Philip O'Sullivan's Market Musings

Financial analysis from Dublin, Ireland

Glanbia (GLB.I): Protein Power Ranger

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(In this blog I update one of my previous case studies, on Glanbia, following the release of its FY 2011 results yesterday).

 

Glanbia posted strong results yesterday, lifting the share price to what appears to be its highest close ever (€5.60).

 

While I admit that I regret selling my position ahead of the report, and as much as I admire the company, I’m not prepared to buy back in at these levels. However, were we to see a pullback from current levels, that could certainly change.

 

The group that is today known as Glanbia was established in 1997 following the merger of two Irish based co-operatives, Avonmore and Waterford. The merged entity chose the name Glanbia in 1999 – an amalgamation of the Irish words ‘bia’, meaning ‘food’, and ‘glan’, meaning ‘pure’. At the time the group was focused on basic commodity markets, specifically dairy and meat. Over time management has repositioned its Irish operations, divesting its meat business and concentrating on dairy, while it has embarked on a significant – and very profitable – international expansion over the past decade. I have previously written a more detailed piece on Glanbia’s operations and business strategy here .

 

In terms of where we are at today, there are three key strands to the group. Dairy Ireland ( 2011 revenue and EBITA €1.35bn and €57.8m, respectively ) was a major beneficiary of firmer international dairy prices in 2011, with these contributing about two-thirds of the impressive 19% revenue growth seen last year. This business exports its products throughout the world, and the removal of EU milk quotas in 2015 provides the group with significant opportunities to grow this unit, due to Ireland’s clear competitive advantage (grass-based dairy farming, moderate climate etc.) over many other countries, coupled with favourable longer-term demand from emerging markets.

 

The second major part of the group is US Cheese & Global Nutritionals ( 2011 revenue and EBITA €1.32bn and €122.2m, respectively ). This is the most exciting part of Glanbia’s operations, comprising a large cheese producing operation and a high margin nutrition business, whose best known brands are Optimum Nutrition and BSN. Both ON and BSN have very strong positions in the sports nutrition segments. As with Dairy Ireland, in this area Glanbia has both a competitive advantage and a structural growth opportunity. The competitive advantage lies in the fact that a major input into these nutrition supplements, whey, is a by-product of its cheese manufacturing processes . Having control over a reliable in-house supply of such a key input helps differentiate Glanbia from many of its competitors. The structural growth opportunity mentioned above is derived from rising demand for dairy and nutritional products from emerging markets. This division posted 35% revenue growth in 2011 , broken down as follows: price +14%, volume +10% and acquisition (BSN) +11%.

 

The third part of Glanbia’s operations is its international Joint Ventures & Associates ( 2011 revenue and EBITA €524m and €25m, respectively ). This comprises its Nutricima joint venture (with PZ Cussons) in Nigeria, its Glanbia Cheese joint venture (with Leprino), which is Europe’s largest supplier of mozzarella cheese, and the US-based Southwest Cheese, one of the largest cheese producers in the world (it has the capacity to process 3.8bn lbs of milk annually ). This area posted 30% revenue growth in 2011, broken down as follows: price +18% and volume +12%.

 

On Wednesday, the group reported very strong 2011 results , with the impressive revenue growth noted above contributing to a 22% increase in reported earnings per share. The market took heart from these numbers, with the shares adding 5.3% to close at €5.60 in Dublin yesterday. Data compiled by Sharewatch show that the share price has increased by 31% over the past year.

 

While noting the recent strong operating performance and the clear structural drivers inherent in Glanbia’s business model, I can’t help but wonder if the shares have run too far.

 

I sold my holding in the company going into the results as the price surged above my previous estimated valuation for the group (€5.05) . While in hindsight the timing of my sale could have been better (!) my instinct is not to chase the group at these levels.

 

There are three main reasons for this – the first being the valuation. Management is guiding 5-7% earnings growth in 2012, and taking the mid-point of this and last night’s share price close puts the group on a prospective P/E of 11.4x. That’s only one part of the equation, though. The group exited 2011 with net debt of €480m and a pension deficit of €48.4m. Adding these to last night’s market cap puts the group on a trailing EV/EBITDA of just over 10x. In my opinion, that’s well outside of ‘cheap’ territory. My DCF valuation for the company, incorporating my revised forecasts and rolling forward the net debt to my estimated end-2012 level (€435m) produces a €5.30 valuation, some 5.4% below last night’s closing price.

 

The second reason why I wouldn’t be a buyer of Glanbia here is that 2012 is not going to see a repeat of 2011’s favourable conditions. As management yesterday noted : “We expect the operating environment in 2012 to be more challenging than in recent years. Current global economic uncertainty has the potential to impact global dairy markets and fragile consumer confidence.” Earnings growth is expected to be a far cry from last year’s 22% increase. While I don’t doubt that EPS momentum will pick up in the medium-to-longer term, I suspect the shares, much like the earnings momentum, could slow in the short term.

 

The third reason why I wouldn’t buy the stock at the current price is that I am nervous on how markets will perform in the near term now that the second LTRO is out of the way. History has shown that markets have gone easier after the removal of similar QE measures in Japan, the US, the UK and Euroland.

 

While my instinct is to play it cautious with Glanbia here, that isn’t to say that I wouldn’t buy back in if the shares pull lower from here. I like its structural growth drivers, and I see potential for further earnings-enhancing deals (management in today’s results presentation  make reference to a potential €150-200m nutritionals acquisition this year).

 

However, like one of the body builders who make up a chunky proportion of Glanbia’s sports nutrition customer base, I’m happy to sit back, make myself a protein shake and wait for a more attractive valuation point to arise before putting this stock back into my portfolio.

 

(This article previously appeared on Marketwatch)

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Written by Philip O'Sullivan

March 1, 2012 at 2:31 pm

Posted in Sector Focus

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