for development of demand in China?

 

Enjoy your week!

Hello readers,
we are sorry for the recent slowdown in blogging activities which are mainly due to time constraints and restrictions on what we can and would like to publish, but the good news is that we will publish two new company analyses in the near future. As I’m recently working on quantitative value portfolios, their backtesting and possible improvements I would like to share two helpful ideas with you.
 
First: The use of the Piotroski-F score seems to increase the returns of nearly all quant portfolios.
 
Second: So called dual momentum seems to work as a protection against high absolute drawdowns
Both strategies are nicely described by Tim of the quant-investing blog.
 
Third: magicdiligence has written about the potential to increase the returns of Earning yield stocks by adding a FCF-Yield, which is on the first view quite similar but seems to effect the overall return positive.  According to the author, the earnings yield screening led to a better outcome (most of the times), as it accounts for minority interest effects, and “smooths out” lump sum businesses for a better idea of ongoing earnings power. Therefore the FCF-Yield is a good verification that the earnings are real earnings to the owner. If the Earnings Yield and FCF-Yield are widely divergent, perhaps the business isn’t as attractive as it initially appeared in the screener.

 

The fundooprofessor has written in interesting article the Coal CAPEX in India and who will benefit from it. As the next stock which will be presented will be a coal stock this was a good read, but it also helps to think about other input costs and their influence on the outcome of a company. The key takeaways are, that the Effects of low/high commodity prices are temporary and lead to big cycles in the producers earnings. But the real money is mad somewhere else: In the businesses which will benefit from this huge capex – businesses which facilitate the capex or benefit from that capex.

There are two different levels of companies:

  1. upstream (businesses that benefit from supplying goods and services to facilitate the capex that is coming) For example SMT Scharf (Where the CEO stepped down today)
  2. downstream (businesses that benefit from cheap energy – a cost benefit they will be able to retain because they have a moat).

What we are looking for are businesses which have very high energy costs, but when those costs go down they can retain a significant part of that benefit for themselves without suffering any loss of business volume or market share. Those two things — protection of business volume and market share — are terribly important. Examples for this are Coca-Cola, Starbucks, Apple etc.

 

Last but not least I would highlight the latest news from Banque Privée Edmond de Rothschild or from now on only Edmond de Rothschild S.A.. Recently they appointed a new Chief Risk Officer, Manuel Leuthold in the same time will step down from his position. Interestingly after the announcement the share price started to rise at, for BPE astonishingly high volumes. Today Rothschild is trading at 17.500 CHF and we are happily waiting for everything what comes next.

 

Have a good week!

 

Dear followers,

the time has come again for our weekly link collection. This time featuring an enlightening article on management compensation, how Charlie Munger picks stocks, seven patterns of inefficiency when pricing a business, some thoughts from the Brooklyn Investor and an ‘Economist’ comment on John Nash’s nobel price 1994, in remembrance of his great life that ended three days ago.

nash

We will be back shortly with our latest investment story. Stay tuned and enjoy your week!

Welcome to a further piece of our ‘Value Essentials’ series. ‘Financial Shenanigans’ is written by Howard M. Schilit, PhD, CPA and Jeremy Perler, CFA, CPA. It presents an empirical journey through many accounting tricks in an entertaining way while teaching its readers what to look for when analyzing balance sheets. This blog post is by no means a summary of all the facts given in the book. It is merely meant to give you an idea and remind you of the key lessons. I would highly recommend reading it as soon as possible, as it is also part of our recommended reading list that you find on our website. After all, there are passages that show the recklessness of managers and the absurdity of huge frauds (that have stayed unnoticed for decades) which makes the reading experience quite joyful.

 

financial shenanigans  

NOTE: In this post we directly quote the book. If you find this interesting, please consider buying it (e.g. via this link).

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  • Competition
  • Other receivables
  • Trade
  • METKA 1
  • Metka 2
  • Metka4
  • Metka 3
  • Aggreko
  • MENA
  • Engery deamand per capita
  • Evolution of the Energy mix
  • Margin Development
  • Development of ROCE and ROE
  • Net Sales By Region

Today we would like to present you METKA, which is probably one of the cheapest stocks in the world. Before we start with actual valuation, we provide an executive summary as this is a rather long post. Afterwards we would like to highlight the history of this over 50 year old company.

 

1. Executive summary

 

The share price is € 8.60. The company was founded in the year of 1964 in Volos Greece and was floated in 1973. In 2008 METKA’s share price hit a high of € 17,50 and slumped in the aftermath of the financial crisis to a share price level of around € 5.50. Since 1999 the Mytilineos Group owns 50.4% of Metka. Ioannis (current CEO of METKA) and his brother Evangelos Mytilineaos together own 31.8% of Mytilineos Group, split almost evenly.

 

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Dear followers,

first of all, we want to wish happy easter to all of those who celebrate! As you know, we share some useful reading from time to time. These are some easter eggs that we think you might like:

 

 

I want to close this entry with some thoughts about chosing business partners. Here is a short quote from “The Ides of March”, a movie from 2011.

 

There is only one thing that I value in this world, Steven, and that’s loyalty. And without it, you are nothing. You have no one. And in politics? It’s the only currency you can count on. That’s why I let you go. Not because you’re not good enough, not because I don’t like you. But I value trust over skill.

 

I think that in business life, there are lots of situations in which you have to be certain you can rely on your peers and I have always spent time getting to know the great people I deal with. Charlie Munger found his own words for this:

 

 Choose clients as you would friends.

 

Some time ago, I heard a talk about by Kent Hahne, the founder of several international food chains (Vapiano, L’Osteria et al). He was very clear about the importance of shared values and friendship in business. For him, it was the ‘key ingredient’. I have to add that I absolutely agree on his thoughts. I hope that I continue to be as lucky as I have been so far when encountering partners, as loyalty is crucial for any long term business relation. Finally, we want to thank all the subscribers that have stayed with us so far. Let’s keep the discussion alive. Happy Easter!

After the success of our last presentation one year ago we are happy to announce two upcoming presentations about value Investing. The first will be held by us at the 23.02.2015 19.30 on the EBS Campus in Oestrich-Winkel in room N3 the presentation will be presented in german and will deal with an introduction to Value Investing and two case studies. The Case studies will be interactive and contain a long pitch which we have not yet presented on the blog. The second will take place on Monday the 09.03.2015 18.30 in N3 and is presented by Frank Fischer of Shareholder Value Management AG eg. Frankfurter Aktienfonds für Stiftungen and is held in english. The topic of this presentation is Value Investing in Crises. You are kindly invited two both presentations but as place is scarce you have to quickly fill out the form below with you name and the number of guest first so that we can plan. We would be glad to host many visitors.

 

ebs

 

Please enter your name into this form to join: http://goo.gl/forms/RyiZmAbqnk Thanks.

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Higher Frequencies: Chicago Board of Trade Futures Market

Avoiding the buzz: Low liquidity beats the market

 

One aspect or explanation why Value works is the low trading volume which is often typical for companies in which we invest. A new paper by Roger Ibbotson and Thomas Idzorek, Roger Ibbotson is a partner at Zebra Capital Management and finance professor at Yale and Tom Idzorek is head of investment methodology and economic research at Morningstar, in the Journal of Portfolio Management which analysed 40 years of stock returns by putting them into a perspective to the average trading volume of the last year.  The Paper finds, stocks in the least popular quartile outperformed those in the most popular segment by seven percent. In their paper “Dimensions of Popularity,” Ibbotson and Idzorek identify the most common market premiums and anomalies, such as:

  • Small cap—Smaller capitalization stocks outperform larger capitalization stocks
  • Valuation—Value companies beat growth companies
  • Liquidity—Less liquid stocks beat those with more liquidity
  • Momentum—Stocks trending up will continue to trend up

Because the risk-return framework does not explain all these premiums and anomalies seen in the market, the researchers propose the unifying “theory of popularity.” The authors explain that the most common market premiums and anomalies are associated with a stock’s popularity or unpopularity. For example, if investors “vote with their dollars,” small cap companies have gotten fewer votes. Value companies commonly have something wrong with them, which makes them unpopular.

 

If an asset has characteristics that investors really dislike, such as low liquidity, little name recognition, or high volatility, its price will be lower and therefore its expected future returns will be higher, all other things being equal. According to the theory of popularity, if an investor were to rank stocks by popularity, he or she could buy a basket of unpopular stocks and systematically rebalance as the stocks become more popular by buying a new portfolio of relatively less popular stocks. As some of the stocks in the portfolio become more popular over time, they become more valuable and the investor will see appreciation. This cycle happens normally in Deep Value situations where trends tend to revert to the mean.

 

“Risk has become a catch-all for all of the attributes that investors do not like, but riskiness does not explain all the anomalies we see in the market. Value premiums are a perfect example. Stocks with low market-to-book ratios or low price-earnings ratios are not necessarily more volatile or less liquid, but we know that over time value stocks beat growth stocks. We need a new model for explaining investment performance that goes beyond risk and return. Popularity may be a better lens through which to view investment behavior,” Ibbotson said. “Many of the well-known market premiums are associated with unpopular stocks. Unpopular stocks tend to be smaller, less liquid, and perceived as lacking growth potential. These stocks, with their low relative prices, may offer investors better future performance as they move along the spectrum toward popularity.”

 

Have a good week.

Recently BPER announced a change in the CEO position of the Group and the CHF jumped after the Swiss National Bank abandoned the CHF/EUR exchange rate of 1,20. Ariane de Rothschild will replace Christoph de Backer, which served BPER for three years, on the 31.01.2015. You can read the full press statement here. You can find our initial analysis here which we think is still intact despite the fact, that the new exchange rate possible decreases the Net Profit a little bit.

Ariane_de_Rothschild

Christoph de Backer was the head behind the ongoing transformation and strategic repositioning of BPER. As we have read some rumors in the newspaper, this transaction has not pleased everybody and some older employees have left the group. The change was quiet surprising for us and we already observed some recent changes in the last years and months which are probably a result of the coming change. For example a new position of a Deputy CEO was created and Sabine Rabald, who worked for the Group nearly 20 years, was announced to serve in this role. But If you read the annual statements of the past years the change is not that surprising as it looks at first. Benjamine de Rothschild mentioned several times that the lead of the group will be taken over by a women in the foreseeable future. As Ariane de Rothschild already served in different banks in New York and Paris and has an education which is focused on finance we  see the change not as a negative step towards the future.

 

Lately the Group announced the acquisition of an extra stack in OROX Asset Management which should strengthen the Property Funds business of Rothschild. The overall stack is now at 82% and the purchase price was not disclosed.

 

In our view the semiannual result of the group was quiet satisfying, the business profit which is the best proxy for the ongoing operations rose by 32,4 %. Sadly this growth was not seen in the Net Profit of the Group which dropped by 18,8% for the half year, due to the result in the extraordinary income, which was quiet high last year. The total Assets under Management in the Group rose slightly by 1% in the half year. This is not really impressive but is explainable with the sale of non-core businesses in Italy. The like-for-like AUM rose by 4%; way more in line with our expectations of the groups’ expansion into Asia. The Tier I ratio remained unchanged on 36,9% under Basel III which is a really comfortable buffer.

This year was the year with my lowest portfolio return which was till 1.12.2014 6.21% after taxes and trading costs including an average cash level of 27.8%, the final result with volatility will be send to me on the 17th of January, but I don’t think that there will be a big difference in the results. This is my weakest performance since the real start of my trading history in the year of 2008.

 

As we cannot and will not discuss our Portfolio Holdings in public we have to speak about the things which were related to the performance. In my opinion we made two major mistakes. First of all, time management. We spend a lot of our time on legal issues related to the German regulation (which did not really take us ahead). This time was missing for good analysis work to evaluate companies. But this is the price that you have to pay if you try to achieve everything on your own.
 

Second, we made fundamental mistakes like the one with Vetropack and with it and our due to our legal structure the mistake of dead money. If a company cannot achieve any growth at all the time plays against you and it doesn’t matter which price you pay. This is something which I learned over the last year and where I would like to give you a short excerpt and math example out of a presentation of RV-Capital:

 

“Whether appropriate or not, the term ‘value investing’ is widely used. Typically, it connotes the purchase of stocks having attributes such as a low ratio of price to book value, a low price-earnings ratio, or a high dividend yield. Unfortunately, such characteristics, even if they appear in combination, are far from determinative as to whether an investor is indeed buying something for what it is worth and is therefore truly operating on the principle of obtaining value in his investments. Correspondingly, opposite characteristics – a high ratio of price to book value, a high price-earnings ratio, a low dividend yield – are in no way inconsistent with a ‘value’ purchase.” Berkshire Hathaway 1992 Annual Report

 

The math example to it:

 

  1. If you buy a business with no growth and 2% cost inflation for a EV/EBIT 10 in T0 you end up paying an equivalent of EV/EBIT 38.7 in T4.
  2. If you buy a business with no growth and no cost inflation you end up with the same EV/EBIT of 10 in 4 years. (Example: Vetropack)
  3. If you buy a business with 5% growth and no operating leverage, you pay an EV/EBIT of 7.8 4 years from now
  4. If you buy a business with 5% growth and operating leverage, you only pay EV/EBIT of 5.4 4 years from now which is clearly a bargain.
  5. If you take company 4 and add pricing power to this equation you end up with an EV/EBIT of 3.2 in 4 years.

So you can see on this easy example: growth matters

“• Focus on the multiple relative to the business and not the absolute
multiple
• At nearly all times, the great business will trade on a higher multiple
than the value business
• For the truly long-term investor, the great business (properly
analyzed) beats all other businesses at almost any price.
• There is a time horizon arbitrage in great businesses trading at high
multiples
• It is perfectly valid to invest in non-great businesses, but be sure to
pay a lower relative multiple
• Longevity of growth is far more important than the rate of growth” RV Capital

 

Furthermore I learned that in investing similar to my favorite sport climbing, it is all about a good fail protection. That is also a reason for the quiet low portfolio transaction and high cash amount. We have only 5 companies from our first goal of 10-12. furthermore I would like to highlight the importance of a defensive thinking and aggressive acting. What do I mean with this? In my opinion it’s about understanding second, third and more level of influence and the time horizon which it takes to affect the underlying stock price. An example can be seen in the Oil and Gas industry where a low oil price isn’t that bad in the short term. But if the oil price stays low for a longer time horizon, like half a year or longer, Oil companies cut back production and CAPEX. As detailed budgets are normally made on a yearly basis and up to 5 years in for big projects, it takes some time till the CAPEX directly influence the earnings of companies which are related to exploration.
 

Furthermore it takes even longer to feel this influence for companies which are not directly related to the exploration. This has led some investors into paying peak earnings for a cyclical company.  Observation has tought us that many losses for investors came from the purchase of low quality companies at time of favorable business conditions. This only means that purchasers view the current good earnings as equivalent of the EPV of the company and assume that prosperity is a synonym for safety. But this is often not the case.
 

Personally 2014 was challenging for both of us: Felix was able to finish his internship, receive good grades in university and lastly score a nearly perfect GMAT score, which he needs for his further studies. For me it was all about finishing my Master, doing the CFA research challenge and the first level of the CFA.
 

In 2015, Felix is hopefully about to enter one of the top universities abroad and to improve as a value investor; the only thing that’s left of my studies is my Master Thesis which I will start in the next couple of days and the level 2 of the CFA which I hope to pass in June. Furthermore I would like to correct some mistakes in my analytical thinking to become a better value investor.
 

To sum it up: our main aim for 2015 is to get better in the evaluation of the value of growth, spend more time on companies and be more rigorous in our selection of companies which enter our portfolio. And of cause the other necessary university stuff 😉