Value Ideas Blog
Update: Banque Privee Edmond de Rothschild

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 😉

In the first part of our analysis we explained the business model of Delticom; now we would like to give you and inside in its valuation. But before we begin with the number crunching we would like to start with a short summary of the key takeaways of our first part:

  1. Some other Value-Investors think that the problems of Delticom are only short-term issues: EBIT-Margins will bounce back to their old highs.
  2. Delticom has a really light business model: everything is outsourced to third party distributors.
  3. No use of purchase power: Delticom uses a fixed premium on the purchase price of every tire, sometimes it uses a flexible mark up to account for seasonality and inventory management.
  4. No customer captivity due to long purchase cycles of over 4 years.
  5. No lock-in of fitting shops.
  6. BBE-Study assumes that the online market share will reach 15% in 5 years, e.g. 2020. In an overall saturated market. (You can see the development of 2014 here)
  7. Bad strategic behavior in the acquisition of Tirendo and bad own brand strategy (The tires get really bad reviews.)
  8. Too high ROCE and ROIC even with small EBIT-Margins, which we will explain in the hereafter

What do we mean with too high ROCE and ROIC, and why is the biggest advantage of Delticom also its weakest spot?

Many other investors think that Delticom is able to return to its old EBIT-Margins, but we don’t think so. Why? The answer lies in the Business Model of Delticom which is extremely asset-light. As you can see in the chart below, the Capital Employed of Delticom is 7,1 % of 2013 Revenues, relatively low in comparison to other companies, but for Delticom itself higher than in the year of 2006 (6,6%) and virtually sky-rocketed from its low in the year of 2010 (0,9%) where Delticom also has shown its highest EBIT margin (11,1%).  The combination of high EBIT-Margins and low Capital Employed lead to an astonishing high ROCE of 276% in the year of 2010. Furthermore the ROCE was still high (51%) in 2013 where Delticom only had a EBIT-Margin of 3,6% and a Capital Employed of 7,1% of revenue. This high ROCE’s is also the reason why this business is so attractive for every competitor, if you cannot defend your turf with a big moat. As we don’t think that Delticom has a moat, we think that every time the EBIT-margins are high enough new competitor will enter the game.

  CE Delticom   So let’s come to our valuation of Delticom.

We have explained already that we don’t think Delticom has a moat and is a pure execution business only, so we use a discount rate of 10%. If we discount our Earning Power Value, assume an EBIT-Margin of 4% in the future and subtract the debt of Delticom we end up with a fair value of 16,62 EUR per share. This is not far away from our current trading price of around 17,5 EUR and is in our opinion quiet low  for an evaluation without any future growth.

 

Delticom was able to growth its revenues by 17,7% p.a. over the last five years. If we now assume a growth of 8,8% in average over the next 5 years (10% in 2015 declining to 7% in 2018) which we think is quiet conservative, we end up with an N-EPV of 28 EUR per Share in the year of 2018 or an IRR of 13,7%. (Capital allocation is assumed to be stable: 43% dividends, 3% growth CAPEX, 2% change in NWC and no share repurchases.) If you than use the Growth Multiple of Greenwald to calculate the Terminal Value with a 3% growth rate, you end up with an N-EPV of 37,92 EUR per Share at the end of the year of 2018. Which is equal to an IRR of 20,1%.

 

We also used the approach of total Market size as an approximation but where not really satisfied with this approach. Therefore the reasonable share price of Delticom should be around 30 EUR which gives you a nice little upside. But if we think in our 3 pillars Model, we end up with a fair or cheap price but with neither a beautiful business, nor a management we would like to be engaged with. (You can inform yourself here and take a look at the insider trading)

 We wish all of you a happy new year! Disclosure: No Position
    Today Hornbach announced that they consider changing the legal structure of the Holding into a KGaA. You can find the news here. The Baumarkt AG of which we are shareholders should not get affected by this considered change. This announcement happened shortly after the change of the CEO of the Group.   We don’t like above mentioned news due to the fact that the CEO has done a good work and that the change in the legal status to an KGaA can lead to a decrease of shareholder rights which we have already observed at STO KGaA SE (you can find our analysis here and here). But as we are not affected by the change of the legal status, no detailed information is yet available and because we think that this is only the first step to reach full controlled over the Baumarkt AG we stay long Hornbach Baumarkt AG.   Also, as you might have noticed, our posts have become a little less frequent recently. We apologize for this and promise improvement!  
Here is a list of our earlier investment analyses. It will be updated on a regular basis.  
3U Holding AG (Part 1) (Part 2) Analysis
Banque Privee Edmond de Rothschild S.A. (Part 1) Analysis
CARMAT S.A. (Part 1) Quick Check
Dangote Cement PLC (Part 1) Quick Check
Hornbach Baumarkt AG (Part 1)(Part 2) Analysis
Kabel Deutschland AG (Part 1) Analysis
Sto SE & CoKGaA (Part 1)(Part 2) Analysis
Vetropack Holding AG (Part 1)(Part 2)(Part 3) Analysis
A link can be found in the side bar menu.

First off, a quick note: Felix is working for an investment bank for a couple of weeks, so he will not be involved in the reporting on German stocks for that period.

Today I would like to present you, in this quick write up, the SMT Scharf AG – ISIN: DE0005751986. SMT Scharf was founded in the year of 1951 and is based in Hamm which lies in the old industrial and mining arear of Germany the so called “Ruhrpott”. SMT Scharf is listed on the German stock exchange since the year of 2008 and the first time I heard of it on a value investing conference was in the year 2012. The company and the investment case was presented by the guys of the Frankfurter Aktienfonds für Stiftungen. Since than the development of the share price looks like this:

 

SMT Scharf_hist_wallstreet_online_20090811_20140811

(Source: WallStreet:Online)

 

SMT Scharf is the world market leader for the production, installation and maintenance of underground rail-bound railway systems which are used in the hard coal mining business. Its market share in this segment is over 40%, you can find an interview with the CEO from the year 2013 here, the number of installed rialways is really interesting due to the fact that you can calculated the future service revenue with it.

Das Segment, das Scharf bedient, sind „Einschienenhängebahnen“ = „Monorails“, eine sehr spezialisierte und kleine Nische: Weltweit gibt es etwa 1200 bis 1400 Monorails, wovon etwa 530 von uns sind, daraus resultiert unser 40%-Marktanteil. Der Jahresumsatz in dem Segment sind etwa 250 neue Bahnen (100 Mio. EUR) und eben so viel Service, also ca. 200 Mio. EUR. Auch davon hat Scharf mit 77 Mio. fast 40%. [https://translate.google.com/]

You can find an older presentation for the EK-Forum here. A nice video about the product can be found here. read more
Since our last post some interesting things happened which we think are still not reflected in the share price of the Hornbach Baumarkt AG. Hornbach-Treppe   1. The representatives of Kingfisher, which had owned 25% of the common stocks of the holding and 5% of the Baumarkt shares have left the supervisory board and have sold the shares back to the family and the Baumarkt shares to institutional investors. Kingfisher is now entering the German market. But I think that was not the main reason why they sold their shares and here is a very good article of the FAZ over the reals reasons.   Kingfisher would like to target the “professional” market and not the retail sector. I think that Hornbach has a little stronger position in the professional market than in the retail sector, but in total we are not concerned about this development due to the fact that Kingfisher’s major markets are in UK and France. At the moment you can observe what happened to Tesco etc. when Aldi and Lidl entered the UK market due to the fact that the German retail market is one of the most brutal markets in the world; our players know how to play the game.   2. A few days ago Hornbach Baumarkt was announced to become a SDAX member, this will attract new investors for the share.   3. Hornbach announced incredibly good Q1 numbers. EBIT nearly doubled for the Baumarkt and same store sales increased by more than 15%, this development actually exceeds our own expectations and you can observe a really big “Schlecker effect”.   But a really interesting thing is the development and valuation gap between the holding and the Baumarkt shares. What you can observe is that the Holding nearly performed twice as good as the Baumarkt shares did. We think this is due to the fact that if a bigger fund would like to establish a position it prefers to buy into the more liquid Holding.   Hornbach   So what can be a potential catalyst to change this valuation gab? We heard some rumors from knowledgable persons that the midterm perspective of the Hornbach family, now after they solve the problem with Kingfisher, would like to merger the two companies back into one company with two different traded shares. This is a logical step for the family due to the fact that they can save the money and still hold the full control over the company. So in our opinion it is way better to hold the common shares of the Baumarkt like the family is doing it, because we think the bearer shares of the Holding AG will be switched to bearer shares in the Baumarkt AG. With this move the family will also increase the free float of the total company, with this Hornbach is a clear MDAX candidate and will enhance the stock price of the Baumarkt AG shares.   We think these facts, the development and the future potential show that our first target price of 41,2 € was quiet conservative and still implies an upside potential of around 25% for the Baumarkt Shares which would lead to the same performance which the Holding AG shares already showed. At the moment the operational performance of Hornbach also exceeds our best case scenario which results in a share price of around 50 €. All in all we are really happy with the outcome and we think that  the future which lies ahead of Hornbach is also bright.   Disclosure: Long Hornbach Baumarkt AG    
You can find a really good article about amazon and its business model and its long-term perspective in the latest economist, her is the link to the  “short” online version. About the, in our opinion, value trap of taxi medallions and potential value investment in the business behind it due to disruptive innovation such as uber, and the strategy behind BlaBlaCar etc. Related to this you can find an older business insider article about the death of Value Investing due to disruptive innovations. A really interesting article by Wexyboy about European Islamic Bank and the value of shareholder activism. For me even more interesting due to the fact that I have written my bachelor thesis about islamic finance in germany and the potential market size for one bank. Moatology explains you how to use stock screeners to find undervalued gems. A great post from oddballstocks over investing styles   Some thoughts about entrepreneurship and what it has to do with value investing:   The job of an entrepreneur is to figure out where opportunities lie, they do it by tinkering with the market, learning new capabilities and creating value. Normally entrepreneurs blend strategic thinking and opportunistic actions at different junctures and become more strategically focused on a small niche (a value investor would say circle of competence) throughout this process and progress in learning within age and career stage. This extensive planning helps the entrepreneur to spot gaps in the market or simpler opportunities to invest his time and money. Realizing an investment idea for both a product for an entrepreneur or an investment thesis for a value investor which is not seen by the market – usually means overcoming significant resistance by others. The more contrarian the idea is, the greater is the natural resistance and normally the payoff. Due to the fact that entrepreneurship and value investing are an iterative, messy and uncertain process, both require a lot of effort, time and hard work.   Entrepreneurship and Risk taking   Usually everyone seems to know: Higher return = higher risk. This is essentially what every economist will tell you, but is this really the truth? I don’t think so. If you talk to entrepreneurs you will hear that they are trying to reduce risk everywhere they can (this is also called risk mitigation). The main difficulty in creating value is that you have to go against the grain, by delivering something new to the market while creating a profit. This normally includes a high level of uncertainty in the process and the outcome of your venture. Often you have to kill your most loved ideas due to the fact that you cannot sell your product in sufficient quantities to make it worthwhile. For this reason the probability that an entrepreneur will succeed with one idea is by far less than 100%. If you see some outcomes by entrepreneurs and what they initially invest into the venture in terms of money and time you will observe that this is often not the case. And in my opinion it is the same with value investing, you have to overcome many hurdles with different percentages of success. So entrepreneurship and value investing are more like poker where you are faced with uncertain outcomes which are influenced by the player’s capabilities, it is an uncertain game with skill. The game depends to some extend on the luck of the draw, but how you play your hands over time is what creates the true champions. For this reason the capabilities of an entrepreneur or a value investor determine whether he or she sits down at the table and plays at all.   Have a great week  

Intro

  This blog post will take us to a continent which is not usually our investment ground. It’s a look on possibly one of the most profitable companies emerging in Africa. It is called ‘Dangote’ and founded by Alhaji Aliko Dangote, a Nigerian entrepreneur who, after studying Economics in Cairo, started importing rice, sugar and cement. Dangote is now the biggest cement manufacturer in Africa, but does also diversify into refining of salt, milling of flour, manufacturing of pasta, noodles and poly products, logistics and real estate. Since its establishment the company has grown rapidly by providing basic goods to the populace, a mission the management is particularly proud of. We will focus on the Dangote Cement.   dangote  

Dangote Cement

  First off, I will give you the financial highlights, values are in billion Nigerian Naira.  
2012 2013 % change
Revenue 298.4 386.2 +29.4
Cost of Sales (118.3) (142.5) +20.5
Gross Profit 180.2 243.7 +35.3
Gross margin 60.4 63.1
EBITDA 174.1 229.6 +31.9
EBITDA margin 58.3 59.5
EBIT 146.5 195.9 +33.7
EBIT margin 49.1 50.7
Net interest (10.8) (5.1) (52.8)
Profit before tax 135.6 190.7 +40.6
  Recent reports: http://dangote.com/downloads/Dangote-Cement-Q1-2014-results.pdf, http://dangote.com/downloads/Dangote-Cement-2013-Presentation.pdf   The first annotation that needs to be made is that inflation in Nigeria is momentarily 7.9 percent, down from 8.5 in 2012. While it has an average GDP growth of 6.7 percent, (developing) Sub-Saharan Africa is at about 4.3 percent growth per year in average. Still this company outruns the economy and inflation significantly. That is due to several reasons.  

Built his house on the Rock

  The keys to success for the cement giant seem to be in my mind:
  • Clear leadership position in sub-Saharan Africa’s largest and most profitable market (62% market share, and going), enabling it to create immense brand value while facing increasing construction in the future
  • A government ban on cement imports in Nigeria, creating an oligopoly with strong pricing power
  • A 5 year tax exemption for each production plant due to the award of an entrepreneurial status from the government, in the chairman’s letter, he seems to thank the government personally for their great assistance
  • Immunity to macroeconomic shocks like recent flooding that might underpin demand in the long term while 65.2% equity prevent financial distress
  dangote2dangote3   read more
After I spend a week in Omaha to attend a German value investor conference and the show of Buffett and Munger, we have a couple of more ideas to work on and even more valuable readings. Overall I can say that this week was a unique experience and I have to be deeply grateful to the organisations of the event and particularly to two persons from which I learned the most and have such a great personality. The two guys I owe so much are  M&MMI, thank you guys for all the lessons which you have taught me.   Created with Nokia Smart Cam   I bought Berkshire Hathaway`s letters to shareholders from 1965-2013  for 12 Dollar in a book form, which is a pure bargain for a guy who does not like to read so much on a screen. I will try to summarize them all (after I have finished my studies) and upload them.   Furthermore I`d like to highlight the book “Dream big” which was highlighted by Warren Buffett at the end of the Meeting. You can read a summary here.   You can read the notes of the Meeting here, I would like to highlight WBs answer to the Cost of Capital.   Additionally I would recommend the lessons of failure from the really good moatology blog. As a person who admits to have failed a couple times I can recommend to use such an approach.   Due to the fact that I like entrepreneurship and like to spend my leisure time on edx courses I only can recommend to read about entrepreneurship, strategy  and learn something new in an edx online course! And last but not least I have learned how important a franchise is, so go out and lean-to account for it! (We will try it as well)   And always keep in mind that the intelligent investor estimates likely returns, and invests if the returns are worth the risk.  Most profitable investing takes an uncomfortable view versus the consensus, and buys when the market offers good deals.  If there are no good deals, profitable investing sits on cash, and waits for a better day. Have a great week!