|Shares Out. (in M):||1,500||P/E||14.5||13.1|
|Market Cap (in $M):||4,112||P/FCF||14.7||12.9|
|Net Debt (in $M):||503||EBIT||397||431|
Summary thesis (including 3 key tenets)
Prosegur Cash (CASH) is the cash logistics spin-off from Prosegur Group and the #2 by size, but most profitable, industry player globally. It is an 'unsexy' but critical part of the global financial system, performing a function which allows CASH to earn 20% operating margin (OPM) / 15% Cash Return on Investment (CFROI) today. The investment case is built on the belief that the franchise's ability to create value through compound growth at a high return on capital for many years to come is misunderstood, and therefore mispriced, by the market. The pricing inefficiency most likely occurs due to 1) the mis-conception of cash already being in structural decline, whereas the core Cash-in-Transit (CIT) market is still growing 4-5% globally, and 2) country risk premia due to its 2/3-plus LatAm exposure. The industry is oligopololistic with key features being high fixed costs and economies of scale, high switching costs and some network effects. Organic growth is hooked to nominal GDP with a tailwind in LatAm from higher penetration of outsourcing (plus an elevated security requirement) and cyclical macro recovery, which will be leveraged on a more than 90% fixed cost base; as such, 8-9% sales CAGR drives ~20% free cash flow (FCF) CAGR. Capital from FCF plus re-gearing the B/S to 2.5x ND/EBITDA (worth €1.24 per share) will be allocated to value-accretive M&A, consolidating an industry still fragmented below country leaders who typically have 30-50% share.
The key tenets of the business model are:
1) Cost leadership: economies of scale through the high fixed cost base of network infrastructure - higher density leads to lower marginal cost per customer drop / pick up - meaning that profitability correlates tightly with market share.
2) Trusted brand & reputation: reputation for a high level of service & security is critical and the entrenched position this provides then enables cross-sell of value-add services;
3) Switching costs: services are tightly integrated into customer business processes and enable cost-effective operational efficiency for the client, e.g. superior working capital (WCap) management, which helps account for 95% retention rates.
The shares today are a clear valuation anomaly at a 20% discount to peers (using consensus figures) despite faster growth, operational superiority and conservative forecasts post the spin-out, all suggesting rerating potential. At 10x my estimate of normalised owner earnings, the stock today already prices in a zero growth outlook, mispricing the strength of the moat and a realistic market growth outlook. Base Case FV €3.56/sh (+55% TSR or 17% 3Y IRR) based on 15x 2019e NOPAT (peers 20x-plus today) and >8:1 bull/bear skew suggest a highly attractive risk / reward setup. There is likely to be a short-term catalyst with a placing from the parent when their lock-up expires in September.
Business background (history, brief division descriptions & market positions, historic financial performance)
CASH has a dominant position in the cash logistics industry predominantly in Spain and Latin America – a position which is difficult to replicate in a market where there is a high correlation between market share and profitability. The acquisition of Juncadella in 2001 was critical in the corporate development, as it established CASH as a leader in Latin America, giving it a presence in seven countries there. They have since used M&A to enter Asia (Singapore and India) and Germany in 2012, as well as reinforcing their position in Brazil with the acquisition of Nordeste. Finally, they entered Africa by acquiring a minority stake in South African based SBV. The overall global cash logistics market is ~$15bn in size and growing at 4-5% CAGR. CASH are number 2 in global CIT market share with 14% (Loomis are number 1 with 20%), with the top 3 (Brink’s number 3) accounting for 47% of global share and the top 5 equal to 61%; the remaining ~40% is made up of 500+ smaller regional players, who often lack national coverage and are therefore operating from a position of significant competitive disadvantage. The shares listed at €2 (low end of the pre-IPO range) in March 2017 and are up ~15% since.
Product mix [N.B. all figs pro forma 2016]
Cash-in-Transit (68% of sales), or CIT, is the collection and transportation of cash from bank branches, ATMs (including refills), retail clients and central banks; this is the known as the ‘first wave of outsourcing’.
Cash Management (28%), or CMS, is the processing and vaulting of cash intake at specialist cash branches operated by the company, as well as cash stock management for some central banks, and is the ‘second wave of outsourcing’.
New Products (6%) is a variety of value-add outsourced services comprising the ‘third wave of outsourcing’, most notably end-to-end ATM management and retail cash automation; the latter provides note and coin acceptors and recyclers for both front and back office, early credit where necessary (based on this visibility of cash flows) and is offered in standard solutions for small and medium sized customers, or customised solutions for larger customers, increasing stickiness.
Banks and retailers dominate market volumes, with retail margins highest due to banks typically commanding larger volume discounts. The regulatory burden is increasingly leading to financial institutions incrementally outsourcing labour intensive activities, which means that the synergistic CMS activities are growing faster than traditional, lower margin (relatively commoditised) CIT for customers seeking an integrated solution; bundled pricing means that overall margins are also trending up.
LatAm (€1.2bn sales, €314m EBITDA): High cash usage (91% of transactions), persistently high levels of inflation, elevated security requirements and still-growing penetration of outsourced services make the key Latin American countries of Brazil and Argentina uniquely structurally attractive cash logistics markets. The region is dominated by Brazil and Argentina, but they also have profitable operations in Mexico, Colombia, Peru, Chile, Uruguay and Paraguay. Overall regional market share across the cash supply chain stands at 57%.
- Brazil: €482m sales / ~30% EBITDA margin, nearly 50% market share. Outsourcing is relatively well developed within financial institutions (~60% of volumes) but more under-penetrated at retailers; the latter is changing with the introduction of automatic cash machines meaning this segment, which ialso higher margin, is growing in double-digits. Competition is predominantly Brink’s (23% share) and local player Protégé Group (~20%), with CASH the only player providing nationwide coverage. There is room for further consolidation of the remaining ~7-10% held by up to 20 smaller regional players.
- Argentina: €435m sales / ~30-35% EBITDA margin, market share 65-75% across Argentina, Uruguay and Paraguay. Demand is concentrated in financial institutions currently, although interestingly Uruguay has the highest penetration of automated retail cash machines in LatAm. Typical CASH contracts only last 1Y due to the high inflation, allowing the company to negotiate the pass-through of cost inflation to clients (backdated to 1 Jan). Despite this, the business has >30 year business relationships with its top 10 clients. Additional growth through acquisition should not be expected due to their already very strong position.
Europe (€0.5bn sales, €60m EBITDA): dominated by Spain and Germany – they have 50% market share in home market Spain, which has served as a testing ground for a number of productivity enhancements (Loomis have 49% of the remainder); they are also market leader in Germany with 40-45% share and the only player with national reach (Ziemann are number 2 with ~25%). These are lower growth regions given higher penetration rates, but a cost-out led turnaround opportunity at the German business - where margins are currently ~5% vs 21% for the rest of the region after a number of years acquiring smaller, lower productivity businesses – will support profit growth, as will mix shift towards the 3rd wave of outsourcing.
Asia, Oceania & Africa (€0.1bn sales, €10m EBITDA): these figures are effectively Australia as I do not include the JVs in India and South Africa, which may be long term growth opportunities provided there is change in legislation re. foreign ownership of majority stakes.
Historic financial performance & current balance sheet position
Sales have grown 10x over the last 20 years to €1.7bn, of which ~1/2 has come through M&A. Over the past 3 years, sales CAGR at constant currency has been 13% (organic ~8%), with operating margins growing from 17.8% to 19.5% over the same period (indicating drop-through margins ~30-35%). CFROI has improved from 10% to 14%.
This compares to OSG / OPM at peers of:
- Brink’s 3% / 5-6%
- Loomis 2% / 10-11%
Higher profitability can be seen as being in large part as being due to better efficiency metrics: both EBIT per CIT vehicle (€67k) and EBIT per branch (€838k) are ~2x higher than Brink’s or Loomis.
EBITDA converts at ~80-90% into Operating Cash Flow (OpCF) with some working capital (WCap) investment as they grow (cash conversion cycle ~40 days). WCap seasonality typically sees collection weighted to the second half of the year; CASH does not make use of factoring or reverse-factoring instrument as a policy for normal course of business. CapEx intensity is ~5% of sales p.a. predominantly on cash centres/vaults (30%) & armoured vehicles (25%). I estimate maintenance CapEx at €46-50m i.e. broadly in line with depreciation.
The current balance sheet (B/S) position is comfortable at ~1.4x ND/EBITDA (pro forma) despite taking on €600m additional debt as part of the spin-off; interest cover is 15x / fixed charge cover 6x. This leaves ample room for the business to continue with the strategy of fill-in acquisitions (see below). 86% of financial liabilities are denominated in €, with the key syndicated loan’s covenants consisting of i) ND/EBITDA below 3.5x and ii) EBITDA/financial interest greater than 5x. Undrawn facilities include €200m 5Y revolver and €60m bilateral credit lines.
[N.B. Much more detail on product mix, the various geographies and this historic financials can be found in the prospectus or sell-side initiations; my aim is to focus on the core components of the investment thesis.]
Business model (‘how do they make money?’) & barriers to entry
Cash handling contract pricing typically references volume (sometime value) of cash handled, in addition to other metrics e.g. visit frequency, collection times. This can drive positive operational gearing effects if inflation-led growth in cash values outstrips handling cost inflation, due to automation or the introduction of larger currency denominations. Price increases are negotiated via contractual indexation (i.e. wage inflation pass-through) or annual renegotiation. In Latin America, CASH passes through wage inflation retrospectively on completion of collective bargaining agreements. Liability for loss or theft is capped in most contracts. Contract duration for CIT is 1-2 years as standard, with integrated solutions contracts, covering CIT and CMS, usually 3 years and retail automation contracts typically 3-5 years, so there are clear earnings quality improvements from building the full integrated solution.
The industry has oligopolistic features at a country level and, while competitive strategies include price, differentiation is dominated by other factors. The following paragraph is taken from competitor Brinks’s 10K: “Primary factors in attracting and retaining customers are security expertise, service quality and price. Although competitive pricing pressure exists in many markets, high levels of service, security and expertise and value-added solutions are used to differentiate the proposition as opposed to competing on price alone.”
Some key factors for business success in the cash logistics industry are therefore (in no order):
- Brand name recognition
- Reputation for high level of service and security
- Risk management and logistics expertise