Friday, August 17, 2012

A European net-net with a P/E of 2x and African upside

It's not often a stock like Conduril is found; they are almost the perfect value investment.  A P/E of 2x, a ROE of 14%, trading at 42% of NCAV, and they're exchange traded on the NYSE Euronext.  Of course the company isn't perfect, but what company is at this low of a valuation.  They are located in Portugal (half of my readers just closed their tabs), they do business in Africa (the other half leaves) and they're family owned (crickets).

Quick Thesis

Conduril is a family owned company that has operated profitably in Portugal and abroad for the last fifty years.  They're consistently ranked as one of the best companies in Portugal.  The following items just don't seem to fit a well renowned company:
  • Insanely cheap valuation
    • P/E 2x
    • EV/EBIT < 1x
    • P/B .25x
  • A return on equity of 14%
  • A NCAV of €47.24/sh
  • A consistently strong earning power, six year average EPS €11/sh
Background

Conduril (CDU.Portugal) is an engineering and construction firm located in Portugal.  The company is owned by the Martins family.  The family is related to the Amorim family which owns another Portuguese investment of mine.

The company bids for and supervises large scale engineering work such as hydroelectric dams in Africa, or the construction of new rail lines in Spain.  The projects can take years to complete and cost hundreds of millions of euros.

The company employes 2169 employees spread across Portugal, Spain, Angola, Mozambique, Botswanna, and Morocco.  The majority of Conduril's work is in Africa (67%) with the rest in Portugal and Spain (33%).  The company has long operated in Africa and is well known and respected in the area.

The company trades in Portugal and publishes their financials in English on their website.  The stock doesn't trade often, but there are a lot of shares available at the current price.

Conduril is the type of company I was thinking about when I read the book Africa The Ultimate Frontier Market.  They have European roots, some business in Europe but most of the company's operations are in Africa.  The shares are easy to purchase in Lisbon and don't require any crazy African bank accounts or brokerages.  The company is also subject to better regulation in Europe than Africa, yet at the same time is very exposed to African growth.  While Conduril isn't a pure African investment at 67% of their revenue they're most of the way there.  And being able to buy this African growth cheap is just a bonus.

What's the problem?

Conduril is clearly cheap, both on an earnings and asset basis.  One question I always like to ask is "why is the company cheap?"  Conduril has all of the obvious factors such as being located in an out of favor country, doing business in an emerging market, and having a large majority shareholder.  They're also somewhat illiquid and trade fairly infrequently.  Combined with all of these factors is the company's accounting is a little different than usual because they use percentage of completion to account for long running projects.  As a result receivables appear large and forboding, and operating cash flow doesn't always match net income year to year.  To make sense of this let's look at receivables first.

The best way to depict this is with the net-net template:


Conduril is a company with a €32m market cap, and an accounts receivable that's 8x the size of their market cap.  What's glaring is if this value is discounted NCAV drops from €47.24 down to €3.56.  The difference in those two values is the hope that the company can collect on their accounts receivable.

The receivables are a scary number, and it's easy to see a large number like this and walk away, but I think that would be passing judgement too quickly.  As I mentioned above the company does large scale construction projects that span multiple years.  Clients on large construction projects pay similar to how a homeowner pays a local contractor.  A deposit to start, a portion as some work is completed, and the rest upon completion.  Conduril gets paid in a similar manner.  The company uses percent of completion to account for revenue recognition as a project is underway.  This method attempts to match revenue with approximate costs through time.  Unbilled revenue is recorded as an account receivable, and likewise cash paid upfront but unbilled is recorded as a liability.  Conduril's statements are consistent with this sort of accounting, they have a large accounts receivable, and a fairly large "Advances from clients" liability.  As a project works towards completion the receivables will move to revenue and the cash advance liability will be reduced.

I looked at Conduril over a year ago, tried to get shares but was unsuccessful.  At the time the item that concerned me wasn't the receivables, it was the cash flow.  I wondered how could a company that earned €19m in accounting profits only have €3.5m in operating cash flow?  My failure to understand exactly how the company accounts for projects led me to think this was a company on the edge of a fiscal meltdown, or was run by shady operators.

The percentage of completion method of accounting captures an approximation of how costs and revenues might be spaced in a project, but it doesn't have any bearing on real world cash flows.  In Conduril's case their cash flow is lumpy, very lumpy.  Over the past six years they've had years where they brought in €98m in cash, and years where operating cash flow was only €1m.  Just looking at a single year can lead to incorrect conclusions.  Since Conduril is constructing and managing over multi-year intervals it's helpful to look at their cash flow on a longer term basis.

I want to thank a reader for assembling the following stats, we've been going back and forth on Conduril after I mentioned them in my Africa book review.  On a six year basis the company recorded net income of €121m and operating cash flow of €98m.  Cash flow is super charged in years when projects are completed, then much lower until the next completion.  This might make some investors uncomfortable, especially ones who love smooth trends, but Conduril's cash flow pattern is a byproduct of the industry they work in.


Catalysts

Everyone loves catalysts.  If I put the word catalyst in a headline I will have almost double the readers for a post.  It's silly, but it's true, supposedly patient value investors want some sure sign that value will be recognized in a short period of time before investing for the long haul (notice the irony).  No one wants to be told they need to wait six years before they realize their return, but it is possible.  I have no idea when value might be realized with Conduril, but there are two things that I find hopeful.

The first is in 2009 the company petitioned the CMVM (Portuguese regulator) to go private and were denied.  The company stated in their annual report they didn't see the benefit of being public.  It's unclear whether they might try again in the future. The company realizes they aren't deriving much of any benefit from being public and would prefer to be private.  Going private could result in a sizable premium paid for the outstanding public shares.

The second is the company mentions in their annual report that they have a 600€m backlog.  The company is expanding into the Cape Verde market and is expecting business to rapidly grow in Africa.  I'm not sure if this is necessarily a catalyst, but it's more of a sign the company expects business to remain strong.

Conclusion

Conduril isn't the type of company I'd concentrate a portfolio around, but they're almost too cheap to not own.  I find safety in the large discount to NCAV and the discount to earning power.  The company has a thriving African operation which could benefit from growth on the continent over the next decade.  This stock isn't going to give a fantastic return in the next six months or even in the next three years, but for the patient investor I don't think you can go wrong buying a piece of Conduril.


Disclosure: Long Conduril

15 comments:

  1. Nate, thank you for this interesting discovery. One of the things to keep in mind with companies that build infrastructure projects in emerging markets is the unbelievable level of corruption that companies need to engage in order to get the deals. This is a very slippery terrain they have to operate in. The risks are not only in the economics of each individual project but also on a reputational level as has been the case with Siemens for example. In the case of Conduril these risks seem to be priced in but I just wanted to mention that it needs to be point of consideration.
    Best,
    Robert

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  2. Genuinely cheap, this one. Thanks for the post.

    The odd thing about this business is how high the operating margins are even though the gross margins are what one would expect -- maybe it's the owner-operator effect.

    On a more general, more long-term point, African growth will benefit African financial institutions, Western consumer brands, and Chinese everything else. Best place to look for exposure is probably in African banks and insurance companies..



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  3. They are located in Portugal (half of my readers just closed their tabs), they do business in Africa (the other half leaves) and they're family owned (crickets).

    Some come for the investment analysis. As for me, I come for the free stand-up comedy hour.

    Good stuff!

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  4. as a portuguese I investigated about 6 months ago if my broker had the option available to buy those shares but there wasn't as such I didn't do a proper analysis and I gave up...

    construction sector is melting down in Portugal with very few companies surviving and in adition at the same time I heard about conduril being cheap I read in a portuguese newspaper that Edifer (belongs in 33% to conduril) was late in wages and had a major order canceled due to poor finantial conditions of Edifer and was near bankrupcy... then they have a big position in Angola but I also read that in Angola companies were having problems in being paid (not sure if it was related to Conduril or not)

    These red flags blew up my curiosity so i didn't check why my portuguese broker didn't have that stock... Maybe after re-reading here about conduril I'll do a proper analysis

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    1. Thanks for the comment, you're right construction on the Iberian peninsula is not ideal, and the company has mentioned being more aggressive in collecting quickly on receivables. If the project sponsors are paying slowly then Conduril is probably trying to delay payments to employees as well.

      This isn't a perfect investment, yet at this price even with problems I think it's cheap.

      I skimmed Edifer's annual report as well, they're a good comparison company to Conduril. I don't know how much the ownership of them means to Conduril, but if they went bankrupt it would be a a major concern.

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  5. Thanks for that interesting idea! I completely missed Conduril when I got through a list of portugese companies (see article on my blog). Surely because it didn't fit my criteria of a simple business. But the situation seems nevertheless worth a few hours of research, can't wait to read the annual report!

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    1. Thanks for the comment and the link to your post. I did the same thing as you and ended up looking at the same set of companies.

      I've found in Portugal all companies file English language annual reports with CMVM the regulator, but don't always have them in English on their website.

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    2. Nate, it's a bit embarrassing to ask. But were do I find the company reports on the CMVM page? I am searching for nearly an hour now... Would be very thankful for a hint ;-)

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    3. No problem!

      http://web3.cmvm.pt/english/sdi2004/emitentes/emit_cons.cfm?num_ent=%23%23%24K%5E%0A

      Here are the last few years annuals in English from their site:
      http://www.conduril.pt/en/grupoprestacaocontas.php

      Delete
  6. Seems very attractive, modulo potential caveat from the anonymous above.
    Is it possible to buy Conduril via Interactive Brokers? I can't
    find this stock in their database.

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    1. I don't think Interactive Brokers offers the stock, I use Fidelity as my broker, they offer Conduril, and I didn't have any problems trading it.

      Delete
  7. hi nate

    great write up. Did you actually get some shares ? I saw 2500 shares were traded on August 16th but I am never sure if those are real trades.

    A few other observations:

    - Conduril pays an OK dividend, 4.5% is Ok for waiting.
    - maybe its a coincidence but 2 of the largest shareholders do have the name Amorim. So you might check the family at some point in time as your other investment seems to be related to them as well.

    MMI

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    1. I did end up getting some shares. I've had the same thought as you, are those phantom volumes or real…

      I'd love a bigger dividend on this one, you're right 4.5% is pretty paltry.

      The Amorim family owns an enormous conglomerate in Portugal, what I've had trouble finding is if Amorim is a common name, like Smith in English. There are millions of Smith Something businesses but none are related.

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  8. I'm Portuguese and it's not an uncommon family name... Thanks for alerting me to this stock... Strangely the PEs in Bloomberg are not as low... I need to do more work and compare it to Mota-Engil which is the biggest listed peer in Portugal... Many thanks for your blog, you do great work here!

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  9. There is really something fishy about these cash inflows. Why are they so lumpy? And why is there no list in the Annual report about the projects they are working on, the contracted value, the estimated end date and on how much they already received?

    I checked the reports back to 2006. In 2008 they were able to cash in big time. But that was it. During all the other years they had to take on loans or spend cash to bridge the gap.

    If you look at the homepage, there seem to be many works.
    http://www.conduril.pt/en/obras.php
    So it is strange that payments are lumpy. Unless all the works are contracted out by one contractor like the Angolan Whatever Authority.

    There is one rather discomforting sentence on page 11 of the 2011 AR:
    "Notwithstanding the delay in payments by our clients and the increased limitations in access to credit, the Group’s performance was positive."

    To me it seems like this company is very dependent on Angola. Looking at human resources numbers for example. If Angola decides not to pay the outstanding invoices. Bad luck!

    Another thing: The Share price in Lisbon: Bid 5 Ask 22. This is an extremely big spread like I have never seen before.

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