Geoff Gannon July 3, 2012

Blind Stock Valuation #3 – Corticeira Amorim

Geoff here.

About a week ago I posted a blind stock valuation. That’s where I give you some financial data from a public company without revealing the company’s name. Then you try to value it.

Here are the numbers I provided:

The company is Corticeira Amorim. It’s a public company. It trades in Portugal.

Nate Tobik of Oddball Stocks did a great 2 part series about Corticeira Amorim.


Corticeira Amorim

It’s a cork company. Amorim is the name of the family that runs the company. Corticeira is Portuguese for cork. Corticeira Amorim was briefly mentioned in my favorite business book: Hidden Champions of the 21st Century.

Amorim has 25% of the worldwide cork stopper market. Cork stoppers are used to bottle wine. Amorim’s share of other cork products is even bigger. It has 55% of the composite cork market, 65% of the cork floor market, and 80% of the cork insulation business.

As I mentioned when I posted this blind stock valuation – the company uses debt. It has bank debt and commercial paper.


Your Thoughts

I got a lot of emails from readers giving their intrinsic value estimates for the company based solely on the financial data.

Here are my 3 favorite responses.


Response #1: Low Quality Business – Probably Using 1 to 1 Leverage

(Estimated Market Cap: 163 million Euros; Enterprise Value: 327 million Euros)

This is a low quality business: assume a 30% tax rate and it is earning an average of just 5.4% on its operating capital.

Its only strengths, such as they are, seem to be an (i) an ability to avoid significant gross profit erosion in the 2007-2009 cycle; and (ii) either a reluctance, or an inability, to grow.

I suspect it is the latter, because the very large swings in EBIT/GP ratio for an otherwise stable business indicates managers with very little discipline. And undisciplined managers generally want to grow, if they can.

(I assume that these swings are either related to marketing and/or SGA bloat in good times, and retrenchment in bad times; foresighted, intelligent managers generally do it the other way around).

So why can’t it grow? Niche market played out? Local market saturated? Or it’s a supplier to one or two big clients who have these problems?

In any case, the managers of this business will want to take on significant debt to (a) make its ROE look better and (b) to reduce its cost of capital. How much debt? Probably 1:1 with equity – in order to get the ROE above 10%.

So, estimating the EV and market cap should be logical and straightforward:

ROC = 5.4%,

  • average operating capital = $429m
  • cost of capital (assuming half the capital is debt) = 7%

And, following from that, market cap = ½  x 327 = $163

Or, put another way: $163m in debt will generate $5m in after-tax interest expense which implies equity earnings of approx $20m which, in turn, implies a yield of 20/163 = 12.25% on normal earnings, which sounds appropriate…


Response #2: Unimpressive Returns – But Impressive Resilience

(Estimated Market Cap: 250 million to 350 million Euros; Enterprise Value: 300 million to 500 million Euros)

Sales are growing at 2-3% annually, corresponding to normal GDP growth of developed countries.  By this measure, the company looks like a mature business.  It is somewhat disconcerting that receivables have risen at a faster pace than sales.  This requires further study.

The 50% gross margin suggests that the company probably has some sort of competitive advantage – being able to sell its product at a relatively high price or obtain resources at a relatively low cost.  It has also managed to grow income from operations at a faster rate than sales.

Nevertheless, the operating margin is average at best.  A large part of the 50 cents gross gets used up in operations.  Five cents goes for maintenance capex as the depreciation rate and PP&E are pretty constant through the years.  Where does the rest go?

You mentioned the company uses debt.  This means, after interest charges and taxes, the company will net 5-6 cents on a dollar of sales, maybe less.  At this rate, I would value the equity at 250,000-350,000, considering the company’s exceptional resilience in the difficult conditions of the past 3-4 years, the steady growth in operating income and EBITDA, and the low capital intensity.

Return on invested capital has averaged 13% and has reached record (for the time frame) levels in the last 2 years.  Again, I find the persistent results and the swift recovery after 2009 more impressive than the level of the returns.  Thus, I’d say the total company is worth 300,000-500,000.

Response #3: Attractiveness of the Stock Depends on the Company’s Use of Debt

(Would buy at Market Cap of 160 million Euros; Enterprise Value of 400 million Euros).

Invested capital has been approximately 400M over the 7 year history. Sales have roughly tracked inflation, I would assume the company is paying out the majority of its profits in dividends/share buybacks. Since it’s still grown from 25 to 51 M in profit without any real increase in invested capital, it probably has something of a “See’s Candy” type business model, where prices are raised annually, but the company doesn’t have any real good reinvestment outlets. It is economically sensitive though, which means I would give it a lower multiple than See’s, especially due to the fact that they have less opportunity to invest as much capital when there are large downturns. Since it’s more of a mediocre predictable business I would expect to pay approximately (51 pretax * 8) or about 408 M for a boring predictable business that pays out its earnings.

Let’s talk about leverage though, since it’s a relatively boring predictable company, I would expect you could lever it up to 3x 2009 depressed after tax operating profit plus current liabilities minus payables and accrued expenses. You could sell the bonds for 7 or 8%. That’s an after-tax cost of ~ 5%. You could even do it by doing sale leasebacks on the PP&E. Since you are earning ~ 9-12% after-tax on invested capital and since you can expect your average shareholder to earn 7-12% over the long run it makes sense to lever up to somewhere in that ballpark. So let’s say you have 120M of debt financing those assets at 5% after tax. That’s 6M of after-tax interest bringing the 51 M of pretax operating profit down to ~43 M of operating profit.

I find it interesting now that I think about it. Even though the company becomes more risky with more debt, I would hold less of it in my portfolio, but up to a certain point I would give management kudos for using it appropriately which would reflect in my valuation. In fact if it wasn’t prudent I would probably throw this company out. If it was levered appropriately as above, I would probably be expecting a reasonable market valuation to be 9 or 10 x (pretax operating profit minus interest) minus the amount of debt.

Right now the average company in my portfolio has a simple-boring-statistically expected return of about 18%. In order to get added to my portfolio it would have to in that ballpark. We’ll give management and the industry the benefit of the doubt because I’m not privy to that information for this stock pick, and I’d say that the price I would pay to earn approximately the same rate of return would be:

if the company used no leverage, approximately 300 M

if the company used 120 M of leverage, approximately 220 M (market cap..) (EV defined as mcap + debt/nonoperatingspecific liabilities minus non-necessary cash of ~ 340 M)

if the company used 240 M of leverage, which they probably could get away with due to their high inventory/receivables/pp&e to current liabilities and if they had consistent highly predictable enough earning power to keep interest rates near above,

I’d buy it at 160 M market cap (EV 400 M)


Actual Market Value of Corticeira Amorim

Corticeira Amorim’s actual market cap is 185 million Euros. The actual enterprise value is 312 million Euros.

The stock is up about 50% over the last year. The market cap has ranged from about 120 million Euros at the low to 185 million Euros at the high. So, the company’s enterprise value hasn’t been consistently below 250 million Euros at any point.