|Shares Out. (in M):||7||P/E||0||0|
|Market Cap (in M):||279||P/FCF||0||0|
|Net Debt (in M):||77||EBIT||0||0|
An investment in Brodrene Hartmann A/S (“HART DC”) is an attractive investment as HART DC is a market leading egg packaging producer trading at 10.6x 2016E P/E, a 44.9% discount to peer Huhtamaki, despite averaging a respectable 20.3% ROIC over the last five years. The egg packaging market is stable due to its oligopolistic characteristics as well as the stable demand for eggs given they’re a cheap form of high quality protein. Due to their low cost, eggs also tend to be resilient during recessionary periods. Catalysts to value creation are increasing profitability driven by management’s restructuring and capacity expansion programs that will drive >20% earnings growth next year. This opportunity exists because HART DC is a small capitalization company with $279mm of market value, no analyst coverage, and limited float of $88mm. Therefore, this might be a PA trade for many on VIC.
|Total Enterprise Value:|
|In DKK Mil|
|FD Shs Out||6.9|
|Summary Valuation:||Peer HUH1V FH|
|In DKK Mil, Based on Mid point of Mgmt Guidance|
|Taxes @ 22%||(49.4)||(59.6)|
Founded in 1917, HART DC is Europe’s oldest producer of molded fiber egg packaging with a 40% market share. HART DC is also a leading producer of machinery and technology to egg packaging manufacturers outside of the markets in which HART DC competes. Barriers to entry in the egg packaging industry derive from technological know-how, long-term customer relationships, a long history and reputation for quality packaging as the producer is dealing with food products, as well as customer demands for localized commodity scale production. For these reasons, smaller players have historically been shut out of HART DC’s markets.
As background, molded fiber egg packaging is made from 100% recycled paper, which is an ideal packaging material due to its strength, versatility, and its significant environmental benefits. As a result, molded fiber has long been the dominant form of egg packaging in Europe and is increasingly becoming popular in America. A study done in the UK highlights the reasons why molded fiber is preferred by both consumers and packers over foam and plastic packaging:
|Volume on a Pallet||3||1||4|
|UK Waste & Resources Action Program Study||Rating Assessment (1 = worst and 5 = best)|
HART DC manufactures a broad portfolio of customizable egg packaging for over 1,500 customers across several countries. HART DC’s technical expertise and ability to customize has driven demand for premium packaging to over 40% of HART DC’s sales today. Premium packaging continues to grow as customers seek ways to differentiate themselves at retail. HART DC’s European business is ~60% of sales and, within Europe, HART DC manufactures approximately 9,000 different labels with packaging of various sizes and colors. HART DC’s scale is impossible for smaller players to replicate and a reason why HART DC’s market share in Europe has been steady for years. HART DC is also well diversified globally with nine plants (four in Europe, one in Canada, and four in South America) with no major customer concentration in any of its markets. HART DC has >30% market share of molded fiber egg packaging in all areas it operates.
HART DC is in the final innings of an operational turnaround that has significantly improved its profitability. HART DC’s legacy management team was both poor managers and capital allocators. Following the 2010 death of HART DC’s Chairman, a new Chairman took over and together with a new CEO, they completely overhauled top management starting with the CFO and COO. New management simplified the business and improved the cost structure by moving away from non-core and loss making activities. While management’s cost restructuring has been successful by more than doubling EBIT margins, there is still considerable room for improvement as management is now focused on optimizing manufacturing facilities and improving HART DC’s sales mix with its premium offerings. By 2017, HART DC will have ~13% EBIT margins (management’s ‘17E EBIT margin guidance is 12-14%), finally in-line with peer levels.
|Huhtamaki||9.4%||8.6%||11.1%||12.5%||14.2%||12.9%||13.5%||13.5%||<< Targets 13-15% EBIT margins so assume midpt for '16 & '17|
The egg packaging industry grows 2-3% each year in-line with increases in egg consumption. HART DC has achieved slightly higher growth rates driven by increased demand for premium packaging and a shift to molded fiber away from plastic in North America. The shift to premium packaging has been an important growth driver for HART DC customers as eggs are one of the most profitable items on grocer’s shelves. A retailer can generally charge $2 more per carton of premium eggs (from $2 to $4) while paying 10-20c more per carton for premium packaging. The increased penetration of molded fiber in the U.S. has been driven by customer demand for sustainable packaging alternatives and growth in chains like Whole Foods – it’s hard to sell organic eggs in plastic/foam packaging. Molded fiber is only 50% of the market in America versus over 80% on average in Europe with some European markets like Northern Europe at 100% penetration. In areas like South America, egg consumption is on the rise with increased urbanization helping drive continued demand for HART DC’s packaging. With fully utilized plants, HART DC will expand capacity in North and South America by more than 10% in the 2H of 2016 to fulfill continued demand. This follows a 33% increase in North American capacity over the past two years that remains fully utilized. The increased capacity plus further plant optimization activities will drive HART DC’s significant earnings growth next year.
The key to an investment in HART DC doing well is that current earnings are sustainable or can increase in the future. Therefore, a risk is that input costs increase and cause margins to decline. HART DC’s largest input cost is recycled paper and pricing for recycled paper continues to remain steady. HART DC’s second largest cost is energy (electricity and gas) and the company signs fixed price agreements for 6-12 months for its energy usage. Additionally, HART DC has reduced its energy usage by over 20% during the turnaround process, so HART DC will likely continue to lower its energy bill. Therefore, input costs are likely to be at least neutral to HART DC and margins are sustainable.
With margins still below normalized molded fiber egg packaging levels and a clear path to >20% earnings growth by year-end 2017, HART DC is significantly undervalued at 10.6x this year’s earnings.
|Entry||06/30/2016 01:33 PM|
According to data from the International Egg Commission and the The Food and Agricultural Policy Research Institute the % of eggs consumed in both Europe and the US in shell form have been stable. The % of eggs consumed in shell form in Europe was 73.8% of total consumption in 2012 and 73.7% in 2015 (data not available for all Europe countries so we're using Denmark, Finland, France, Sweden, Switzerland, and the UK). The % of eggs consumed in shell form in the US was 70% in 2012 and 69.8% in 2015. Our households prefer eggs in shell form, but we haven't seen many studies done to show why consumers would prefer liquid over shell form and shell form continues to hold its high market share.
|Subject||Re: Re: eggs|
|Entry||06/30/2016 02:03 PM|
thanks for the stats. i prefer the liquid variety because i'm health conscious and only want the egg whites... but i'm clearly an outlier.
|Subject||ROCE and ownership|
|Entry||07/01/2016 02:10 AM|
Thank you for the write-up chewy, just a couple of questions.
1) The Returns on Capital (ebit/tangible capital) have been quite consistent for this type of business in Europe over the past decades (~15%). This is true for some competitors in this business as well. There are some but no really huge barriers to entry and if this market is too attractive usually competition kicks in. In the US Hartman was earning huge amounts in 2012 and thereafter (Roces of >40%) which started to trend downwards lately but are still far above average or returns I would expect. (currently mid 20ies)...
|Subject||Re: ROCE and ownership|
|Entry||07/06/2016 12:30 AM|
Thanks for the questions. Profitability in the US was abnormally high in 2012/2013 as a result of increased market demand that had HART DC’s US factory running at full capacity, which is more than the ~85% HART DC targets to ensure they keep machinery well maintained, etc. This is one reason why HART DC increased capacity in the US market. Additionally, HART DC benefited from a fire at a competitor’s plant in 2013 driving another spike in demand, as well as benefits from FX and lower energy prices. Results have normalized to a more sustainable level now. Peer Huhtamaki itself targets >20% returns on its molded fiber business, so I don’t think HART DC is a big outlier.
So profitability in the US has not been driven lower by increased competition and we haven’t heard of any new significant competition launching in the market. Recall HART DC is one of the primary technology providers to competitors outside its markets and has a good pulse on global capacity as a result, so would know if competitors were moving in. While anyone in theory can buy equipment and set up a plant, it’s very difficult and costly to replicate the scale and customer relationships that deeply entrenched market leaders like HART DC and Huhtamaki have.
The reason HART DC structurally earns higher profits in the US versus Europe is due to the differences in the operations and markets themselves: (i) HART DC’s US factory is highly automated and modernized versus the European factory base making it much more efficient/profitable (management has noted fixed costs in the US plant are half that of the European business), and (ii) the market for egg packaging in the US is more standardized versus Europe making it easier for HART DC’s US plants to run optimally (in Europe there are 9,000 different labels and packages of various sizes, colors, etc. that are unique to each specific country, whereas in the US there is 50 labels).
HART DC used to be a levered, unfocused mess – they had a capital intensive industrial packaging business, loss making Asian and North and South American operations, and were levered ~4x versus 1.3x today. So the business looked very different then versus now and the company needed to divest its loss making operations given the heavy losses and debt load.
One of the businesses HART DC sold in 2007 was its loss making South American assets which were mismanaged. They sold the operations to Thornico and over that time Thornico greatly improved/streamlined the operations – South America went from EBIT of -25mm DKK in 2006 to 45mm DKK in 2014. Therefore, the South American assets HART DC sold in 2007 were much different than the ones HART DC bought last year. When Thornico bought the assets they were a 5% shareholder and today Thornico is a 68.6% shareholder. Overall, we thought the deal to re-acquire the South American assets from Thornico was a great deal as HART DC paid 5.5x EBITDA for assets it knew well as HART DC sold the technology and machinery to Thornico while they owned the business.
While we’re always cautious of controlling shareholders, Thornico has only pushed for positive changes to HART DC. For example, Thornico was instrumental in challenging the largest HART DC shareholder in 2007 – the Hartmann Foundation – to do away with their super voting rights as the Foundation had 12.2% of the economics but controlled 58.1% of the voting rights. This opened the path towards getting a more shareholder friendly and competent Board and management team in place for the restructuring. Eventually Thornico acquired the shares taking their ownership to 29% of HART DC at which point they tendered for all remaining shares at DKK 95/sh. Only 0.04% of shareholders tendered and 37% indicated the offer was too low – a view that was supported by investment bankers and new management as well. We don’t blame Thornico for trying to be opportunistic in this regard. However, since that time Thornico has been a relatively passive shareholder preferring to stay away from the Board and day to day management. They eventually bought two pension funds ownership in HART DC as the funds needed to exit their position, but Thornico has kept their ownership steady since then. Our understanding is that Thor’s son is now running his main operations and is more interested in the technology, new media assets than Thor and so Thor has moved industrial assets into entities that he knows will take good care of the assets. This is why Thor sold the South American assets back to HART DC. Thor likes the dividend as it provides income to his heirs and feels it’s protected given the stable and well capitalized business of HART DC.
|Subject||Nice call! Any new thoughts after the latest quarter?|
|Entry||08/18/2016 09:30 AM|
Any new thoughts after the latest quarter?