Description

Summary and Thesis:

At current levels we believe that Bell AG (SWX: BELL) represents a highly compelling risk / reward profile. In our view, BELL represents an opportunity to own a dominant, high quality, and under levered consumer staples business at 5x EBITDA and a mid-teens FCF yield (based on maintenance CapEx). BELL’s downside protection is a function of its severe undervaluation and asset rich and overcapitalized balance sheet. Businesses with the characteristics BELL possesses are rarely worth less than the extremely low multiples at which BELL currently trades (and all the more so when the 10 year Swiss bond has a negative yield). Applying more reasonable valuation multiples results in share prices 35%-100% above current levels.

BELL is the largest meat processor in Switzerland with dominant market shares across both fresh meat (≈45% of revenue) and value added meat products (≈35% of revenue). BELL also generates ≈20% of its revenue from value added non-meat products. BELL derives ≈75% of its revenue from Switzerland and the balance from subsidiaries operating in neighboring EU countries, most significantly Germany.

BELL’s controlling shareholder (owning ≈66% of the Company) is the Coop Group, the largest retailer in Switzerland. Coop is also BELL’s largest customer, representing ≈50% of BELL’s sales. The relationship with Coop provides BELL a stable, predictable, and highly cash generative channel. The benefits to BELL and its shareholders are manifest in the Company’s long-term performance: since 2000, BELL’s EBITDA has grown from ≈CHF 75mm to ≈CHF 205mm, or a ≈7% CAGR. Over the same period, BELL’s dividend has grown at a 16% CAGR

The Swiss meat industry is highly consolidated. BELL has 30%-40% market share across categories and the top 3 companies control ≈85% of the market. BELL’s most significant competitor has a ≈30% market share across categories and is a wholly owned subsidiary of the second largest retailer in Switzerland. By contrast, there is no US meat processor that has a 30% market share for their leading product, let alone for all meat products.[1]

Not surprising for a consumer staples business, BELL’s volumes have remained exceptionally stable through various economic environments. More noteworthy, however, is that BELL’s margins have also been very consistent despite significant volatility in major variables such as raw material costs and foreign exchange rates. BELL’s margins have not experienced anywhere near the same level of volatility as the major US meat producers/processers – rather, BELL has exhibited margin stability in line with high quality value added CPG companies.  Since 2001, BELL’s EBITDA margins have averaged 7.6%, with a minimum of 6.8%, a maximum of 8.5%, and a standard deviation of .5%. We believe that BELL’s margin consistency is a function of the Company’s dominant market position, strong operational execution, and its relationship with Coop. Said differently: in our view BELL’s historical margin profile testifies to the quality of its business.

Reasons for mispricing:

 We believe that one primary reason explains BELL’s mispricing, with a secondary factor likely having weighed on shares over the past 12 months:

1. Underfollowed, relatively limited float, limited liquidity: Despite a CHF 975mm market capitalization and a business that has ubiquitous presence throughout Switzerland, BELL is covered by only one sell side analyst. The Company does not hold conference calls and does not actively market itself to investors. Due to Coop’s ownership, BELL’s free float is relatively limited (≈CHF 330mm). Lastly, the Company has a nominally high share price which may reduce its appeal to certain investors.

2. Legal overhang: In July 2014, the German anti-trust authorities levied a €100mm fine against BELL for price fixing allegations relating to their German division. BELL has appealed the decision and has not reserved any amount against it, stating that they consider the fine unjustified and wholly disproportionate. The alleged illegal pricing agreements took place before BELL owned the entities and the amount of the fine is woefully high for a business which has generated losses since BELL acquired it, and likely also in the years prior. BELL shares declined 6% immediately following the announcement and – based on discussions we’ve had with analysts in Switzerland – have continued to be weighed down by the fine. Final resolution of the matter will take time, but we expect that the overhang will gradually recede before that.

 Valuation:

 BELL currently trades at ≈5x 2015E EBITDA. Notably, BELL’s economic net income is understated (and therefore its economic P/E is overstated) because BELL follows a non-GAAP and non-IFRS convention of amortizing goodwill. Excluding amortization of goodwill, BELL trades at ≈8x net income. Using normalized non-growth CapEx (which is lower than reported D&A because recently elevated CapEx has led to elevated D&A), BELL shares trade at a ≈13% unlevered FCF yield and a ≈15% levered FCF yield. At a 9% levered FCF yield, BELL shares would trade ≈75% higher than current levels.

On a relative basis, BELL is severely discounted versus European and US meat processors, and both groups have less value added exposure and much greater historical volatility of profit than BELL. BELL’s valuation versus companies with greater presence in branded meat products is even more dramatic. At conservative/reasonable peer multiples, BELL shares would trade 35%-100% higher than current levels.

BELL’s undervaluation is enhanced by the Company’s under levered balance sheet and the Company’s ability to borrow capital at extraordinarily low interest rates. Despite BELL’s asset rich balance sheet and highly consistent profitability, BELL is levered at ≈1x net debt / EBITDA and the average interest rate on its outstanding debt is 1.375% (7.5 year weighed average duration at issuance). Moreover, benchmark interest rates have fallen by ≈75 bps since BELL issued its outstanding debt (indeed, benchmark interest rates in Switzerland are negative out to 10 years). The delta between BELL’s unlevered FCF yield and the interest rate on its long term debt is perhaps the largest we have ever encountered for a stable and high quality business.

1H15 results / FX considerations / and non-Swiss operations:

BELL reported strong 1H15 results. EBITDA was +11% y/y and EBITDA margin were +71 bps y/y. The results were especially impressive because they were achieved in the backdrop of a generally tepid Swiss economy and a period during which the CHF strengthened dramatically. 

In January 2015, the Swiss National Bank shocked markets when it removed the effective peg that existed between the CHF and the EUR, resulting in an immediate and dramatic appreciation of the CHF. The SNB’s action had wide ranging implications for Swiss companies and the Swiss economy. The Swiss companies most impacted by the higher CHF are those with substantial portions of their cost bases in Switzerland but which derive substantial portions of their revenues outside of Switzerland. Those companies will be impacted on both a translational (FX) and transactional (cost/revenue mismatch) basis.

BELL’s Swiss operations have both costs and revenues in CHF and generate ≈75% of the Company’s consolidated revenue. From 2008-2012 BELL acquired a number of companies outside of Switzerland which currently generate ≈25% of BELL’s consolidated revenue. The non-Swiss operations have both costs and revenues in EUR. BELL discloses revenue by geography but does not disclose profit by geography. However, based on analysis of the Company’s financials and discussions with the Company, it strongly appears that prior to 1H15 the non-Swiss operations had been modestly loss making since they were acquired.

Accordingly, unlike the vast majority of Swiss companies, BELL’s profit was not expected to suffer direct impact on either a translational or transactional basis from the CHF strengthening. However, a derivative effect of the CHF strengthening appeared reasonably likely to negatively impact BELL: ‘shopping tourism’ (Swiss individuals crossing the border to purchase goods at cheaper prices in neighboring countries).

Switzerland’s meat industry is highly regulated with effective bans or substantial restrictions existing on the import of all meat products. As a result, even before the CHF strengthened, meat products could be purchased at significant discounts in neighboring countries. With much of the Swiss population living in close proximity to national borders, there was concern that ‘shopping tourism – something long practiced in Switzerland – would increase dramatically and negatively impact BELL’s results. .

BELL’s 1H15 results were notable insofar as they confirmed that BELL’s Swiss business was not materially impacted by shopping tourism despite the actual increase of such activity. BELL’s performance in 1H15 is in fact consistent with BELL’s strong performance during previous years of significant CHF appreciation (2008, 2010, and 2011), highlighting the resiliency of BELL’s business.

BELL’s 1H15 results were also noticeable because the Company called out the significant improvement achieved in its non-Swiss operations, in particular Bell Germany. Again, BELL does not disclose profit by geography so we do not know the magnitude of the improvement or the current overall profitability of the non-Swiss operations. But the Company’s commentary certainly implies meaningful improvement and we view further positive development of BELL’s non-Swiss operations as a potentially catalyst for shares.

Lastly, BELL’s outlook for the remainder of 2015 is positive, with the Company’s 1H15 earning release stating: “Overall we assume a continued upward trend in results for the second half of the year and a further improvement in profit compared to 2014.”

Catalysts:

We believe there are two developing catalysts for BELL shares:

1. Consolidation of significant subsidiary: as of May 2015, BELL began consolidating an important subsidiary which should increase reported revenue and EBITDA/EBIT by 15%-20% (Hilcona / Gastro Star). 1H15 results included only two months of earnings contribution but the period end balance sheet reflects the full consolidation. Previously, the subsidiary has been held on BELL’s balance sheet at its equity value and its earnings ran through the Company’s equity income line. From a purely economic perspective, the change in reporting makes no difference. From an optics perspective, however, the difference is notable as reported revenue/EBITDA/EBIT will increase substantially. Perhaps more significantly, the subsidiary has recently completed a major restructuring program. Accordingly, whereas the subsidiary was contributing anemic earnings to the equity income line, it should begin to report materially improved earnings to the operating income line.

2. Achieving profitability in non-Swiss operations: as referenced, BELL’s non-Swiss operations had been operating at modest loss levels. Over the past few years, BELL had been highly focused on restructuring those operations, with the aim of seeing the operations turn to profitability in 2015. 1H15 results appear to confirm that BELL has made substantial progress with its non-Swiss operations and that they are now profitable. If BELL’s non-Swiss operations achieve peer EBIT margins (amongst EU meat companies), they could add an incremental CHF25mm of EBIT to BELL, worth ≈20% of the current share price at 10x net income.

Additional potential catalysts include:

• BELL is likely to recommence its acquisition strategy outside of Switzerland; using its appreciated Francs and reasonable leverage, BELL could make significant acquisitions at attractive prices.

• For 2015, BELL paid a CHF 65 per share dividend (≈2.7% yield). BELL fairly recently hired a new CFO, and our understanding is that the Company’s payout ratio is under review. We believe BELL could (and should) support a higher payout ratio.

• Although we believe it is unlikely, Coop could decide to acquire the remaining portion of BELL that it does not own.

Even absent catalysts, our view is that over an intermediate time period BELL’s prodigious cash flows will force shares higher. Even if CapEx remain elevated, BELL will generate ≈35% of its market capitalization in cash over the next 3 years. Those cash flows will most likely be put towards earnings assets (acquisitions) or returned to shareholders, in either case likely resulting in an attractive outcome for shareholders.

Risks:

1. Market liberalization: as referenced, Switzerland’s meat industry is highly regulated. For many years there have been discussions about liberalizing the industry. BELL views liberalization as ultimately inevitable and supports it. The politically strong farming lobby, however, fervently opposes liberalization. Although assessing the impact of liberalization on BELL is difficult, we believe that it is certainly not a near or intermediate term risk to and that over the long-term it is unlikely to represent a material risk. To summarize key points: 1) the outcome which would be decidedly negative for BELL is a liberalization which removes the restrictions on the import of processed meat products but maintains the restrictions on the import of unprocessed meat products. Such an outcome would create significant headwinds for Swiss based meat processors. Based on our study of the situation and discussions with industry participants, we believe that half-way (and wholly wrongheaded) liberalization is extremely unlikely; 2) even to the extent liberalization occurs, it is not expected to commence for 7-10 years and will be phased in over many years thereafter following initial implementation; 3) part of BELL’s aim in acquiring non-Swiss operations was to prepare the Company for liberalization and ensure that if it occurs BELL has experience with operating (and ownership of) a production base outside of Switzerland; 4) lastly, it is possible that BELL’s business could benefit from liberalization insofar as the end result would be cheaper meat prices which could spur volume growth in Switzerland. Due to the very high prices of meat in Switzerland, meat consumption in the country is substantially below the levels in other parts of the developed world.

2. FX: further CHF strengthening could result in incremental ‘shopping tourism’ and weaker profit translation of the Company’s non-Swiss operations (insofar as they are profitable on a go forward basis). See previous discussion.   

3. General Swiss macro risk: the Swiss economy could certainly weaken further. However, BELL’s business has historically been highly resilient during previous periods of economic weakness.

Summary:

In our view, BELL represents an opportunity to own a dominant, high quality, and under levered consumer staples business at a mid-teens free cash flow yield. We believe an investor’s capital is very well protected as a result of BELL’s severe undervaluation and asset rich and overcapitalized balance sheet. Applying reasonable – but still conservative – valuation multiples yields share prices 35%-100% above current levels.

Catalyst

See above