Description

Parmalat

 

Overview:

 

Parmalat is an international dairy company with operations in Italy, Canada (which jointly make up 66% of sales), Africa (mainly South Africa), Australia, and Latin America (Venezuela, Colombia and Nicaragua). PLT’s main products are milk, fruit juices, and milk derivatives. It is ranked number 3 in global market share after Nestle and Dean Foods. Its main brands are Parmalat (milk products) and Santal (fruit juices). The company is also entering high value added milk products.

 

The stock has precipitously de-rated after a Q1 profit warning due to raw material price hikes. Higher milk prices are now leading to higher production in local markets, which is leading to price stabilization. This has created a very attractive valuation, whereby the company, which is very under-levered, trades at a meaningful discount to peers DESPITE the added upside of likely cash proceeds from legal suits against their former financial advisors.

Post a bankruptcy / re-organization brought on by excess M&A and fraudulent accounting, Parmalat is currently in litigation and pursuing:

 

1. Clawback claims: company is seeking to void payments made to the defendants by Parmalat group companies, claiming worongful / fraudulent advice. Out of 76 actions to void in bankruptcy filed with the Court of Parma, 34 have been settled so far. This amounts to circa €1.2bn of settlements (recovery rate of about 30%) There is currently €3.2bn of unsettled clawbacks outstanding which are expected to settle by early 2009.
2. Class act litigation, US: Parmalat has field lawsuits against Citigroup, Bofa, Grant Thorton and Deloitte & Touche with regards to alleged fraud, misleading representations and conspiracy to violate fiduciary duties. D&T has settled its claims (recovery of $149m out of $10bn). Grant Thorton, Bofa and Citigroup claims are at $10bn each. Citigroup has launched a counter claim of $699m.  More clarity will emerge on the Citigroup trial in July / August.
3. Italian damage claims: Damage claims against different parties such as Deutsche, Credit Suisse, Banca Intesa in connection with their involvement in alleged fraud. So far total  the compared has received €165m in settlements (implying a recovery rate of 0.8%). There are €16bn of claims outstanding.

Further, in May of 2008 Parmalat reached an agreement, subject to the approval of a court in the US, to settle the securities class action against it. Parmalat will issue 10.5m shares of stock in full satisfaction of any and all claim asserted against it in class action suits, worldwide

 

Parmalat is currently a strong buy candidate at current levels for the following reasons:

 

1. Valuation of the actual dairy business (see below): 5.8 times forward EBITDA with average peers trading above 8 times EV / EBITDA
2. Stabilizing milk prices, which in turn leads to margin recovery
3. Launch of several premium, high margin functional milk products in H2 2008 (impact not incorporated into analysts’ estimates) 
4. Substantial potential upside available from claw-back and damage claims outstanding. Recent claw-back settlements from UBS and Credit Suisse (announced June 13) amounted to recovery rates of around 50%. Note that we assume 10% recovery on claw-backs and 5% on litigation going forward.
5. Once the legal proceedings are completed, Parmalat is a clear take-out target given its steady cash-flow, net cash position, geographically diverse operations and strong market share. Potential buyers include financial and industrial entities.

Valuation:

 

Price:                      1.78 Euros ($2.75)

Market cap:           3,138 million euros ($4,865 million)

Net Cash:               1,269:      915 net cash

384 million euros in settlements from UBS and Credit Suisse

 

P/E 2008: 16.2                        EV/EBITDA 2008: 5.0                          EV/(EBITDA-Capex) 2008: 7.4

P/E 2009: 15.5                        EV/EBITDA 2009: 4.7                          EV/(EBITDA-Capex) 2009: 6.9                           

P/E 2010: 13.2                        EV/EBITDA 2010: 4.4                          EV/(EBITDA-Capex) 2010: 6.2                           

 

Our valuation is based on 2008E EBITDA estimates of €370 million (vs. management guidance of 390 million €). At 7.0x EBITDA multiple (a 15% discount to peer group average) the dairy business is worth €2.19, implying 23% upside from current levels. In addition, a 10% recovery of remaining claw-backs (previous recovery rates have been around 30%) would yield an additional €0.17 per share. A 5% recovery from US litigation claims and 1% from Italian damage claim (again implying lower recovery rates than historically observed) would also add additional €0.25. we therefore believe that PLT is worth €2.61 per share, implying total upside of 47%.  

Should management implement its focused purchasing plan (improving purchasing contracts with farmers) and pass through price increases, PLT should achieve management’s EBITDA targets of €390-400m resulting in a target price of €2.75 resulting in 53% upside.

 

Risks / concerns:

 

• Irrational acquisitions (currently dairy farmers auction in Australia – note that management in recent meetings has indicated it would not pay the purported14 times EBITDA multiples)
• Increasing raw material costs (being passed on to clients)
• Inability to increase prices (a genuine concern given increased private label market share in Italy, but that has already happened)

Catalyst

Ongoing Resolution of litigations
Accretive acquisitions / cash return back to investors / stock buy-back
Margin recovery through Pass-through of raw material costs to clients, more efficient sourcing of raw materials
Ultimately: take-out by industrial or financial entity