Description

Edenred is a French company that spun-off of Accor in 2010 and operates a global payment network that allows 530,000 employers in 38 countries to bestow 34.5mm employees with pre-tax lunch money and a wide variety of other perquisites (commute, childcare, event tickets etc.). The company has limited capex (5% sales), negative net working capital (i.e. EUR 2.25bn float) and the ability to deploy incremental capital at respectable rates of return. 2/3 of customers have fewer than 200 employees, which helps Edenred maintain pricing and margins. The company also offers expense management solutions for Fleet expenses, travel spending and work uniform laundry. They offer paper vouchers, debit card and smart phone payment options and have a joint agreement with Mastercard. Founded in 1962, Edenred is headquartered in Paris and employs 6,000 persons globally. The company's longest running product, Ticket Restaurant, was based on the idea that employees who eat lunch perform better in the afternoon and local governments benefit because otherwise unreported cash payments in restaurants are instead accounted for and taxed.

Edenred was spun-off of Accor in 2010 at EUR 14.80 and from 2013 until recently has been priced to perfection in the range of EUR 20-26. In the last two weeks of September, the stock tanked and fell just below its spin-off price. Why? Three reasons (1) earnings were shocked by a devaluation in the Brazilian Real (2) an 8/26/15 Morgan Stanley sell side initiation report that showed that the company was more levered than it looked (5.6x Net Debt/EBITDA) because it has spent part of its float over the years on small M&A that has not really contributed EBIT and (3) the CEO and CFO departed inside the same year (and have since been replaced). It would have taken a combination of these three things spooky sounding reasons to knock down a business possessing unusually favorable characteristics, and even when it was 'taken out to the woodshed' by investors it seemed to find a bottom at a 6% free cash flow yield.

These videos are designed to help one develop an intuition for their mix of products: https://www.youtube.com/channel/UCkFYDT2ZIeGxAK_iqeAORRQ/featured.

EDEN FP generates EUR 200-250mm of free cash flow that seemed permanently expensive as the franchise value grinded a bit higher each year. In both 2013 and 2014 the company paid EUR 193mm in dividends and bought back EUR 42mm of stock, a total of EUR 235mm in each year. Edenred expects to pay EUR 193mm in dividends again this year, and has so far bought back EUR 25mm stock.  So, as shareholders we very much enjoy the benefits of the free cash flow. As mentioned above, the company actually invests part of its float to fund small corporate acquisitions (unlike an insurance company that would use its float to buy stocks or real property). The unused portion of the EUR 2.25bn float is invested in interest bearing government securities, and 18% denominated in Real.

Edenred reports in Euro but thanks to a large and growing presence in Latin America, generates 1/3 of its payment volume in Brazilian Real. The Euro/Real exchange rate has fallen by roughly 1/3 year to date (including a 1/5 drop in 3Q15). At the start of the year the exchange rate was 3.2 Real to one Euro but at the low of September it took 4.67 Real to buy one Euro. The Real has rebounded somewhat to 3.99, but the market was spooked.

What's the damage from the devaluation of the Real?  Last year Edenred did roughly EUR 1bn of sales on EUR 17.7bn of payment volume. Put differently, they kept 5.84c of every Euro issued to an employee through the Edenred system. Brazil accounts for 1/3 of payment volume so 1/3 x EUR 17.7bn = EUR 5.9bn of issuance volume in Brazil. In the Latin America segment (that includes Brazil), the company retains a somewhat lesser amount of its issuance volume as sales (5.3c) but reports an EBIT margin from the segment of about 43% versus the company average of 30%. So, EUR 5.9bn of volume x 5.3c = EUR 312m of sales from Brazil. If we then apply the 43% Latin American segment EBIT margin, we get an EBIT contribution of EUR 134mm (about 1/3 of total company EBIT). If we held payment volume constant and lowered the amount of the EBIT contribution by 1/3 to reflect a full year of currency devaluation EUR 134mm x 1/3 = EUR 45mm. Therefore, if the currency had devalued by 1/3 on Jan 1 and stayed down it would have lowered EBIT by EUR 45mm for the full year.  On '15E EBIT of EUR 360 that's about a 12.5% hit, and on free cash of around EUR 250 that's about an 18% hit. So, the currency devaluation partially explains why the stock moved down about 1/3 from July (before the big move in the EUR Real exchange rate) to present. We could fine tune this analysis a bit more, but we'll wind up with the same conclusion on slightly different magnitude.

In September, when the stock dropped, the market was pricing in the potential effect on 2016 earnings not 2015 earnings.  We would not see the full year effect of the devaluation on 2015 results because the Real declined only modestly in the first half of the year. If the company does EUR 250mm of free cash flow and if we reduce that to $205mm that would make the 2016 multiple 19.5x instead of 16.0x. That said, organic growth of issuance volume in Brazil in 2Q15A was 11.1%, and has run in the low teens in the trailing four quarters. It remains to be seen whether a decline in payment volume in Brazil from the devaluation and ensuing rise in unemployment will outweigh the combination of secular growth in-country and a new deal with Daimler. In July of this year, Edenred signed a deal in Brazil with Daimler to issue and administer payment cards to 450,000 Mercedes-Benz heavy vehicle customers. The payment card can be used for both fuel and maintenance, and will work at Mercedes-Benz maintenance workshops and at Edenred's network of 11,000 service stations. This should boost earnings from Brazil and help offset the effects of the currency devaluation, though at this point I'm unable to quantify the benefit. The main idea is that we've had the currency shock in Brazil already, and that there is a material new contract that may dampen the approximate EUR 45mm shock to 2016E EBIT (calculated above).

Conclusion:

The recent executive changes and realization of the hidden leverage, along with an earnings shock, have cheapened the shares. But unless the company starts to contract, and there are no signs of that, net working capital will remain negative and the company will have plenty of time to delver should it opt to do so. Overall, I like Edenred because of its low capital intensity, negative net working capital and recent price dislocation related to the Real devaluation. The company has limited competition and offers a set of simple services that benefit both employers and employees alike.

Catalyst

2/11/16 Full-Year Results

4/14/16 1Q16 Results

5/4/16 Annual Shareholders' Meeting