Cheapest stock of the week: Apetit

Apetit is a food industry conglomerate from Finland trading about half of book value and is the cheapest stock I stumbled on this week. On the face of it Apetit looks like to be particularly good “low P/B” case as it has low leverage and is operating in seemingly stable food industry. But despite the apparent  safety and good upside if the issues Apetit is facing gets solved perfectly the problem is that the base case prospects are too mediocre to warrant investment.

Apetit has three main subsidiaries that can be labelled as ‘good’ and three subsidiaries which can be labelled as ‘bad’. The good ones include the branded frozen vegetables and pizza business in Finland, processed fish products business in Sweden&Norway and grain trading business which is one of the biggest in Finland.

The frozen food business is stable and high quality with 11% EBIT margin and 26% ROIC but is growing only with inflation. Last year it earned 5,2 meur with 20 meur invested capital and is probably worth some 50 meur+.

The grain trading business, which buys grain from farmers and sells them to food industry, looks like a good one also as it has long profitable history with 9-20% ROIC. Last year it earned 8,7 meur with 43 meur invested capital of which most is grain inventories. The business is operated through Avena Nordic Grain Oy, which is 80% owned subsidiary of Apetit. It is probably worth at least the 43 meur tied to invested capital because returns on capital are so good, of which 80% or 34 meur would belong to Apetit. It could be worth even more as it has growing seed oil processing business among other growth initiatives.

Last one of the good businesses are the Swedish and Norwegian processed fish and shellfish producers operating under Maritim Foods A/S concern. The Norwegian business showed losses in 2009-2012 but turned around in 2013-2014 with 2-3% operating margins and 10-15% ROIC. The Swedish business seems to be little bit better as it has less unprofitable years but on average the profitability metrics are similar as the Norwegian one. The business was bought for 15 meur in 2007 which is probably good estimate of the fair value today as it implies about 10x EBIT multiple.

Taking all the Apetit’s bigger ‘good’ businesses together they are probably worth some 50+34+15=99 meur. Apetit also has small 6 meur minority interest in Taimen-concern, which farms fish mainly in Finland. With the 6 meur minority included the total value estimate of the good business is 105 meur. Cancelling out the 25 meur capitalized concern costs and 3 meur net debt leaves 77 meur value for equity claim holders. Apetit’s current market capitalization is about 84 meur so essentially if my 77 meur valuation for the good businesses is correct then the ‘bad’ businesses are selling for 7 meur. It also means that any upside related to investment in Apetit’s stock depends of value of the ‘bad’ businesses. Let’s look at them, then.

First one is Caternet which is kind of distributor of vegetables and fish products for professional restaurants in Finland. Part of the business is the low level processing it does for the distributed foods, which includes slicing of tomatoes, cutting fish and peeling potatoes etc., which it then sells to the restaurants as prepared fresh products. Problem is that since the acquisition Caternet has not been profitable even once. Reason is decreased volume of business as sales have dropped from 30 meur to 23 meur probably because of the prolonged recession in Finland.

Apetit bought the business in 2012 for 18 meur which seems quite expensive given that current invested capital is only 11 meur earning nothing. To be worth even the 11 meur tied to invested capital Caternet should be earning at least 1,1 meur. But current operating costs are about 11 meur and therefore gross profits should be about 12 meur to achieve the 1,1 meur operating profit. As gross margins are about 37% to achieve the 12 meur gross profit the sales should be about 32 meur or about at the same level as they were in 2012. Rebound to that that kind of level from current 23 meur seems like it’s not going to happen any time soon. But given that the sales have historically been at the 32 meur level I guess it’s not impossible either. I would therefore say that only in best case Caternet could be worth the 11 meur because it really requires 1 meur+ profits and 30 meur+ sales which seem like to be far far away currently. More likely scenario in my mind is that the difficult years will continue and the fair value therefore significantly less than the 11 meur.

The second one is Apetit Kala which is in similar situation as the Caternet. It has never really been profitable and sells undifferentiated products. It imports fish from Norway or buys it from local fish farms, after which it is sliced, diced and packaged in production facilities, and then distributed to retail stores across Finland. There is very little processing to the fish products so pricing power is low against the large retail chains. Last two years sales have been around 70 meur and the retail fish market has been growing so Apetit Kala’s problems are not in volumes but in profitability.

Solving the profitability problem therefore requires either development of new products with higher margins, improvements to operational efficiency or more pricing power. There is little change expected in the pricing power or in the new product development so only thing left is the efficiency gains.

Currently there is around 18 meur tied to invested capital and acceptable 10% returns would mean that Apetit Kala should be earning about 1,8 meur. Problem is that last year the losses were 2,8 meur, so about 4,6 meur should be squeezed out of the cost of doing business to get to the 1,8 meur operating profits. That seems like difficult to do as total operating costs are only 16 meur. The 4,6  meur profit increase could also of course come from increased gross profits but it seems like difficult task also as 4,6 meur gross profit increase with 20% gross margins implies 23 meur sales increase. With about 70 meur sales last year it would imply about 33% growth which is not going to happen anytime soon.

In reality the 4,6 meur is going to come, if it’s going to come,  with some combination of cost savings and increased sales but given the hurdles I would expect that it’s going to take some time. The decent Swedish and Norwegian fish businesses how ever gives hope that earning 10% economic profits is possible and therefore valuation close to 18 meur invested capital also. Bu I think that 18 meur is the absolute best scenario that can reasonably be expected. More likely scenario is that the difficulties will continue and the fair value is significantly below the 18 meur.

Third one is the 20% owned Sucros which operates sugar factory in Porkkala and beet sugar plant in Säkylä.  Sucros is little bit different case from the other two bad businesses as it is currently profitable. The problem is that it is facing existential threat, at least according to Finnish agricultural research institute, because EU is abolishing production quotas of sugar in 2017. Sucros itself seems to disagree as it has invested to more efficient equipment recently. But I admit that I don’t yet fully understand what is the mechanism behind the institute’s assessment as there is so many moving parts with the regulation, subsidies, very volatile market price of sugar, import tariffs and the economics of doing business.

On the face of it it would seem that if quotas are abolished then more beet sugar could be produced. How ever, the problem preventing continuance of the operation seem somehow be related to supply of sugar beet which apparently cannot be for some reason guaranteed when quotas are dropped.

One reason is probably that Finland is one of the worst place in the world to farm sugar beet and therefore fully dependent of subsidies for farmers. Any lowering of subsidies would lead to decreased supply of sugar beet to Säkylä’s beet sugar factory and therefore it would have to be closed. Closure of the Säkylä’s factory would further mean that the sugar plant in Porkkala would lose its main source of raw material and therefore would have to be closed also. I don’t understand the situation well enough but the threat of plant closures seems real as there has already been beet sugar plant closures in Finland earlier after the 2006 changes in EU’s sugar regulation.

The point of the discussion was to highlight that there is some serious issues facing Sucros and its value could in worst case be zero if not negative because of the closure costs. That would be serious blow to Apetit as Sucros has been one of the main contributor to group earnings over last few years. But if there wouldn’t be serious issues facing Sucros as cyclical business it would probably be worth at least book value or about 24 meur.

So if everything goes right in the bad businesses they could all be selling close to their respective book values or total of 11+18+24=53 meur. Adding to the 53 meur the 77 meur value estimate of the good businesses gives 130 meur total fair value estimate for Apetit. That is 55% more than the current 84 meur market cap. In reality the upside might be higher because I was probably low balling the value estimate of the branded frozen food, the grain trading and the sugar businesses in good scenarios, so there is ample upside if everything goes perfectly for Apetit.

But if it would happen that the bad businesses would fail, that is the sugar operations would have to be closed and the fish and fresh food distributions turnarounds didn’t succeed, they could be worth zero. Then only valuable part of Apetit would be the good businesses which I estimated to be worth some 76 meur, which is very close to the current 84 meur market cap. That is good thing in terms of margin of safety as failure in the bad businesses would not lead to permanent capital loss for investor with current market price. So in addition to ample upside if things go well Apetit stock has limited downside if things don’t go so well.

The problem is that if things go as expected the returns looks too mediocre to be very appetizing. If the good businesses continue to perform well as they have pretty much done historically, and as there doesn’t seem to be quick fix for the bad businesses, it seems that Apetit’s future will resemble more or less like the present. And present facts doesn’t seem to warrant much higher valuation than the 0.5 P/B currently.

To conclude I think Apetit is an interesting cheap looking case. But it has so many moving parts, complexities and problems to solve that despite nice upside if things go perfectly and somewhat protected downside if things go badly it doesn’t warrant a place in my portfolio because the returns in my ‘base line’ scenario seems like to be too mediocre.

For now I’m skipping this one.