….continuing from Part 1.
4. Problematic parts that seem well contained
As said in the Part 1, after the Seafood business disposal Apetit has only one problematic part, namely the Food Solutions segment.
But it was also shown that the Food Solutions segment includes the highly profitable Frozen Food business.
Therefore, it must mean that something else than the Frozen Food business is causing the losses for the Food Solution segment.
By cleaning out the Frozen Food business EBIT and allocated concern costs from the Food Solutions segment, it can be seen that the “something else” is losing some serious money:
And looking at the Fresh Food business, in all likelihood it has been the main contributor for the losses, although there is only information up to 2015 (in addition to other restructurings the Fresh Food business was merged to Frozen Food business in Q1’16):
So, the Fresh Food business has been deteriorating fast and in 2015 operating loss was -3,7 meur.
As the table shows, in 2016 the losses were probably significantly higher:
Firstly, revenues have declined compared to the 2015 partly because the legacy HORECA business is in difficulties due to weak market and partly because according to the new strategy business focus has been shifted to consumer products in retail channel.
(By clipping and gluing the merged subsidiaries it can be estimated that the revenue decline has been at least 2 meur.)
Secondly, distribution, marketing, product development and other reorganization costs have probably increased because of the shift in business focus and especially because of the new prepared vegetable mix and fresh salad product launches.
(Similarly to the revenues, it can be derived with some accuracy that the Fresh Food segment’s EBIT contribution was about -7 meur but estimate is very rough as during the Fresh Food/Frozen Food merger unknown amount of some other costs were also shifted to the new subsidiary.)
While the business reorganization seems to have caused double whammy of declining revenues and increasing costs, the effect will most likely to be temporary.
The mentioned new products are targeted for consumers and management has very high expectations for them. They play a key role in achieving Apetit’s new ambitious 20%/~20 meur revenue growth target for the Food Solutions segment by 2018.
To get indication of the opportunity, competitor (and potential acquisition target) Fresh Servant Oy AB, that services the same HORECA customers and makes the same salads and vegetable mixes for consumers as the Fresh Food business, has about 42,8 meur revenues and 3,2 meur EBIT (7,5% margin).
With the same margins and the 40 meur target revenue (20 meur existing revenues + the ~20 meur growth target), the Fresh Food’s EBIT could be about 3 meur. Add that to the Frozen Food’s 4 meur concern cost adjusted EBIT and the Food Solution segment’s EBIT could be 7 meur in the future (vs. the current -2,5 meur and vs. the management’s 5 meur vision by 2018).
More over, management’s policy to not tolerate unprofitable businesses and rationalizations made in the Seafood business before disposing it indicate that the management is willing and capable of cutting cost and getting rid of businesses that are not working out.
Therefore my conclusions is that the Fresh Food business losses should be interpreted as temporary and thus not capitalized in valuation (by say taking historical average earnings and multiplying them by x).
But to account for the likely future losses from the Fresh Food business somehow, I haircut my original valuation by arbitrary 10 meur (say 5 meur annual losses for two years).
The negative valuation for the Fresh Food business is slightly unfair because for sure the management is incurring the temporary losses because they think that the NPV of future profits will greatly exceeds the accumulated losses and investments.
After taking into account the net debt and proceeds from the Seafood business equity valuation looks as follows:
Compared to the current 86 meur market cap the baseline upside is about 26%.
Add in the 5% dividend yield, potential catalyst from the management actions to fix the problematic business units by 2018 and significant discount to book value, the short-term risk/reward profile looks pretty reasonable to me.
5. Excess liquidity for acquisitions as result of the divestments
The previous valuation was based more or less on current facts and situation.
But as mentioned many times, the management has ambitious growth and profitability targets for 2018:
The stated vision is to grow revenues in the Food Solutions segment by 20% mainly through the new product launches and in the Grain Trading by 25% mainly through Baltic expansion.
There are also new profitability targets for each segment.
For the Food Solutions segment profitability targets seems realistic as the Frozen Food business is already exceeding the whole segments target margins and peer companies in the problematic Fresh Food business indicate that it can be very profitable business.
As for the revenue growth target, early signs are good and the vegetable based food trend surely offers nice tail wind.
On the face of it, the Grain Trading and Oil Seed Products segments’ goals seems achievable too.
By increasing consumer products’ share in the Oil Seed Products business revenue mix the profitability “should” increase and by expanding Graind Trading capacity in Baltic by 25% the revenues (and margins) “should” grow.
But rather than try to guess what will happen I have tried to get grasp how achieving the goals would affect the valuation.
Using management’s vision numbers and same valuation multiples as in my original valuation, except for the Grain Trading business where I use 1,1xNAV instead of 1,0xNAV to reflect the management’s envisioned 14% ROIC, the share would be worth 24,5 eur/share. That’s 77% more than the current share price.
More over, if achieving the goal would take 1-3 years the 0,7 eur/share annual dividend wouls add up to 2,1/share.
Together the “best case” exit value 24,5 eur/share and the 2,1 eur/share cumulative dividends would bring the potential pay off to 26,6 eur/share and upside from the current 13,9 eur/share market price to 90%+.
Because of the new management’s clear strategy and past actions following the strategy (new products, cost rationalizations and non-core business divestments), achieving the envisioned goals seems like being decently probable outcome.
More over, after the Seafood business disposal Apetit will have approximately 20 meur excess liquidity to do growth acquisitions.
The cash could be coupled up with say 45 meur financial debt to stay at management’s target of 40% equity ratio (actual leverage potential to stay within the self imposed 40% equity ratio depends of the target companies’ balance sheets).
The 65 meur potential purchasing power would buy some serious value enhancing earnings if done in the fragmented SME market where valuation multiples are very low compared to public markets.
To get some indication of the opportunity, if the 65 meur purchasing power would be used to buy private businesses with say 8x earnings multiple, the hidden earnings potential behind Apetit’s over capitalized balance sheet is 8 meur.
That’s almost 60% increase relative to the envisioned 14 meur EBIT for 2018. Value effect would be even higher if the incremental earnings would be valued with say 10-15x earnings.
From decent return perspective the question is whether Apetit is worth a book value.
With all of the core businesses being profitable, growing and leaders in their industries the answer is resounding yes. More realistically, they are probably worth significantly more.
But currently the profitable core is hidden under the Fresh Food business losses. As Fresh Food business is at heart of the management’s growth strategy I’m not too worried that the losses would continue for very long.
If the book value or my base line sum of parts value, which are almost the same, is reached the base line upside is 26% +5% from dividends.
With the new management as a catalyst the short term expected return look reasonable.
But the real icing on the cake is if the management vision will be realized and if the excess liquidity provided by the Seafood business disposal is utilized in earnings and value enhancing acquisitions. For if both of them happens the potential return easily exceeds 100%. More over, given the time frame we are speaking here, it could happen within few years (for example the management vision is for 2018).
With high subjective probability for making reasonable return in the base scenario and decent probability of making high return in the management vision/acquisition option scenario the outcome distribution seems attractive for me. This coupled with margin of safety from profitable core businesses, dividend commitment and sub-book value market price.
(Part 1 of the post can be found from here).
Disclosure: Long Apetit with 7% position