Metro AG (preferred stock)

I've accumulated a couple of Metro's preferred shares last fall and thought since the investment case is still promising and figures haven't changed dramatically it's still worthwhile to do a quick write-up of the investment idea here.

Metro is a German retail giant who brought the cash & carry business to Europe. They came onto my radar since their market capitalisation is a mere 10% of their sales. Business is divided into three business units which contribute vastly different shares to the overall sales of the group:

Cash & Carry
From the annual report:
"METRO Cash & Carry is a leading international player in selfservice wholesale trade. METRO GROUP’s largest sales line, which lent the company its name, celebrated its 50th anniversary in 2014. In 1964, founder Otto Beisheim opened the first METRO Cash & Carry wholesale store in Mülheim an der Ruhr. Its concept was revolutionary at the time: professional customers could select their own purchases all under one roof, pay for them in cash and take the items with them. Over the decades, METRO Cash & Carry has continually expanded this business model, adding new items and services geared to customer needs and local requirements."

The cash & carry business line with its 766 stores is responsible for roughly 30% of overall sales.

Media-Saturn Group
From the annual report:
"In terms of sales, Media-Saturn is METRO GROUP’s second largest sales line and number one among consumer electronics stores in Europe. Media Markt, Saturn, the online retailer Redcoon and the Russian online shop 003.ru belong to the group of companies. These sales brands carry out business autonomously in the marketplace. The company 24–7 Entertainment, one of Europe’s leading providers of technology for the distribution of digital content, is also part of the sales line. In addition, Media-Saturn holds a stake in Xplace, a technology service provider that is one of the leaders in the European market for interactive customer information, as well as in Flip4New, a leading German platform for purchasing used electronic products."

Real
Contributing some €8.4bn in revenue real is a supermarket chain operating only in Germany. The 300 locations are usually hypermarkets with up to 80,000 SKUs on sale.

Galeria Kaufhof
Galeria Kaufhof is a department stores chain. It was sold last week to the Canadian Hdson's Bay group. It was valued at around €2.8 bn. The 135 department stores generated revenues of €3.1bn in 2014 which wasn't a big chunk of the more than €63bn the metro group boosted last year. Nonetheless the €2.8bn is huge compared to Metro's market capitalization of only €7.3bn (measured by the preferred stock's price).

Key Figures & Valuation
Let's start with a quick run-down of some key figures:

As it seems we had a quite good business up until 2011 when net profit was around €800 million for several years. More recently profits deteriorated. 2013 was marked as a transitional year and accounting was changed from 1st January - 31st December to 1st October - 30th September. So that year in the above table is missing the crucial Christmas business and hence is deeply red. Dividend payment was suspended and the stock tanked as the long term chart shows:

Source: www.onvista.de

The above chart compares the non voting preferred shares with the common shares. Interestingly the preferred shares have lost much more in the past 10 years and trade with a discount of almost 25%. Since there is hardly a take over scenario I suspect the only reason for this discrepancy is the fat, that there is much more attention for the common share due to its membership in the German index MDAX. Trading volume for the preferred stock on the other hand is very low.

At just shy of 23€ per preferred share you can buy Metro at a valuation of around €6.5bn. That's roughly 10% of overall sales. Considering the valuation of their recently sold department stores (around 100% of sales) this seems to be a rather cheap price tag,

Why is the stock so cheap? Several reasons play a role: First of all retail hasn't offered attractive profit margins for quite some time now and this is not likely to change very soon. Media-Saturn weren't exactly the first to discover the internet as an important revenue stream. Metro dropped out of the main German index DAX in 2012 due to the stock's poor performance. That same year Olaf Koch was appointed as new CEO. With 41 years of age he is one of the youngest CEOs among Germany's top companies and has yet to prove that he can bring the company back on track. Events in Ukraine and the Russian crisis weighted heavily on the stock as well since Metro had ambitious plans to sell their Russian activities before the conflict started. These are minor in terms of revenue but the topic certainly didn't help turning around the sentiment for the stock.

Why do I think the stock is a buy?

1. The stock has an upside potential of 30% to the common stock. There is no reason for this discount and I think time is on my side here.
2. Metro traditionally paid a dividend north of 1€ and this makes for a good (and rare) 5% dividend yield. 60% of common stock are with institutional investors who are usually interested in a stable dividend.
3. Metro had some €10bn in Real Estate in their books before the Kaufhof transaction. This will now be around €8bn. Although the group is heavily indebted (20% equity ratio is not unusual for retailers) this is a cushion many competitors don't have.
4. The cash & carry business and the Media-Saturn Group are market leaders in their industries and will most likely be able to return to decent profit margins at some point in the next couple of years
5. All the bad news are already factored into the stock price. Buying a retailer with very strong brands and market position and a solid real estate portfolio for 10% of revenue doesn't sound like a bad deal at all. Tesco for instance with all their recent problems trades at 28.4% of revenues. Walmart almost trades at 50% of total sales. 

This is an attractive contrarian bet on a solid company with the extra perk of a heavily discounted preferred stock. I've entered this position at €20 last fall but still think (especially after the recent transaction) that this is a very good risk/reward ratio.

February Favorites

My favorite links from February, enjoy!

- Old school value with a list of tools to improve and speed up your research
- Credit Suisse came out with their Investment Returns Yearbook 2015
- Graham & Doddsville with an obituary for Irving Khan
- Berkshire's 2014 letter to shareholders
- Recording of Tobias Carlisle's Webinar Portfolio Construction, Concentration and Diversification for Value Investors

Aeroflot Airlines - Another Russian Stock With Asymmetric Risk/Reward Ratio

After discussing Gazprom some four weeks ago I'll be looking at Aeroflot today. It is another deeply discounted Russian stock with very promising long term risk/reward ratio. Aeroflot is the poster airline of Russia and has come onto investor's radars last year when Jim Rodgers mentioned the stock as one of his top picks for the Russian market. Let's have a quick look at the long term chart:

We had an impressive development from the early 2000s up until the financial crisis catapulting the stock price from well under 2 Euro up to 15. In a year's time the stock then lost all the gains from the previous years. It was trading close to 10 again in February last year before it started yet another dramatic decline down to 2.10. Before we look at what made that happen, apart from the obvious fact that Aeroflot is pretty much a bet on the Russian economy, let's get a quick overview of the company's financials over the last ten years:

Revenue, apart from the 2009 drop, rose steadily. Bottom line was positive all the time which is unusual to say the least for the industry and peaked in '07 and '11. Current market cap (at around 3 Euro per share) is $760 MM. You read that right, that's 8% of 2013's revenue for a company that operated profitable for the past 10 years at a net margin of close to 5% on average.

Why is Aeroflot successful in an industry that is known for loosing tons of money? The reason is Aeroflot has a somewhat monopolistic position in it's home market. Market share of domestic flights is 36%, on all air (domestic + foreign) travel 30%. Aeroflot's biggest shareholder is the Russian state (51%) which is obviously not at all interested in allowing too much competition for it's strategic businesses. I'd call that a moat in Buffet's sense that's unlikely to disappear all that soon. The first low cost carrier entered the market in late 2014 which has eroded margins in other parts of the world. In Aeroflot's case however this is rather regarded as a chance to service even more travelers than a threat as the new carrier was founded by themselves. This carrier will be operating from another Moscow airport (also serviced by Lufthansa for instance) to minimize cannibalization effects.

Those who think of Soviet style Tupolevs when they hear of Aeroflot will be surprised to hear that the Russians actually operate the youngest fleet (all Boeing and Airbus) of all carriers with 100+ jets in operation. And the margin is not thin as illustrated here (average fleet age in years):

Source

So what happened in 2014 to bring down their stock by more than 3/4?

• 12 month figures are yet to be announced (2. Mar) but 9M figures were red (less than $1 MM loss though!)
• This was partly due to a sharp drop in air travel to and from Ukraine
• With the massive Ruble drop revenue measured in US$ was cut in half!
• All the aircraft are leased on contracts in US$ 

Especially the last point is worrying as the fx situation can carry on for a long time or get even worse. Aeroflot makes more than half of their revenue on foreign routes and these will certainly be able to be repriced accordingly. However, it seems obvious that repricing domestic flights will lead to less travelers. Overall air travel in a country like Russia is certainly more volatile and dependent on economic development than in OECD countries. Lower oil prices should help but are settled in US$ which, at the current fx rates, doesn't really help lower cost for the domestic flights. These issues are certainly serious and have put an awful lot of pressure on the stock.

On the other hand you have to look at odds when investing. So in case Aeroflot is still around in a couple of years what will the business be worth? I've worked out an overview of some carriers and their current valuations:

5 and 10 years earnings are averages of the according periods, revenue is 2013's, all numbers in US$. I haven't even tried to calculate P/E ratios as there are so many loosing years. Only other carrier trading at less than 10% of their overall sales is Air France KLM which lost 5 billion dollar in the past 5 years, chapeau! Interestingly Aeroflot sports a higher equity ratio than all the other carriers apart from Singapore Airlines who are apparently very conservatively managed.

In a scenario where the fx situation normalizes and Russia makes a soft landing form the current crisis I reckon a valuation similar to pre-crisis levels is absolutely reasonable, in the long run easily more as air travel in Russia and the former Soviet states is expected to grow above industry growth. That would mean a stock price of 10 Euro or more compared to 3 Euro today. At 10 Euro Aeroflot would trade at a P/E ratio of around 11 when considering the earning power of the last 5 years. Another scenario is obviously a prolonged crisis and a very adverse business environment for Aeroflot. They managed the financial crisis quite well and have been profitable for at least 14 years in an extremely competitive industry so even if the situation around Russia gets a lot worse I don't really see them going belly up but there are substantial risks involved to say the least.

Overall however I think this is a buy. An opinion shared by Aeroflot's CEO Vitaly Saveliev who increased his stake in the company in December. Considering their very young fleet and extremely strong position in their market (manifested by solid profits for more than a decade) I will disregard my aversion for the air travel industry and pick up some stocks on weak days at around 2.75 Euro.

As with any investment ideas, do your own research and never buy anything because someone else thinks it's a great idea. 

Big Oil - Big Dividends?

Looking for solid dividend returns has become an increasingly tougher task with ever less major stocks returning north of a 3% dividend yield. The sliding oil price has however pushed major oil stocks to levels not seen for quite some time and thereby boosted their dividend yields to very attractive levels. With Friday's massive surge in oil prices and a temporary bottom of $45 a barrel this might be the time to look at Big Oil for dividend investors.

While the US runaway stock market leaves the investor with very little attrative options in the mother country of the shale oil that brought about this tremendous opportunity I'll focus this analysis on European companies that boost 5%+ dividend yields that are extremely hard to get by with comparable risks as I shall show.

First of all let's have a look at the seven major oil companies that are open to the dividend seeking investor. The following table has been compiled from several sources, mostly the companies' investor relations pages and Mornigstar:

What I'm looking for here is the dividend yield for the last ten years. I've calculated that yield with the average dividend payments for 2004 through 2013 and the current stock prices. While this is obviously no guarantee for likewise payments in the future it does give you a very good proxy for the dividend paying power of the corresponding stock.

Eni and Statoil both sport trailing dividend yields of more than 7% while the rest of the European pack comes in around 5%. Chevron and Exxon stop shy of 3% and "suffer" from their lower payout ratio which tends to be around 30% compared to their European counterparts' 50%.

Second ratio I look at is the trailing P/E (also referred to as Schiller P/E) which is a tremendous indicator for valuation and which stands at an absolute alarming 26.7 for the S&P500 as I write this. BP comes in first in this regard with Eni and Statoil following closely. While Chevron and Exxon are still very cheap with trailing P/Es of 10.1 and 10.4 they are again pricier than the most expensive European oil majors.

Three Favorites
So from a valuation perspective I'm most interested in Eni, Statoil and Total. BP does not compare too badly against them especially considering the ramifications from the Deep Water Horizon incident but then again they do show the by far lowest tax rate which might align with the average going forward. Royal Dutch Shell is certainly attractive from a balance sheet perspective but doesn't compare too well on the multiples. There is so much more to speak for or against these stocks but from a purely valuation oriented standpoint I feel most comfortable with these three.

Dependence on the oil price
In order to better understand the impact of the oil price itself on the earnings and dividend paying power let's have a look at the following table:

There are two major observations here. Firstly, there is only one data point which shows a loss (2010 Deep Water Horizon oil spill) which speaks volumes about the rock solid earnings power of the industry's leaders. Secondly there is certainly a correlation between profitability and oil prices but that's rather unpronounced in magnitude with oil prices between $40 and $110 and average net profitability between 5.7 and 9.2%. Here is the corresponding chart, oil prices are yearly averages of Brent oil:

I have no idea to what level oil prices might fall and at what prices any of these players might struggle to make decent profits but given the basic workings of finite resources I suppose that any price level that would severely impact the bottom line of Exxon and the like would be temporarily at most. The world needs incredible amounts of oil and refined products every single day and that is hardly going to change sometime soon. While there is plenty of money going for returns that provide more than just inflation compensation I think there will be a lot of demand especially for proven dividend aristocrats like Total, Statoil and Eni and to a somewhat lesser extent for BP, Royal Dutch Shell and the American oil majors.

The bottom line
Particularly Eni, Total and Statoil demonstrate rare opportunities to invest in industry leaders whose earnings proved to be resilient towards oil price volatility and who are at the same time trading at single digit P/Es. There is no reason to expect dividend cuts even with future oil prices substantially lower than the current $50. In case oil prices and valuations of the sector should revert to their long term averages we should see some pleasant appreciation in the stock quotes as well.


As with any investment ideas, do your own research and never buy anything because someone else thinks it's a great idea. 

Gazprom

At times Mr. Market comes by and offers you irresistible bargains. I think we're just being offered a tremendously cheap entry point into one of the major global energy companies with quite limited downside in the long run.

Before jumping to the pros and cons I'll quickly introduce the company with their own words:

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Gazprom is a global energy company. Its major business lines are geological exploration, production, transportation, storage, processing and sales of gas, gas condensate and oil, sales of gas as a vehicle fuel as well as generation and marketing of heat and electric power.

Gazprom views its mission in reliable, efficient and balanced supply of natural gas, other energy resources and their derivatives to consumers.

Gazprom holds the world’s largest natural gas reserves. The Company’s share in the global and Russian gas reserves makes up 18 and 72 per cent respectively. Gazprom accounts for 14 and 74 per cent of the global and Russian gas output accordingly. At present, the Company actively implements large-scale projects aimed at exploiting gas resources of the Yamal Peninsula, Arctic Shelf, Eastern Siberia and the Far East, as well as hydrocarbons exploration and production projects abroad.
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Gazprom's main area of business is obviously gas which accounts for roughly 60% of their overall sales. While almost 60% of the gas is sold in Russia less than 30% of the corresponding revenue is accounted for in their home country. This is grounded in the fact that domestic gas is sold at a much lower rate to local consumers. Last year the gas business accounted for 72% (73% in 2012) of the group's net income. Obviously most of this comes from European customers who drew 30% (26% in 2012) of their total gas consumption from Gazprom.

Around 30% of total sales come from Gazprom's subsidiary Gazprom Neft which produces oil, engages in refining activities and operates some 1,600 filling stations. The remaining revenues stem from Gazprom's heat and power generation facilities mainly in the Moscow area. These two are more or less (more in the latter case) side activities. One should bear in mind however, that Gazprom Neft alone contributed between $3 and $5 billion in net profits in each of the past 5 years.

Talking about past performance, how about a quick look at a weekly chart of the stock traded in Euro:

You can see that we are currently trading near a 10 year low and that the stock has had a rather volatile past in general. Owing to the 98 Russian crises and the subsequent state bankruptcy Gazprom's stock hit its low in 1999 and had an incredible run right up onto the financial crisis of 2008 since. All that was backed by an enormous expansion in their business activities. Revenues increased eightfold from $16B in 1998 to $132B in 2008.

Despite the increasingly weak performance of the stock business has further picked up since. Here's a rundown of the last 10 years key numbers (from Gazprom's annual reports & own calculations):

At around $4.50 per share the whole company is valued at $53B. Yes, that's less than two years of earnings. A company that has earned an average of $34B in net income in the last six years is valued at $53B.

Energy is out, Emerging Markets are out, Russia is clearly out, South Stream is cancelled, but that cheap? What's the reason for such a valuation? There are really plenty of reasons but I don't deem any of them a reason not to invest.

The main reason why the stock tanked in the recent past is the massive fall in the Ruble. Where you could have bought a dollar for more or less 30 Russian Ruble in the past years pressure started to mount on the currency with the Crimea and Ukraine crises. The rate peaked in December at over 80 RR for the dollar. That day was also the multi-year low in the Gazprom stock. So while the stock has been essentially flat on its main stock exchange in Moscow it has, just through exchange rate fluctuations, lost up to 60% in dollar. Would Gazprom generate all their revenues in Ruble this would be perfectly logical. However, as we've seen earlier, almost three quarter of the profit derives from exports which are settled in US dollars. On top of this Gazprom will even benefit from the fact that the dollar (main revenue) appreciates vs the Ruble (main costs) as they will have more Rubles per dollar to cover for their production costs back home.

The other main driver in the valuation of the stock has been the political situation between Russia and the west. I don't want to go into a political analysis of this as this in the end is a rather emotional debate on American Imperialism. Suffice to say that there is a reasonable fear of a (de facto) nationalization of Gazprom either through law or taxation. While I see this as the biggest long term threat to an investment into energy stocks (in any country) I think the probability in this case is lower than mostly anticipated. First of all, Gazprom has assets in European countries, mostly gas infrastructure in Germany. These assets would certainly be seized by dispossessed stockholders. Germany is too an important market for this to happen. Gazprom has countless joint ventures with European companies and is dependent on the know-how and capital these partners bring in in its exploration efforts, this again would be at stake in case of nationalization. Gazprom's close linkage to the Kremlin makes a Sistema scenario rather unlikely. Even if the worst is yet to come the 1998 state default left Gazprom stockholders untouched. However, a potential discrimination of foreign shareholders shouldn't be completely dismissed.

Another factor to consider is the weakening gas demand in Europe. Although long term perspectives are still very promising demand was slightly down in the recent years as gas power plants became less profitable. Just recently Gazprom signed deals to connect Turkish and Chinese consumers to their networks which will more than offset the losses in the European market. Since North Sea gas will be running out in the years to come and is also associated with higher production cost Gazprom's position on the European market is hardly to deteriorate.
Additionally to the aforementioned issues the plunge in oil prices does certainly not help to create a brighter short term sentiment for the stock.

So there is a multitude of reasons which brought the stock to these levels. What is to expect from the future? My assumptions are that Gazprom will be able to further grow their business. While there might lay rough roads ahead in their home market the European business will continue to provide the biggest chunk of income. Since there is ever more €/$ and ever less energy resources (which are ever harder to extract) I can't come up with a scenario where gas prices are deemed to fall off a cliff. The opposite is to expect.

Looking at Gazprom’s balance sheets doesn’t deliver any bad news. Equity ratio stands at 71.9% with literally no goodwill or intangible assets on the asset side. Most global oil companies run on an equity ratio of around 40% so Gazprom looks very solid. Total current assets (RR 2.9T or $ 85B) almost make up for total liabilities (RR 3.9T or $ 114B). All these figures are as of Q2 14 so there might have been some movement due to the sliding Ruble although cash and accounts receivables are unlikely to be balanced in Ruble.

So what is the fair value of Gazprom in say 2020? If one assumes a 7% increase YOY in Gazprom's revenue and put their past profitability onto that we would end up just shy of $250B annual revenue in 2020 and net income of $60B. Let's say Gazprom will, along the way, trade at a P/E ratio of 8, this will put the total market value at $420B or 35$ per share. If we give that scenario 50% probability and have two further scenarios, one with flat business and a P/E ratio of 5 in 2020 (30%) and one with nationalization (20% - accounting for other risks as well) we get a mathematical target share price in 2020 of
(0.5*$35.00) + (0.3*$15.10) + 0 = $22.03
Compared to the current share price of $4.50 this would offer an opportunity to quintuple your money, translating into a 30% annual return. Any dividends would be on top of that.

While there are literally no investors left to sell out their Russian investments I'm happy to take the risk of short term volatility at the benefit of acquiring a solid asset rich business at bargain prices.
I’ve accumulated a quite significant position for my portfolio at an average price of around €3.85/$4.50 and intend to hold on to this position for at least a couple of years.


As with any investment ideas, do your own research and never buy anything because someone else thinks it's a great idea. 

Welcome

Welcome to my blog about value, growth and dividends. In this blog I will write about stocks and financial markets, present my investment ideas and hopefully discuss these ideas with interested readers.

The first couple of stocks I will write about in the weeks to come will be focused on dividend income. Currently I find value as well as growth stocks ever more overvalued on almost all markets. I'm based in Europe and my main focus lies on stocks from the continent for the time being.

There is one exception to the lack of undervalued stocks and that is currently the Russian market. Since there are some fantastic opportunities for value fans right now my first post will be discussing an investment into Gazprom, which I recently purchased at bargain prices.

Thanks and read you soon!