Description

Selling for 10x earnings ex-cash I think the French manufacturer of industrial weighing machines Precia is undervalued.

Precia’s business model is quite simple. It manufactures, sells and maintains weighing machines ranging from scales to measure the load of dynamic fluids in an assembly line to machines that measure a static mass of concrete. This unsexy business model is interesting because is not cyclical at all and benefits from competitive advantages.

Un-Cyclicality

Imagine you own a factory that produces cement. The need for scales to weigh the cement is essentially unrelated to the amount of cement you produce and sell in a specific year. Additionally Precia minimizes the credit risk from receivables by working with large multinational companies. Most of them have proven to be resilient to bankruptcy even during extreme downturns of the business cycle. Moreover Precia benefits from a diversified client base so that no single client comprises a significant portion of sales.

Well, I can imagine what you might be thinking. How can he say the business is not cyclical? Precia sells machines. New factories usually open during good times. What does Precia sell during bad times? The short answer is that during economic recessions Precia sells little. Very few companies open new factories or expand capabilities on economic downturns. Even fewer companies are founded.

The long answer is that despite not selling a significant number of new machines on bad times, Precia benefits from sustained profitability which comes from its after-sale maintenance contracts. Precia Service, the high-margin division responsible for the installation of new equipment, after sales service, maintenance and calibration comprises  ~40% of total sales and 60% of profits. Imagine you sell cement, packaged potatoes or bottled milk. You cannot afford measurement mistakes. The weigh simply must work properly, and the guarantee for that is regular maintenance and calibration. And that is just to weigh simple products. Think about how necessary periodic calibration is for other high-precision niches as pharmacy and lab companies which Precia also serves. Unsurprisingly, Precia’s customer base is mostly captive as a result of this sale & maintenance business model.

Competitive advantages

Precia strong competitive position comes from the following sources:

• ·         The maintenance contracts already explained which translate into sticky customers and recurring inflows at least for the service life of the contract.

• ·         The required specialization in the industry, distributed into niche markets with specific technology and different competitors focused on different weighing solutions –i.e.  scales for forklifts, scales integrated in warehouse trucks or hand pallet trucks, weighbridges, rail scales, post, mail and shipping scales, load cells, weigh bars. This point is central as it protects Precia from larger competitors. Metter Toledo is as far as I know the largest player in the weighing industry worldwide. Metter Toledo market cap is 9 billion $ whereas Precia’s is less than 100 million. Metter Toledo’s sales are 26x Precia’s. Metter spends more in R&D every year than Precia’s annual sales. However, Precia can protect itself and grow in specific niches. The technology of a potato weighing machine has not so much to do with that of a lab weighing scale for pills or an integrated weighing circuit for fluids. This industry customization has two effects. First, it makes Metter’s R&D not fully scalable to every market niche without incurring in additional expenses. Second, there are quite a few end-niches where the resources that Metter should employ to capture that niche are not justified in terms of the impact of such small addressable markets for such an already large company. It is simply not worth the time, not worth the pain. For a micro player like Precia, dominating those niches the effort is worth a lot on the contrary

• ·         Small cost of the weighting systems as a percentage of total investment in equipment and capex. In other words a small cost yields enormous incremental benefits, which means lower price sensitivity from clients and then enhances Precia’s pricing power.

• ·         Customer captivity once the weighting product of Precia is integrated in the customer’s equipment and production process. Just think about how costly is to stop the production process to implement new machines and once installed, the time it takes to teach and train the employees until they get used to the new system. This is especially true for highly specialized niches.

Unsurprisingly, these barriers to entry translate into Precia’s consistent ROCE of 25% on average for the last five years and 20% for the last 15. Indeed, I think ROCE is still understated as a result of some expenses derived from Precia’s growth that will not be recurring in the future. For example, Precia has accelerated selling expenses by 6% annually for the last five years as the company makes commercial efforts to enter new niche end-markets and new geographic areas. Also there are significant efforts in R&D for growth. Therefore I think the current EBITDA margins, south 11%, are temporarily depressed. As an indication, Precia has historically achieved margins so far circ.12%. More interestingly, Metter’s normalized EBITDA margins are above 20%. The more Precia grows and entrenches its dominance in the niches where it currently operates, the more recurring cash available and the more likely to exploit new opportunities in more specialized and more profitable niches. That is exactly the way Metter expanded its margins over time, so this is more about good capital allocation and niche dominance than about size.

How can Precia grow?

As I have already stated, I think Precia’s captive customer base lets the company increase prices on rolling maintenance contracts and machine renewals. In addition, with just one third of total sales out of France, Precia has enormous room to grow internationally. The niche fragmentation makes it also possible for Precia to position in new end markets and products. The most common way to exploit this opportunities has been M&A insofar. Following this pattern, Precia has made three acquisitions on last year. Antignac Pesage with more than 40 years history was a major player in the south-west of France region, Shering Weighting Ltd. with more than 65 years history with a large existing client base in the UK and abroad was a renowned weighbridge manufacturer and Le Barbier Pesage and Affiliates with more than 50 years history was one of the biggest weighting sales and service companies in the north-west of France and Paris regions.

The common factor of acquisitions is threefold. First, Precia focus on acquiring leaders in specific geographic areas and niches to complement its existing portfolio. Second, Precia pays cash for these acquisitions. I think that from the perspective of a shareholder-friendly company paying cash rather than exchanging own stock shows confidence that the prospective synergies will materialize and that Precia is willing to bear all the risk to benefit from the entire potential reward. Additionally and absent share buybacks as cash is now needed to fund further growth, paying M&A in cash rather than own stock is sort of an indication that Precia’s management does not really believe that Precia’s stock is overvalued.

Third and last, Precia generally pays low multiples in acquisitions, generally single digit P/E or very low P/S in case of loss-making businesses. Why is Precia able to pay so little for high quality businesses leader in their respective niches? Additionally, why supposedly high quality mature businesses are still loss-making? The answer to both questions relates to the legacy nature of these businesses. Most of these small businesses were founded decades ago and were generally run successfully by their founders, but as soon as more recent generations inherited them the new owners-managers were not experienced or not interested enough to still manage them properly. What was the usual response of sons and grandsons to their ownership of struggling micro businesses whose operations were vastly unknown to them? If they could not fix them, they just got rid of them. This urgency and inexperience from the side of the seller is what generates the opportunity for Precia. Precia’s size and expertise matter a lot in this arena. It can integrate unprofitable units under its corporate umbrella eliminating cost redundancies. It has also an edge in the assessment of the maximum fair price to pay for these acquisitions.

The corollary of all these facts concerning their inorganic growth strategy is that Precia seldom generates large goodwill accounts or has to write-off acquired assets. Precia does not dilute shareholders through stock issuances either.  Precia’s management is an excellent capital allocator and value generator.

Alignment of interest between Management and Shareholders

Alignment of interests is provided by the founding family, Escharavil, who holds approximately 50% of the shares and more than 60% of the voting rights. The family members watch over the business and impose a successful capital allocation discipline from the Board where the Chairwoman Anne-Marie Perin-Escharavil, the Vice-Chairman and two members of the Supervisory Board are members of the family.

Strong balance Sheet

After deducting debt and pension liabilities Precia has 22€ per share in net cash, 20% of the current market cap. We have here the perfect combination: lots of cash, a management aligned with shareholders with terrific capital allocation skills and lots of opportunities to grow organically and especially inorganically by acquiring high-quality businesses from either uninformed or forced sellers.

Why does the opportunity exists?

In other words, why I think Mr Market is not giving to Precia the value it really deserves?

• ·         Precia’s market cap is below 100m€. Many institutional investors’ mandates have constraints to invest in such a small company.

• ·         Daily volume is really small, around 5K€, and many times the bid –ask spread moves around 3%. Most institutional investors cannot invest by mandate in such an illiquid stock.

• ·         Sell-side coverage. Think about it. There are quite a few analysts covering the industrial sector. Yet there are hundreds of industrial sub-segments, end markets and applications. Now think about how many sell-side analysts can seriously follow the weighing sector. Moreover, think of yourself getting a call from a broker telling you that he strongly recommends you to buy a micro business in France that sells industrial weighs. Is it as sexy as hearing Amazon or Apple on the phone? Does it generate so many fees for the broker?

Valuation

Since 2000, sales have compounded at 3% annually, and net income and EPS at 14%. Unsurprisingly, this numbers have boosted the share price 10 times over the period.

Precia is currently trading below 13x NTM P/E or 10x P/E adjusted for net cash. First then we have 22€ net cash per share. Additionally and estimating 8.6€ 2015 EPS, I think that a multiple of 15x we would have 129€ per share. The reasons to think that 15x is reasonable are twofold:

i)                    15x multiple assumes EPS growth in the 4-5% level, which is conservative given historical growth numbers, the significant new investment opportunities in terms of new products and geographies and the possibility to exploit operating leverage via spreading fixed costs amongst larger sales.

ii)                    Comps are selling for much higher multiples. Metter Toledo trade at multiples above 20x NTM PE. I think that the gap between Precia and Metter is too wide and is not really reflecting the actual fundamental differences between both companies. I think that Precia is selling so low for its illiquidity and because the market is overestimating the importance of size in this industry, misunderstanding how numerous and atomic some end markets are and how difficult is to replicate R&D amongst them.

Therefore the intrinsic value would be around 151€ per share conservatively speaking, 35% upside.  

Main Risks

• ·     Value destructive M&A. Mitigant: Management has historically proven to be very good capital allocators. Legacy businesses for sale generate opportunistic opportunities.

• ·     Standardized segments: With its product and geographic rapid expansion and acquisition of other companies Precia may see reduced the profitability from operating in niche markets due to operating in more standard segments, therefore reducing its margins in the long run. Mitigant: There are so many end markets and geographies and Precia is still so small that it can choose the very best niches in terms of ROCE without compromising growth.

Catalyst

Precia is leading the concentration in its main markets (France and Europe) and is expanding successfully abroad (Brazil, Malaysia, Australia and above all India), enlarging its installed base of weighting systems, source of income of its profitable service and maintenance division, being still a small player in a fragmented business with huge potential to grow and a strong and stable cash flow generation to fund it.