Long Picanol Group

All values are given in Euro.

What if you could buy a company at 3-4 times earnings, about 2,5 times EV/EBITDA, a strong balance sheet, very high return on adjusted equity and excellent management with big insider ownership?

Picanol Group offers this opportunity.

Background

Picanol Group is a Belgian company originally founded in 1928. Over the years it has become the World leader in what it calls the market for industrial “weaving solutions”.
In essence, they make weaving machines for both natural and synthetic fabrics.

In the past, this market was characterized by very low margins which Picanol Group also experienced.
Starting in the year 2008, the financial crisis wreaked havoc in this industry and removed about half the players in this industry. Picanol too was affected by this and nearly went bankrupt. It had to raise capital in a public placement which drew in new management which has a very high stake in this company (around 90%). So incentives are very much aligned.

This new management has been responsible for the dramatic increase in performance at Picanol. The company increased its market share in almost every market (in some markets they have a market shares of close to 90%) while cutting costs to the bare bone. In this 7-8 year period, they managed to more than halve both the G&A and the Marketing costs while also increasing its gross margin. Management here created both value and cut costs, a rare combination.

This has created a very efficient company with returns on equity and returns on fixed assets which many companies could only dream about. On top of that, management is very conservative and prefers to have zero debt on the balance sheet. The last 3 years, this return on equity looks less dramatic due to the big buildup of cash on the balance sheet until the year 2012 when they decided to invest the cash in a new project. After scouring the textile market, they decided to invest close to 200 Million in Tessenderlo Group because they found the prices in the textile market too high. Management is very price sensitive, which is good for shareholders.

Besides the mentioned acquisition, Picanol has a few more assets which can experience some growth in the future, but on their own aren’t large enough to move the needle.
They own a precision casting division which does casting work for both in-house production and caters to outsider clients. Picanol also own a small but growing (and profitable) 3D printing business. These offer some optionality in the event of returning economic growth to the region.

Tessenderlo Group

On paper, Tessenderlo Group has been a complete nightmare for shareholders over the last decade. The company had declining margins and revenues. The main reason was the French government who was their major shareholder (about 27%) and syphoned away all the excess cash in the form of dividends. That is why this company always had a relatively high valuation for its lackluster performance because it had a 7% dividend yield.

Picanol Group took over the stake from the French government and became its reference shareholder. Their first moves were halting the dividend, rationalizing the corporate structure (selling off divisions which were unpromising or too unprofitable) and naming the Picanol CEO Luc Tack as its CEO. At picanol, Luc Tack, the CEO and majority shareholder didn’t take a wage at all. At Tessendelo he finally took a wage, but nothing too eccentric.

The Tessenderlo acquisition was made because it is a business which is complementary in risk profile to Picanol (besides the relatively cheap valuation). The company is pretty resilient to market fluctuations because its largest divisions (Agro and Bio-valorization) cater to both the agriculture and the food processing industry. As an added bonus, where the weaving business is exposed to Asia, Tessenderlo is mostly exposed to Europe and America.

There is very much which can be said about these businesses, but I will keep it short. These are pretty commodity style industries where operational efficiency and location are responsible for most of the profitability. This management is excellent to guide a business with these characteristics because of their focus on operational efficiency and cost control.

Valuation

At first glance, this company doesn’t look too cheap. The PE of 6,5 looks very good compared to last year, but the forward PE of 9 looks cheap but not really outrageously cheap (I think forward PE wil be closer to 7-8).
The market has punished this company because their guidance for the weaving division’s 2014 net profit is like that of 2012, a 30% drop. This is completely understandable considering this is a cyclical industry, and the fabrics industry is not really that good this year. In the long run all elements are still there for this industry to stay healthy. The demand for clothes is one of those things which are very much correlated with GNP growth in developing and developed countries.

The company has a market cap of about 480 Million. Included in this market cap, there is 50 Million in excess cash and some working capital surplus. On top of that, there is the stake in Tessenderlo Group worth around 190 Million.
Subtracting these, you get a company of around 240 Million in market cap with zero financial debt (and very little other debt). Meaning, you buy Picanol Group for about 4 times 2012 earnings (or about 3 times 2013 earnings). The EV/EBITDA is also spectacular at between 2 and 2.5 (when you take the Tessenderlo share as cash equivalents).

Why is it now the time to buy this company?

Despite the fact that this company has been this cheap for a whole while, it is just now that their investment in Tessenderlo Group is starting to show results. When you compare Tessenderlo results over the half year reports, management has been able to cut SG&A costs by 40 Million compared to last half year. This has resulted in an increased (mentioned in a very subtle way in the last half year report) EBITDA guidance for the year. So more cost cuts are expected in the next income statement.

In essence, they are repeating the success they had at Picanol. The market reaction to the increased EBITDA guidance at Tessenderlo Group was somewhat muted, due to a subtle hint at an eventual capital raise to finance growth capex and to repay the bond which matured next year in October.

It is here where you as an owner of Picanol Group have an advantage to the owner of Tessenderlo shares. Picanol generated quite a lot of cash flow, which they can’t pour into the weaving business because it has already reached the point where they have the optimal size in this market segment. It is my assumption that the cash which will be generated over the next few months will be put to work at Tessenderlo by participating in the public placement and perhaps increasing this stake.

I hope this write-up wasn’t too short, but I think this is a no-brainer and needs very little extra explanation.

The biggest issue here is the small amount of free float due to the sunstantial insider ownership. That aside, it has never been the ambition to take the company private.
Over the last 5 years, there have been ample opurtunities do this. The CEO has also stated on numerour occasions that it has never been his intention to do this.