Description

Gurktaler AG is a high-quality Austrian spirits company with interests in a collection of market leading herbal liqueur brands trading at less than 7x underlying LTM FCF, 8.5-10x normalised FCF, and a 50%+ SOTP discount. It does not screen well because its accounting policies and opaque shareholder structure obscure the true value of its businesses and assets. There is a competent, long-term family shareholder at the helm, and significant scope for value realisation with a buyback program, increased dividends, and a planned sale of one of its brands which may be completed before the end of 2019.  It is under-followed by both professional and private investors due to its small market cap, low liquidity, and lack of analyst coverage.

Background

Gurktaler AG is an Austrian spirits company listed on the Vienna Stock Exchange and is controlled by the Underberg family. It is predominately a herbal liqueur company and has interests in a number of leading spirits brands in the CEE region such as Underberg, Unicum, Asbach, Gurktaler, Leibwächter, and Rossbacher. It was originally spun out of Schlumberger AG in 2012 in order to separate the Underberg family’s herbal liqueurs interests from Schlumerger’s core sparkling wine business.  Gurktaler was then listed as a separately traded entity in February 2013, while Schlumberger was ultimately acquired by Frederik Paulsen. While Gurktaler’s current corporate form is relatively young, its underlying spirits brands date all the way back to the 18th century. Its spirits assets can be separated into 2 categories: minority investments and wholly owned brands.

Shareholder Structure

The opaque and circular nature of its shareholder structure masks the underlying economic value of each Gurktaler share. On paper the company has 2,250,000 shares outstanding, made up of 1,500,000 ordinary shares (Stammaktien) and 750,000 non-voting preference shares (Vorzugsaktien). 81.62% of the ordinary shares are held by Underberg family members and Underberg controlled entities (75.07% of the voting rights), while 880,086 ordinary and preference shares (8.67% of the voting rights) are publicly traded on the Vienna Stock Exchange. The underlying economic reality is slightly different. Though this not stated or spelled out in any of the company’s filings, 2 of these Underberg controlled entities are in fact circular holdings. Gurktaler is part of a “Breton pulleys” or “Matryoshka dolls” type corporate structure. 

Gurktaler owns 14.42% of Underberg GmbH & Co KG, which in turn owns 100% of Semper Idem Underberg GmbH, which in turn owns 2.07% of Gurktaler and 100% of H. Underberg-Albrecht GmbH & Co. Verwaltungs- und Vertriebs KG, which in turn owns 50.05% of Gurktaler. The economic reality behind this circular structure is that Gurktaler ultimately owns 7.52% of itself and therefore there are effectively169,139 hidden treasury shares.  Therefore, Gurktaler’s adjusted shares outstanding are 2,080,861, and not 2,250,000 as is used in the financial statements and various data sources. The publicly traded common and preference shares have only 8.67% of the voting rights, but in fact own 42.29% of the economic rights once adjusted.

(For reference, I have included a group structure chart as an appendix below.)

Minority Investments

Zwack Unicum

Gurktaler’s most valuable (and simple to value) holding is its 49.98% interest in Peter Zwack & Consorten Handels-Aktiengesellschaft. This is a joint venture holding company with the Zwack family which owns 50% + 1 share of Zwack Unicum Nyrt, which is the dominant spirits company in Hungary and is listed on the Budapest Stock Exchange. Diageo is a 26% shareholder and 24% is publicly owned. Gurktaler has an effective 25% equity interest in Zwack Unicum which is worth €25.48m or €12.25 per share at the current market price of HUF16,750. However, this value is somewhat hidden because of the consolidation rules in IFRS and the EU Accounting Directive (as transposed into Austrian law). As Gurktaler’s interest in Zwack is held through a non-controlling interest in a JV company, it is accounted for using the equity method and is only valued on the books at €13.18m. Gurktaler currently trades at a 25% discount to the market value of its Zwack interest alone. 

Zwack produces a herbal liqueur called Unicum, which is the national drink of Hungary and has a long and fascinating history dating back to 1790 during the Habsburg Empire. It has been produced by the Zwack family in one form or another over the past 229 years.  Zwack also produces a small number of other spirits brands and is the leading spirits distributor in Hungary. It is the sole distributor of Diageo products in Hungary. Its distillery and museum are also major tourist attractions in Budapest. The company has consistently produced 25%+ cash returns on capital over the past 15 years, while gross margins and EBIT margins have averaged 57% and 17% respectively. The coefficient of variation in its EBIT margins over this period has been a staggeringly low 12%, while cash conversion has averaged 115%. Zwack operates with pretty much no debt and has distributed nearly all its earnings in dividends in recent years.

However, Zwack’s business has been affected by recent adverse legal changes in the Hungarian spirits industry. Legislation enacted in 2010 provided for the small-scale home-distillery of spirits and palinkas in Hungary, a practice which had previously been heavily restricted.   While this law allows for production for personal use only, an effectively unpoliced black market for home-made palinka has dramatically increased supply. This has significantly damaged Zwack’s palinka business and its revenues are still 25% below 2009 levels. Zwack’s management did react well to this market change by scaling back, maintaining margins, and distributing capital back to shareholders, but this legal change has clearly damaged the business for the last decade. There are calls for legislative change and better policing from commercial distillers, but it appears that personal spirits production will continue indefinitely in Hungary.

While the company had an excellent 2018, it will face more short-term headwinds in the next 2 years with significantly higher alcohol products tax in Hungary which was mandated by EU tax law. Management are forecasting 40% lower profits in 2019 and there are significant political risks with the current Prime Minister Viktor Orbán. Even still, I think Zwack’s long term prospects remain good. The company still has an irreplaceable brand and a strong local moat. It will benefit from increasing GDP per capita in Hungary and the general "premiumisation" trend in the spirits industry, despite the country’s poor population demographics. Zwack’s export sales have grown at a CAGR of 2.4% over the past 15 years and represent only 10% of total revenue. While this is a clear area of potential growth for Zwack, it should be noted that the company has yet to achieve any real penetration in the key North American and Asian spirits markets.

Zwack’s current market price provides a 6-8% normalised FCF yield and a 12x normalised EV/EBIT. This seems reasonable considering the quality of its business, but also its more limited growth prospects than other market leading spirits companies, which trade at roughly double Zwack’s EV/EBIT on average.

Underberg GmbH & Co KG

Gurktaler’s 14.42% interest in Underberg GmbH & Co KG (“Underberg KG”) is its most difficult asset to value. As noted above, part of this interest is a circular holding in Gurktaler’s own shares.  As we are adjusting the shares outstanding to account for this, I will be backing out any Gurktaler exposure when valuing Underberg KG to avoid double counting.

While I have been unable thus far to obtain the accounts of Underberg KG, the German IP register confirms that the Underberg and Asbach brands are housed at the Underberg KG level. We are also able to access the financial statements of its 100% subsidiary OpCo, Semper Idem Underberg GmbH, from the German Federal Gazette. Semper Idem produces and distributes various Underberg-owned brands such as Underberg, Asbach, PITÚ, XUXU, Grasovka and Riemerschmid (80% of revenues), and distributes brands such as Amarula, BOLS and Túnel de Mallorca (20% of revenues). Underberg and Asbach in particular are market leading spirits brands with established local moats in Germany.   Underberg is the market leading herbal digestif brand in Germany (21% market share). The Underbergs have never changed their secret family recipe and the drink is only available in a distinctive 20cl bottle wrapped in a paper sleeve (hence the motto Semper Idem, “always the same”). Asbach is the no.2 brandy in a somewhat declining German brandy market, behind the market leader Chantré. While the German brandy market is shrinking, Asbach remains a strong premium brand with a 125-year history in the market. An Underberg presentation to bond investors from June 2014 valued the Underberg brand at €95.5 and the Asbach brand at €149.3m.

Semper Idem’s normalised EBITDA is in the €11-13m range (€10-12m if you exclude its earnings from Gurktaler). It has some leverage with a 0.6 debt to capital ratio and around €80m in low cost net debt. If you exclude its share of profits received from Gurktaler, Semper Idem has transferred back on average €5m to Underberg KG annually in recent years pursuant to an inter-group profit and transfer agreement, of which Gurktaler entitled to around €710k. Gurktaler AG has received a profit transfer from Underberg KG of €368k in 2019 and €570k in 2018, but such financial income has not been consistent or reliable. The Underberg KG holding is valued at €2.9m on Gurktaler’s balance sheet, which appears to be the strike price of a put option entered into between Gurktaler and Underberg AG, the Underberg family's private holding company. This implies only a €20m valuation for the Underberg KG and would be overly favourable to the Underberg family if exercised given the quality of the Underberg and Asbach brands, the large valuations ascribed to those brands in Semper Idem’s presentations, and the level of profits beings transferred to back to it by Semper Idem.  It is not possible to satisfactorily evaluate Gurktaler’s 14.42% interest in Underberg KG without knowing its capital structure, but a range of €2.9-€10m, or €1.39-€4.80 per share, seems reasonable based the put option strike price and a 10-14x multiple of profits transferred from Semper Idem.

Wholly Owned Brands

Gurktaler leases its intellectual property rights in 3 wholly owned Austrian herbal spirits brands, Gurktaler Alpenkräuter, Rossbacher, and Leibwächter, to its former parent company Schlumberger AG. Schlumberger produces, bottles, and sells these herbal bitter brands through its Top Spirit distribution subsidiary and in return pays Gurktaler a commission royalty calculated in accordance with revenue and profit margins. The clear advantage of the lease model is that Gurktaler offloads all operational risks to Schlumberger and has virtually zero associated capital commitments or expenses. There is a mere €20k in expenses directly associated with maintaining the IP rights. These brands have consistently produced over €800k in royalty/commission income since 2013, peaking at €948k in 2018/2019

The Gurktaler board have valued the IP assets at €11,532m, implying 12x pre-tax multiple. This is at the lower end their historic valuations which have been as high as 15x pre-tax royalty income. Of note, Rossbacher has been gradually impaired by 50% over the past 5 years, while the overall royalty income from the 3 brands has remained steady. It is possible to envisage a higher multiple for these brands because of their steady and consistent cash flows, and their minimal maintenance capex requirements. The brands could also command a higher price to an operating spirits company who would benefit from synergies. Gurktaler announced its intention to sell Leibwächter in January 2019, which is by far the most valuable of the three brands. Gurktaler has noted that it is currently in negotiations with a purchaser and that a sale could be completed by the end of the 2019. This is a clear opportunity for value realisation and will provide clarity on what kind of price these brands can command. A value of €10-15m, or €4.80-€7.21 per share, seems conservative and reasonable for the 3 wholly owned brands. 

Conclusion

Gathering together all of the parts, adjusting for net cash including a €2.03m dividend received from Zwack on 24 July 2019, and capitalising corporate expenses at €4m (~€500k per annum at a 12.5% cap rate), we get a SOTP valuation of €17.25-€23.07 per share. Gurktaler is trading at a very large 45-60% discount to NAV for what is a high-quality company with interests in market leading spirits brands.   Even if the discount does not narrow in the medium term, we are conservatively sitting on a 10-12% normalised FCF yield (15% LTM FCF). There is also a possibility for the underlying brands to grow their exports to North America and Asia, which are untapped markets for all of Gurktaler's brands.

There are also a number of potential catalysts for value realisation. Gurktaler has used the majority of its free cash flows to pay down all of its debt over the past 5 years. It is now in a great position to return substantial amounts of capital to shareholders. It is doubling its dividend payment in 2019. The Board approved a share buyback program in September 2018 to repurchase 10% of the share capital (although this has been unsuccessful thus far). The company intends to sell the Leibwächter brand before the end of 2019. Furthermore, there is reason to believe that the controlling shareholders will not sit on their hands, as the Underberg family have a history of value realisation through corporate actions, e.g. the Gurktaler spin off and Schlumberger sale in 2014.

The stock is unfollowed by most investors. It is a minuscule component (less than 1 basis point) of the Wiener Börse Index.  There is no analyst coverage and I could only find one German equity fund (IP White-Pro T) who own the stock. This fund only owns 40 legacy shares which were distributed to it during the Gurktaler Schlumberger spin off. This is clearly due to its small float and very low liquidity.  Furthermore, Gurktaler’s accounting policies and shareholder structure mean that it does not screen well for quants. However, there is abundant value on offer for smaller investors in this obscure, unique company.

Note: Since the time of writing, 26 preference shares were traded for €9.50.

Appendix

Catalyst

Sale of Leibwächter brand.

Buyback program & increased dividends.

Corporate action by controlling shareholder.