Description
Bacou-Dalloz is a French manufacturer of personal protective gear that is selling for 8 times what I think it can earn two years from now.
The company earned about 48 million euros adjusted for depreciation and before special items in 2004, or 6.30 euros per share. So the stock is trading for 11.4 times trailing earnings.
The company reported operating profits of 87 million euros in 2004. This was down from 90 million euros in 2003, 118 million euros in 2002, and a peak (pro forma) of 138 million euros in 2001. Much of the decline is attributable to the translation effects of a weak dollar on their North American operations, which represent close to half their revenue. The operating margin from continuing operations was 13.8% in 2004. Historically, the company’s operating margin from continuing operations has been 16-17%. Bacou’s new CEO, installed this past June, is confident that they can get the margin back up to 16%. Based on the changes being implemented since the new CEO’s arrival, I think that the company is on track to increase its revenue by 5% over two years, to 712 million euros, and that the company can get the operating margin back up to the historical 16% rate, which would yield operating profits of 114 million euros.
Like most foreign companies, Bacou depreciates its PP&E at an overly rapid rate in order to save on income taxes. They’ve been depreciating PP&E at a rate of 8-9 years. If we adjust the depreciation rate to 12 years, which is typical for a U.S. industrial company, this tacks on 10 million euros to pretax profit.
If we capitalize 124 million euros in estimated operating profit at 11 times earnings and subtract net debt of 321 million euros, we get to a valuation of €1,043 million, or 137 euros per share on 7.6 million shares outstanding. The stock closed at 72 euros on 3/11/05.
(The ticker symbol BDZAF.PK represents the ADR listed in the Pink Sheets. It trades maybe four times a year.)
This is a nice business that makes proprietary products and that has a strong position in its markets. Bacou-Dalloz makes goggles, oxygen masks, protective gloves, shoes, and jackets; face protection devices, headphones; and cables, straps, harnesses, and metal bracing to protect against falls on construction sites.
Half of sales are to industrial customers, mostly to protect workers on the factory floor. Fifteen per cent of sales are for homeland defense, 12% are to utilities, and 8% are to construction customers. I presume that “homeland defense” includes policemen and firefighters.
The bulk of revenue is split evenly between Europe and North America, with about 5% of sales going to the rest of the world, mostly Asia.
Bacou-Dalloz is the world’s largest personal protection equipment manufacturer. Other competitors, in descending order of PPE sales level, include 3M, Mine Safety Appliances, Drager Safety, Norcross Safety, Ansell, Aearo, and Tyco. Bacou-Dalloz is not No. 1 in most product lines, however. Bacou-Dalloz is No. 1 in Fall Protection and in Eye and Face Protection in North America. They are No. 3 in Gloves and Respiratory Equipment, and it shows in the results. Respiratory sales were down 9% in the fourth quarter of 2004, while Gloves revenue was down 13%.
The Bacou family, Dalloz family, and Essilor International own 13.8%, 13.3%, and 15.1%, respectively, of the shares outstanding, and 11.2%, 17.1%, and 24.6% of the votes. Essilor is a French eyeglass lens manufacturer.
There does not appear to be a formal division of the common stock into multiple classes, though obviously there is a mechanism to allocate supervoting privileges to the parties that collectively own 42% of the stock.
Bacou-Dalloz is a good business. Return on assets (adjusted operating profit divided by tangible operating assets) averaged 23% from 2001 to 2003, and this was despite the results of a moneylosing distribution subsidiary, divested in July 2004.
Interest coverage is adequate, with EBIT in excess of 4 times interest.
Sales peaked in 2001 at 928 million euros, pro forma combined for the merger between Bacou and Dalloz. Sales declined by 5% in 2002, 9% in 2003 and 11% in 2004. The decline is not as bad as it looks, however, because it was accentuated by divestitures and by the effects of a weak dollar on a company that does a lot of business in the U.S. The weak dollar drove down revenue by 9% in 2003 and by 4.4% in 2004. Acquisitions and divestitures increased revenue by 1.7% in 2003 and decreased revenue by 4% in 2004.
The weak dollar has a limited effect on U.S. shareholders. This is because the goods Bacou-Dalloz sells in North America are by and large produced in North America. Therefore, as the value of sales in euros depreciates because of the falling dollar, the costs translated to euros decrease also. The value to an American shareholder of profits from North America, earned and stated in dollars, is relatively unaffected. This is shown by Bacou’s margins, which would have been boosted by just 30 basis points if the dollar hadn’t moved in 2004, despite a 9% drop in the currency.
Bacou-Dalloz’s organic revenue, or revenue excluding the effects of currency and acquisitions and divestitures, was down 2% in 2002, 2% in 2003, and 3% in 2004. The rate of decline in organic revenue slowed to 1% in the fourth quarter of 2004, a favorable sign that suggests the new CEO is having some success in righting the ship.
There are a couple reasons why organic revenue has been dropping.
Management says this is a mature industry. I have to wonder whether this is the case, however, when I see the strong revenue for Norcross and Mine Safety Appliances. I think that loss of market share has been a major issue that management needs to attack.
A driver of growth in this industry is when governments raise safety standards on equipment.
Another cause for weakness in revenue is the ongoing migration of manufacturers, Bacou’s principal customers, from Europe and North America to Asia. The management recognizes this trend and is working earnestly to increase its sales to industrial customers in Asia. There has been tremendous growth for Bacou-Dalloz in that part of the world, off a small base. Bacou-Dalloz is also getting in on the act itself, by reducing employment in Europe and North America by 27% while raising employment in Asia by 43% from year-end 2001 to year-end 2004.
Another reason for soft revenue is that the company ran into integration problems after the September 2001 merger with Dalloz.
I also suspect that the former management didn’t have much panache when it came to introducing new products. I get that impression when I look at the results of Mine Safety Appliances, which does have a reputation for innovation, and which expanded its reported revenue by 16% a year between 2001 and 2004. Also, Norcross has had close to 20% annual growth in sales.
The new management says that they are finalizing their analysis of the company, after which they will put a strategic plan into action. So far, the new CEO, who was formerly the head of Kodak’s Asia-Pacific operations, says he wants to improve customer service levels, expand the customer base geographically, centralize purchasing in order to save on materials, optimize the product line, and step up the level of innovation so that new products constitute at least 20% of total sales. They launched 70 new products in 2004.
Also, management sees an advantage in how Bacou-Dalloz, with the broadest product line in the industry, can offer the customer one-stop shopping: body protection from head to toe. The alternative is going to the trouble of buying a helmet from, say, MSA, gloves from Drager, goggles from Ansell, and so forth. Bacou-Dalloz management is pressing this marketing angle.
Bacou-Dalloz has what I look for when I look to buy a dollar bill for fifty cents (or, more precisely, buying a dollar bill for fifty-three cents --- ou, autrement dit, un euro pour 53 centimes). (I would note that these are my personal views. I have no interest in imposing my views on fellow value investors.) The company is investment grade (I seldom am interested in a company with less than 4x interest coverage). It has not lost money in the past five years. It has at least a 10% operating margin (to state the obvious, a decline in margins of 2 percentage points cuts profits by 10% for a company with a 20% operating margin, but by a whopping 50% for a company with a 4% margin). Bacou-Dalloz does not make commodity-type products; it makes sophisticated products that have a fair amount of engineering put into them. The company has a return on assets of at least 10% (I don’t want to buy businesses on a going concern basis if they don’t make enough money to justify being in business in the first place). The company has more than 105 dollars coming in for every 100 dollars going out. (Bacou-Dalloz has 110-115 dollars coming in for every hundred dollars going out.) And, finally, it has a new management that is determined to turn the company into a powerhouse.
Catalyst
New management