In the first quarter of 2016 the portfolio gained
1.4% 1.9% (Edit 4/13/2016: I forgot to include City of London Investment Group’s dividend paid on 3/11/2016; Edit 5/6/2016: I forgot to include Fairfax Financial’s dividend paid on 1/28/2016; Edit 8/4/2016: I forgot to include dividends paid by Unicredito Immobiliare on 3/16/2016 and by Amundi Europa on 3/23/2016) while the benchmark lost 4.7%.
Largest contributors to performance were Fairfax Financial
(+0.7%) (0.8%), A&O Johansen (+0.6%), Dundee Corp. (+0.6%) and Houston Wire & Cable (+0.6%). Largest detractors were Par Pacific Holdings formerly known as Par Petroleum Holdings (-0.8%), City of London Investment Group (-0.8%) (-0.7%) and Lancashire Holdings (-0.5%).
A detailed overview of the current portfolio can be found here.
Investment update on one of the portfolio’s core positions
A&O Johansen was one of the first investments of WertArt Capital which I presented more than two years ago. I got hold of this business when I was searching a list of all listed Danish companies from A like A.P. Møller – Mærsk to Z like Zealand Pharma for investable companies.
A&O Johansen is a distributor of electrical and plumbing/heating/sanitary equipment to the Danish construction market. Over the last 20 years, average return on equity is close to 10% per annum. At the time of my investment shares traded at a price-to-earnings ratio of less than 8 times, while financial obligations were barely existent.
According to this document from the Danish antitrust authorities (explaining the reasons for blocking a merger between A&O Johansen and a competitor), A&O Johansen possesses a number of competitive advantages. The large majority of the customers on the relevant markets are minor companies that make frequent use of day-to-day delivery of minor orders, but have limited buying power. Entry barriers are high caused by high customer demand of service level, geographical coverage, and due to the breadth and depth of the product range. New wholesalers have not been able to take significant market shares during the last 5-10 years (as of 2009) unless it happened as part of a merger with already existing wholesalers.
After a five year period of modest investment spending from 2008 to 2012 when excess cash was used to repay outstanding debt, management started to accelerate capital expenditures in 2013. This culminated in the acquisition of Denmark’s leading online distributor of plumbing/heating/sanitary equipment Billig VVS in 2015. According to the company, the transaction was priced at an EV/EBIT multiple of 14.3 times. Operating cash flow contributed strongly to last three years’ investment activity. Consequently, net debt to EBITDA of 1.9 times as of yearend looks manageable.
In February 2016, management made a bold move, when they announced that A&O Johansen will acquire all of the company’s preference shares held by Sanistål. Sanistål is a struggling competitor owned by a consortium of banks. The share buyback concerns 39% of the company’s capital at a price of DKK 1,797 per share. The purchase price is equal to book value as of yearend 2015. The transaction was closed at the end of March 2016.
This transaction is turning the capital structure upside down. Net debt is more than doubling from DKK 320 m to 720 m. In addition to that, the company has to finance the remaining portion of the purchase price for Billig VVS of DKK 40 m and will spend at least DKK 100 m for capital expenditure (including DKK 75 m for a mini-load system in one of the company’s warehouses) in 2016. Assuming that A&O Johansen will generate DKK 200 m of operating cash flow in 2016, net debt will stand at DKK 660 m at yearend or roughly 3.5 times net debt to EBITDA.
The current situation resembles 2007, when the last investment cycle peaked and net debt to EBITDA reached more than 5 times. Despite the following economic downturn, the company was able to generate ample cash which was allocated to debt repayment.
Under the assumption that the business model is intact, this transaction should be beneficiary to equity holders. Following the buy-back, the number of outstanding shares has been reduced with the equity value falling from DKK 1,070 m to DKK 636 m. Hence, the company’s equity value might decline from 12 times to roughly 8 times trailing earnings due to relatively low financing costs. So far I do not know the terms of the additional debt financing. However, based on the current low interest rate environment and the company’s last year’s finance costs, the company might be able to receive incremental financing at around 3% interest. So far the company has not informed shareholders whether the treasury shares will be cancelled. Hence, there is some uncertainty coming from this side.
Normally, I stay away from companies using high financial leverage. However, management has made a very good job in increasing value per share over time. Over the last 20 years (with the exception of 2008), the company increased book value per share each and every year. So far my experience with the existing management team indicates, that I have aligned interests with very capable stewards of shareholder capital (despite a dual class share structure in place).
While being part of a cyclical industry, A&O Johansen has shown relatively consistent cash generation which brings me to the conclusion that the company should be able to cope with the high degree of indebtedness in the coming years. I will therefore increase my position by another 50 bps with a share price limit of DKK 2,000 from today on.
Currently, the portfolio consists of 26 investment with an average weighting of 3%.
During the quarter I made three new investments including SHL Telemedicine, LogiCamms and BrainJuicer. I have added to my positions in Dundee Corp (see comment), Olympic Entertainment Group and LogiCamms. I exited SHL Telemedicine and BHF Kleinwort Benson Group.
A detailed overview of the portfolio’s cash flows can be found below:
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!