Philip O'Sullivan's Market Musings

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Market Musings 19/9/2012

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It’s been a busy couple of days on the newsflow front, with a lot of the Irish smallcap exploration names prominent in this regard. Let’s round up on what has been happening since my last update.

 

To kick off with the energy sector, Kentz was awarded a $50m shutdown services and operations support contract by Exxon in Sakhalin, far-east Russia.

 

 

(Disclaimer: I am a shareholder in PetroNeft plc) Siberian oil producer PetroNeft released a reassuring update this morning, which revealed that output is steady at 2,000 barrels of oil per day, while early results from the Arbuzovskoye well 101, the first of ten planned new production wells on the Arbuzovskoye oil field, are encouraging. We should see a marked pick-up in newsflow from this stock over the coming months as the Arbuzovskoye campaign gathers momentum.

 

Elsewhere, Petrel Resources announced a “new start” in Iraq, with a new team in place that will “work with national and regional authorities in Iraq to identify projects in which Petrel can be involved”.

 

Providence Resources provided an update on its Rathlin Basin acreage. While this project is very much at an early stage, the company has identified a number of anomalies that it will now focus on evaluating.

 

In other resources related news, there was an interesting backward integration move by Samsung, which has invested in a gold mine in exchange for getting a cut of the output. This follows Delta Air Line’s recent purchase of an oil refinery, and may mark a shift by companies to ensure greater security of supply of key inputs and/or margin capture by buying key suppliers.

 

(Disclaimer: I am a shareholder in Smurfit Kappa Group plc) There was further M&A activity in the European packaging sector, with Mondi acquiring Duropack’s German and Czech operations for €125m. This is extremely welcome on two counts. Firstly, the European packaging sector has traditionally suffered from overcapacity and volatile pricing, but as I have previously noted, in recent times there has been a wave of consolidation in the industry. This should lead to more rational pricing and supply policies going forward, which will lift profitability across the sector. Secondly, from a Smurfit Kappa Group perspective, the multiples these deals are being done at highlight the value in the stock. As Davy note, using the Mondi-Duropack multiple would imply an equity value of €11.30 a share on SKG, well ahead of the €7.60 it is trading at this morning.

 

In other Smurfit Kappa news, following a recent similar move the company announced the sale of €250m worth of senior secured floating rate notes due 2020. The proceeds will be used to pre-pay term loans maturing in 2016/17 and while they will not make a significant dent in interest costs (the new notes will pay 3 month Euribor +350bps, versus the 3 month Euribor +362.5-387.5bps the term notes pay) they do push out the average maturity of the group’s debt, thus reducing the risk around the company and giving it enhanced financial flexibility.

 

In the food sector, Origin Enterprises released its full-year results this morning. These revealed a solid performance by its core agri-services business, with like-for-like operating profits up 7%. Net debt has fallen sharply to €68m compared with €92m a year earlier, which reflects the strong cash flow generation of the business (free cash flow was circa €70m, which implies a FCF yield of 12% or thereabouts). Given this, management has upped the dividend by 36%, which moves dividend cover from last year’s 4x to 3x now. Overall, these are solid results from Origin and shareholders (not least its majority owner Aryzta) will no doubt welcome the significant increase in the dividend.

 

(Disclaimer: I am a shareholder in Independent News & Media plc) There was some unexpected fall-out from the Irish Daily Star’s (appalling) decision to publish pictures of the Duchess of Cambridge, with 50% owner Richard Desmond saying that he would take “immediate steps to close down the joint venture“. This is easier said than done, given the troubles this would involve with redundancies, property leases, a loss of profits and printing contracts. While there has been speculation that this could be a stroke by Desmond to replace a 50% owned JV with his 100% owned UK Daily Star in the Irish market, I can’t see INM abandoning its sole presence in the national daily tabloid space. So, either this dispute is settled amicably (perhaps with INM agreeing a call option to buy out Desmond?) or not, in which case INM will likely launch a new tabloid (using a different title, as Desmond owns the rights to the Daily Star name) which should be able to more than hold its own against any imported competitor whose relevance to the Irish market could well prove to be uncertain.

 

In the blogosphere, Lewis looked at Wincanton, with his blog providing enough to persuade me that I don’t need to look at it in more detail!

 

And finally, if you’ve ever wanted to learn more about money and banking, UCD’s top-rated Professor Karl Whelan has very kindly put up his lecture slides from a course on this very topic.

Market Musings 3/9/2012

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(Disclaimer: I am a shareholder in Abbey plc) While the macro outlook is challenging, it is interesting to see that two UK focused housebuilders have been the subject of takeover approaches from management in recent weeks. An investment vehicle controlled by Abbey’s Executive Chairman now owns nearly 62% of the company’s shares, with its offer remaining open for acceptances until 1pm (Dublin time) on 7 September 2012. Elsewhere, the Chairman of Redrow has also made a preliminary approach to buy out the firm using a consortium comprising his own investment vehicle and two funds. When management teams, who presumably (!) have access to better information than the likes of you and me, are making such moves, this suggests to me that there is decent value still to be had in the sector.

 

Staying with UK stocks, I sold out of Marston’s this morning. My reasons for doing so were twofold. Firstly, the three catalysts that had been identified for the stock (The Queen’s Jubilee, Euro 2012 and The Olympics) are all over and I am guessing that the regular newsflow from the many quoted UK pub groups means that the impact of these have all been priced in. Secondly, the shares have increased by over 25% (in euro terms) since I added it to the portfolio earlier this year. You can read about why I was originally attracted to Marston’s here. In terms of where the proceeds are being recycled into (Harvey Nash plc), I will upload a blog later today outlining my rationale for the inclusion of ‘an old friend’ back in the portfolio.

 

In other food & beverage sector news, tropical produce importer Fyffes today raised its full-year adjusted EBITA guidance to a range of €28-33m versus the previous €25-30m. This improved outlook is based on decent organic growth and FX effects in H1 2012. Extrapolating from the adjusted EBITA of €23.3m Fyffes achieved in the first half of the year and adjusted diluted EPS of 6.48c in the same period, this points to full-year earnings of at least 8.5c, putting the stock on less than 6x earnings, so clearly cheap. Its sister company, Total Produce, which I hold, reports its interim results tomorrow.

 

(Disclaimer: I am a shareholder in Smurfit Kappa plc) There was a bit of news out of Smurfit Kappa Group since my last update. This morning it announced the launch of a senior secured notes offering, which will raise €200m and $250m, maturing in 2018. The proceeds will be used to repay all of the existing 7.75% senior subordinated notes due in 2015. Given the relatively low rates on offer for similar rated debt at this time, this should, I estimate, shave at least €7m from SKG’s annual interest bill, as well as extending the weighted average maturity of its debt, which reduces the perceived riskiness around the group. In all, a win-win move for Smurfit Kappa. Elsewhere, the group is to invest €28m in a new bag-in-box facility in Spain, which  is a further sign of how Smurfit Kappa’s improved financial position is giving it enhanced flexibility on both the M&A and capex fronts.

 

(Disclaimer: I am a shareholder in Independent News & Media plc) It was confirmed that total Irish newspaper advertising declined 10% in the first 6 months of 2012. Annualising it, and putting in a little bit of a kicker for Christmas related spending, means that it’s still a circa €180m market, so not to be sniffed at despite the confident predictions of certain ‘new media’ devotees who assure me that ‘old media’ is completely toast. While I don’t for one moment dispute that old media is in long-term structural decline, my central thesis on the sector remains that it will not disappear for many years to come, with larger newspaper groups (such as INM) being able to mitigate against the effects of a shrinking market by gaining share as weaker competitors exit the industry. Of course, the extent to which equity investors can benefit from this depends on how successfully INM can prevail over its liabilities, and in this regard I was pleased to read reports of a third bidder entering the fray for INM’s South African unit. The more the merrier, clearly, as this should mean a satisfactory sale price for the business.

 

In the blogosphere, I was pleased to see the launch of two new blogs by Paul Curtis and Mark Murnane. I’ll be updating the blogroll later today – if there are any other investment and/or economics sites you think I should be following, please suggest them in the comments section below.

Written by Philip O'Sullivan

September 3, 2012 at 10:02 am

Market Musings 4/8/2012

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The past week has been quite hectic, with two weddings and the deadline for completing a 200 page report for the company I’m on an internship with as part of my MBA studies to safely negotiate. Hence, blogging has been a necessary casualty of my lack of free time. So, what has been happening since my last update?

 

(Disclaimer: I am a shareholder in Ryanair plc) Ryanair released its Q1 results. These contained few surprises. The company is sticking to its FY net income guidance of a range of €400-440m which is reasonable in light of the early stage of its financial year. However, with the likes of Easyjet and Aer Lingus recently upping their forecasts, allied to Europe’s biggest LCC’s form for low-balling guidance (it upgraded its guidance twice in its last financial year) and healthy passenger numbers, I suspect the risks to Ryanair’s profits lie to the upside.

 

Elsewhere, as noted above Aer Lingus upgraded its FY earnings outlook in its interim results. Having previously said that 2012 profits “should match” the 2011 out-turn, it now says they will “at least match” last year’s performance. One aspect of the Aer Lingus results release that was particularly encouraging was the long haul performance – compared to the same period last year, in H1 2012 Aer Lingus’ long haul passenger numbers, load factors and yields all increased by 11.0%, 5.0% and 9.0% respectively. This is a magnificent performance given the tough economic backdrop and illustrates the success of Aer Lingus’ moves to leverage Dublin and Shannon, the only airports in Europe offering US pre-clearance, to win transatlantic customers whose journeys originated in other parts of Europe. This means that news of United Airlines terminating its Madrid-Dulles JV with Aer Lingus is not particularly concerning given that Aer Lingus clearly has sufficient demand to justify redeploying the Airbus A330 currently on the JV route to its own branded Ireland – North America routes.

 

(Disclaimer: I am a shareholder in BP plc) In the energy space BP released its interim results. Market reaction was extremely downbeat, but I am (perhaps foolishly?) taking a contrarian view to this and assuming that its run of disappointments means that management will either: (i) come up with shareholder-friendly goodies (a large buyback, chunkier dividends, sensible M&A) to revitalise the share price; or (ii) come under irresistible pressure from investors to unlock the value in the firm through a break-up of the company.

 

(Disclaimer: I am a shareholder in Trinity Mirror plc) In the TMT segment Trinity Mirror erupted this week, with its share price gaining circa 40%, helped by strong interim results. Regular readers of this blog will know that I’ve been an uber-bull on this name for a while, based on my view that it offers a compelling mix of: (i) Very strong cashflows; (ii) Substantial tangible asset backing; (iii) Rapid deleveraging facilitating a re-rating for the equity component of the EV; and (iv) An absurdly low (and unwarranted) valuation. I’m pleased to see that my central thesis is playing out, with the first six months of 2012 bringing a £60.5m reduction in its combined net debt and pension deficit, an amount equal to 75% of what TNI’s market cap stood at on Tuesday. The catapulting of its share price since then indicates that the market may be starting to wake up to this reality. I suspect the TNI story has a lot further to run – if you annualise the H1 earnings the stock is trading on a forward PE multiple of only 2.3x!

 

In the food sector Greencore issued an upbeat trading statement which revealed healthy underlying volume growth allied to management expressing confidence that it can meet full-year earnings expectations.

 

(Disclaimer: I am a shareholder in AIB plc and RBS plc) Switching to financials, I was surprised to read criticism of AIB’s announcement that it is to close a number of branches as part of its efforts to right-size its cost base. As its recent interim results showed, AIB is currently loss-making before you even take provisions into account – which is a clearly unsustainable position. Moreover, the vast majority of transactions these days are done using ATMs, cards and internet banking. Due to all of this, AIB (and indeed its domestic competitors) simply does not need as many branches as it did before.

 

Elsewhere, RBS issued an in-line set of interim results. While LIBOR, IT problems and a daft total nationalisation suggestion by elements within the British government have dominated headlines around the group, it is continuing to make impressive progress in terms of repairing its balance sheet. Investec’s Ian Gordon makes some good points around the numbers (and indeed the outlook for RBS) here. One aspect of the results that I found concerning was Ulster Bank’s impairments. RBS’ Irish unit saw impairments widen to £323m in Q2 2012 from £269m a year earlier, with mortgages to blame for this worsening trend. This has ominous read-through for the other banks operating in the Irish market.

 

(Disclaimer: I am a shareholder in Smurfit Kappa Group plc) In the packaging space Smurfit posted another great set of results, with Q2 EBITDA of €255m coming in right at the top of the range of analyst expectations (€236-255m). Management reaffirmed its full-year EBITDA and net debt targets, but I suspect the risk to both is to the upside given that the two largest European packaging firms, Smurfit and DS Smith, have both recently announced chunky price increases.

 

(Disclaimer: I am a shareholder in Abbey plc) There was more good news for my portfolio from the construction sector, with Abbey’s majority shareholder, Charles Gallagher, making an offer to buy out the minority shareholders in the company. The price being offered isn’t exactly stellar, at 0.86x trailing book value, but it’s one I’m happy to accept given that it represents a 42% return on what I paid for the shares in 2009. If only the rest of my investments worked out so well!

Written by Philip O'Sullivan

August 4, 2012 at 8:21 am

Smurfit Kappa Group (SKG.I) – Think Inside The Box

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(This is the seventeenth installment in my series of case studies on the shares that make up my portfolio. To see the other sixteen articles, on Bank of IrelandAIBRBSMarston’sFrance TelecomRyanairPetroNeftIrish Continental GroupIndependent News & MediaTotal ProduceAbbeyGlanbiaIrish Life & PermanentDatalexTrinity Mirror and Datong, click on the company names. I remain an investor in all of the above stocks, save for Glanbia, which I sold earlier this year)

 

Smurfit Kappa Group (SKG) is one of the leading integrated producers of paper-based packaging in the world. It is the largest European containerboard (paper specially manufactured for the production of corrugated board) and corrugated (two outer layers of paper with an intermediate layer of fluting) producer, with a circa 17% share of capacity. In Latin America, which accounted for 18% of revenues in 2011, SKG is ranked #1 for corrugated and #2 for containerboard across the 9 countries it has a presence in. The group, which generated revenue and EBITDA of €7.4bn and €1.0bn respectively in 2011, has 331 operating facilities across 30 countries, employing 38,000 people.

 

In this piece I look at its business model, performance since its 2007 IPO and outline why I believe its shares offer great value at current levels.

 

SKG’s business model has a number of attractive qualities. Firstly, as an integrated producer, this provides a competitive advantage due to its control of supply of a critical input — Smurfit is the world’s second-largest recovered paper user. This is particularly valuable given that rising Chinese demand in recent years (in 2010 some 13% of recovered paper collected in Europe was exported to China) has impacted the availability and pricing of this commodity. A second big advantage for SKG is its scale — given that 60% of its customers are in the fast-moving consumer goods segment, the group has the capability to support some of the biggest firms in this area due to its wide geographic coverage. On this point, 18% of SKG’s customers by volume are described as ‘Pan European’, with a further 16% classified as multinational. In addition, SKG has a considerable breadth of product offering, which allows it to meet a wide variety of customer needs.

 

The group had its IPO in March 2007, just before the economic storm hit. The shares, which were initially priced at €16.50 apiece, soon came under severe pressure due to a combination of wider economic concerns and the firm’s level indebtedness at the time. At the end of fiscal year 2007, SKG had net debt of €3.40 billion, or 3.2x that year’s Ebitda (€1.06 billion).

 

The firm’s response to these pressures has been impressive. The group focused on maximising cash flow by reducing working capital, suspending dividends, implementing significant cost takeout measures and minimizing capex (the ratio of capex to depreciation fell from 98% in fiscal year 2007 to 67% in 2009). These efforts helped offset the pressures on profitability, and net debt, which fell to €2.75 billion by the end of 2011 (a 19% reduction in four years), represented only 2.7x that year’s Ebitda. This has been done without any recourse to shareholders (the number of shares in issue has increased by only 8.4% in the five and a quarter years since the IPO).

 

In terms of recent milestones, since the start of 2012 the group has announced a successful extension of its debt maturities, which pushed the weighted average debt maturity out to over five years and left the group with no significant maturities until 2015. This gives the group greatly enhanced financial flexibility.

 

In March, one of the private equity vehicles that had retained an investment in Smurfit post its IPO had placed nearly €150 million worth of stock. While this applied downward pressure to SKG in the short-term, in the longer-term SKG will benefit from the improvement in the free-float (the placing increased SKG’s free-float from 65.4% to 75.1%). Clearly, the potential for further placings cannot be ruled out, but for reasons set out below I believe that this is more than factored into the current share price.

 

SKG’s Q1 results, released in May, surprised on the upside, with Ebitda of €246 million coming in comfortably ahead of the top of the range of sell-side estimates (€181-233 million). At the time, management said it expects: “to deliver an Ebitda performance broadly similar to that achieved in 2011” (i.e. €1 billion) this year.

 

Since then, we have seen further turmoil in the euro zone, coupled with some pressure on containerboard prices, which may put this guidance under threat. Against that, SKG does have a lot of levers on the cost side that it can use to counter these developments. The firm’s next set of quarterly results, due on August 1, will presumably provide more clarity on this.

 

Tying it all together, in terms of the investment case for Smurfit, the company represents a very attractive way of playing the European packaging sector, given: (i) its competitive advantage on the input side; (ii) its breadth (both geographic and product); (iii) its relentless focus on cash flow generation; and (iv) its cheap valuation. On the final point, based on last night’s closing price (€5.40), SKG is capitalized at €1.20 billion. Considering that the group is presently guiding Ebitda of €1 billion for this year, I see potential for a significant re-rating as debt is paid down. On this note, SKG exited 2011 with net debt of €2.75 billion and an employee benefits liability of €0.65 billion. Keeping things simple, its EV (based on the last audited figures and the current market cap, along with taking the pension into account) is €4.60 billion. By the end of 2012, net debt will have reduced further given the impressive cash generation of the business (over the past 4 years SKG has reduced net debt by an average of €163 million per annum). In my model I forecast that net debt will fall to €2.5 billion by year-end. This puts the group on a prospective EV/Ebitda of 4.2x, while the shares yield 4.2% at these levels. This is cheap both in absolute terms and also relative to its sector peers.

 

There are, of course, some threats to the company, such as the challenging economic conditions across much of Europe and the possibility of further placings. However, given the low multiple of what are far from peak earnings (SKG’s Ebitda margin of 13.9% in fiscal year 2011 is 70bps below 2007 levels, despite the significant cost takeout measures undertaken since then) the company trades on I would contend that this is priced in. Furthermore, I note that the current share price is roughly 25% below where the recent placing occurred.

 

In all, I view SKG as a story of industry leader + significant operating leverage from an eventual recovery in the European economy + attractive emerging economy assets + a de-risked balance sheet (given the recent refinancing deal) + cheap rating + debt paydown driving a significant re-rating over time. I like this stock a lot, hence I hold it in my own portfolio.

 

Note: This is an edited version of an article that I wrote for Marketwatch yesterday

Written by Philip O'Sullivan

July 11, 2012 at 7:53 am

Posted in Sector Focus

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Market Musings 10/5/2012

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We’ve seen a deluge of trading updates in the past 24 hours or so. Let’s run through what new insights they’ve provided us with.

 

In the construction sector, Kingspan released a trading update today. The group has made a solid start to 2012, posting an 8% rise in sales in the first four months of the year, “of which Mainland Europe was up 9%, UK up 2% and North America up 10%”. Despite this impressive performance, I note that management caution that: “in general, the year opened with relatively more optimism regarding potential activity levels in some construction markets. This dissipated somewhat as we progressed through the first quarter with sentiment weaker now than at the beginning of the year”. As I’ve stated before, Kingspan has undoubted ‘structural growth’ qualities that set it apart from most construction related stocks, but I don’t see anything in this statement to warrant Kingspan shares pushing significantly ahead of their 13.0x forward earnings multiple in the short term.

 

Elsewhere, Grafton issued a trading statement this morning which revealed diverging trends across its operations. Its UK business appears to be gaining market share, but Irish conditions remain very challenging. It was interesting to see, despite many of its competitors having exited the market, that Grafton’s Irish retail (Woodie’s DIY, Atlantic Homecare) and merchanting (Heitons, Chadwicks) sales were -16% and -9% respectively in the first four months of 2012. This bodes ill for the state of the domestic economy.

 

Glanbia released a trading update yesterday that contained few surprises relative to my expectations. While management is sticking to its full-year guidance, the impact of tough comparatives is shown by a forecast of flat earnings in H1 relative to year-earlier levels. Within the different business areas, nutrition continues to perform strongly, posting a 9% jump in revenue in Q1 2012, but Dairy Ireland’s revenues fell 5% in the same period. Overall, this statement reinforces my view that I was right to ‘step out’ of Glanbia for a while.

 

In other food sector news, Fyffes upgraded its FY EBITA target to €25-30m from the previous €22-27m. This is a great performance by Fyffes in light of the headwind of high fuel prices in particular.

 

UTV Media announced that it has inked a new 5 year bank facility today, which to me reflects the very impressive progress the group has made in terms of rebuilding its balance sheet in recent years.

 

(Disclaimer: I am a shareholder in Trinity Mirror plc) I was delighted by Trinity Mirror’s interim management statement today. While advertising conditions remain under pressure, cash generation remains very strong, as evidenced by the £24m (11%) improvement in its net debt in the year to date. On top of that, the pension deficit has also seen a £54m positive movement since the end of 2011. The combined improvement in Trinity Mirror’s long-term liabilities is equivalent to 100% of its closing market capitalisation from yesterday. This also shows that my narrative around the company appears to be playing out.

 

(Disclaimer: I am a shareholder in Smurfit Kappa Group plc) Speaking of narratives, I was pleased to learn of another containerboard mill closure in Europe, which is supportive for pricing in an industry where Smurfit Kappa is king.

 

In the retail space, Clinton Cards went into administration yesterday. This is bad news for its employees, and for retail REITs – Clinton’s over 700 stores are to be found in most large shopping centres in the UK and Ireland.

 

In the blogosphere, Lewis came up with an interesting way of gauging fashion ‘trends’ – might this offer new insights into trading retail stocks?

Written by Philip O'Sullivan

May 10, 2012 at 10:05 am

Market Musings 4/5/2012

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Happily most of the newsflow I’ve seen since my last update has involved encouraging Q1 updates, so let’s run through what’s been happening in the markets.

 

(Disclaimer: I am a shareholder in Smurfit Kappa Group) I was delighted to see a blow-out set of Q1 numbers from SKG this morning.  EBITDA of €246m was well above analysts’ forecast range of €181-233m. Other points of note include an increase in the cost take-out goal (from €150m to over €200m), while management now expects to match 2011’s EBITDA outcome this year, which is ahead of what most analysts had expected given the poor state of many of its end markets. This is the latest in a series of encouraging announcements from the company, and I’m a very happy investor in the stock. The only potential negative I see at this time is the troublesome rise of economic nationalism in some Latin American markets. That region contributed 23% of SKG’s EBITDA in the first quarter of 2012, and I am somewhat concerned about its assets in Venezuela (where the government stole some of SKG’s property last year) and Argentina, where the president has been actively implementing insane economic policies of late. However, against that I note that most of SKG’s Latin American assets are located in more stable countries such as Mexico, Chile and Colombia.

 

(Disclaimer: I am a shareholder in RBS plc) Another firm to issue a Q1 update today was RBS. I will refrain from passing judgement on the overall group performance, as I’m in the process of building a model on the company as a precursor to a detailed case study, but from an Ireland Inc perspective I was interested to see what it had to say about Ulster Bank in particular. In the event, RBS says Ulster Bank “still faces exceedingly difficult market conditions”, with impairments continuing to rise in the residential mortgage book. The unit’s total impairments in Q1 2012 were £654m, compared to £570m in Q4 2011 (and £1294m in Q1 2011). Ulster Bank’s Q1 pre-impairment profit was -12.5% yoy. Overall, to me this reads like a ghastly performance by RBS’ Irish operation.

 

Staying with Irish financials, I was interested to read that financier Edmund Truell is raising up to £200m this month to put towards “deals in the European financial services or business administration sectors“. Interestingly, Truell is already the biggest shareholder (via the Fiordland investment vehicle) in Irish listed IFG, which is the biggest administrator of bespoke SIPPs in the UK market. His next moves will be interesting to watch.

 

Aer Lingus issued a strong Q1 interim management statement. Within it management upgraded full-year guidance from the “Our expectation for 2012 is that the Group will remain significantly profitable albeit below 2011 levels” provided at the time of the full-year results in February to the new guidance of “If current trends continue, Aer Lingus’ operating profit for 2012 should match that achieved in 2011“. Aer Lingus has done an excellent job of managing yields and capacity against the headwinds of a high oil price and very difficult economic conditions in its home market.

 

(Disclaimer: I am a shareholder in Ryanair plc) Elsewhere in the airline sector, one of the key themes I’ve been pushing in recent months has been the demise of and/or capacity reductions by numerous European carriers and the benefits that this translates into for Ireland’s relatively more efficient carriers.  Denmark’s Cimber Sterling, which carried 2m passengers in 2010, went bust this week. It operated out of Copenhagen, Aalborg and  Billund. Ryanair has a presence in Billund. Another carrier that has been slashing capacity is BMI Baby. It is pulling out of Ireland West-Knock, where its passengers will presumably switch to Ryanair and Flybe, and also out of Belfast, where its passengers will presumably switch to Aer Lingus, Easyjet, Thomas Cook and Flybe. Reduced competition is facilitating fare increases for Ryanair and Aer Lingus at this time.

 

(Disclaimer: I am a shareholder in France Telecom plc) Switching to the TMT sector, France Telecom issued its Q1 results. I was pleased to see the group reaffirm guidance of operating cashflows in 2012 of close to €8bn, but was less pleased to see the group pull back from its guidance for 2013-15. The stock trades at a discount to my estimated valuation on the company, but I am loath to raise my exposure to it, due to the deteriorating outlook noted above and the risk of elevated political interference (over and above Sarkozy’s meddling) going forward, assuming that France swings to the left in the second round of the upcoming presidential elections.

 

(Disclaimer: I am a shareholder in Total Produce plc) Total Produce made a small acquisition, buying a 50% stake in Flancare (Clonmel) Distribution Limited. As the target was in liquidation, I assume the consideration is very modest, but nonetheless take heart from the inference in the statement that these are very well-invested assets.

Written by Philip O'Sullivan

May 4, 2012 at 9:35 am

Market Musings 22/4/2012

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Given events over the past few days it’s no surprise that this blog is once more focused on the TMT sector.

 

(Disclaimer: I am a shareholder in both Trinity Mirror plc and Independent News & Media plc) On Friday Richard Beddard asked me why I didn’t appear to be particularly concerned about Trinity Mirror’s pension deficit. Regular readers of this blog know that pensions are always a concern for me – I always incorporate the pension deficit or surplus into my valuation models, while as a former shareholder in Uniq (now a part of Greencore) I know all too well what can happen if the pension deficit gets too big. In the case of Trinity Mirror, at the time of writing the company has a market cap of £79m, while it exited 2011 with a pension deficit of £230m and net debt of £200m. So net long-term liabilities of more than 5x its current market cap, which is certainly concerning. This concern is somewhat alleviated by its freehold property assets of £177m, while last year it generated after-tax operating cash flow of £75m. With well-documented cost take-out measures underway and the UK advertising market still tough, I think it’s reasonable to assume that as the cost measures flow through and advertising picks up that Trinity Mirror can hold cash generation reasonably steady for the next 2-3 years. With modest capex requirements for the business and no dividend payout, this should see net debt more or less eliminated by end-2015. While it’s tricky (if not impossible) to predict where the pension deficit will be by then, it only has to improve by £53m (for information, it deteriorated by £70m last year, so moves of this magnitude are not unthinkable) before it’s covered by the property interests. Obviously, a marked deterioration in the UK newspaper sector or adverse market moves that significantly impact the pension deficit pose risks to this thesis, but if I’m right, I should see the value of my TNI shareholding rally strongly from current levels. One thing that TNI observers may wonder about the above analysis is why I’ve left out the current discussions between the publisher and the pensions authorities in the UK about temporarily reducing payments into the scheme – all other things being equal, these cashflows will be used to nuke liabilities (i.e. less money going to fix the pension deficit = more money going to fix the net debt), and given that I treat net debt and pension deficits the same in my investment models it has little impact on my sentiment towards the company.

 

Speaking of media, I came across an interesting survey of advertising expenditure in Ireland, which is quite timely in light of recent developments in the media sector here. While digital is growing at a rapid rate, it is worth noting that ‘old media’ still accounts for the lion’s share of advertising expenditure. I accept fully that there are clear structural shifts underway in terms of where ad spend is migrating to and from, but I remain confident of my central thesis for both INM and TNI that even though the overall ‘pie’ is shrinking, they have the ability to counter this to at least some degree through market share gains as weaker competitors exit the market. INM, as it likes to remind people at every opportunity (!) “is the only profitable newspaper and media firm in the country“, and many of its titles, at both a national and local level, compete with financially challenged rivals. For Trinity Mirror, the firm’s 130 regional titles and  5 national papers appear to be well placed in terms of right-sizing the cost base (this list suggests that it has been more proactive to date at weeding out underperforming titles than its peers) while the well-documented challenges faced by rivals such as Johnston Press could see an acceleration in rival titles exiting the market in 2012/13.

 

(Disclaimer: I am a shareholder in Smurfit Kappa Group plc) Following the recent news that two Norwegian kraftliner mills have gone bust, another of Smurfit’s rivals, French containerboard producer Papeterie du Doubs, has gone into liquidation. All of this is supportive for pricing in an industry long known for its problems with overcapacity.

 

(Disclaimer: I am a shareholder in Playtech plc) In the betting space, William Hill’s IMS revealed a solid overall performance, led by its online division, where net revenues rose 33% (relative to a 12% increase in group net revenue). This has bullish read-through for the minority shareholder in the William Hill Online joint venture, Playtech, and it was no surprise to see PTEC’s shares gain 7% on Friday to close at 370p. This is just 10p below my breakeven level on a stock that has repeatedly disappointed me, and if I can get out of it at 380p or better it will be an escape of Harry Houdini proportions!

 

(Disclaimer: I am a shareholder in Ryanair plc) I was interested to read that Flybe has pulled out of Derry Airport in Northern Ireland. This will likely result in (very) modest gains for Ryanair, whose Derry-Liverpool and Derry-Birmingham routes will presumably pick up some traffic from Flybe’s discontinued Derry-Manchester service.

 

In the construction arena, Irish heating and plumbing supplier Harleston bought Heat Merchants and Tubs & Tiles, which came a little bit out of the blue for me given all the chatter linking Saint-Gobain to these assets. The future of the 11-strong chain of Brooks’ builder provider units remains unclear, so hopefully we’ll get some clarity on that this week.

 

(Disclaimer: I am a shareholder in Tesco plc) In the blogosphere, Valuhunter did up (with a little help!) an absolutely fantastic post on Tesco that’s well worth checking out.

 

Finally, if you ever feel like you’ve made a serious blunder in work, just remember that it could be worse – at least you haven’t accidentally fired every single one of your colleagues.

Written by Philip O'Sullivan

April 22, 2012 at 10:37 am

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