Description

We believe Elis SA (ELIS FP) provides the opportunity to buy the European version of Cintas (CTAS), with many of its same competitive advantages and consistent growth history (albeit with lower absolute growth… this is Europe after all… and a higher flat linen business mix), at a significantly discounted valuation.  But, unlike other Covid-recovery investment plays, Elis isn’t a discounted valuation on some theoretical future recovery year… it’s a discounted valuation on actual 2020 FCF.  Management has done a stellar job managing costs through the crisis, and has guided to keep EBITDA % margins and FCF flat year-over-year in 2020, allowing one to invest in Elis at a HSD% FCF yield on 2020.  This is for a company that has consistently grown top-line ~2.5% to 3% organically with very steady EBITDA margins (i.e., suggesting low-double-digit % value accretion from growth plus yield, even assuming no valuation multiple expansion), and local scale and first mover advantages. 

We believe Elis has the potential to generate 30%+ returns over ~3 years, assuming 6.5x EV/EBITDA (slightly discounted to historical trading).  Part of the reason potential returns are so high is that the company is levered (3.1x on FY ’19 and we believe ~3.5x on FY ’20), but the primary reason is that it’s so discounted relative to its history, growth potential and strength of business.

Business Overview

Elis SA (ELIS FP) procures and launders (1) flat linens and (2) workwear for the industry (29% of sales), hospitality (27%), healthcare (26%) and trade & services (18%) end‐markets. Additionally, Elis supplies and maintains hygiene and well‐being products to these customers.  Service segments include:

(+) Flat linens (47% of sales) are laundered for hospitality (i.e., hotel and restaurant) and healthcare (i.e., hospitals and nursing homes) customers, and include bed sheets, pillowcases, towels, duvets, tablecloths, napkins, dish towels, aprons, etc. 

(+) Workwear (34% of sales) is supplied across all the company’s target end‐markets, and includes company uniforms, firefighter suits, cleanroom suits, etc. Workwear garments are typically made exclusively for a single employee, and thus are embedded with microchips to ensure that the cleaned uniform is distributed to the right person.

(+) Hygiene and well‐being (19% of sales) products include washroom appliances and consumables (e.g., toilet paper, soap dispensers, hand towels, electric hand dryers, air fresheners, etc.), water fountains, espresso machines, dust mats, pest control, etc. These products are largely cross‐sold to the company’s existing flat linen/workwear customers. 

Elis is the #1 or #2 player in most of its markets.  There are no large, pan‐European players that compete with Elis. Closest European competitor is CWS‐boco, who is big in Germany, Netherlands and Sweden.  Locally, Johnson Service Group (ticker: JSG LN) competes in the UK. Cintas (ticker: CTAS) and Aramark (ticker: ARMK) operate workwear in the US (Elis does not compete in the US).

Textiles are largely purchased directly (i.e., without use of subcontractors) in Asia and Africa. Asian textiles are cheaper but take longer to procure. Raw material inputs are largely cotton and polyester.

Flat linens and Workwear are processed in industrial laundry plants.  Flat linens cannot be processed in a Workwear plant, and vice‐versa... each is laundered with a dedicated machine.  Elis uses both (1) “multi‐service” plants, which are smaller and closer to the customer, house both Flat Linen and Workwear machines, but are less efficient and (2) product‐ dedicated “specialized” plants that are larger and more efficient, yet further away. Workwear is customized (i.e., labeled with the employee name and employer’s logo, and inserted w/ a chip) at a plant in Portugal.

Products are distributed together to smaller customers by Field Agents with 3.5 ton vans, and to larger customers with dedicated 12+ ton trucks.

Elis’s serves a largely fragmented base of 400,000 customers.  Customer contracts (both small and large customers) are 3 to 5 years, and typically have 94% renewal rates.  Flat linen customers are charged a flat fee per piece laundered (e.g., a bed sheet costs €1.20), which can be laundered 2x to 3x per week.  Workwear customers are charged a fixed monthly fee, regardless of usage. This ranges from €20 to €1,000’s per month, depending on the customer’s targeted volume. 

The company was founded in 1883 by the Leducq family and was reorganized in 1968 and renamed Elis for “Europe Linge Service.” The company expanded via M&A from 1973 onwards, with its most recent acquisition Berendsen (2017) effectively doubling its size.

Thesis

Competitively advantaged, recession-resistant compounder 

Elis has demonstrated steady historical organic growth of ~2.5% to 3%, with a consistent margin profile, even through the Eurozone’s 2012 recession (sovereign debt crisis).

The company’s competitive advantages are more pronounced in Workwear and include: (1) scale and (2) first mover advantage. Company has leading local market shares which is critical to driving margins, and is the only pan‐European provider of its services.

More specifically, scale competitive advantages include: (1) Supply chain advantages – industry experts suggest Elis buys workwear linens at a 20% to 30% discount to smaller peers. These discounts apply to workwear that is more specialized (e.g., does not include hospital gowns, which are commoditized and thus difficult to procure at a discount). Linen purchases are ~13% of sales, (2) Manufacturing efficiencies – experts tell us that larger workwear plants can process 75 to 80 garments per plant employee per hour versus only 40 for smaller plants. Elis employs larger plants in ~80% of its workwear business, given the company’s greater local market share and thus ability to service large volumes. One offset to this efficiency is that larger plants are located further from the customer, so distribution costs are somewhat higher, and (3) European‐wide reach ‐ preferred provider of large customers that want to only deal with a single national or European provider.

Elis’s first mover advantage rests in the fact that workwear is a relatively sticky product b/c (1) customer switching costs are high (employees become attached to their clothing, and if you use a different supplier, the uniform will look somewhat different) and (2) workwear is a small expense to most customers, yet provides a real value.

Flat linen operations have high barriers to entry b/c (1) they require very high plant utilization to be profitable, keeping smaller players w/ low volumes from starting new plants and (2) they are complex to run and highly labor intensive, which creates difficulty for any new potential entrants.

Disrupted valuation with high leverage drives high FCF yield (Public Market LBO) 

Elis currently trades (on normalized FY ’19 figures) at 5.1x EV/EBITDA and an 8% FCF yield.  Historically, Elis consistently traded at 7x to 8x EV/EBITDA (NTM).  Compare this to Cintas, which historically traded at 14x to 18x EV/EBITDA (NTM), but now trades at 24x EV/EBITDA (’19).

Valuation is compressed largely due to Coronavirus, which as of July ‘20 has driven YoY revenue declines of ~‐18%.  We believe that eventually Elis will recover from the impact of Coronavirus, but even more importantly, we believe Elis is so cheap that its valuation on FY ‘20 Coronavirus‐impacted financials is actually at the low end of its historical valuation on normalized financials. Therefore, you are basically buying Elis at a low point in valuation on a low base of earnings. In other words, you don’t even need a post‐Coronavirus recovery in order to be convinced that you are buying Elis at a reasonable valuation. 

The European public market’s general distaste for leverage and Elis’s exposure to the hospitality segment (27% of revenues) are likely contributing to Elis’s valuation discount, but these issues are simply tied to the Coronavirus and its impact on near term earnings. We believe this issue will dissipate as the company recovers from Coronavirus.

Additionally, we believe Elis’s high current FCF yield is due to: (1) high underlying leverage, especially if linens are counted as opex, and not capex (credit markets view leverage as lower due to this accounting treatment, resulting in lower cost of debt and higher credit rating), (2) a low cost of debt (i.e., 1% to 2%) with a long duration (no maturities until 2023), and (3) the company’s ability to maintain 3x Net Debt/EBITDA, ensuring FCF is not used to pay back low‐cost debt.

We believe the company’s consistent growth and margins enable it handle this debt load. Historically, private equity has sought this business given its high potential for leverage (PE owners have included BC Partners, PAI Partners, and Eurazeo).

Industry consolidator 

The relatively recent Berendsen acquisition (2017) created a pan‐European platform for consolidation.  Smaller acquisitions are typically very accretive at 4x PF EV/EBITDA valuations. Local market share drives higher margins.

Margin expansion upside potential (not captured in base case) 

The company believes that the UK and other regions that are currently < 30% EBITDA margins can be brought to at least 30% EBITDA margins.

Catalyst

Post Covid recovery