Saturday, May 26, 2012

An asset and earnings discount for Nexeya

Sometimes it's easy to start off by answering the question why is this stock cheap?  Often a stock will have a story for its cheapness that requires a leap of faith on the part of the investor.  Other times a stock may fall out of favor due to neglect or fear.  Sometimes a company just fails to execute well, sentiment shifts and the stock begins to trade at a low valuation, that's the story of Nexeya.

Who is Nexeya?

If you go to Nexeya's website you're met with the generic business-speak answer of "NEXEYA combines the design, realization and support of most advanced electronic products and provides high value services."  I don't think I could have written a sentence that said nothing better than Nexeya's marketing department did.  Their description is like a horoscope, you could probably slap that little message on most company's websites and it would apply.

So let me try to craft a better description, Nexeya is a vertically integrated French technology firm that produces specialized equipment for the military and aviation markets.  They design, build, test and integrate their products with complex existing systems that require precision.  Nexeya is the type of company you contract with if you want to design and build a satellite, or a military software system.

The company began in 1997 and has slowly grown organically and through acquisitions.  They acquire small companies that are what most would consider "bolt-on" acquisitions.  This means the company has a nice slug of goodwill on the balance sheet, something a lot of value investors detest, but not necessarily a bad thing.

For American investors the best comparison I can make is that Nexeya is like an integrated defense manufacturer such as General Dynamics or Northrup Gruman but on a much smaller scale.

Napkin thesis

Nexeya is clearly undervalued selling at a discount to both book value and earnings power.  The following points support this assertion:

  • The company is selling for €21m against working capital of €24.85m
  • Book value is €62m and tangible book value €21m
  • EV/EBIT of 3.57x
  • EV/FCF of 3.77x
  • P/E of 5x, P/B of .37x
  • The stock yields 3.8%
  • Sales grew at 18.9% annually over the past seven years, profits grew by 23% annually over the same period.
  • The company has a debt to capital ratio of 30%

It's hard to imagine how a company could become this cheap, but it is, and there's a reason for it.  In the past semester the group's profits have dropped considerably due to problems in the mechanical and thermal systems group.  Sales fell off in those areas and the company expects to end the year flat, they made operational changes which they believe will resume the growth trajectory in 2012/2013.

So the company hits a bump in the road, the market seems to measure them on revenue growth and growth didn't slow, didn't stall, it fell.  For investors who fixated on this metric it was a sign to sell.  I'm not sure if missed expectations is enough of a reason for Nexeya's cheapness.  In the past I didn't put much weight to the idea that size and illiquidity could be a reason for a stocks discount.  I'm starting to slowly adopt the view, that those two factors do play a part.

Nexeya has a market cap of €23m where only 52% (€11.9m) is free floating and available for purchase by the public.  Couple that small float with the fact that the average volume is 5,000 shares (€29,000) daily and you have a stock most professionals wouldn't go near.  Maybe a small hedge fund, or a wealthy individual, but no major players are going to be buying Nexeya shares.

The two pillars of value

The idea behind the two pillars of value is that both the assets and earnings of a business give a reasonable valuation.  Earnings and asset values reinforce each other, it's always better to have both pillars supporting an IV calculation over just one pillar.  Both of these values work together to create a strong margin of safety.  It's preferable to have a margin of safety that exists both at the asset and earnings level.

Balance sheet

The first item an investor will see on Nexeya's balance sheet is Goodwill.  This isn't figurative they put that value at the absolute top, it currently stands at €40m.  Nexeya has a lot of great things going for it on it's balance sheet, great cash, little debt, but most people will get hung up on the goodwill, so I want to address it.

For a company that is a serial acquirer goodwill is going to naturally come as part of the package.  Some investors ignore goodwill or eliminate it from the balance sheet.  There's a reason it's there, Nexeya purchased something beyond some buildings that is real but not quite tangible.  The most important question to me isn't whether there goodwill, it's whether the is company earning a respectable return on the goodwill or not.  After all if Nexeya is acquiring companies for cash and debt and earning less than their cost of capital on these companies this is a value destroying investment.

Using my ROIC formula I come up with a TTM ROIC of 10.98% which is acceptable to me.  Just eyeballing a few other previous years the ROIC would actually have been a bit higher maybe in the 13% range.  I think it's clear Nexeya is using some of their goodwill whatever it is to generate a reasonable return.  Because of this I don't mind leaving it on the balance sheet and considering it part of book value.

So with that little discussion over Nexeya's book value stands at €15.73.  If you're uncomfortable with such a high figure you can lop off a 30% discount and it's still over €10 a share.  A side note, if I'm looking for a company to trade up to book value at some point I like to see if it ever traded at or above book value in the past.  The good news is that Nexeya traded above book back in 2007/2008.

Earnings power

Nexeya has been profitable every year over the past ten years with earnings ranging from €.62/sh on the low end to €1.48 on the high end.  Earnings have been steady, and steadily increasing so I don't think showing an average ten years EPS is unreasonable.  The company has a ten year EPS of €.77 which at a value destroying multiple of 8 is still above the current price.  The company has grown considerably and there's no reason to think they won't show some growth in the future.  The past four years earnings have been stable at an average of €1.23/sh.  A value destroying multiple of 8 on this is €9.88 a share.

I think a multiple of 8 is too low, but what do I know, apparently the market believes a multiple of 5 is preferable.  The market is viewing Nexeya as a company who's in decline and will be facing the bankruptcy judge soon.  I think the opposite is true, the same management who grew the company in the past is still in place, and I don't see any reason why they won't be able to execute at a similar level to the past.  If they can do that they should at least deserve to trade at the market multiple which is around 14.

Wrapping things up

If we put both pillars together there's an intrinsic value of something between €7.70 and €15 a share. That's a wide range, I think Nexeya has the ability to earn close to what they did over the past four years, and at a 10x that's in the €12 a share range.  In this case both earnings power and asset value support each other at €12-15 a share.  I don't know if Nexeya will ever trade above book value again, or close to their earning power, but I do know that buying at €5.80 gives me a wide margin of safety for something good to happen.

When I looked at Gevelot I took the two pillar approach as well but decided to walk away because Gevelot's earnings and margins were at an all time high.  Nexeya is different, their earnings are depressed and the two pillars are still supportive of a much higher value.  I decided to take a plunge this time and buy some shares.  Third quarter sales which were reported recently were up, so I'm hoping they've turned the corner and the market price will reflect that soon.

More info

If you've read this far you either have nothing else to do or you're actually interested in this company, interested enough to look further.  Here are some links that might help you:

Ticker: ALNEX.Paris
Website: English version (everything but the financial reports are in English)
2010/2011 annual report: link

Talk to Nate

Disclosure: Long Nexeya

8 comments:

  1. Very cool Nate thanks a lot. There are a lot of companies in france that are very depressed. One can definitely cite the obvious reasons but thankfully the equity market is quite active which leads to bargains such as these. The fact that the French are reluctant to speak english also makes bargains more likely. You should also have a look at Faiveley, which has a much higher market cap but also trades far below EPV. Well managed, high ROIC and cheap at 7x average PE.

    Reg

    Floris

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    Replies
    1. Floris,

      I agree, I was surprised at the state of French small caps. While everyone is looking in Portugal and Greece it seems that France actually has some of the best deals.

      I've noticed the reluctance for a lot of these companies to speak English which makes accessibility difficult for a lot of foreign investors. I don't see this changing anytime soon, so investors who want a piece of these small caps need to either learn how to read some French or use Google Translate.

      Thanks for the comment.

      Nate

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  2. Hello Nate
    Bought some shares last week and this week. I agree with your analysis - I thought that the reaction was excessive after the warning.

    This document from Nexeya decribes better what they do.
    http://www.nexeya.com/images/stories/site/investisseurs/publications/nexeya_plaquette_uk_2010.pdf

    Defense activities make up 28% of sales, and it's likely that there'll be budget cuts. However, the management in the 2011 annual report was not too worried, because a big part of the activity is maintenance and/or upgrading obsolete but vital electonic systems. Activity in civil aeronautics and railway security is good.

    One last point I'd like to make is that a possible risk is a public buyout at a low price, just as happened to me on LaCie this week. Especially when the free float is low.
    http://valueinvestingfrance.blogspot.fr/2012/05/lacie-lac.html

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  3. Great find, I am going to look into this one for the part of my portfolio that is in shares. For starters, with a valuation a PE of only 5x, one would have to assume that provider they don't go bust, the downside is surely pretty limited. On top of that, they could perhaps be a candidate themselves to be acquired, likely at a healthy premium?

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  4. Hi Nate,

    Very compelling. Great work!

    But I'm sitting on my hands at the moment. I'm concerned about a chaotic breakup of Euro which may cause the currency to depreciate quicker and deeper than the value in the company can be realised. I suppose one can hedge the currency risk via derivatives. But it's getting too complicated for me.

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  5. John,

    Thanks for the comment, I think a lot of people are waiting for things to get worse. In my view there's no way of knowing if the worst will happen. Back in 2009 I remember "experts" saying the market would be getting worse and bottoming at 300-400 (S&P). We never know how bad it'll be, but there seems to be some blood in the streets so I'm buying.

    You of course can hedge, I haven't hedged. I'm sure the Dollar's day in the trash heap is coming soon as well, we've just kicked the can far enough down the road we seem safe. I saw a compelling stat showing that for developed countries over 15 years currency movements almost totally equal out.

    The easiest hedge is to just buy a put on an EURAUD hedge (for yourself), US investors EURUSD.

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  6. Hi Nate,
    How were you able to decipher the financials? Can you read French....

    ReplyDelete
    Replies
    1. Hi,

      Yes, I can read French. You can also translate financials through something like Google Translate which will translate whole PDF's at a time. When investing in a country that speaks something other than English or French that's what I do.

      Delete