Bunzl (BNZL): A Distributor with 20 Straight Years of EPS Growth and 27 Straight Years of Dividend Growth – Facing a Virus That’ll Break At Least One of Those Streaks
Bunzl (BNZL) is a business I’ve known about for a long time. However, it’s not a stock I’ve thought I’d get the chance to write about. The stock is not overlooked. And it rarely gets cheap. EV/EBITDA is usually in the double-digits. It had a few years – the first few years of the recovery coming out of the financial crisis – where the EV/EBITDA ratio might’ve been around 8 sometimes. It’s back at levels like that now. Unfortunately, the risks to Bunzl are a lot greater this time around than in the last recession. Why is that?
First, let me explain what Bunzl does. This is actually why I like the business. The company is essentially like an MRO (maintenance, repair, and overhaul) business. It’s a little different from them. In fact, I think it’s a little better than businesses like Grainger, MSC Industrial, and Fastenal. But, it offers its customers the same basic value proposition: we’ll take the hidden costs out of you procuring the stuff you buy that isn’t really what your business is about. What do I mean by that? Well, with Bunzl – the company is basically a broadline distributor of non-food, not for resale consumables. So, you go to a supermarket. You get a bagel out of the little bagel basket, glass case, whatever in your supermarket – you throw it in a brown paper bag. Bunzl doesn’t supply the bagel. It supplies the brown paper bag. You pick out some tomatoes and put them in a plastic bag and add a little green wrapper to the top to seal off the bag – Bunzl might supply the clear bag and the twist thing, it won’t supply the tomatoes. Obviously, I’m using examples of stuff the customer might come into contact with. Bunzl actually supplies a lot of stuff you wouldn’t come into contact with that also gets used up. But, the point is that Bunzl is neither a manufacturer of anything nor a seller of anything that goes on to be re-sold. It’s a pure middleman. It buys from companies that produce products that businesses will use – but won’t sell. It does bid for these contracts (like Grainger does with its big accounts). But, it’s unlikely that the price of the items is the most important part of the deal. Stuff like whether the company can do category management, deliver direct to your door (or, in some cases, beyond your door and into your stores and factories and so on), order fill accuracy, order delivery speed, consolidating orders, consolidating everything on one invoice, etc. is important. The case for using a company like this is usually not that you save a penny on some product they buy in bulk – instead, it’s that you eliminate the work that would be done inhouse by finding a bunch of different suppliers, comparing prices, tracking inventory, etc. That’s why I say Bunzl is like an MRO.
However, Bunzl would normally be probably more resilient than an MRO – in fact, Bunzl’s annual report uses the word “resilient” a lot – in any year other than a coronavirus year. MROs are usually more exposed to industrial stuff. Bunzl isn’t. Here’s the company’s breakdown (the first industry served is the biggest problem):
Foodservice: 29%
Grocery: 26%
Safety: 13%
Cleaning / Hygiene: 12%
Retail: 11%
Healthcare: 7%
A lot of that stuff will get disrupted this year. Two categories stand out as very negatively affected – foodservice and retail. They add up to 40% of the company’s sales. Bunzl has increased both its earnings per share every single year for at least the last 20 years (I don’t have data past that). Sales have grown for more than 15 straight years. And the company has increased its dividend for 27 straight years. The increase in the dividend over 27 years has been done at a 10% CAGR. Generally, the company tries to increase the dividend in line with EPS. It’s very possible – based on that fact – that intrinsic value per share has compounded at close to 10% a year for close to 30 years. Shareholders also got a dividend on top of that. The company is super resilient in normal years. It won’t be resilient this year though. And it does use debt. Bunzl had 2 times net debt to EBITDA going into this. If you add in leases – I guess it’d be closer to 3 times. But, that’s misleading, because I didn’t add back rent. I think a level of about 2 times net debt EBITDA – keeping in mind they also have leases – is the best way to look at this company. Based on the most recent annual report, Bunzl had about 1 billion Pounds undrawn on a credit line and was rated BBB+ by S&P. The company’s goal is to maintain an investment grade rating. There is some discussion of coronavirus in the annual report. However, the risk section on coronavirus – even when speculating about it spreading in the future – does not discuss any impact outside of China. Bunzl sources a lot of its stuff from an office in China. It talks about this a lot. It talks about how sourcing could be disrupted. It doesn’t talk about the possibility of customers being hurt.
There’s a good reason for that. Bunzl is a U.K. listed company. However, its biggest market is the U.S. Operating profit comes about 53% from the U.S., 28% from the E.U., and about 13% from the U.K. At the time the company’s annual report was prepared – the idea of shutdowns of restaurants in the U.S, U.K., and E.U. would not have seemed possible. Coronavirus was then only a Chinese phenomenon.
The annual report is not very informative. The company seems pretty big and bureaucratic. It does seem very disciplined though. The metrics they talk about in the annual report are the ones shareholders would care about. For example, Bunzl focuses on return on invested capital – including goodwill. That’s what you’d want a serial acquirer to focus on. Bunzl buys smaller companies all the time. So, it’s good that the company discloses the 13-14% type returns it has on capital including intangible assets instead of just focusing on the more like 30-50% returns it has on tangible capital. This is a great business. But, you always have to acquire things at far above book value. To give you some idea of the “goodwill” in this business – Bunzl amortizes its acquired customer relationships on a straight line basis over 10-19 years. Amortization is just a non-cash accounting charge. The fact the accountants chose 10-19 years doesn’t prove anything important about the business – and it does flatter reported earnings to take longer to amortize stuff. But, it also suggests high customer retention. You don’t normally choose a 10-19 year amortization period if your customer churn is like 30% a year.
Bunzl describes “a one stop shop” as being “the very essence of the Bunzl business model”. It talks about its approach as being: “one order, one delivery, one invoice”. The company also mentions – as I discussed earlier – the importance of “beyond the back door” service for some customers. Bunzl doesn’t disclose a lot about specific customers. The annual report included some pictures where I knew who the customer was based on the picture. I also recognized some brands from stuff in pictures. Bunzl supplies both brand name and private label stuff. I believe – but can’t prove – that Bunzl often (but not always) serves at least one of the biggest supermarkets in a given market. This is just a guess based on some stuff the company said and on the materiality to specific segments of the loss of a single supermarket customer or winning that customer back. The company mentions situations like this twice in ways that – by my math – wouldn’t make sense unless the customer was a very big market share player.
Bunzl mentions something in its acquisition criteria which is probably core to its business approach – and is usually a defining characteristic of the “MRO” type businesses to which I’m comparing Bunzl – and that’s the requirement that a customer’s purchases from the acquired company must represent a small percentage of the customer’s total spend. A key to this business is that Bunzl is not a supplier of anything you re-sell – so, you aren’t obsessed about your margin on the product. And secondly, Bunzl is not a very high cost service provider either. The level of diversification here is meant to be more like MROs, big ad agencies, etc. Although Bunzl does discuss key customer losses and wins – they’re mostly noticeable because the existing customers change their purchase levels so little. So, a big customer win or loss could swing one of the countries I discussed by maybe like 6% or something and more like 2% or 3% for the entire company. I don’t see a really high level of growth potential or of risk of lost business due to a single customer coming to or moving away from Bunzl.
This is a “survival of the fattest” business as Buffett would say. The economies of scale in a broad, middleman business like this are pretty awesome. They aren’t noticeable at first. But, they snowball. One, you probably get the best returns on your acquisitions. Bunzl has a lower cost of capital than the companies it acquires. It buys several small companies every year. Bunzl uses debt to finance these purchases. It’d be hard for companies that are sometimes less than 1% of Bunzl’s size to access capital at the rates Bunzl can borrow. And, of course, these companies aren’t public. Bunzl is. On top of this, the return on the acquisitions is largely from synergies. Bunzl intends to sell more through the same system to the same customers by making these purchases. It’s difficult to get lower purchase prices on supplies than Bunzl, because you’ll often be buying less than they are. And it’s easier to make money on the customer side of things if you can get more of the spend of each location at each customer. This increases gross profit per order and stuff like that. Bunzl rents warehouses and employs truck drivers. It also has more than 3,000 sales people and more than 2,000 customer support people. I’m sure smaller competitors can compete with Bunzl just fine – the industry is very fragmented – on an “also” basis. But, not on a consolidated basis. What I mean is that it’s typical for smaller companies to be able to supply a narrower line of products and make good money as long as they have high customer retention, a strong position in a specific region, or a strong position in a specific industry (and often a specific industry in a specific region). However, the risk to smaller companies is that customers will simplify their purchasing by consolidating their supplier list into fewer, bigger, and more entwined relationships. That seems to always be the pattern in industries like this. And that’s why I say this is a survival of the fattest business.
Bunzl will have a bad year in 2020. It may have a bad year in 2021. All this coronavirus and recession talk is speculative. Bad stuff will happen. But how bad and for how long – I don’t know. And I definitely don’t know how to price that into a stock like Bunzl.
How cheap is Bunzl?
The P/E ratio is about 13. The dividend yield is about 3%. Both of those are really attractive for a company that had grown EPS for 20 straight years and dividends per share for 27 straight years. The company is super resilient outside of freak years like this one. EV/Sales is 0.77. I think the company can normally have an operating margin of 7%. Cash conversion is good. Returns on mergers is adequate (13%+). Returns on organic growth would be amazing – but, organic growth is awfully close to nil in an industry like this.
So, I think I’d like to pay less than 0.7 times sales for the company. I’d like to get it at less than 10 times pre-tax earnings. It might be cheap enough now. But, I’m not in a buying mood yet. And, as with almost all businesses this year, things will get worse for Bunzl before they get better.
Still, this could be a buying opportunity.
Geoff’s Initial Interest: 70%
Geoff’s Revisit Price: 1,200 GBP (down 27%)