Description

Loomis AB

Description
Loomis spun out from Securitas on December 9, 2008 through a 5-for-1 share offering. Pressure from Securitas holders' selling has weighed heavily on the stock out of the gates, creating a compelling opportunity for this turnaround story that should be relatively resilient in the downturn and benefits from foreign exchange movement reversals. With reasonable improvements in operations, I believe Loomis can earn SEK8/share in 2010, which should merit a 10x multiple given BCO, its closest competitor is trading at 13x 2009 estimates. This represents roughly 30% upside from current levels.

Industry
Loomis AB is a cash transportation and logistics company based in Sweden with operations in the United States and Europe. The majority of its revenue comes from its armored car cash transportation business, which represents 83% of US revenues and 59% of European revenues, with the balance coming mainly from cash management services (cash checking, counting, etc.). Technical services (ATM servicing) make up less than 3% of revenue. Loomis is a top player in the US market, with roughly 25% market share, second to Brinks' 30%, and is the #1 or 2 vendor in most of Europe, with roughly 30% market share. Its customers are largely in the banking (75% of US revenues; 50% of Europe) and retails sectors.

The cash transportation and management industry is dominated by four vendors (Brinks, Loomis, G4S, and Prosegur) who hold roughly 70% market share combined. The remaining share is held between small, independent providers who have been slowly losing share over time to the bigger players. Market share between the main operators has been stable over time, with little movement. As such, the market remains competitive, with price being a dominant factor. Since 2005, Garda, a small Canadian firm, and other smaller vendors have been aggressively undercutting larger operators on price. This trend has largely reversed, with prices resuming their normal inflation-rate increases in most regions, due to Garda's debt troubles and consolidation in the industry. Contracts generally range between 1-5 years and are priced largely on the number of stops for the cash transportation segment. Profitability in this segment is also mainly determined by the density of truck routes, ie: the number of stops along a route.

Recent problems
Loomis has experienced some margin pressure in due to problems in the US and UK. In November 2007, Loomis divested its ownership in Loomis Cash Management ("LCM"), a joint venture in the UK with HSBC and Barclays. Loomis was responsible for handling the banks' cash operations, including cash management. Due to certain variances between the banks' and Loomis' cash numbers, an investigation was set up in 2005, running through to the end of 2007. Reported numbers include the costs associated with the investigation, provisions to correct the variance in the banks' favor, and a charge accounting for the sale of the operation at a loss in 2007. Additionally, in May 2007, LCM noted it reported incorrect numbers to the Bank of England under an arrangement known as the Note Circulation Scheme ("NCS") as part of its operations in the UK. Loomis' reported numbers include a charge relating to the variance in these numbers in 2007.

Following the divestment of LCM, which was a loss-making venture, Loomis experienced a staffing shortage which contributed to significant decrease in EBITA for its European region in 1H08. The issue has since been resolved, with operating margins on par with 2007 levels, excluding LCM in 3Q08. In the US, operational inefficiencies have contributed to a drop in profits in 1H08, along with rising fuel costs. The company believes it is making progress toward improving this region, having already consolidated locations and rationalized personnel. Following these problems in 2007, Loomis installed a new CEO.

Investment opportunity
Loomis has already shown some evidence of a turnaround in place, posting a 7.3% EBITA margin in 3Q08 over 5.7% (ex. LCM) in 3Q07. This increase was driven by increased pricing to cover higher fuel costs which negatively impacted 1H08 and benefits from improvements in efficiency. While the second half of the calendar year is generally stronger in the industry, I believe Loomis can continue to improve its operations in 2009. Conversations with industry experts indicate that the competitive environment remains rational and cash volumes have actually increased following the recent market turmoil.  

I expect the cash transportation industry to remain strong, with bank failures likely having a minimal effect. For historical perspective, net branch closings represented less than 1% of total FDIC-insured branches in 1992, and branch locations grew in 1993. (Savings banks information not available prior to 1992.) Retail bankruptcies and store closings are more likely to have an impact, but this should be mitigated by the lower contribution from retail clients in the US and the relative difficulty of shutting down stores in Europe. Additionally, weakness at smaller operators could shift market share toward larger, more stable firms such as Loomis. Another tailwind for Loomis is the strengthening of the USD and Euro against the Swedish krona.

The impact around customer losses also appears to be minimal. Around 2007, Garda undercut Brinks on price, winning away Washington Mutual as a client - so far, there does not appear to be a noticeable hit to Brinks' sales or operating profit. Brinks' business is more diversified than Loomis, but this provides some evidence that the loss of what would seem to be a major customer has a relatively minor impact.

I believe with minimal operational improvements and some benefits from recent pricing increases, Loomis can earn roughly SEK7/share in 2009. The stock currently trades at SEK62.25, at a 2009 P/E of 8.2x, a significant discount to Brinks, its closest competitor, which is trading at a 2009 P/E of 13x. Loomis also generates strong free cash flow at roughly SEK108mn in the first nine months of 2008.

Management holds a long-term operating margin (EBITA) target of 10% and FCF to EBITA target of 85%. It believes it can achieve an EBITA margin of 8% exiting 2010. Assuming inflation-rate revenue growth and adding currency effects, I believe Loomis is capable of earnings over SEK8/share in 2010, implying 30% upside using a 10x multiple.  

Loomis' net debt stands at SEK2.4b, with its main covenant being a maximum net debt-to-EBITDA level of 2.75x, which I do not believe will be a problem, particularly given expectations for free cash flow and debt paydown.

Key risks
With most of its customers in the banking and retails sectors, Loomis is exposed to some of the more troubled end markets in the economy. Its profitability and revenue for its cash transportation business depend mainly on the number of stops trucks make along their routes, and its cost structure is largely fixed, with personnel comprising 60% of costs. A significant rise in branch closings presents the largest concern for Loomis, in my view, given these dynamics. High wage inflation in Europe also remains a problem.

In the event that Loomis experiences only modest improvements in profitability, only reaching 6.8% in 2010, I calculate earnings of SEK6.6/share, limiting the downside for the stock at an 8.5x multiple.

Catalyst

Earnings