2013 ¿ The Great Irish Share Valuation Project (Part VIII)
Company: Greencore Group
Prior Post: Here (valuation, see here & here for commentary!)
Price: GBP 95.75p
Well, I guess my perspective on Greencore last year was horribly wrong…! I¿ve long considered GNC a distressed company, but the market clearly disagrees. So much so, the share price rallied almost 70% in the past year ¿ my price target (of GBP 32.5p) was certainly left choking in the dust! But if my distressed premise is correct ¿ and, objectively, I can¿t see how you¿d disagree with me ¿ this rally isn¿t so surprising. What…?! But companies like this are always a binary proposition ¿ they simply die, or they survive & maybe even thrive eventually. And if everybody still feels blithely happy about them, they present a temptingly cheap buy. Greencore¿s also a nice scary reminder of how dangerous shorting can be ¿ poor underlying fundamentals are often ignored far longer than you can take the pain¿
But it¿s 2013, let¿s try a fresh slate! I mean, what a stock ¿ look at the price chart, even finding equine DNA in their bolognese sauce doesn¿t appear to have scared the¿er, horses too much!? And they qualified for FTSE inclusion in Mar-2012, significantly broadening their potential shareholder base. Perhaps their Sep-2011 acquisition of Uniq plc is nicely bedded down now? And finally, there¿s perennial speculation GNC may be taken over by a private equity bidder, or a larger industry player. Fairly recent FY results look good: Revenues of GBP 1,162 mio were up +44% (reflecting the Uniq acquisition), but underlying growth was still up a decent +10%. This produced adjusted operating profit of GBP 71 mio, a 6.1% margin. Which led to a 71% jump in adjusted net earnings to GBP 49 mio, plus a 22% increase in adj. EPS to GBP 12.8p (a rights issue funded the Uniq deal). Net Debt of GBP 258 mio resulted in net debt:EBITDA leverage of less than 2.5 times.
All sounds great, but this completely ignores the (totally un-) exceptional charges being expensed every single year, the increasing levels of capex, the continuing & quixotic acquisition spree in the US (believe me, $200 mio of pro-forma US revenues does not make you a player there), and let¿s not forget the whopping GBP 116 mio net pension deficit. Again, this is a great reminder to focus on the cashflow statement, not the P&L, and certainly not the management commentary. Op FCF (operating free cashflow, inc. the usual un-exceptional charges) amounted to GBP 55 mio, an underlying margin of 4.8%. That¿s an improvement on last year, when I assumed a 4.3% margin, so I¿ll now bump my fair value Price/Sales multiple up to 0.4375.
But that¿s appropriate for a financially clean company, which GNC most definitely isn¿t…! Net interest expense was GBP 15.6 mio, which implies a rather alarming 3.5 times interest coverage (and net debt¿s increasing!). I look for 6.7 times coverage at a bare minimum (i.e. net interest¿s limited to 15% of Op FCF), so I need to impose a debt haircut of, say, GBP 149 mio (to reduce debt to an acceptable/sustainable level) on my valuation. I¿ll also deduct the pension deficit ¿ no acquirer would volunteer to take it on, unless they severely adjusted their acquisition price. After all that, somewhat astonishingly, I come up with a new valuation that¿s almost double last year¿s! But small changes in (larger) gross figures are often amplified in the resulting (smaller) net figure (take a look at GNC¿s pension on a gross basis ¿ bloody scary!). Which, of course, means GNC remains significantly over-valued.
The outcome here, as I¿ve mentioned, will be binary. Things might just chug along ¿ if only management laid off the capex & acquisitions, they¿d manage a decent debt pay-down schedule & steadily grow into their current valuation & prospects. Unfortunately, they probably won¿t ¿ a diet of acquisitions & rationalization (i.e. more exceptional charges) are a tempting way to keep the headline figures trotting along nicely. [And how many investors read past the results headlines anyway…?!] On the other hand, if things start to slip (or another nasty surprise rears up), sentiment & fundamentals could start to fall apart v quickly ¿ in which case, my target would likely prove hopelessly optimistic! [Another nasty reminder: Trade payables exceed receivables by GBP 176 mio! If GNC’s suppliers ever get nervous, this might present another huge funding issue].
Yes, I¿m the Greencore mule again¿just beat me!
Price Target: GBP 61.9p
See the Wexboy Blog for full post, links, etc.