Ibersol - a profitable Portugese Restaurant Operator

2012-07-30 08:00 -  , Value Investing

After going trough a list of portugese stocks and identifying some interesting candidates, I now looked a bit closer at the first candidate: Ibersol.

General Business description

Ibersol operates restaurants in Portugal and Spain, in which Portugal represents the larger part with about three quarters of revenues. Main restaurants that are operated are Pizza Hut (one third of revenues) and Burger King (one fourth of revenues). Besides that a number of other brands are operated (some own brands, some in franchise agreement).

In 2011 the market entry in Angola was started by Ibersol. A first KFC-Restaurant will open there in 2012.

So far for a first overview of Ibersol. That seems like an understandable business. But now let’s come to the point, that really draw my attention.

long-term financials – steady growth

The thing that is really interesting, is the very consistent development of Ibersol over many years.

Tip: you won’t find english reports before 2008 on the website. But reports in portugese language are available until 2002. With Google translate it is quite possible to get some infos out of them.

Here we see the development of revenues:

Revenues of Ibersol

We can see a really steady rise of revenues until the financial crisis. Since then revenues were flat and 2011 showed even a decrease.

The same picture with EBIT and profits of shareholders after minority interests.

Ibersol: EBIT and Net Profits

Since 2009 earnings were flat, in 2011 they were cut in half because of falling revenues and the fact, that fixed costs couldn’t be reduced to the same extent by Ibersol.

Profitability: above average

Let’s look at Ibersol’s profitability now. The first measure I always like to look at is EBIT-Margin. It’s not, that EBIT-Margin shows you, if a business is profitable, that depends on the combination of EBIT-Margin and capital turnover. But nonetheless it can show you some things.

Ibersol EBIT-Margin

The EBIT-Margin of Ibersol is stable about 10%. That’s a good sign, because it makes a valuation easier. A constant EBIT-margin makes it possible to estimate future profits, at least if you can assume, that future conditions will not change much.
And that is the big question with Ibersol. EBIT-Margin was almost cut in half in 2011. Is this a temporary weakness because of adverse economic conditions or is this a “new normal”, that will last for a long time and will eventually deteriorate further?
I think that is the question you must ask yourself, when you try to value Ibersol. If you can be certain, that this is a temporary thing, the rest of the valuation is third grade mathematics.

But let’s look on another measure of profitability for now. How much earns Ibersol on the capital that it must invest? Return on equity (ROE) is the relevant measure from the perspective of the shareholders for this. But sometimes this number can be a bit misleading. It is possible to boost ROE if a company replaces equity by debt. This can be positive for shareholders, if everything turns out well, but it reduces the ability of a company to survive difficult times. I don’t know what is the right level of debt, but I know that I generally like low risk and therefore low debt levels. But lets look on that later.

The other important point is, that to compare two companies or to the profitability of one company in different years, you have to take in account different debt levels. So if there are relevant amounts of debt on the balance sheet, there is a better number than ROE in my view: Return on Invested Capital.

ROIC measures the profitability of all invested capital, wether equity or debt. For the calculation of ROIC we must answer one question: should we include goodwill in the Invested Capital? So which of the following equations should we use:

1. ROIC = EBIT / (Equity + Debt – Cash), or
2. ROIC = EBIT / (Equity – Goodwill + Debt – Cash)

I think both are right, it depends, for what purpose you calculate ROIC. Value Investors often tend to exclude intangibles, especially goodwill, because they are not “real”. Most goodwill on Ibersol’s balance sheet results from the aquisition of Lurca, that operates Burger King restaurants in Spain. And that goodwill, that Ibersol paid, resulted in a real outflow of cash, there is nothing unreal. So if you want to measure, how effectively Ibersol used its capital in the past, you should not exclude goodwill.

Another thing is, when you want to know, how much Ibersol must invest for organic growth. If Ibersol grows its business, they don’t have to increase their goodwill. So you should exclude it from your calculation in that case.

The following figure shows both types if ROIC:

Ibersol: Return on Invested Capital (ROIC)

We can see good, but not spectacular returns here. Remember, ROIC is a number before taxes. So if the company would be financed by equity only, ROIC would be the same as ROE before taxes. If we assume Ibersol pays say 25% taxes, this would translate to a “non leveraged” ROE of 12 or 13% roughly estimated. Or if you exclude goodwill, 16 or 17%.
So you could maybe expect, that Ibersol can earn returns on equity in the range of 16 or 17%, if it grows organically and pays down its debt (what it actually may, as we will see later). Of course only, when the level of profitability can be regained.

Balance Sheet – everything okay here too?

I already mentioned, that there are relevant amounts of debt on Ibersol’s balance sheet. So let’s examine the balance sheet a bit further. All data mentioned here is that from the annual report 2011.

The relevant assets (in mn. €) are:

non-current
Tangible fixed assets 123
Consolidation Differeces 43
Intangible Assets 16
current
Stocks 3.6
Cash and equivalents 29
other current assets 9

What tells us that? First, tangible fixed assets is by far the biggest position. It consists mainly of land and buildings. Additionally, one should notice, that there is a big amount of rented buildings, that is not on the balance sheet. Ibersol paid more than 20 mn. € rents in 2011.

Consolidation Differences is, what is normally called goodwill. As mentioned above, a big portion of that belongs to the aquisition of the operator of Burger King restaurants called Lurca.

Stocks is what I normally call invetories. They are pretty low in relation to sales. That has two reasons. First, cost of sales is low in relation to sales, which is quite normal for a restaurant. Second, the inventory turnover is relatively high. But this is no result of a superior working capital management. It’s a pure necessity in the food business.

Furthermore, there is a significant amount of cash on the balance sheet.

How are the assets financed? Let’s view this in some different ways. First, as presented on the official balance sheet. Second, excluding goodwill, therefore reducing the equity by this amount. I would describe this view as how would the balance sheet look like, if all operations would be built by Ibersol itself and no aquisitions took place? I think this view is in most cases a more accurate view of the underlying business. (in mn. €)

including goodwill excluding goodwill
Equity 115 72
Loans 58 58
non interest-bearing liabilities 55 55
financial ratios
equity-to-assets 51% 32%
gearing 25% 40%

Let’s first look at a short example, that may explain my approach, to exclude the goodwill from the balance sheet a bit better.

Assume, Ibersol had paid 10 times as much for Lurca, as it actually did (that would certainly have been a dumb thing, but that is no obstacle in the corporate world). Ibersol would not have been able to finance that big aquisition through debt, so they may have had a capital increase. How would the balance sheet than look today? Much more goodwill and much more equity. Therefore a much higher equity-to-assets ratio and a much lower gearing. That would look great, right? But would the economic reality be another than today? I don’t think so. It would be the same company, with the same assets and the same earnings power.

That’s the reason, why I always would exclude goodwill from the balance sheet when examining how a company is funded.

So if we look at some financial ratios with goodwill excluded, we see for example an equity-to-asset ratio of 32% and a gearing of 40%. Note, that for calculating the gearing, I subtracted the cash from the finance debt.
One could summarize my opinion on the debt level as following: I would like it to be much lower, but I don’t think it is dangerously high. The last point is essential. It may be common practise, to accept dangerously high debt levels and compensate for that with a higher expected return. I don’t think that is a good practical approach. How much does the risk rise with very high debt levels? I think that is really hard to measure. So I am only interested in companies with comfortable debt levels, whereas that level differs from company to company, particularly with the continuity of cashflows.

A good point in my view is, that Ibersol steadily reduces its debt. The dividends paid are only a relatively small part of earnings. The biggest part is used to reduce debt. A step in the other direction was in fact the aquisition of Lurca in 2006.

I am not sure, if the aquisition of Lurca was good for shareholders. As I see it, about 1 times sales was paid. That could be okay, if we assume an ebit-margin that is as high as that of the whole company. But all in all I feel I have not enough information to decide that.

Summary

Now here are the most important points again:

  • We have a company, that operates in a business, that is not too complicated
  • operating results were very stable in the past
  • Ibersol showed an above average profitability in the past, whereas the numbers where not spectacular
  • Ibersol is a bit leveraged, net debt is about 40% of tangible equity. That’s ok, but not exciting… Good thing is, that the debt is reduced steadily
  • Since 2009 Ibersol is facing difficulties, because of lower consumer demand as a result of the sovereign debt crisis. Especially 2011, when net profit was cut in half

All in all I think, Ibersol is a really interesting company. I am optimistic, that I am able to justify a price, where Ibersol is a good investment with a very high degree of certainty. And I think, that price could be well below the current price. But let’s proceed with an attempt to value Ibersol in another article later.

» next article: Valuation of Ibersol


Comments [4]

  1. — Henky · 2012-11-29 15:16 · #

    Hi

    Interesting write-up. It is very clear that the weak markets reduce sales and force added costs (closing costs etc) on Ibersol and that this impacts earnings and margins unfavorably.

    But these are macro headwinds, not company specific issues. To me, this looks like a very good business at a very reasonable price.

    The question is, is it too early still? Looking at normalized earnings multiples, I would say we are somewhere between 10-30% above an adequate margin of safety today. But then it is time to buy, without a doubt.

    What is your fair value estimate of the company, and how did you reach it?

  2. Stefan Mohr · 2012-11-30 17:09 · #

    Hi Henky,

    thx for your comment. Please check Ibersol: The key question for valuation for my valuation of the company. I forgot to link to this article below this one. Have added a link now.

  3. — Rodrigo Couto · 2013-03-06 23:50 · #

    Stefan Mohr

    I’m a portuguese value investor (value investing is my passion too).

    I have some ideas about some investments in portugal. I would like to share them with you and to know your opinion if you are interested.

    Send me an e-mail.

    Regards

    Rodrigo Couto

  4. — Rodrigo Couto · 2013-03-07 21:24 · #

    rodrigocouto_1988@hotmail.com

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