|Shares Out. (in M):||443||P/E||0||0|
|Market Cap (in $M):||460||P/FCF||0||0|
|Net Debt (in $M):||80||EBIT||0||0|
Oriental Weavers (“ORWE”) is a low-cost Egyptian manufacturer of rugs and carpets trading at a very high free cash flow yield (>12%) for a high quality emerging market “gem” with near-monopoly local market share, growing global exports, low leverage, a high dividend, smart, aligned founder/owner management, and a history of stable, growing earnings. Equity upside is 50-100%+ if ORWE trades closer to global peers.
Business Description: Oriental Weavers Company for Carpets (“ORWE”) manufactures rugs and carpets mostly in Egypt and was founded in 1980. Revenue is approximately half from exports to countries outside Egypt, primarily the United States and Western Europe, and approximately half from sales within Egypt, where ORWE has very high 85% market share. ORWE is organized as 6 operating subsidiaries which produce different types of rugs and carpets, of which 4 are wholly owned by ORWE and 2 are majority owned by ORWE and partially owned by founder Mohamed Khamis. ORWE publishes English-language financials quarterly including information on volume and pricing for domestic and export segments, available on the IR webpage; it’s also covered by local brokers including HSBC, Renaissance Capital, EFG Hermes, CI Capital, and Beltone. To trade local Egyptian securities you will need a UID number (local market investor ID) which either your prime broker or a local broker can set up.
Resilient business: ORWE has maintained its real (USD) earnings over the past 6 years during a challenging environment in Egypt.
Attractive valuation: ORWE trades at a 12% free cash flow yield on current (2017) FCF. If ORWE traded at 12x 2017 FCF, the stock would be worth EGP 28.3 or 52% upside from current 18.6; if it traded closer to global carpet/flooring peers at 16x FCF, it would be worth 39.1 or 110% upside.
Management has proven committed to returning capital and the free cash flow yield translates into an attractive dividend with current yield of 7.5%.
Leverage and downside protection: ORWE is underlevered and has a significant net working capital position (27% of TEV) that provides additional downside protection and additional upside optionality if monetized.
Net debt of 112M is only 19% of TEV. Historically ORWE has run with higher leverage levels, as high as 43% of TEV in 2012, and re-levering could create additional equity upside.
Strong capital allocation and alignment:
Over the past six years ORWE’s cash flow has mostly been used to expand the production capacity of the business and pay down debt. Management has indicated they will use cash flow to continue to grow production capacity and maintain/grow a dividend to return capital to shareholders.
Founder Mohammed Khamis, along with the next generation of the family who currently run the business, own 42% of the business. Independent references confirm that the ownership of ORWE’s public stock constitutes the vast majority of the family’s net worth and the family is highly motivated to create shareholder value.
After a painful revolutionary period beginning in 2011, we believe Egypt is poised for recovery. The revolution was a period of political instability which led to lack of private investment, severe contraction in tourism, and more recently an inability for businesses to access foreign currency due to capital controls. With Sisi in control of the country politically plus the IMF loan package and the currency’s flotation, we believe the country is poised for economic success and will be able to recapture some or all of its prior GDP growth rate before the severe decline, as the cheaper real FX rate will stimulate growth, along with FDI, private investment, a recovery in tourism, and energy investment in the Nile Delta. We believe Egypt’s normalization and return to growth will be a catalyst for re-rating the market and ORWE.
Competition and margins: ORWE’s inability to maintain 100% of USD earnings and decline in exports was mostly due to losing volume with Ikea, its largest customer. After the 2015 decline in oil prices a European competitor undercut ORWE’s pricing with a Turkish manufacturing facility and took share from ORWE.
Mitigant: Management and industry experts told us that ORWE is currently regaining Ikea share, which will benefit export growth, as well as growing share at US big box retailers, all while price per sqm continues to rise, so the highly competitive environment to supply Ikea has abated; additionally, our review of the rug/carpet/flooring manufacturer industry (including conversations with other players) indicates that while pro-cyclical and levered to housing starts, rugs should be a low-mid single digit grower over time, as they have been historically. Additionally, ORWE is one of the lowest-cost rug producers for its retail channel – (i.e. the lowest-cost producer for Ikea) and is a known brand for home good retailers globally, so should continue to earn their share of the market’s growth. EBITDA margins have been stable historically at an average 12.5% (excluding export rebates), including in 2015 when ORWE was losing volume to Ikea but kept EBITDA margins of 13.7%; margins bottomed in 2011, the first year of the revolution, at 9.7% but then recovered to 11.3% in 2012 and have not been below 12% since.
Misalignment with management: Mohammed Khamis has independent, personal ownership in two of ORWE’s subsidiaries and a 20% stake in its primary supplier of polypropylene, a key input.
Mitigant: From conversations with former employees, we believe that he does not control pricing at the supplier and all interactions are done at arm’s length and market prices. The subsidiaries he owned were semi-independent businesses he started outside of ORWE with independent investors, and eventually swapped most of his ownership into the company to avoid a conflict of interest in 2006; we believe the price of the swap (determined by 3rd party valuation) was fair and agreeable to investors at the time.
Export rebates: The export rebates paid by the Egyptian government to encourage exports in certain sectors, which have constituted 10-20% of ORWE EBITDA over time, could decline.
Mitigant: ORWE is valued attractively even without any rebates and many conversations indicate that the Egyptian government and El Sisi view the program as important to promoting Egyptian exports. Though the export rebate program could continue indefinitely, if it did go away, it would be after 2020 and would be staged slowly.
ORWE grew revenue at 7.7% through 2015 and 9.2% through 2016, and EBITDA at 4.1% through 2015 and 8.4% through 2016, in local currency. Maintaining dollar earnings and growing in local earnings during a period of significant instability for Egypt, including two revolutions and multiple port closures, is impressive financial performance.
On a volume basis, ORWE has grown domestic sales at 3.8% through 2015 to 51.0 million square meters while export volume has shrunk at 3.4% CAGR to 60.0 million square meters. We believe the primary driver behind the contraction in export sales was 1) shrinking volume with largest customer Ikea due to competitive offerings from the Belgian rug manufacturing competitor Balta which opened a factory in Turkey specifically to produce low ASP SKUs for Ikea in 2014-2015 and 2) some pressure from other international accounts who sought to diversify suppliers due to instability in Egypt. Ikea has shrunk from ~20% of sales to ~8% in 2016, but will grow to ~10% in 2017 based on contracts into which the company has visibility and confirmed by independent industry experts with familiarity with the competitive landscape, eliminating a 24 month headwind on the export segment. Additionally, the company believes it has visibility to increased YoY contracted volume with its anchor big box US retailer Home Depot.
On a price basis, ORWE has grown ASP in local currency at a CAGR of 8.1% through 2015 or 7.0% EGP 53.74 per square meter. Per discussions with the company and industry leader Mohawk (a major producer of carpet and other flooring including hardwood, with a smaller focus on rugs), the global rug market has and should grow pricing at low single digits and volume with home formation.
Mohawk, the US flooring player, commands a 24x FCF multiple and 11x EV/EBITDA multiple. Developed Market flooring comps have traded at an average 8.6x trailing EBITDA over the last 10 years, and currently trade at average 8.7x 2017E EBITDA. Emerging Market flooring comps have traded at a long term historical average around 11x (EM comps have high variability and low data fidelity, but by focusing on a few with good historical data like Alabdullatif in Saudi, Dogtas Kelebek in Turkey, Thai Carpet Mfg in Thailand, Textile-Garment in Vietnam, etc. the space has generally traded between mid single digits and mid teens EV/LTM EBITDAS multiple). On a P/E basis, Developed Market comps have traded at a long term average 18.5x and currently trade at 16.6x 2017E.
In ORWE we believe that we are mostly aligned with a smart owner-operator in founder Mohammed Farid Khamis. Multiple reference checks on Mohammed Khamis and his most important family members with influential positions in the company, including daughters Yasmine (in charge of operations) and Farida (in finance), and nephews Amr and Mohammed, including feedback from other investors familiar with Egypt, industry analysts, former employees, sell side research, etc. all came back positive that Mohammed Khamis and his family are smart operators with a strong track record of prudent capital allocation, innovative growth strategies, and focus on creating value for minority shareholders.
Ownership: Mohammed Khamis owns 41.8% of the stock. Additionally, he privately owns stakes in two of the operating subsidiaries, EFCO and MAC (which make tufted wall-to-wall carpet and poly fibers.) Additionally, Yazmine Khamis, the most important of the next generation who runs operations for ORWE and is formally the Vice President of Sales and Marketing, owns some of the family stake independently.
Mohammed Khamis’s private ownership of the subsidiaries EFCO and MAC. Khamis founded these businesses outside of ORWE in 1985-1990 with third party investors including private individuals who are friends with the family. Later, in 2006, he did a share swap to combine them into ORWE “to avoid misalignment,” according to the company. The company does not have a compelling answer as to why he swapped into 58-68% ORWE ownership rather than 100%. We have no indication that there is anything untoward or off-market transactions in these companies. We have not yet translated the document of the 3rd party valuation firm which recommended the price for the swap, but one independent source told us that shareholders were pleased with the transaction.
Mohammed Khamis also owns a 20% stake in Egyptian Propylene and Polypropylene Company (“EPPC”) which is the primary supplier of polypropylene granules which are melted into fibers to create many of ORWE’s rugs. This is an independent business which is also owned by the Egyptian Ministry of Petroleum and the Saudi private equity firm Amwen Al Khaleef, and ORWE has no ownership of EPPC. We believe that all transactions between the company occur at market prices and arm’s length negotiations, based on the company and indepdnent conversations. EPPC exports 75% of its production and considers ORWE competitive with other potential sales. ORWE has other sources for polypropylene (although EPPC is its main source) and evaluates the pricing offered competitively. Additionally we take comfort that Mohammed Khamis would be incentivized to benefit ORWE over EPPC based on his relative ownership.
Potential areas of risk where we are not aligned with the Khamis family include:
Mitigants to these potential misalignments are 1) the majority of the EFCO/MAC ownership is ORWE and independent sources tell us all selling is at market value and 2) the evidence we have is that EPPC transacts with ORWE at market prices, plus the founder owns more ORWE than EFFC so would presumably work in our favor.
Dividends: the company has returned a material amount of capital to shareholders through dividends. Over the last 10 years, in USD the company has paid $0.71 per share in cumulative dividends, nearly the entire current entry price.
The company’s dividend policy is to pay 50-70% of net income as dividends, which varies depending on Capital Expenditure needs.
ORWE earns Export Rebates from the Egyptian government, paid as tax rebates. Export Rebates are calculated as a percentage of the export value sold. The rebate percentage paid is 6-10%, depending on:
Percent of production in tax-advantaged “free zones” or in Upper Egypt
Percent of local vs. imported COGS
Energy usage in production
Other factors including additional incentives for companies exporting to new countries, companies demonstrating “innovative trends,” companies with facilities that only produce exported goods,
ORWE earns rebates at the lower end of the range due to their use of production facilities in “free zones” or approximately 6% of export revenue. Historically rebates have averaged as a percent of total (export and local) revenue 2.7% and ranged from 2.1 to 3.4%; as a percentage of total EBITDA, they have averaged 23.8% or 20.6% since 2013 and ranged from 19.1% to 35.0%. The Export Rebates are accounted for as “other revenues” on the income statement as an item below net income from operating activities. It is accounted for on a cash basis as the rebates are received from the government.
History: The Export Development Fund (“EDF”) was founded by presidential decree in 2001-2002 to subsidize producers Egyptian exports more competitive. The EDF fund board meets annually to approve a budget for the June-ending Egyptian fiscal year. For FY16/17 a budget of 4.0-4.5B pounds was approved, an increase from the prior year of 3.5B pounds. In 2014, there was a delay in the payments of rebates (visible in the decline in the 123M of 2015 rebates received). The company’s view is that not paying rebates was an unsuccessful experiment for the country and the EDF board quickly went back to paying, and in fact increased the rebates in 2015. Additionally, ORWE expects that they will eventually receive compensation for the foregone rebates, although they do not think it’s a near-term upside.
Future: Though the company believes that export rebates are crucial to incentivizing value-added production in Egypt, the government is trying to decrease or potentially eliminate subsidies over time. There were delays on the payment of subsidies in 2014-2015 so current subsidies are being collected on a delayed basis. Though the IMF loan did not target the export subsidies specifically, we believe that budgetary pressure or adherence to orthodox economic policy will decrease Egypt’s support for the export subsidies over time. One local consultant we talked to believes the government is trying to eliminate subsidies by 2020. We believe ORWE is cheap both including and excluding the rebates, and do not require rebates in the base case to make it an appealing investment. We do not have strong conviction in the duration of the rebates or strong reason to disbelieve the company’s view that they will continue. The company does not lobby explicitly, although they report that one board member is also a member of the EDF board and represents the company at committee hearings.
There is some evidence that companies, not including ORWE, structure themselves to receive inappropriate subsidies, for example by exporting goods from within a free zone to another company which then exports it abroad, and capturing the subsidy twice. An independent source told us that ORWE does not engage in this “double” collection.
The author is presenting the views of an investment firm that has a material long position in the securities of the company discussed herein. The author is not otherwise affiliated with such company, including as an employee, director or consultant. The views expressed herein are provided solely for informational purposes and do not constitute an offer to sell, or the solicitation of an offer to buy, any security. The information provided herein is not intended to be, and should not be, relied upon as an investment recommendation in connection with any investment decision. The contents of this message should not be construed as legal, tax, accounting, investment or other advice. No representation, warranty or undertaking, express or implied, is given as to the accuracy or completeness of the information or opinions contained herein by the author or its affiliates and no liability is accepted by such persons for the accuracy or completeness of any such information or opinions. The information and opinions contained herein are provided as of the date this message is originally posted. The author has not independently verified all information contained herein and has no obligation to update any of the information provided. The views expressed herein are subject to change without notice at any time and the author and its affiliates may trade in any manner in the company’s securities, whether consistent or inconsistent with the information provided herein, as they deem appropriate. Past performance of a security is neither indicative nor a guarantee of future results of such security. There can be no assurance that an investment in the company will be profitable or that the assumptions regarding future events and situations will materialize or prove correct.
- Recapturing export share
- Egyptian consumer recovery
- Capital return