Geoff Gannon November 19, 2013

Geoff’s Avid Hog Watchlist: Catering International & Services (CTRG:FP)

The following stock may appear in a future issue of The Avid Hog.

Catering International & Services trades in Paris under the ticker “CTRG”. The company was founded in Marseilles, France in 1992. Two families control 71% of the shares. The founder, Regis Arnoux, controls the majority of the company’s shares. He still runs the company. Catering International provides remote site services (mainly catering) in extreme conditions. Revenue is about evenly divided between serving mining customers (51%) and oil & gas customers (47%). Operating profit – but not revenue (more on that later) – is about evenly divided between Asia/Pacific (54%) and Africa (46%). So, we’re basically talking about a company that caters for mines and oil fields in Asia and Africa.

Let’s start with how I found the company.

I ran a screen at Stockopedia looking for E.U. stocks sorted by their gross profits relative to net tangible assets. I then eliminated companies that either had lost money in one of the last few years or that now traded above 8 times EBITDA. I also eliminated companies where the business description suggested they were far from all 3 rings of my circle of competence: 1) consumer habits, 2) business support services, and 3) industry standards. This left a little over 40 stocks. I then looked for English language information on all 40 stocks. About 14 of these stocks had multiple annual reports in English. Catering International was one of them.

A few things appealed to me immediately about Catering International. The business sounded both mundane (catering) and niche (extreme conditions). It’s a business support services provider. Gross profitability was adequate.

A few things also concerned me right away. Catering International serves mining and oil & gas customers. That means the commodities these companies are extracting – their reasons for being at these sites – are at bubble levels. I’m not saying they are in a bubble. The supply of oil and gas is finite. So you can argue that bubble prices relative to the past could be justified throughout the future. But there is no long-term history of prices being this high. Therefore, we don’t have a relevant record of consumer or producer behavior to go on. We don’t know how marginal – high cost and high risk – some of these sites are. Catering International has been a very fast growing company. Some of that growth was driven by customer interest in more extreme conditions which high prices for commodities like oil and gold have to encourage.

The good news is that you don’t have to expect a lot of future growth to invest in Catering International. Using the most aggressive estimates of EBIT and enterprise value you get a price of 6.5 times EBIT for the company. Using the most conservative estimates of EV and EBIT you get a ratio of 8.2 times. Any price less than 10 times EBIT seems quite fair for a company like this – even without a lot of growth.

I need to explain the “estimates” issue for both EV and EBIT. The company has two noteworthy items. First, it has money losing operations in South America. Today, that is Peru and Brazil. South America contributes 18% of the company’s revenue. However, those operations actually cost the company 3 million Euros in losses. We need to consider those losses in our analysis. But, we certainly should not capitalize them. For example, if we assume Catering International is worth 10 times pre-tax profit – we should not lop 30 million Euros off our valuation for contracts the company can simply stop bidding for in the future. So, this raises the question of whether EBIT is 21 million Euros (companywide) or 24 million Euro (profitable segments only).

And now the cash question. Catering International has 16 million Euros of cash in Algeria. The Algerian government does not want Catering International to transfer that money to a subsidiary that would allow us to consider it net cash at the corporate level. If you count all Catering International’s cash around the world – it comes to 38 million Euros of net cash. If you count all the cash except what’s in Algeria – it comes to 22 million Euros.

So, if you value the company at 10 times pre-tax profit, your decisions on how to treat South American operating losses and the Algerian cash could change your valuation of the company by 46 million Euros. Catering International’s market cap is 192 million Euros. So, the questions are significant. But, an analysis for The Avid Hog, could simply present the best and worst cases. It would almost certainly write-off the Algerian cash entirely because we have no ability to predict court cases in Algeria.

All this talk of Algeria – which is Catering International’s largest market at 22% of revenue – is a good place to tangent toward the special headline risks present in owning Catering International. These risk (mostly) don’t concern me. However, they greatly increase the risk of negative publicity for the company. And some of the potential headlines could make investors – especially investors far from both France and the sites where the company operates – quite uncomfortable.

First, there is the special risk that Catering International’s employees could be violently killed. The company’s largest single subsidiary is Cieptal in Algeria. Over 130 local workers – and one French citizen – of this subsidiary were among the 800 hostages taken at the In Amenas gas facility when it was attacked in January. None of Cieptal’s employees were executed. However, the French employee was hidden and presumably would have been killed if found. About 39 foreigners were killed. They worked for or with Cieptal’s customers at the site: Sonatrach (Algeria’s oil company), Statoil, and BP.

This brings up another risk. Catering International works with companies like Sonatrach that are controlled by governments like Algeria. In fact, local investors have minority stakes in some of Catering International’s subsidiaries. The countries Catering International operates in are often corrupt. Catering International is run from France by French citizens who – in very small numbers – rotate through these countries for short periods of time. So there is a risk Catering International’s French employees will bribe people in these countries. When you consider that Catering International bids for contracts and that they have a stated goal of 500 million Euros in revenue by 2015 (up from 316 million Euros in 2012) the incentive to bribe is high. Furthermore, these are French – not local – employees dealing with local (not French) decision makers in a country where bribery is more common than in France and where the French employee will not be living permanently. This is a good recipe for justifying your own bad behavior.

Of course, as I’ll explain in a moment, many of Catering International’s direct customers are multinational oil and mining companies. But in all cases, Catering International has to set up local subsidiaries in these countries. They may sometimes have to take on local investors in these subsidiaries. And there will always be issues like whether they can access their Algerian cash. So there will be constant temptations to bribe.

Finally, there is simply the public relations problem of a French company doing business in very different parts of the world from where it is headquartered. About 9 out of 10 Catering International employees are local men. In France, the company employees equal numbers of men and women. In the rest of the world, it’s about 9 to 1 men versus women. French employees are paid anywhere from about 4 to 11 times more than local employees. They receive plenty of benefits. They work less. And their employment is more secure. Local employees have a very different situation. To a large extent, this just reflects the relative power position of workers in each country. Workers in France have a lot of power. Workers in the countries where Catering International does its catering have very little power. And women are excluded from much of public life.

On an annual – which is not how local workers are employed – basis, wages are about 3,816 Euros a year in Africa, 5,256 Euros a year in Asia/Pacific, and about 10,284 Euros a year in South America. Catering International makes all its profit in Africa and Asia/Pacific. These are places where employees make less than 6,000 Euros a year.

So, you have the special headline risks of terrorism, bribery, and exploitation. Any coverage of these – or any topic about Catering International – are as likely to have a political angle as a financial angle. So, the experience of holding Catering International may feel a little different than other stocks you own.

With that out of the way, let’s get some basic information about the company. They have 11,600 employees (of which about 88% are local, low-paid men). The company operates at 170 sites in 41 countries. They serve about 120,200 meals a day. Their biggest single market (22% of sales) is Algeria. The subsidiary that now handles all Algerian operations is called Cieptal. It has a website (in French) that you can see here.

Catering International was founded in 1992. It went public in 1998. It has compounded revenue at 40% a year since its founding. Growth in recent years has continued in sales. However, the operating profit picture is fairly mixed (losses in South America have widened). In the latest annual report, the company mentions a sales target of 500 million Euros in 2015. With sales of 316 million in 2012, that would require sales growth of more than 15% a year. If profit growth was anything like that, you’d obviously be paying a very low multiple of 2015 EBIT. Enterprise value – excluding the Algerian cash – is 172 million. EBIT – including losses in South America – is about 21 million Euros. If operating profit grew 15% a year, you’d be paying 5.4 times 2015 EBIT. That’s a very good deal. The reality – because of the South American losses and Algerian cash – might be even better than that. Of course, we don’t know that operating profit will track sales or that sales will grow as expected. However, you can see that by any growth at a reasonable price measure – this is a very, very cheap stock.

Business is conducted in the local currency. Most customers are excellent credits. In fact, legal risk (like the Algerian cash) are probably as meaningful as the risk that a customer would fail to pay due to insolvency. Catering International paid 1.4 million Euros to settle a customer’s claim last year. I imagine this is a company where you will be seeing a lot of items like that from time to time. Last I checked, the company’s Algerian subsidiary was still being prevented from transferring a dividend (of 16 million Euros) out of the country. They filed a claim with the Algerian Supreme Court.

Catering International has a huge list of its subsidiaries. Many are inactive. In the annual report, there is a couple sentence business commentary for many of the active ones. If you’re interested in the company, you should read this list of subsidiaries in the annual report. It’s the highlight of that document.

Instead of reproducing it here, I’ll just focus on a few examples where we know both the name of a Catering International customer and the country where they serve that customer. For a full list of customers, see the back of the 2012 annual report. Almost all are multinational companies active in mining or oil & gas. There are a few exceptions (Nestle is on the list). The exceptions aren’t meaningful contributors to sales.

Examples of customers and countries where Catering International operates are Bechtel in Guinea Conakry, Kinross Gold in Mauritania, Total in Yemen, and Avocet Mining in Burkina Faso.

I think the Yemen business is small. It sounds like they just want to work with Total and show off what they can do outside of catering. Catering International has almost no business in the Middle East. Although they hope to one day do meaningful business in Iraq. Like I said, all profit really comes from mining and oil and gas sites in Asia/Pacific and Africa. None of the other stuff is meaningful.

The company has money losing businesses in both South America (meaningful at 3.8 million Euros in operating losses) and the former Soviet Union (not meaningful). South American operations seem to be ongoing in Brazil and Peru and pretty much just inactive subsidiaries elsewhere. The former Soviet Union includes subsidiaries in Kazakhstan, Turkmenistan, and Russia (the arctic).

The company refers to its employees in New Caledonia (part of France near Australia) in a way that makes it sound like they may be organized. It’s unclear to me whether this “dialogue” has to do with New Caledonia’s special status (and Catering International being a French company) or some past problem with these employees. Generally, my impression of the worldwide workforce is that they are local, low paid men who are not unionized.

So what’s the verdict?

It’s unlikely Catering International will make it into The Avid Hog. The stock is statistically attractive in both a “magic formula” and “growth at a reasonable price” way. It will probably perform well. And it would make an excellent addition to a diversified value portfolio.

However, there is not enough information on how a customer decides to go with Catering International. The company’s customers are very large multinationals who do not provide details on such information in their own reports. The business is far from the consumer. And I do not know a lot of people in this industry or these countries.

This is a research problem. I don’t have – and am unlikely to get – enough info about the actual purchase decision. I don’t see a way to gain enough confidence in the future behavior of customers when it comes to their catering needs. And I know nothing about Catering International’s competitors.

Basically, the annual report wasn’t informative enough about what I most need to know. So, unless someone emails me after reading this to tell me they know a lot about Catering International specifically or catering at these sites generally – I just don’t see a path forward for this company.

So, I’m suggesting Catering International as a stock blog readers should be interested in. But I’m also passing on it for The Avid Hog. This one is a “no”.