Guinness Peat Group (GPG) is a continuation of the write-up of Coats that I posted to VIC in February, 2003. Shortly after the write-up, GPG put Coats out of its misery by taking the company private. Coats is now GPG’s single largest investment at approximately 1/3 of assets, the rest of which is cash and a portfolio of publicly traded securities in New Zealand, Australia, and the U.K. (All figures in NZ dollars).
GPG is the investment vehicle of Sir Ron Brierley, the New Zealand born value investor. Since Brierley and his team took control of GPG in the early 1990s, the company’s NAV has grown at 17.4% compounded versus 8.0% for the FTSE, 12.3% for the ASX, and 11.3% for the NZX. GPG is an activist investor. A typical strategy is to buy an influential stake in a publicly traded company and then agitate to unlock value. GPG also takes companies private, improving their operations over the course of a number of years, with a subsequent realization of value through a trade sale or flotation. GPG’s team has operational experience across a broad range of industries and GPG controlled companies often enjoy excellent reputations in their respective industries. Target companies tend to be ugly on the surface but asset rich and very cheap, although not apparently so at the time of investment. Coats fit this description when I posted my write-up to VIC.
To value GPG, you need to look up the market value of the publicly traded portfolio (which is approximately $950m), net out cash and debt at the GPG level (cash of $504m, receivables, subsidiaries and unlisted assets of $360m, and convertible debt of $465m), and then come up with a value for Coats. Coats has debt of $620m and reserves for minorities and EU litigation relating to price-fixing of $140m. At $2.02/share with 1,060m GPG shares outstanding, GPG’s market capitalization is $2,141m. If you add and subtract the numbers above to get rid of GPG’s portfolio and other stuff, by process of elimination you get an adjusted EV of $1550 for Coats, versus Coats’ estimated current year EBITDA of $285 or 5.45x.
Coats has some public comps: Ruddick, Dollfus Meig, Ningbo Veken Elite Group, and Linz Textil. The EV/EBITDA multiples of the public comps are 3.4x to 9.7x with the average of 6.3x based on FY04 numbers. Of these companies, Coats is the 800 pound gorilla with more revenues than the combined group and 5x larger than the nearest comp. Also, Coats has out-spent the group by a huge margin on trailing 3 yr Capex - $300m for Coats versus less than $100m for the rest combined. Given Coats’ industry position, improving fortunes and heavy recent Capex spending on brand spanking new facilities, a market average multiple is easily justified for Coats. With Coats at a 6.3x multiple, GPG would be worth $2.25/share today, but that misses two key points: Ongoing improvement at Coats and upside in GPG’s portfolio.
Coats recently posted EBITDA margin improvement from 8.8% in 1H04 to 11.4% in 1H05. After interviewing management, a 15% growth rate in EBITDA for 2006 and 2007 seems very reasonable. That assumption is even less heroic when you consider that estimated FY05 EBITDA will still be just under FY02’s result. If Coats achieves 15% growth for FY06, a 6.3x multiple would result in a $2.50/ share NAV for GPG, and similar growth in FY07 would result in a $2.80/share NAV for GPG. Another way to look at it is that you are paying 4.7x FY06 or 4.1x FY07 Coats’ estimated EBITDA. Either way, the appreciation potential is attractive.
The above estimates assume no growth in GPG’s other assets, which goes against past experience. As stated above, GPG’s long term rate of growth in net asset value is 17.4%. If ¼ of the historic growth rate, or 4.35% per annum, is applied to GPG’s portfolio and no credit is given to returns from future investment of cash on the balance sheet or other assets, the resulting NAV would be $2.54/share in FY2006 and $2.88/share in FY07. If the portfolio were to grow at 6%, all other things being equal the resulting NAV would be $2.55/share and $2.91/share for those years, respectively.
Analyzing Coats in a little more detail maybe useful. Coats' earnings profile will primarily be driven by cost reduction in the thread business. At the time of GPG's acquisition of Coats, production was primarily located in developed nations. Over the last four years Coats has relocated production to lower cost developing regions of China, India, Mexico, Brazil, Romania and Indonesia and refocusing its developed nation operations on distribution and customer service. While this transition has been taking place, Coats has suffered from high ongoing restructuring charges and low margins due to the duplicate facilities needed to maintain production. The benefit of Coats' new cost base will begin to impact on operating margins in 2005. By the end of 2006 Coats will have eliminated is overlapping capacity.
The regional impact on operating margins will be:
UK and Europe: 2005 will be the first year without a duplicate cost base for this region, which was formerly one of Coats' largest cost centers. Forecast operating margins are still only 3%, growing to 5% by 2008 due to ongoing reorganization costs. Once these stop margins could well exceed the pre-2000 level of 7%, however I have not factored that in.
In North America the same shift in production and a reduction in overlapping facilities will boost margins from 3% to 7% by 2008. There is considerably more upside on a historic basis with pre-restructuring margins around 10% - which again has not been factored in.
Operating margins in South America & Asia will not be impacted to the same degree, (margins are already in the 10-11% range). The exception is Coats' Shenzhen plant which opened in late 2004 and is expected to be fully operational (and not masked by start up costs) by 2006. There is upside here in revenue growth as more manufacturing moves to the region, however, any growth is likely to be volatile. Should revenue grow, margins will increase over and above the 10-11% range as fixed costs are spread over larger production runs.
Over and above cost savings from Coats' production relocation there is upside in Coats' capital management following its recent installation of a group-wide SAP system.
The final realization of Coats’ value for GPG could take the form of a trade sale, a sale to a financial buyer, a flotation (I would guess London, since that is where Coats disappeared from), or possibly a liquidation of GPG’s other assets with the remaining entity comprising Coats. The time frame for any of these scenarios is not knowable, but the market should accord a proper valuation to Coats (and therefore to GPG) as the above-outlined changes in operating margins unfold.
Improvement at Coats and appreciation of investment portfolio giving rise to growth in net asset value.