BankNordic: Community Bank Far Away from the North Atlantic


BankNordic is a community bank operating in Faroe Islands, Greenland and Denmark. It’s middle of turnaround with goal to increase ROE from 6% average to 10% by 2020. New board, management and strategy has been put in place to reach the goal.

If BankNordic reaches the goal by 2020 I’m expecting 15% annual returns from P/B-multiple expansion from 0.6 to 1.0 and accumulated dividends in my “best case” scenario, as illustrated in table below.


To reach the 10% ROE goal BankNordic’s earnings before tax must be 180 DKKm by 2020, assuming 1430 remaining equity after announced buybacks, dividends and disposals.

Adjusted for known downward trend in net interest and fee income and operating costs, as extrapolated from Q1 earnings report, and expected decrease in finance cost as result of recently announced subordinated capital refinancing, BankNordic’s run rate earnings before tax is some 200 DKKm, making the 180 DKKm EBT/10% ROE goal by 2020 seem trivial.


The 200 DKKm run rate earnings however implicitly assumes very low impairments as it is based on 2015 impairments, when they were record low 20 DKKm or 0.1% of assets.

Despite company attributing the low 0.1% impairment ratio to sound credit standards I think long-term average 0.5% impairments is more reflective of the future impairments because the recent 0.1 % impairments coincides with seemingly temporary positive economic shocks in Faroe Islands economy:

1) record high fish prices (by their nature volatile and will likely lead to a supply response)
2) fish export growth to Russia, thanks to EU food import bans not applying to Faroe Islands (temporary?)
3) exceptionally high fishing quotas, thanks to Faroe Island government going rogue from international quota agreements (temporary)
4) big infrastructure investment (temporary?)

More over, in the end of 2014 management expected the 2015 impairments to be at the same level as in the 2014 when they were close to the historical average 0.5%, but what really ended up happening was the record low 0.1%. If the low impairments would have been conscious effort to improve credit standards it would not have come as surprise.

With very high probability impairments mean reverting I think BankNordic’s normalized earnings power is closer to 150 DKKm instead of the 200 DKKm starting point (see table below, red lines new).


Alone the mean reversion of impairments would not mean insurmountable headwind for reaching the 180 DKKm EBT/10% ROE goal because the required earnings improvement would be only 180-150=30 DKKm.

But combined with potential big adverse effect of Danish Corporate Bank division disposal that has also been announced, things start to look more difficult.

Earnings effect of Danish Corporate Bank division disposal

There is great uncertainty how big impact the Danish Corporate Bank division disposal (through gradually winding it down) will have on BankNordic’s future earnings power because of limited disclosure.

It’s known (implicitly) that it will reduce net interest and fee income by 80 DKKm but it’s not known how much it will reduce costs. I have tried make an estimate of the savings and narrowed it down to some 20-60 DKKm.

The 20 DKKm low range of the cost saving estimate is based on 15 employees’ salaries who will most likely be layed off as result of the disposal, at least the employees were part of the deal when BankNordic tried to sell the unit earlier.

Assuming there is no other direct cost related to the Danish Corporate Bank than employee costs then the 20 DKKm estimated employee cost reduction is the natural minimum that can materialize from the disposal.

But note that the 20 DKKm cost savings would be too small relative to the 80 DKKm lost net interest and fee income to the disposal to make sense. That’s because the resulting 60 DKKm earnings decrease implies 30% incremental ROE relative to the announced 200 DKKm capital tied to the Danish Corporate Bank business.

Only way the disposal makes sense is that the 200 DKKm equity tied to the business is not earning its cost of capital.

If the cost of capital is 10% then the division must be earning less than 20 DKKm to the disposal to make sense, meaning that with the 80 DKKm net interest and fee income the cost relating to the segment must be more than 60 DKKm.

Hence I’m using the 60 DKKm as my high range of the potential cost savings from the disposal.

And because there is so much uncertainty regarding to the earnings effect of the disposal it is in pivotal role in determining how much earnings growth BankNordic needs to find from business expansion and cost savings after the disposal to reach the 180 DKKm EBT/ 10% ROE goal.

That’s because if the disposal is “bad” and decreases earnings by 80-20=60 DKKm then earnings growth required from other activities is is 180-(200-60-50)=90 DKKm, assuming normalizing impairments.

For comparison, if the disposal is “good” then earnings would decrease only by 80-60=20 DKKm, and combined with the normalized impairments, earnings growth requirement would be 180-(200-20-50)=50 DKKm, much less (new lines red at scenario table below).


Growth requirement

As seen, with the high probability of impairments normalizing the disposal has a pivotal role in determining how much earnings growth must come from future business expansion and cost savings to reach the 180 DKKm EBT/ 10% ROE by 2020.

To simplify a bit, if the impairments will normalize then depending of outcome of the disposal earnings growth requirement for the 180EBT/10% ROE is either “doable” 50 DKKm or “difficult” 90 DKKm.

I say the 50 DKKm required earnings improvement is “doable” because initiatives required to do it seem to be barely within a reach and the much bigger 90 DKKm therefore “difficult”, because I just don’t know and cannot easily perceive where it would come from.

Doable improvement

For example the “doable” 40 DKKm earnings improvement would materialize with combination of “only” 2% balance sheet expansion, 2% cost savings, repayment of expensive subordinated capital and capitalizing on private bank growth opportunity in underpenetrated Faroe Islands:

a) Expanding balance sheet by 2% is not going to be easy with sound credit standards due to deleveraging economy and fierce competition, but I guess doable due to small absolute scale of the bank (estimated 10 DKKm earnings effect)

b) Saving cost by 2% (relative to 2015 cost base) seems possible as according to management there is still room for cost reductions despite lot of rationalizations have already been done over last years (estimated 10 DKKm earnings effect).

c) Full repayment of subordinated capital will happen with very high likelihood because it was set as five-year goal in 2012, although not restated ever since, and because it would be continuation of existing repayment trend (estimates 10 DKKm earnings effect).

d) BankNordic’s goal is to grow its private banking and asset management business. AUM is not known but according to management there is opportunity to grow especially in Faroe Island, which is “comparatively immature market”.

With ~40% market share of deposits in the small 50 000 people Faroe Islands BankNordic has customer contact and distribution channel to best capitalize on whether market growth there is available. At least high deposits per person compared to other Nordic countries and some change in pension saving regulation suggests that there is real opportunity to move cash from bank accounts to private bank products.

With negative interest rates customers should be also perceptive in buying various private bank, giving tailwind in growing the business. BankNordic has also operation in mainland Denmark where the private bank products will be offered, but there the competition will be harder due to worse competitive position.

Earnings effect of the private bank expansion unknown, but in addition to the 30 DKKm potential earnings improvements specified above (a,b and c) it needs to be about 20 DKKm to reach the 50 DKKm earnings improvement.

All in all there seems to be enough opportunity and tailwind to grow the private bank business at least somewhat.

Difficult improvement

Point of the previous “Doable improvement” discussion was that while finding the 50 DKKm more earnings seems “doable” it’s not going to be easy.

It’s not easy for example to grow lending by “just” 2% because market is deleveraging and competition is fierce. And even if it could be done, further decrease in net interest income either from price competition or general decline in interest rates would offset the effect quickly.

It is also not easy to grow the private bank business. For example the 20 DKKm increase in fee income would require 2000 DKKm more AUM with 1% fee base, not an easy feat.

Lot of things has to go right to find the 50 DKKm more earnings.

And if the pivotal disposal ends “bad” then the required earnings growth for reaching the 180 DKKm EBT/ 10% ROE increases to 90 DKKm, which would be almost double more difficult than the “doable” but not easy 50 DKKm.

That’s why it is so important to know the earnings effect of the disposal, because if it’s “bad” then reaching the 10% ROE goal becomes difficult and therefore unlikely.


BankNordic published its second quarter results few weeks ago, which gave support to the theory that in fact the Danish Corporate Bank disposal has been “bad”.

My expectation was that if the disposal would be “good” i.e. that annualized cost savings from the disposal would be more than the estimated 60 DKKm, then operating cost should be coming down quickly from Q2 and onwards

How ever, what the report showed was that operating costs were down by only 2 DKKm relative to the first quarter, very low absolutely and relative to the run rate 460 DKKm annual cost base. If the cost base would be in trend of declining by 60 DKKm annualized pace, the quarterly cost reduction would have been much bigger.

With so slow cost reduction I took the second quarter report as sign that the disposal is more likely to have been “bad” and therefore that the earnings headwind for reaching the 180 EBT/10% ROE by 2020 becomes (too?) difficult.

And as in my mind after the Q2 report probability of reaching the 10% ROE decreased significantly, I think the expected value of stock returns did the same.

My best case estimate was 15% total return for shareholder if the ROE goal would be reached, which would have implied satisfactory expected value of returns at time of the analysis if the likelihood of it materializing would have been sufficiently high.

But as the likelihood of the 15% best case returns seems to have decreased significantly so has the expected value of the situation below my hurdle rate of some 10-15% making the investment a non-go for me.

That said, while 15% annualized returns seems unlikely, so seems loosing money. In fact, as shown by the earlier tables my “bad” scenario earnings before tax power estimate was some 90 DKKm which implies some 5% ROE, which with current 0.6-0.5 P/B valuation implies some 6% shareholder returns few years ahead.

Earning positive return if things go “bad” is actually quite good scenario compared to some other situations where “bad” scenarios really means bad.

Yet, while downside seems protected, so seems upside. For me the outcome distribution is not just very exiting because the foreseeable best case is only some 15% shareholder returns and that scenario seems too unlikely.

To me get exited either stock price has to come down or something has to happen that the probability of reaching the 10% ROE increases significantly. That would mean signs of impairments staying at the current record low levels, faster balance sheet expansion, faster private bank growth, increase in interest rates, more cost savings or higher leverage, of which I see none currently or think very unlikely.

Disclosure: No position but following closely



Catella: Cheap Price Signal or Noise?


Catella is a collection of loosely connected financial businesses where obscure reporting hides potential value.

Catella owns corporate finance, property asset management, mutual fund, hedge fund, wealth management, private bank and a credit card processing businesses. Depending of the subsidiary ownership is 50-100%, adding complexity.

It also owns ton of net cash and investments in non-bank related operations which are hard to identify because bank and non-bank related items are not clearly separated in the financial statements.

Catella has 1495 MSEK market cap and 770 MSEK adjusted net cash so enterprise value is 725 MSEK.

With 190 MSEK operating earnings after tax for parent EV/E is 3.8. With my 98 MSEK earnings power estimate based on long-term averages and excluding temporary bank losses EV/E is 7.4.

Valuation is too cheap for growing business like Catella, absolutely and relative to similar alternatives (EQ is trading at 13x EV/E multiple based on peak earnings).

Typically so low EV/E valuations are found in situations where there is a problem with cash, earnings or management

But with the heavy adjustments included in the net cash figure, opportunistic management which was for example buying subprime mortgage portfolios in 2009 and mostly growing and profitable businesses, I think there is a problem with none of them.

1. Swedish Mutual Fund Management

Catella’s crown jewel is the well established mutual fund business in Sweden which has been around since 1995.

It’s responsible of more than half of group’s operating profit and 100% owned by the parent company. Earnings were 150 MSEK in 2015 and 57 MSEK on average in 2008-2015.

To understand the earnings power better I think it is helpful to split the 2008-2015 period into two different periods, 2008-2013 and 2014-2015, because of the significant change in scale of operations between them.

In the 2008-2013 period average earnings were 34 MSEK, when AUM averaged 18 BSEK, and in the 2014-2015 periods average earnings were 127 MSEK, when end AUM was 45 BSEK.


From valuation point of view the question is whether the 34 MSEK average earnings in 2008-2013 or the 127 MSEK average earnings in 2014-2015 is most reflective of expected future earnings power.

I think the earnings power as having three parts, “base rate earnings power”, “hot money earnings power” and “growth earnings power”.

Base rate earnings power

I define the base rate earnings power to be 34 MSEK which is the same as the 2008-2013 average earnings.

It is based on the 18 BSEK average AUM at the time, which I consider long-term sustainable level of AUM without significant risk of in- or outflows because it was the normal level for Catella’s AUM before recent run-up.

With 10x earnings multiple the 34 MSEK base rate earnings power would be worth about 340 MSEK.

Hot money earnings power

The hot money earnings power is more difficult.

Catella has 28 BSEK hot money by which I mean the new AUM over the 18 BSEK base AUM.

I think the new AUM as hot AUM because most of the new AUM went to three “market neutral” or “higher yield low risk alternative” funds, themes that have been hot in recent years among yield chasing public.

Hot money AUM is problematic because it has higher probability of leaving than the base AUM if market environment changes, and therefore it’s worth less than the base AUM, although not worthless.

Catella’s average earnings with the 18 BSEK base AUM was 34 MSEK.

The 28 BSEK hot AUM is 55% more than the 18 BSEK base AUM, so I assume that the hot AUM earnings are 55% more than the base AUM earnings, about 50 MSEK.

If the base earnings are worth 10 times earnings, the hot money earnings could be worth say 6 times earnings, to reflect the hot AUM’s higher probability of leaving sooner than the base AUM’s.

With these valuation parameters Catella’s 50 MSEK hot money earnings would be worth 50×6=300 MSEK.

Growth earnings power

Since the new management took over in 2010 Catella has developed and has increased efforts to develop new products. As per its strategy goal is to develop product portfolio suitable for all market environments and to grow.

One Example of successful product launch is the Corporate Bond Flex fund which went from 0 to 4.6 BSEK AUM in four years, but there are others.

Part of the strategy has also been to improve distribution and sales.

There is a lot of talk about third-party distributors, proprietary institutional channels and recently cross selling to private bank/wealth management segment’s clients. Last annual report also mentioned shortly something about direct sales through internet.

Evidence of improved sales, distribution and products is the doubling of Catella’s market share from 0.7% to 1.4% in three years, mainly through better than market net inflows.

My no-growth valuation model for the base earnings power assumed 10x earnings multiple, which is suitable for some average company with no clear direction but quite low for constantly developing company like Catella.

If the valuation multiple is increased to say 13, to allow for some growth, the 34 MSEK base earnings would be worth 440 MSEK (100 MSEK more than the 340 MSEK base valuation).

That 100 MSEK “growth value” can be assumed to include some value for growth initiatives, and also some value for the occasional performance fees, which were not included in the base earnings value.

Total value

Including all the components, my fair value estimate for the fund business is 740 MSEK; 340 MSEK for the 34 MSEK base earnings, 300 MSEK for the 50 MSEK hot earnings and 100 MSEK for the growth initiatives and performance fees.

Note that my 740 MSEK fair value estimate implies about 5x P/E multiple for the 150 MSEK earnings in 2015 so it doesn’t seem like overly enthusiastic based on current facts, but inclusion of unknown but unsustainable level of performance income in recent earnings prevents me from capitalizing them fully with say 10x earnings multiple.

I consider my method of valuing the business by its earnings component better.

The 740 MSEK fair value estimate is alone more than the implied 725 MSEK enterprise value. If I’m right, essentially rest of the businesses comes for free.

2. Corporate finance

Catella Corporate Finance is a Swedish corporate finance advisory focused on real estate sector. It’s no joke either.

Catella is fourth largest property transaction adviser in Europe with stableish 6% market share over time (excluding UK where it doesn’t operate). It’s number one adviser in Sweden with 20% share and number three in France with 15% market share.

Year on year earnings fluctuations are big and typical for the industry. For Catella stability over time comes from fact that real estate speculators need help both in bull and in bear markets and the strong market position.

Catella has had two unprofitable years since 2001 (after Lehman collapse) and two years of abnormally high earnings (just before Lehman collapse). Other than that earnings have shown some stability and average about 80 MSEK over last 15 years

Last year earnings were close to the long-term average so they don’t seem abnormally high relative to historical standards, although it must be admitted that European real estate market looks uncomfortably hot currently.

With the many 50-100% owned subsidiaries I assume that 75% of the earnings belong to parent company which from the 80 MSEK average earnings means 60 MSEK.

With eight times long-term average earnings my fair value estimate for corporate finance business is 480 MSEK.

3. Banking business

Catella has a “Banking” segment which processes credit card transactions and offers private banking/wealth management services. Both businesses are reported in the same segment which showed 30 MSEK losses last year.

Without the segment’s losses Catella’s core earnings for parent would have been 220 MSEK instead of the 190 MSEK, so currently the losses are major drag on Catella’s earnings (and without the losses EV/E would have been 3.3).

According to management the credit card processing business is profitable and the losses are caused by the wealth management business. Management’s comments indicate that they are committed to building the wealth management into profitable business and suffer the losses meanwhile. Management says that the wealth management segment will get fixed but it will take some time to gather enough AUM to be profitable.

They said same thing few years ago from the credit card processing business and it got fixed, which is the reason I believe them and consider the 30 MSEK losses temporary and will not capitalize them in valuation.

The transaction bank together with some wealth management parts was bought for 270 MSEK in 2010 with P/B 0.7. There has been some add-on acquisition afterwards for 50 MSEK, implying 320 MSEK original price for the whole banking segment.

It might be worth similar amount today as it is not in worse shape than at the time of acquisition; transaction volumes are higher, computer systems have been updated and there is more AUM.

Yet, to account for few years of the losses going forward I haircut my the original acquisition price by 120 MSEK to 200 MSEK.

4. IPM hedge fund and property funds

Catella bought last part of their 51% stake in IPM-hedge fund in Q3’2014 for implied 200 MSEK valuation for the whole business.

Since then IPM has cumulatively earned about 88 MSEK, implying that 44% of the purchase price has been paid back in little over a year. Excellent acquisition.

IPM is a macro/quant hedge fund offering services for institutional investors with 49 BSEK AUM and seems like a real deal. It manages Swedish National Debt offices interest rate and currency risk, for example.

After Catella bought the majority company new CEO was hired with idea of taking the business to new level.

The 51% stake was bought for 100 MSEK fairly recently so I use it as my target valuation, although in light of recent performance and growth prospects it looks cheap.

Catella also has property fund and asset management business with 31 BSEK AUM.

Property fund management is conducted through Catella Real Estate AG in Germany which has 12 funds and 20 BSEK under management. It invests all over Europe.

Property asset management operates in France and in Finland. It has 11 BSEK under management and is expanding to Spain, Norway and all over the place. Business is little bit of a black box as it is unclear to me what exactly they are doing.

Together the two businesses earned 27 MSEK in 2015 and 20 MSEK on average in 2013-2015. Long term profitability, which can be inferred only with some accuracy, is dismal at best, hovering between small profits and small losses.

With 10x average earnings the business would be worth 200 MSEK, but because black box nature of the segment, some minority interests and because latest figures include a lot of performance income, I haircut the valuation by half to 100 MSEK.

That’s equal to four times 2015 earnings and therefore should not be exaggeration and account for my ignorance.

6. Total operating business value

Combining all the operating valuations together Catella’s operating businesses are worth 1260 MSEK.

(Note that the valuation assumes that 30 MSEK concern costs are capitalized with 12x multiple to 360 MSEK.)


The valuation more or less assumed steady state value for all the entities. But Catella is forward-looking company with several growth initiatives.

Catella’s operating businesses were bought as separate independent entities in 2010-2014. New strategy is to build coherent whole so that each segment cooperates with each other, and that products are cross sold between the entities.

For example wealth management segment can sell property fund and mutual fund products for their clients. Wealth management segment’s deposits can be used to finance deals in asset management and corporate finance segments.

And as the corporate finance segment has office in every major town in Europe with local knowledge, it can be utilized by developing property fund products based on proprietary local knowledge.

There is not much talk what the management’s plans are but direction is clear, more cooperation and cross selling.

In addition to building coherent whole Catella is expanding geographically and otherwise.

Recent property asset management expansion to France was success and now it is trying to do the same in Norway and Spain.

Corporate finance is expanding in Germany and increasingly conducting capital market transactions.

IPM’s goal is jump to next level.

Credit card processing business grew 19% last year.

Wealth and fund segments are gathering new AUM with more resources put on sales.

Excluding the Swedish mutual fund segment, I did not put any value on these growth activities, which in the future could become considerable source of earnings.

7. Adjusted net cash by component

Investment portfolio

Catella has 100% owned investment portfolio. It includes first and second loss tranches of residential mortgage-backed securities where underlying assets are in Spain, Portugal, Germany, France and the UK.

The portfolio was bought during 2008-2010 for pennies and valuation has since H1/2014 been adjusted up 50% as discount rates, arrears, default rates and prepayment have trended down.

The portfolio is valued mark-to-model by outside consultant as there is no active market for the portfolio.


Catella has 832 MSEK consolidated cash excluding the bank operations. Some of the cash is in subsidiaries of which Catella owns less than 100 % so it must be adjusted.

One problem area is the 220 MSEK cash in the Corporate Finance segment.

Worst case would be that all of the cash is in the subsidiaries which parent company owns 50% and best case that all of the cash is in subsidiaries which parent company owns 100%.

As I don’t know any better I have taken mid-point of the two and assume that 75 % or 165 MSEK of the segment’s cash belongs to parent, a 55 MSEK haircut.

Second problem area is the IPM-hedge fund of which parent company owns 51%. It has 140 MSEK cash of which 51% or 71 MSEK belongs to parent, a 69 MSEK haircut.

After the 55+69=144 MSEK haircut to Corporate Finance and IPM cash my estimate of the group’s cash belonging to parent company is 832-144=688 MSEK.

Sale of Visa Europe shares

Catella’s credit card processing bank is member of Visa Europe which Visa Inc. decided to buy in late 2015.

After the transaction closes in Q3’2016 Catella will receive about 180 MSEK in cash and Visa Inc. preference shares as compensation for selling the shares, which I assume to be a financial asset already now.

Bonus payment liability and debt

I think the 233 MSEK bonus payment liability must be deducted from financial assets to get realistic estimate of how much financial assets could be taken out of Catella and still continue operations normally, although strictly speaking it’s not a financial liability.

Catella also has 200 MSEK outstanding bond loan.

Combining the two, total “financial” liability is 433 MSEK


After all the adjustment items my estimate net financial assets belonging to parent company is 769 MSEK or 770 MSEK as a round number.

Adjusten net cash_

Net cash is not much value for shareholders if it is not paid out or invested to operations.

As per the CEO Catella seems to have some plans for it:

“The Board and Management see a number of growth opportunities in existing and new businesses, which are expected to generate long-term shareholder value. Accordingly, we think that the group should retain a significant portion of earnings so it can realise these opportunities.

Note that Catella’s subprime investment portfolio was bought in 2008-2009 and fund management business in 2010 during major market turmoils.

Doing so unpopular things at so unpopular times suggests that Catella is willing and capable of deploying capital opportunistically.

The IPM acquisition I told earlier shows that they are not likely to over pay either.

Thus I think the 770 MSEK adjusted net cash and investment portfolio can be valued at face value with full expectation that something useful is done with it when the time is right.

8. Conclusion

So the 3.8 EV/E multiple based on the 190 MSEK earnings in 2015 looks illusory cheap. That’s because to high and temporary performance fees in asset management businesses.

Yet with the 98 MSEK long-term average earnings (122 MSEK EBIT excluding bank losses from the summary operations valuation table above, minus 20% tax) the EV/E valuation is still only 7.4.

I think that’s too cheap for growth company like Catella.

Another way to say the same thing is that my no-growth fair value estimate for the operating business is 1290 MSEK and valuation for the net cash 770 MSEK, total of 2060 MSEK.

Catella’s market cap is 1495 MSEK so there is 38% baseline upside.

In addition Catella has the many growth initiatives going on which could increase the operations value in the future.

There is also the giant cash pile that management can use opportunistically to buy more earnings, which it has done successfully many times in the past.

If the discrepancy with price and my fair value estimate diminishes, and some of Catella’s growth initiatives proves successful, returns should be satisfactory.

Disclosure: Long Catella with 12% position

Kotipizza: Bigger Slice of Pizza Market


Finnish pizza franchisor Kotipizza updated its restaurant concept recently to communicate sustainability, quality and freshness, as per the latest food trends, and it seems to be working.

Since the update Kotipizza has grown double-digit and outperformed the market by wide margin. Because only 60 of the 252 stores have been updated and there are 16 new restaurant openings in the pipeline I’m expecting the strong growth to continue.

Kotipizza has also opened online sales channel which is growing 10-20% monthly without significant marketing effort. This year marketing will probably start in bigger scale, which should accelerate the growth.

International experience is that opening online sales channels are game changer events for branded pizza franchisors. For example Domino’s UK’s online sales have grown 30% for two years in a row. I’m expecting same to happen in Finland and play in Kotipizza’s, the only national brand focused on pizza, hand favorably.

Kotipizza has also opened new mexican restaurant concept Chalupa with joint venture partner which tries to catch the latest mexican food trend so successful internationally. Start has not been bad and the store opening goal for this year is 6-18 stores.

Despite already rich 16x P/E valuation, possibility of doing “Dominoes” with the online store and “Chipotles” with the Chalupa concept, I have decided to hold my shares.

Summary statistics (MEUR)
Sales 56
Adj. EBIT 4.6
Adj.Interest -0.8
Adj.EBT 3.8

EBIT% 8.1%
ROIC% ~150%

Net debt/EBIT 2

Market cap 49
Net debt 9
EV 58

EV/EBIT 13 (16x with normalized tax rate)
P/EBT 13 (16x with normalized tax rate)

System sales growth after the pizza concept update (2015):

Jun 15.7%
Jul 12.3%
Aug 6.8%
Sep 0.4%
Oct 15.5%
Nov 15.5%
Dec 17.9%

Business model

Kotipizza is unique fast food concept in Finland because it’s the only one focused on pizza. It is the fourth largest fast food chain measured by system sales which were 76.5 MEUR in 2015. Everybody knows its logo and red and yellow colors, not dissimilar to McDonald’s.

There are 251 restaurants which are all run by franchisees. The 160 fixed restaurants are located in populated areas to serve take-out customers but typically not in high traffic trophy locations. Rest of the restaurants are shop-in-shops, which can be found in gas stations. About half of the stores are in big cities and half in small cities.


Sales in average fixed restaurant are 400 000 euros and 150 000 euros in shop-in-shop. Pizzas cost 9-12 euros which are significantly higher than competition (say 6-8 euros for local kebab). About 70% of system sales are take-out so main competition seems not to be against burger chains, but home food and local kebabs.

In addition to franchise fees Kotipizza gets revenues from selling food ingredients for the franchisees, which are under obligation to buy them from Kotipizza.

Business needs hardly any capital and most of the operating costs are fixed so any changes in revenues go more or less directly to bottom line. Management’s “10% rule” guides that each incremental million in system sales increases profit by 100 000 euros.


Kotipizza was found in 1987. It was among the first franchise chains in Finland and under its legendary founder spread everywhere in Finland. There were about 300 restaurants in early 2000’s when it considered listing to stock exchange.

Listing was canceled after which Kotipizza seemed to lose its way. It unsuccessfully tried to expand to SwedenChinaKorea and Baltics.

Same time local kebab phenomena took over Finland. There was less reason to go to Kotipizza because its pizzas were smaller and prices more expensive than the kebabs. For me at least Kotipizza became a forgotten brand in my prime fast food eating age, 20’s.

Finnish private equity fund Sentica Partners bought majority stake in 2011 from the original founder, presumably with idea of fixing and growing the business.

In 2012 they hired new CEO. Under his leadership franchise average satisfaction score improved from 2.9 to 3.7 (28 questions, 1-5 scale), according to management because new franchise contract allows higher profitability for franchisees and because the leadership has improved under the new owner (Investor presentation Q&A).

Meanwhile Kotipizza tried international expansion unsuccessfully in Serbia and again in Sweden. In Finland Kotipizza continued to underperform the market in 2011-2014. When the market grew, Kotipizza grew but slower, and when the market declined, Kotipizza declined even faster.

In 2014 game changed as Kotipizza published its new concept to fight the stagnation. The new concept changed Kotipizza’s marketing message, color theme, store design and packaging. New online sales channel was also developed, non core assets sold and the international operations closed down. System sales started to grow immediately.

New concept

Kotipizza’s old marketing communication was about aggressiveness. Attention was sought with big fonts, bright colors, bold statements, price first, logo second and food on the background.

Old marketing material

In the new marketing strategy food quality is in the main role, colors have been toned down, message is about sustainability and prices are brought forward but not to signal cheapness.

New marketing material

Similar change was made to tv/video marketing. Instead of easiness and price focus was moved to sustainability and domestic food sources.

Old video marketing

New video marketing

Color theme in the restaurants was changed away from the signature red and yellow. Now the main colors inside and outside of the restaurants are dark grey, silver, green and white to look fresh and support the high quality image promoted by the new marketing.

Old store

New  store

Old interior

New interior

Same update was made to packaging. New higher quality packages are clean brown carton with designed graphics instead of the, if my memory serves me well, bright red and yellow in the old ones.

New packaging

Also new products, sides, pizzas and healthy options were developed to drive restaurant traffic. Some ingredient suppliers were changed to higher quality and domestic ones.

Food sustainability marketing

Idea with the new concept is to capture the food sustainability trend Chipotle took main stream in the US.

New online shop

In addition to the new concept Kotipizza developed new online sales channel with idea that pizza could be ordered with one click and have it brought home quickly.

First Kotipizza developed website where orders could be made, then started cooperation with Finnish food delivery app Wolt and last month proprietary mobile app was released.

Idea for online sales channel was copied from the big international fast food pizza chains which have been very successful with their online strategies. For example Domino’s UK’s online revenues have grown 30% for two years in a row and are now 67% of total sales. Papa John’s online sales in the USA was 52% in 2015 and reports are that Pizza-Hut’s online sales are in the same 50% range.

Goal with Kotipizza’s online strategy is to capture the online food ordering trend expected to start in Finland, similarly to what has happened internationally.

Market reaction

After four years of underperformance in 2015 Kotipizza started outperform the market. Kotipizza grew 9% while the market only 3.6 %.


From monthly system sales figures it can be seen that most of the outperformance started in second half of 2015 with increasing speed, which is when most of the updated stores were opened. In May sales growth was 8.5% and by December almost 18%.

monthly growth

The system sales growth was caused by both growth in average ticket size and store traffic.

Average ticket was up 13%  from 15 to 17 euros and monthly store traffic up 8% from 1850 to 2000 visitors. Combining the two, average annual sales per fixed store is up 23% from 333 000 to 408 000 euros.


Given that the outperformance coincides with the new concept roll-out, it’s probably because of the new concept roll-out.

Reasons behind outperformance

There are four main explanations for the outperformance, in my opinion.

1. New concept is actually appealing

Compared to the old marketing the new one is so much more appealing. Pictures of pizzas look good and makes you want to eat them. Video marketing now focuses on sustainability and high quality ingredients, which is in tune with the times.

Fast food restaurant business is promotion driven business. To get people in stores customers need to be pounded with new products and good offers. Kotipizza has upped their game significantly on this. There are new gluten-free pizzas, “Timber plank” pizzas (bad translation), Monster pizzas etc., which look appealing and are more expensive than the traditional products.

New packages are so beautiful that you want to have, carry and open them.

Restaurants look fresh.

Looking back at the old marketing, package and stores, they really were outdated.

2. Improved marketing reach

The new online marketing is probably reaching new audiences and old audiences that Kotipizza might have lost (like me).

With help of Facebook, Instagram, Twitter and cooperation with blogs it reaches people who don’t watch TV or read marketing brochures, the old tool box of reaching customers.

Digital marketing is one of management’s key focus areas and it seems to working. For example CEO is handling customer feedback in Twitter on weekends.

3. Congruence of image and price segment

Fast food restaurant visit is partly visual, partly locational, partly temporal, partly “socioeconomical” and partly habitual  experience.

To restaurant concept to work every aspect needs to be right but also congruent with each other. It’s like good food. It’s not enough to have the best ingredients, they must be mixed together in right proportions.

Historically Kotipizza’s marketing was focused on price and the red and yellow colors signaled as if it was a hard discounter.

Yet, despite giving appearance of cheap it always was more expensive than its competitors. Price and quality appearance were not congruent.

That’s a contradiction many customers are not willing to accept when there are competitors who not only signal that they are cheap but also are cheap.

Why would anyone buy expensive product that appears cheap when there are cheap appearing products that actually are cheap, in this case local kebabs.

With the new concept that signals high quality customers might perceive that the higher prices Kotipizza is charging are actually justified.

Now that Kotipizza markets effectively that its products are sustainable and high quality, it has moved step away from the kebab competition who cannot do the same.

The move to the higher quality/high price segment is especially good because there are no international or national pizza brands in Finland who could move to the same segment.

4. Online channel works

In May 2015 the online store had 18 000 registered user and over 55 000 by end of the year.

The Wolt food delivery application which started last year and which handles Kotipizza’s food deliveries in the big cities has been downloaded some 10 000 times in Android market.

Kotipizza’s own app have been downloaded 500 times today, but it has been on the market only about a month.

The increase in online channel user base is from standing start last year without any noticeable marketing and therefore considerable.

With the online user base growing, so is sales. In January 2015 Kotipizza’s online sales were approximately zero, 250 000 euros in May and 400 000 euros in December.

With interpolation it can be estimated that Kotipizza’s online sales were about 3.2 MEUR in 2015, which is 4% of total 76.5 MEUR system sales.

To total 6 MEUR system sales growth online contributed about 50%. In recent investor presentation management told about 10-20% monthly sales increases in the online channel.

Clearly the new online channel contributed to Kotipizza’s outperformance in 2015 and will probably continue to do so in the future.

Going forward

Year 2015 was excellent for Kotipizza. It outperformed the market and verified that the new concept and the online strategy works. First two months of 2016 continued on a same note, system sales growth was 12%. There are few key performance indicators to follow going forward.

1. Online strategy roll-out

First big thing in 2016 will probably be stepping up the pace in the new online strategy.

I expect marketing campaign to start this year as Kotipizza released one YouTube video recently which related to the online sales channel.

Kotipizza’s long-term target is presumably to increase online sales to 50-60% of system sales, up significantly from the 4% in 2015. Then it would be on the same level with the internationals.

Note that partly the online growth is just channel shift from traditional channel, not net increase in total system sales. Instead of phone order or carry-out, people order online. And the emphasis is on the word partly.

International experience is that the decreases in traditional sales are more than offset by increases in online sales. For example in Domino’s UK’s comparable stores every pound lost in traditional sales was offset by five pound increase in online sales in 2015.


Decrease in traditional sales is more than offset by increase in online sales because average online ticket is higher than traditional ticket and because people order more often through online than through traditional channel.

Online ordering is also coming increasing popular. Main reason is easiness that the pizza-apps provide. One click and delivery guy brings warm pizza to you in 15-30 minutes.

Problem with online strategy

In my opinion there is one big aspect which will slow Kotipizza’s online growth at least in the short-term, namely that about 78% of restaurants don’t offer home delivery.


Most of the restaurants that don’t offer home delivery are in the smaller towns and in the gas stations (shop-in-shops).

Average Kotipizza is small and I have impression that most of the time there is only one employee working at them. Working alone means that home delivery cannot be offered. When home delivery is not an option online ordering loses most of its appeal.

And hiring extra employee to handle the deliveries is a problem for smaller restaurants. Employee cost is 30 000 euros annually. With 50% gross margin the online+delivery option should increase sales by net 60 000 euros to cover the cost, which is 15% growth relative to average restaurant’s sales (400 000 euro) and much more relative to the less than average restaurant’s sales.

And the emphasis is on the word “net” because it’s not enough that customers just move from phone ordering or visiting store to online ordering, they must first order as much as they used to and then some more to total sales to grow.

It’s not impossible for average restaurant to increase sales by 15% (or much more for the less than average restaurant) but it’s not easy either, because the growth must come from winning market share. To Kotipizza to sell more, somebody else has to sell less, which is tough call, especially in the periphery locations.

Currently the success of the online strategy relies on the 54 fixed restaurant that offer the home delivery. They are enough to get the online growth rolling.

The 54 fixed restaurants that offer the home delivery option contribute about 22 MEUR to total system sales, assuming the 400 000 euros average sales each of them.

If they grow say net 10% through online, system sales will grow about 2 MEUR or 2.6% relative to the 76.5 MEUR system sales in 2015. And the online growth could well contribute more to the growth than the net 10%.

But for longer term online growth case more restaurants needs to offer the home delivery. It should be possible.

Of the 75 big town restaurants that don’t offer home delivery many should be in the margin of being big enough to offer it in the future.

In my opinion this is firstly because the new concept is winning market share, so average store sales are growing. And growing sales makes it viable to hire new employees, including delivery guy.

Secondly, international experience is that when pizza wars move online, branded pizza franchisers are the winners and independent restaurants the losers (probably because independents cannot offer credible home delivery and they lack the online marketing skills).

Thirdly, when the home delivery option is offered with online channel, customer behaviour changes considerably. They order more often with significantly higher average checks, because it is so easy.

Examples of the towns that should be on verge of being big enough to offer home delivery in the future would be student town Jyväskylä with 7 locations, energy industry growth and student town Vaasa with 7 locations and technology growth ‘hot spot’ and student town Oulu with 8 locations. There are probably also many smaller but lively towns where the delivery option can become viable.

With the big towns and the viable small towns my rough guesstimate is that doubling the number of restaurants offering home delivery should be possible. If so, the online channel sales should have a lot of room to grow.

It will be interesting to see how Kotipizza will solve the home delivery problem but this year will probably tell a lot whether the online strategy will work or not.

If it is going to work I would expect to see most of the restaurants in bigger towns start offering the home delivery option+online ordering this year because the technology is available. And if they don’t start to offer it within this year the “online growth case” for Kotipizza starts to crumble.

The smaller town and shop-in-shop restaurants in the periphery are a wild card but I’m little skeptical of their ability to win enough market share to make the home delivery option viable for them and therefore don’t expect them to contribute to the online growth meaningfully at least this year.

2. Restaurant update program

Second big thing in 2016 is finishing the restaurant update program that started in 2015.

Only 60 of the 252 restaurants have been updated so far and the goal is to get the rest updated by end of this year.

Last year monthly like-for-like system sales growth was 8-16% towards end of the year, average number of monthly visitors in fixed store grew by 8% and average ticket by 13%, success which can be mostly attributed to the updated stores.

If same success can be repeated in the non-updated stores system sales have plenty of room to grow in the future. This in addition to the potential online channel growth.

In investor presentation CFO told that in addition to updating old restaurants they have goal to open 16 new restaurants this year. Few of them are already under way according to social media.

Kotipizza has also joint venture related to Chalupa, a new Chipotle style Mexican food concept. First restaurant was opened in September 2015.

Last quarter its sales were 165 000 euros for three restaurants or 55 000 per restaurant. Annualized, average Chalupa sells about 220 000 euros, which is lower than average Kotipizza’s 400 000 euros.

So so far the concept hasn’t hit the jackpot but I guess it’s not bad either from standing start. Future will tell how well the Chipotle style food will work in Finland.

Management’s plan is to open 6-18 Chalupa restaurants by end of this year, which could further increase Kotipizza’s growth.


To recap, what we have is a pizza franchisor selling at 16x adjusted earnings. It hardly needs capital to run and operating cost are fixed. Thus any increase in sales goes directly to profits, free cash flows and dividends, which is why notionally high P/E can be a bargain if there is even moderate growth.

And Kotipizza’s growth seems to be more than moderate. Last year system sales grew 10% and first two months of this year growth was double-digit. They will probably continue grow because the new restaurant concept works. The new concept’s message of sustainability and high quality seems to resonate with customers and there is no sign that it would stop in the near future.

And sales will probably continue to grow because only 60 of 252 of the stores have been updated. Plan is that the rest will be updated this year. There is also plan to open 16 new stores this year which should further enhance growth.

More over, sales will probably continue to grow because the newish online sales channel is gaining traction (10-20% monthly growth according to management). Internationally opening online sales channels have been game changing events because they change customer behaviour. Relative to fixed store visits and phone orders online orders are more frequent and they have higher average ticket.

Internationaly winners have been branded pizza franchisors not dissimilar to Kotipizza, except Kotipizza does not have directly comparable competitors, so it should be in better relative position than its international peers (no need to compete against Pizza-Hut or Domino’s).

Offering the home delivery in many restaurants is a big problem and needs to be solved and it is the biggest concern I have in Kotipizza’s growth case.

Another concern for me is that the small organization might be overstretched. There is only 16 employees in the franchise organization and 35 in the whole concern. They have two big projects that they are doing simultaneously, launching of the online store and launching of the Chalupa concept.

In a way, they are trying to do in Finland what Domino’s did in revolutionizing the online pizza market and what Chipotle did in revolutionizing the sustainable fast food market, both at the same time.

The many international expansion failures makes me question the organization’s ability to execute. How ever, the new management seem to be respected by the franchisees and their record of increasing the system sales last year makes me hopeful that historical management performance is not good guide of the future performance.

If system sales continue grow 10%+ speed, as they did for first two months of this year, the system sales growth will be around 8 MEUR this year. As per the management’s “10% rule” guidance profit growth would be 800 000 euros, which is 21% increase to 2015 adjusted EBT.

In reality profit growth would be less in such scenario because this year depreciation expense increases by 600 000 euros relative to 2015 due to increased capitalized IT-investment.

Two or three years down the line, the growing system sales should start to show up in the profit line and valuation look cheap also notionally as per illustration below.


With 16x adjusted earnings I’m betting that Kotipizza’s new concept will win further market share, that Kotipizza will open new stores and that they will make considerable progress with the online strategy and therefore that the earnings will grow. I’m betting that the pizza sales will move increasingly to online and that Kotipizza will be the winner.

It’s off to a good start but time will tell.

ps. At the time I was finishing this post Kotipizza released its March 2016 system sales, which were up 19.3% and like-for-like 20%!

Kotipizza’s new concept and strategy looks to be working better than I’m assuming in the simplified valuation sheet above (assumes 10% growth).

So far this year monthly system sales growth numbers are:

Jan 12.3%,
Feb 11.6%
March 19.3%

In light of good start of the year my simplified profit forecast estimate could be adjusted upward and therefore that the forward P/E look more appetizing also notionally.

Say with 15% system sales growth assumption for the whole year the forward P/E multiple would be 14 which is too cheap for company growing double-digit without meaningful incremental capital needs.

Disclosure: Long Kotipizza with 8% position.

Still no respect for Martela: Q4’15 update

Last Thursday Martela, the largest office furniture manufacturer in Finland, announced its full year result for 2015 which showed 4 MEUR operating profit, almost net debt free balance sheet and significant increase to dividend, highlighting the successful turnaround after three years of losses.

Still, market was disappointed and rewarded the stock with solid 10% move down from last Wednesday’s close, setting the enterprise valuation to six times EBIT and three times EBITDA.

Low valuation is surprising as management guided same earnings for the next year and even more for the future with 1-2 MEUR new net savings to flow through earnings in 2016-2017, suggesting that the current earnings are on a solid footing and not just temporary phenomena that the market move seemed to imply.

All else equal income statement effect of 1 MEUR net savings, the low range of management guidance as it is a bit vague, for next two of years would look as follows:


And implied hypothetical workout valuation assuming current market cap, 50% payout rate, accumulated dividends from years 2015-2017 and 10x exit multiple for 2017 earnings:

Investment (market cap) in 2016: 20 MEUR
Cumulative dividends 2015-2017: 4 MEUR
Exit value (10x earnings) in 2017: 36 MEUR
Total cash inflow 2016-2017: 40 MEUR
Upside 100%
CAGR 42%

Clearly “all else equal” scenario looks very appetizing, especially as that seems to be in line what the company itself is expecting and not relying on rosy future, just the same old same old. But I have ventured to guess that the future might be better than the same old.

As regular readers remembers in my earlier posts I have tried to figure out how the changes in working habits and inevitable shift to activity based offices effects to general office furniture market demand.

On the one hand activity based offices reduce required office furniture per employee and thus decreases demand on the long term, but on the other hand offices must be completely redesigned and refurbished before they can be shifted to activity based offices, presumably increasing demand in the short term.

And the Q4 report gave indications that the short term trend of shifting to activity based offices might be in early stages of starting.

In Finnish segment sales were up 10%, despite recession continuing for 8th year with no end in sight, a success which management attributed to new activity office based office products combined with life-cycle contracts, which include design, installation, service and recycling of office furniture during lifetime of the contract.

More over, media has started buzz about activity based offices, conferences are being arranged around the subject and employers show a lot of interest towards it because of the obvious cost savings, attention that has started to increase as of last year.

If it is so that companies start to shift to activity based offices with increasing speed in the next few years, which I would expect as they save costs, quality that should be in demand especially during difficult times like now, the workout valuation sheet might actually understate the true future cash flows, as sales and profits would be higher than in the “all else equal” scenario presented.

The valuation sheet also did not assume any sales or profit improvement in Sweden or Poland, currently both loss making, where Martela reported to now have full capability to deliver the same activity based office products with life cycle contracts that have been so successful in Finland.

More important than the forecasts about the future developments though is the succesful turnaround through aggressive cost savings which puts Martela back on solid footing. It seems to be much safer investment than say year ago when it had elevated debt and no earnings, despite that stock price having already increased a bit from historical low levels.

Now with almost net debt free balance sheet, earning money in recession, about 10% lower break even sales than current sales due to cost savings and good prospects there seem to be more operational safety buffers against negative surprises. Yet, valuation is still cheap and supported by “two pillars”, namely price below book value and low price to earnings ratio.

After the heavy restructuring and with new management and product lineup Martela seems to be in better condition than it has ever been, yet it is also almost the cheapest that it has ever been. Thus, I continue to hold my shares with about 10% position.

Disclosure: Long Martela

See below summary data and valuation from 2015 and links to my older Martela posts:


Older writeups:

Cheapest stock of the week: Martela

Martela revisited: Will iPad kill the furniture industry?

Few more thoughts on Martela (part 3)

On Swedish electricity grid business dynamics

Reader left a comment to my earlier posts about Swedish electricity grids and their profit orientation.

I have talked about investment opportunities in the grid sector here:

Cheapest stock of the week: Elverket Vallentuna Ab

Elverket Vallentuna revisited: Time for workout?

Cheapest stock of the week: Skånska Energi

Background is that energy market regulator originally determined that Swedish electricity grids can charge from their customers about 150 BSEK in 2012-2015. Then, after years of fighting, court decided in 2015 that the grid companies should have been allowed to charge 200 BSEK.

As the grids have been charging their customers up to the end of 2015 based on assumption that the allowed charges are 150 BSEK, they essentially have been under charging their customers by 50 BSEK.

And the rules say that grid companies are allowed to charge any deficits at one regulatory period in the next regulatory period (2016-2019 in this case).

Question is, will they, and that’s what the commenter is wondering and what my answer is all about.

It’s bit long, so I decided make a post about it and some other random thoughts of the grid business (probably interesting only for people with some understanding of the grid busines in Sweden).

However, I would say it is too optimistic to assume that the distribution companies will raise prices to the extent that they use the total allowed revenue according to the latest court order, if they have not explicitly said they will do it. Only the distribution companies which accept large raises of the fees 2016-2019 and then are willing to lower the fees 2020 will do this. I’m not sure Vallentuna is that type of company. Every company with municipal ownership (Dala and Skånska?) will just do business as usual. However, I’m not sure what Vallentuna will do.

Yes, this was initially my first concern too with Elverket Vallentuna , but talk with CEO, their stated strategy to pursue highest risk adjusted returns and some organizational changes that signals profit orientation gives me confidence that they will charge all the allowed revenues and accumulated deficits from customers.

For rational operators it shouldn’t be a problem to increase revenues temporarily and then decrease them back to “normal” level so I don’t see any reason why that should be problem, other than political that is.

And Skånska Energi I rejected because they have not communicated anything that would suggest me that they would utilize the deficits.

If they do it [increase prices to charge the accumulated deficits from customers], they will probably be forced to lower the network fees in 2020, because the new regulatory regime in action since 2016 is much stricter if they don’t increase investments pretty much, which in that case instead hits the free cash flow.

For those who charge the accumulated deficits in 2016-2019 revenues will decrease from 2020 onwards, of course. But after the temporary deficits have been charged from customers in 2016-2019, revenues from 2020 onwards fall back to 2012-2015 actual revenue levels, approximately.

So relative to what actually was charged from customers in last four years, the new stricter regulatory model doesn’t bring big change.

There’s just temporary blip in the revenues due to the court order and that’s that. That’s why I value the network businesses according to what the underlying business is worth based on the latest regulatory model (2016-2019) and then the deficits from prior years separately, as they are only temporary.

Grid business dynamics, WACC and free cash flows

Little bit side of the original commentators point, but in the 2016-2019 regulation model “WACC-part” of the revenue cap will be calculated based on depreciation adjusted replacement value of the grid, which will lower the allowed revenues relative to what was allowed in the 2012-2015 model (where the WACC-part of revenue cap was calculated based replacement value of the grid, that is, without adjusting for depreciation).

And because the WACC part of the revenue cap in the 2016-2019 model depends of depreciation adjusted replacement value, revenue caps will decrease as the grid gets older and depreciate.

So to keep revenues intact, grids must keep reinvesting to the network constantly, which will of course hurt the free cash flows.

But it’s not a bad thing to not have free cash flow by itself. Berkshire doesn’t have free cash flow (100% reinvestment rate) and nobody complains. It’s bad not to have free cash flow only if investments doesn’t cover cost of capital. If they do, then it’s good not have free cash flow.

As long as regulators WACC is equal to grid company’s true cost of capital, the reinvestment create value and therefore you WANT them to reinvest to the network. Only scenario you want free cash flow is that regulator’s WACC is below true cost of capital.

So really, the question of do you want free cash flow or not depends of do you think the 4.5% allowed WACC is enough for taking grid business risk or not.

And, for what it’s worth, I think the 2012-2015 regulator’s 6.5% WACC is too high and the current 2016-2019 4.5% WACC sounds about right.

Grid business is low risk because the regulatory model guarantees that grid operator does not have price risk, volume risk, inflation risk or interest rate risk, so seemingly low regulatory WACC is fully appropriate. There is very limited cost risk, too (there is 2% cost reduction requirement but with most grid’s it should be easy target, given the big unexplained (according to regulator) differences in profitability across the industry).

If electricity consumption decreases temporarily or permanently, grid can increase prices so long until its profits will be equal regulator’s WACC, no matter what. In extreme case, if all but one person leaves a city, the one person’s electricity bill will be increased until grid’s profits equals WACC. No matter MWh, grid companies will get paid.

And if interest rates rise the regulatory WACC will be increased, and therefore grid can increase prices and therefore profits. So essentially grid investment is like is a variable rate floating bond where the interest rate change not the principal value (check “floater” in google). To put it another way, if interest rate rise Elverket’s present value of free cash flows won’t decrease because the increased allowed cash flows will be proportional to the increase in the discount rate, essentially offsetting each other.

So grid companies are protected from change in interest rates (desirable quality in this interest rate environment?). There is also similar inflation protection mechanism, so grids are inflation protected also.

But the point was about the free cash flow and my take is that with current regulatory WACC you want 100% reinvestment rate because every SEK reinvested will be worth at least that one SEK earned back. And with 100% reinvestment rate, you get the compound interest.

That’s why Elverket Vallentuna is in so good position, because it’s located in the growth regions of Sweden and therefore CAN and SHOULD reinvest most if not all of the profits.

That’s what Berkshire Energy is doing with its regulated gas pipeline and grid businesses – reinvesting 100% of earnings, because the reinvested earnings will compound.

To his genius, Buffett boosts the regulatory profits with leverage so that he will get his 10%+ guaranteed compounding. Remember, he want’s 1) stability and 2) long road ahead for compounding 10%+. Grids and gas pipelines provide that, if you use leverage.

Elverket Vallentuna has had conversations with banks about leveraging up but I don’t know why it’s not moving. Current net cash position is ridiculously conservative. Either reinvest, acquire other networks (there’s about 160 small networks to choose from), or pay dividends, I say.

So I’m not at all worried about free cash flow for the grid companies, especially of my horse Elverket Vallentuna, as long as the regulator allows decent WACC from the investments.

There is also another court process regarding the WACC for 2016-2019 going on. I would say that the decided 4,53 % will be abandoned and be changed to some 6,2-6,3 % but that will take some years with repeated court processes, so the effective WACC (that companies have to assume then they calculate and follow up their maximum allowed revenues) will probably be 4,53 % until say 2018-2019 when the court has finally decided.

Yeah that would be positive news, if the 6%+ WACC would happen. We will see.

The management consultants’ estimates of the WACC for 2016-2019 in the regulator’s website are on average actually lower than the 4.53% allowed by the regulator, if I remember correctly, so interestingly the regulator chose higher allowed WACC than what the professionals suggested for them, clear sign that they are trying to find the right balance between attractiveness of the grid business for investors on the one hand and protection of the consumers on the other.

Interesting to see how this latest court debate ends.

If you read the court documents relating to the 2012-2015 debate of the WACC, it’s just ridiculous. It seems that the judge just had to pick one, as the estimates of “true” WACC given to court by industry professionals ranged between 4-6% or something. Essentially the 4 year court debate was about what parameters one should use in the CAPM model that determines the WACC set by the regulator.

There is a quite big regulatory uncertainty in Sweden because every regulation since ~2003 has been objected by the electricity companies. There will with 100 % certainty be more regulatory changes in the future and no changes will have the objective to give greater profits to the monopoly companies…

Yes there will be changes, but my take about them is that now (2016-2019) the Swedish model actually makes sense and is consistent with western standards, and therefore that the coming adjustments will be only fine tuning.

Regulatory uncertainty has decreased, is my take.

To give example of the mistakes in the 2012-2015 model, it gave the grid companies the 6.5% WACC without taking to an account age of the grid (the real annuity method based on replacement values).

I think it was a big plunder. Only too late they saw what the calculation method means for distribution prices (go up significantly) and invented the “transition method” to prevent too fast price hikes, which the grid industry subsequently challenged in the court and won.

I think the regulator chose to use the real annuity method based on replacement values because they did not have the age data of the grids collected, but needed for some reason to change the model to modern pre-regulation direction already in 2012-2015.

If they would not have hurried they could just have gone with the old model for another four years, collect the age data, and only after the age data was collected and analyzed, move to proper pre-regulation model which takes in to account the age of the grid.

But now that the model makes in principle sense, so I think it’s stable. There will be fine tuning, but just that.

I agree that regulator won’t give any extra profits that the grid doesn’t deserve. But there is mechanism to increase deserved profits through improving electricity quality.

Max electricity quality incentive for example was increased from 3% to 5% in the 2016-2019 model.

Elverket Vallentuna has some 100 mkr revenue cap. 5% quality incentive is 5 mkr. But as Elverket’s regulatory profits are some 15 mkr, that’s 33% profits increase if you can improve the grid!

So there is profits on the table. Imagine you have bad quality network which has maximum 5% revenue penalties. Now update it to new network and get the 5% revenue incentive. There is temporarily 100% increase in profits.

I think the regulator is generous enough for those who deserve it and the model in general good for all parties therefore on a road to stability.

However, as a buyout case there is of course a huge upside in all three of Skånska, Vallentuna and Dala Energi. As long as they are reasonably valued according to recent profits they are indeed interesting companies to own.

Yes exactly.

But one thing must be remembered that what cheap means in grid context. It means P/E<20.

If grid invests directly to network it gets say 5% return on it, that’s essentially P/E=20 investment. So if you buy company which invests to grid the fair value multiple should be the same P/E=20. So essentially no growth P/E=15 grid stock is a bargain.

Second point is that one should use the regulatory profits as estimate of the owner earnings instead of accounting profits. For example Elverket’s accounting depreciation is for historical reasons lower than true replacement capex needs of the business, which is well approximated by the regulatory depreciation.

Thanks for the comment and feedback!

Good investing,


Should’ve, could’ve, would’ve…hindsight wisdom re Kotipizza

I don’t know why I’m doing this. I had done quite a lot of work on Kotipizza but did not make a decision on buying it. Waited and procrastrinated all that, waiting for lower prices etc. And did nothing, and now the stock had a big move (at the time it was below 5 and as of yesterday it’s like 6.5 as bank started to cover it with 8 EUR target).

There is still value I guess and I don’t know why this move felt so bad, the agony of missing out?

So here is my “pitch” to a reader from 27.11.2015 when the stock (with benefit of hindsight) was still extremely cheap, to share the pain and console myself that “I almost got it from the bottom.”:

“Never heard of Kotipizza, finding anything interesting?

Largest Pizza Franchisor in Finland (hem pizza would be straight translation). They are 4th largest fast food joint in Finland. System sales some 70 meur. Their brand awerenes in Finland is same as Mcdondalds.

It was failed IPO nobody wanted it. It has difficult past. Investment media has plaqued it as ultimate muppet stock for retail investors.

Nobody ever has spoken about the numbers though in the new articles, just some random ranting.

Well I did (tap in the back for that lol).

So basically they have new marketing and store concept. They are nailing 10% sales growth.

That will go directly to earnings, because franchisor gets the franchise fees from increased sales wo. increased costs. PURE INCREMENTAL PROFIT.

Point is that you adjust the figures for new sales and one offs, p/e 8. For company growing 10% with extremely stable model.

And then there is internet and pizza app sales option which they are building infrastructure, which have been EXTREMELY SUCCESSFULL in other countries by other brand name pizzerias like Dominoes, Papa johns etc..

So if their mobile app is as successful as other brand name pizza apps then it will be like 20% compounder.

And note, Kotipizza is only big brand name pizza joint in Finland.

Kebabs can’t create similar credible competing mobile app. Kotipizza will win the pizza app sales in Finland, is my bet. Depending of the size of the pizza app market is therefore the question.

Yeah and they also just started Chipotle concept. If it could be succesful too (I actually dreamed, but left it there, to start this kind of concept myself so I’m biased to think that it will be successful).

And so forward p/e 8 if I’m right + new store concept in pizzas + 10% same store sales growth + mobile app option + chipotle option. Roe 40-100 % I don’t know.

I think that’s decent. Buffett stock with non-buffett prices.

And Kotipizza just copies everything from the big boys(Dominoes, Chipotle). That’s good.

Other than that I think the management has questionable track record.

Then they have guaranteed all their franchisors rents so it could blow up on them if the model stops working.

And horrified because institutions wasn’t interested of the ipo. What do they know that I don’t?

No reinvestment need (they just collect the franchise fees) so earnings growth = directly to dividends. So 10% growth w.o. new capital to business. That’s hugely valuabe  (like 20-30 p/e theoretically)

No position.”

I will continue my rsch despite move because I still have some unanswered questions. But this kind of real time emotional reaction of “market finding my “gem” before I acted” -update this time. 

And that’s that end of story. 





Medical Investment Trust: Private investment company 0.57 P/B


Medical Investment Trust (MIT) is an investment company from Finland traded at private/OTC markets. It last traded at 0.57 P/B valuation despite lower fees than index fund and decent performance, presumably due to VERY low liquidity and no public reporting, not even a website.

MIT used to be listed in the 80’s and was investment vehicle of one famous Finnish investor, Jouko Brade. He has since passed away and the company is controlled by his family.


Current market price of MIT is 64 MEUR while book value on last reporting date 2/2015 was 112 MEUR. That’s 0.57 P/B.

MIT has 125 MEUR assets, of which 120 MEUR is actively traded shares, ETFs and bonds and rest 5 MEUR cash and undisclosed unlisted investments. No debt, some tax liabilities.

Portfolio is well diversified but focused on medical and technology sectors. There is no information of the portfolio weightings as a private company it has no obligation to report them.

In 2014  portfolio’s net return after all fees and taxes was 6% and 14% in 2013, so the performance has been decent. They have paid ~2 MEUR dividend for last two years, which is about 30 % of earnings.

Annual operating fees are about 250 000 EUR annually, or only about 0.2% of book value, so valuation gap to NAV is not explained by high fees. I’m guessing that the low expenses are explained by some expense sharing arrangement with other Brade/MIT related companies (there are at least two), because the fee% is so extremely low (lower than index fund).

MIT should be able to do at least 10% over time. So assuming 10% ROE and historical 30% payout rate in 2016-2018 book value development would look as follows:


And return for investor, assuming entry with current 64 MEUR market cap and exit @ 0.8x estimated 2018 book value:


Owners and history

There is very little information available for outsiders.

MIT was founded by Jouko Brade in 80’s. It was era known as the “casino years” in Finland. Opening of financial markets led to giant flow of foreign capital to Finland which lead to one of the biggest real estate and stock market bubbles (and busts) in history. From old magazine articles and Wikipedia one finds that MIT used to be listed in Helsinki Stock Exchange during that time.

I don’t know the story behind the unlisting but it must have happened 20-30 years ago. I presume that the few shares now floating around in private/OTC markets are leftovers from that era. Probably private investors getting rid of their shares (with any price) as there is no stock quote provided every day.

Brade passed away two years ago. He was famous Finnish stock investor and I think I have seen a story that he was one of the few in Finland who became very wealthy primary through stock investing. I have faint memory from old magazine article that he was kind of Graham type, but I might be wrong.

He seems to have been very well connected and regarded in Finnish business circles, as evidenced by board seats and other connections in major companies.

Unfortunately there is two-tier shareholder structure so not all are created equal. Currently control seems to be in Brade’s family hands, at least surnames of board members point to that direction.

Someone from the company answered to phone when I asked for annual report and was very helpful in sending it for me. Quite understandably as private company they didn’t want to go further to giving detailed information when random outsider like me started to ask questions.  But I was left with an impression that for shareholders they are more open of their matters.

Given bits and pieces from Brade’s and MIT’s history I get a feeling that this is well run and shareholder friendly company.


Diversified active investment portfolio with P/B 0.57. Book value will compound 7% over time and pays 5% dividend on market price. That’s 12% fundamental return.

Multiple expansion from 0.57 to 0.8 would increase returns by 40% or x% compounded, depending of length of period that the multiple expansion would take, but who’s counting since it would be speculation?

Discount to book, dividend while waiting and participation of “legendary investors” legacy vehicle provides safety.

Very little information for outsiders and two-tier share structure is of course cause of concern but that can be dealt with small initial position sizing. Then buy more if things look alright after, say, recon operation to annual meeting.

I think MIT is good fit to clunker/netnet type investors with respectable portfolio size (high trading fees in private markets rules out the smallest ones), who like to collect deeply discounted shares with not too much effort.

For deeply discounted it seems.

Disclosure: No position. I would have to take too big position relative to my portfolio to make up the high transaction fees in the private markets. Other than that I would venture some 5% position.

(Shares have last traded on July 2015, but I have seen sell offers recently. Price was lower than assumed in this post. I think other than for Finnish citizens it is impossible to trade the stock as it only trades private markets brokered by Privanet.

Address to the brokers site: