Ibersol - the key question for valuation

2012-08-06 08:18 -  , Value Investing

In the last article on Ibersol, a restaurant operator from Portugal, I concluded that Ibersol is a stable company with a historic profitability slightly above average and a not too complicated business. So lets now try to answer the question, what price we would be comfortable to pay for Ibersol, to see if it is a profitable investment.

In most investments there are one or few key questions, that have a very high importance for the estimation of the value of the company. What are the key questions you should ask yourself for Ibersol?

Ibersol showed a very steady profitability in the past, as we saw in the last article. In 2009 and 2010 there where some problems, that resulted in stagnant sales but had no dramatic influence on profits. In 2011 then, sales dropped nearly 10% and operating profit was cut in half. I think the key question for valuation now is:

Is the lower profitability of Ibersol a temporary problem or will it last for a longer time period?

I will first clarify, what I mean with a longer time period. As the value of a company is in theory the present value of all cash an owner can take out of the business from now to eternity, the results of a single year are of minor importance. Short term results have only an important impact, if they are really dramatic. For example, if a company loses half of its equity in one year, future earnings power can be seriously affected. But if a company earns 5 mn. € or 10 mn. € this year, has nearly no impact on the business value. Important are the long term results.

It is hard to say, what time period can be regarded as long, because there is a smooth transition. But we can say one thing for sure: it is relatively unimportant, if operating margins will be 5 or 10% for the next two or three years. But it is really important, what average operating margins Ibersol can earn in the next 10, 20 and 30 years.

What caused the bad 2011 results?

To try to find an answer to our question, let’s first examine, what the causes where for the much lower earnings in 2011. For that cause, I prepared an earnings statement for 2011 and 2010, that shows no absolute numbers but the percentage part of the individual positions.

2011 2010 change
Sales 100.0% 100.0% 0.00%
Rendered services 0.4% 0.5% -0.13%
Other operating income 1.9% 1.8% 0.06%
Total operating income 102.3% 102.4% -0.07%
Cost of sales 22.6% 21.8% 0.82%
External supplies and service 32.9% 31.8% 1.05%
Electricity, water, fuel and other fluids 4.6% 4.0% 0.68%
Rents and rentals 10.6% 10.5% 0.10%
Royalties 3.4% 3.3% 0.12%
Advertising and propaganda 3.7% 3.3% 0.43%
Personnel costs 33.6% 32.3% 1.32%
Amortisation, depreciation and impairment losses 6.7% 5.2% 1.43%
Other operating costs 1.2% 1.1% 0.02%
Total operating costs 96.9% 92.3% 4.64%
Operating Income 5.4% 10.1% -4.71%

Sales dropped by nearly 10% in 2011. Operating costs did not shrink with the same extend. So operating profits shrank much more. In the table we can see the causes for the fact, that operating profit fell to 5.4% of sales from 10.1% in 2010.

We can see, that not only one position caused the lower earnings. Cost of sales, as well as external supplies and services, personnel costs and depreciation contributed their part. External supplies and services I broke down a bit further and showed some specific items included in that position.

Let’s start to take a closer look at the specific positions. We start with Amortisation, depreciation and impairment losses. The increase of that position relative to sales had the biggest impact on operating earnings. Why the increase? This was mainly due to impairments of tangible assets. So we can assume, that this is a temporary effect. It may happen, that there will be impairments next year again, but this will not happen indefinitely in the future. We should also keep in mind, that these are non-cash effects.

The second largest impact had personnel costs. I think it is quite clear, why the relative portion of these increased. Sales dropped, but no company will or can immidiately fire employees, if sales drop. But if sales remain on that lower level, is there a possibility, to also reduce personnel costs? Keep in mind, that sales dropped on a per restaurant basis. One can’t only close some restaurants to reduce personnel costs and assume, that the customers will go to your other restaurants then. You must lower personnel costs per restaurant. Is that possible? I think yes. First, the lower demand will remain, if the economic conditions in Portugal and Spain will remain bad. Bad economic conditions may make it easier to lower or at least not rise wages. Second, it may be possible to operate a restaurant with fewer personnel, if fewer customers come.

The third item is External supplies and service, especially the sub items Electricity, water, fuel and other fluids and Advertising and propaganda. Take electricity: The demand for electricity doesn’t fall much, if you sell a lower number of burgers. But you can certainly make some adaptions here, if the lower level of demand remains over longer periods. Advertising is a completely other thing. That is an active decision of the company. Ibersol could easily decide, to pay only half the amount for advertising next year. That may not be wise. But I think we should not overestimate the rise in 2011.

The last item is cost of sales. If the product mix and raw material costs remain the same, the percentage slice of these costs relative to sales should remain the same. Obviously, that was not the case in 2011. I am not really sure, why exactly this happened.

So here is my conclusion after examining the causes of higher costs relative to sales:

There were various causes. But most were caused by a lower demand and a higher price sensitivity of consumers. It was not possible for Ibersol, to adapt fast enough to compensate that completely. But there are certainly ways, to adapt, if this situation remains. That will not be easy by any means, but if that lower level of demand remains for a greater number of years, I am optimistic, that Ibersol will be able, to at least achieve similar operating margins like in the past again.

How long will the crisis last?

But the question is: should we interpolate the current economic difficulties in southern europe 10, 20 or 30 years into the future? Will Portugal and Spain live in poverty from now on and have no appetite or money to eat outside their homes? Will restaurant operators in southern europe operate under completely different conditions in the future?

It is hard to predict the future. But for me it is hard to imagine such a scenario. I don’t know when and how the sovereign debt crisis will be solved. I don’t know, what impact it will have on the consumer habits in the next few years. But I would be surprised, if the conditions for a restaurant operator like Ibersol will be completely different in 2020 than they were in 2010.

Ibersol showed very consistent results in the past. Isn’t it natural to assume, that this will proceed in the future, if conditions will not change? I don’t see any point, that could make the following assumption completely wrong:

Ibersol will face some difficulties in the next following years. But Ibersol has the financial strength and the size, to master this. Somewhere in time, the economic conditions will be better again. And then Ibersol should be able to earn EBIT margins of about 10% and ROIC of above 20% again, like it did in the last 10 years on average (including the bad year 2011!).

Trying to value Ibersol…

I will now try to value Ibersol. Or better said: I will decide, at which price level Ibersol would be interesting for me. A company begins to be interesting for me, if I can expect an annual return as a long time holder of at least 10% (before personal taxes and inflation). I would never feel comfortable, if I would require an annual return below 10%. At 15% I start to be excited.

I think a relatively certain 10% return is available often enough in the stock market, to simply wait, if you can not receive it now. And you should note, that 10% is not that much. After 25% taxes and two percent inflation only slightly above 5% real return remain.

So in a first step we could assume the following:
EBIT-Margin was 9.6% in the last 10 years. Let’s assume, this will also be the case in the future. Let’s assume a revenue of 200 mn. € (about the level of 2011), that would result in an EBIT of 19.2 mn €.
After subtracting finance costs (1.2 mn in 2011), 18 mn. € remain. After 25% income taxes this is 13.5 mn €, after minority interests 13 mn €. So lets take these as a rough approximation of the current earning power of Ibersol. Multiply this with 10 to get a 10% return and we get:

130 mn €

I think there are some points, that make that approach a bit too much simplified. Ibersol pays down its debt steadily. A good thing. But that results in earnings that are not available for shareholders but are used to pay down debt. Let’s assume the following: We buy a 100% stake in Ibersol. Use the cash and some of our own money to pay down its debt. What would Ibersol be worth, if we do this and demand a 10% return? After paying down debt, EBIT will equal EBT, this remains at 19.2 mn €. After 25% taxes, 14.2 mn € remain. 13.7 mn after minority interest. That multiplied with 10, would be 137 mn €. But the cash is not enough, to pay down all the debt. We will have to pay an additional 28 mn € to pay down all debt. Therefore we should only pay the following amount for Ibersol:

109 mn €

But there is another fact, that we should take into account. We assumed, that Ibersol will earn that amount beginning from the following year on. It is hard to predict these things, but I think it is not unrealistic to assume, that Ibersol will face some problems in the following years. Just to see, what this would mean for the price we should pay, let’s estimate the following: In 2012 Ibersol will earn nothing. In 2013 and 2014 it will earn half the normal earnings power. So we would “lose” the following, in comparison to the scenario before: 13.7 + 13.7/2 + 13.7/2 = 27.4 mn €. Theoretically we should discount that amount to the present value, but let’s calculate without that, because the impact is not that big for 3 years into the future. Note, that this is only a very rough estimate. I have no idea, what the earnings in the following years will be. But I simply think, that the following years could be not that easy. And with my rough estimation of the impact on value, we come to a maybe more realistic estimate. I hope this prevents us from overestimating the value of Ibersol. If I subtract that “missing” earnings, we come to a value of about

80 mn €

But now there is one point missing. Can’t Ibersol grow? Will it not earn much more in 10 or 20 years? Sure, it may. And if only because of the impact of inflation and therefore higher numbers despite stagnating volume. My 10% minimum return wish is before inflation, so it is ok to take into account even growth before inflation. But for growth, no matter if volume growth or only due to higher sales values because of inflation, requires an additional investment. For new assets, that will cost more, than the ones have cost, that are replaced. For higher invetories, receivables and so on. How much must be invested, depends on the returns on capital, that the business can achieve. For businesses with a return on capital that is above the return that we want, we have an additional privilege. The company will retain a part of the earnings, and reinvest it for a very good return. So we can pay a bit more, and nevertheless get a return of 10%. Our, now in our mind deleveraged Ibersol, will earn a return on equity of about 15% on average. So the reinvestment privilege is not that big, but it is not zero. Please feel free to prove, that I am completely wrong, but I would estimate, that we could justify to pay a multiple of 11 instead of 10. So we add 1 times earnings to our value estimate and get a value of about

90 mn € or, with 18 mn shares outstanding, 5 € / share

Please keep in mind, that this is only a very rough estimate. But as Warren Buffett says, it is better to be roughly right than precisely wrong. If you think I did it even worse and did it roughly and wrong, please write a comment below and give me a hint, which important fact I did forget.

checking for plausibility

To prevent the possibility of serious errors, let’s calculate some basic valuation metrics, that would arise at a share price of 5€.

P/B: 1.25 (excluding goodwill)
P/E 2011: 14.8
P/E 5 year average: 7.3
EV / EBIT 2011: 11.4
EV / EBIT 5 year average: 5.9
Dividend yield: 1.1% / 0,83% (before / after withholding tax, keep in mind that most earnings are reinvested)

For me, these metrics show no warning signs. If you take earnings of 2011, the numbers seem indeed a bit high. But as mentioned, I see no justification, to write these forth long into the future.

Conclusion

Ibersol is valued in the market at 65 mn € or 3.65 € per share as I write this. That is nearly 30% below my calculated maximum amount I would pay.

Note, that at the calculated maximum amount, at which I would buy Ibersol, I would already regard Ibersol as cheap. Not dirt cheap, but I would feel comfortable to buy it. I think it is worth more than that amount, although it is hard to say, how much more.

I think at the current price, Ibersol is a quite recommandable investment. And I will certainly buy some shares.


Comments [9]

  1. — sky_ · 2012-08-19 22:19 · #

    as a portuguese I must add some facts here:

    1- Ibersol owns many restaurants/coffee stores in motorways. Many of these motorways were previously unpaid and have started to be paid last year some and the rest this year. The prices of this motorways are much higher than on the other motorways so the sales reduction there is probably permanent.
    2- including all motorways (previously paid or not) people are reducing a lot circulation also because of expensive fuel
    3- they own many restaurants on shopping ccenters. People used to spend a lot of time there and that was an habbit. This habbit is being reduced do to the lack of money
    4-so the key question is will this stay like this or even get worse or not? IMO gas prices and payed motorways are probably irreversible… shopping habbits? well that’s the objective of the troika memorandum so if it works well (and I believe it is working well) the change of habbits might never recover to previous crisi level
    So I believe you might be overestimating a bit future prospects..

  2. Stefan Mohr · 2012-08-20 06:22 · #

    @sky_

    Thanks for your comment. Very interesting to have an opinion directly from Portugal!

  3. Hugo Roque · 2012-08-20 16:56 · #

    Hi,

    I’m also from Portugal (Lot’s of value here :)).

    I agree with you that Ibersol is a very good profitable and low leveraged (considering the average here) company in Portugal.

    But environment right now is very difficult. I would add one more point to sky’s facts which is the government’s rise in value add tax for restaurants from intermedite rate of 13% to the normal rate of 23%. That also pressured consumers a lot.

    I agree with the valuation method but would be a bit more conservative on stable revenue and operating margins and demand a large margin of safety.

    Hugo

  4. — sky_ · 2012-08-21 00:50 · #

    agree with Hugo.. 5 minutes after my post I remembered the tax increase as another problem…and this problem is bigger than it seems at first sight. restauration is one of the main tax evasion businesses in Portugal (probably the main one by far), which means that a tax increase from 5 to 23% will increase (a lot) the competitive gap between the tax evasive and the non tax evasive restaurants. And Ibersol as a public company is on the worst position…

    ps: hugo Roque Recently wrote an article about another portuguese company I also comented but in which I have a considerable position F Ramada….you should read too even if it is from the start of the year things havent’t changed that much..
    ps2: at the moment I don’t have any position in Ibersol but I might consider in due time either if it becomes more clear the company’s future or if the margin of safety gets big enough (maybe somewhat neareror inferior to their price/tangible book value which is about 2€ if I remember correctly… I checked it less than a month ago but I think that’s about it)

  5. — Federico · 2012-11-06 23:36 · #

    What about the downside protection derived from having around EUR 100 M in land and buildings (which probably worth more than their book value)? I am guessing many Ibersol units are well-located… This variable should also be taken into account when assessing the 40% equity/debt ratio; when debt is financing strong value assets like real estate it’s something to bear in mind at the time of interpreting this ratio.

  6. updated blog post · 2012-12-05 08:39 · #

    Thank you for the auspicious writeup. It in fact was a amusement account it.
    Look advanced to more added agreeable from you! However, how can we communicate?

  7. — henky · 2012-12-10 20:01 · #

    does anyone know whether the company plans to buy back stock? The company has little leverage and ample interest coverage even now. Lots of cash, too.

  8. — Henky · 2012-12-11 11:33 · #

    Stephan – it’s been a while since your write-up. Have you discovered anything new about Ibersol that you would like to share?

  9. Stefan Mohr · 2012-12-13 22:09 · #

    @henky:
    no, nothing new about Ibersol. But if I find the time, I should review the company again. Maybe I discover something new…

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