Description

Long recommendation: Semapa (Euronext Lisbon: SEM)

SUMMARY. SEM has traded at a large discount to its sum of parts since 2018, implicitly valuing the equity of its cement and waste management businesses as a zero despite high but controlled leverage and a well-distributed debt maturity profile. A narrowing of the current sum-of-the-parts discount to pre-2018 levels implies c. 30-40% upside, and the family that owns ~80% of the company (through its holding company Sodim) has recently attempted to take the business private through a tender offer at approximately the current share price. The bid failed to reach the minimum 90% of votes needed to carry out the delisting, and two large shareholders publicly rejected it for being too low, but it highlights insiders' confidence in the business and a desire to narrow the current discount (as the bidder stated in the tender documents).

BUSINESS OVERVIEW. Semapa is an industrial group founded in 1991 by the Portuguese industrial family Queiroz Pereira, later listed in the Euronext Lisbon in 1995. The group has evolved to become a portfolio of industrial assets that includes:

• The Navigator Company (69% stake, ~60% of consolidated EBITDA adjusted to remove portion not owned by Semapa): integrated paper & pulp producer leader in bleached eucalyptus kraft pulp in Europe; listed in the Euronext Lisbon, the company focuses on office paper (68% 2020 revenue) and pulp sales (11%) but has been diversifying into tissues (10%) and also sells co-generated energy (10%);

• Secil (100% stake, ~37% of consolidated EBITDA): cement producer with 9,750k ton cement production capacity and operations across Portugal (72% of Secil 2020 EBITDA), Brazil (17%), Tunisia (10%), and Lebanon and Angola (2%); the company grew revenues and EBITDA 8% and 13% p.a. 17-20 on a constant FX basis, respectively, but suffered from large devaluations in the Lebanese pound and Brazil Real, resulting in actual revenue and EBITDA growth of -3% and +9% p.a.

• ETSA (100% stake, ~3% of consolidated EBITDA): waste management and food / animal protein recycling company with residual contribution to the Semapa portfolio.

Semapa has long suffered a conglomerate discount, but since 2018 this discount has widened significantly, coinciding with the passing away of chairman Pedro Queiroz Pereira, troubles in Secil's African business units, and weakness in Portuguese paper & pulp stocks (Altri and Navigator). Since the start of Covid lockdowns the company has further underperformed peers and the Portuguese stock index, prompting the majority shareholder to take advantage of the low price at the start of this summer and attempt to delist the company at €11.66. Reputed value investing firms Bestinver and Cobas AM own 5% of the shares (17% of free float) and rejected the offer publicly. After the failed bid, Semapa presents the opportunity to invest in an undervalued, family-owned industrial group where the majority shareholder looks confident and motivated to unlock value (main motivation given for the tender was the family wanting to resolve the conglomerate discount it deemed excessive). Although the bid failed, the family kept the shares it acquired, in another sign of confidence. Exhibit 1 below shows an evolution of the share price against these events.

VALUATION AND RETURNS. Semapa has a market capitalization of c. €950m at the current price of €12 / share, while its 69% stake in Navigator is worth €1.5bn at market prices.

The Semapa stub, which includes Secil and ETSA, generated average EBITDA of €90-100M over the last 8 years, and an average cash flow of €50-60M. Margins improved significantly in 2020 and in 1H21, resulting in higher figures (€145m EBITDA LTM), but given the company’s cyclical and commoditized nature I believe looking at long term average earnings power is safer - many industrial companies saw margin improvements last year on the back of cheaper raw materials, electricity, and gas prices. Still, if you take out the Navigator stake and the corresponding net debt, Semapa is trading at an EV of negative €30m, while it has historically traded at 3-4x this average EBITDA of €90m and 6x average cash flow before 2018 - itself a discount to typical cement multiples of 6-7x EBITDA (as shown in Exhibit 3). Although Secil has more leverage than the typical cement peer, this does not seem enough to justify the current discount as distress risk looks limited (~2x net debt / LTM EBITDA at Semapa excluding Navigator, and 3x consolidated with Navigator - note that the net debt figure at the top of this idea includes the Navigator NCI so it is overstated as a measure of actual leverage -, with well-distributed maturity profile and +€1B in available liquidity between cash and undrawn commitments). In addition, the problems at the African BUs of Secil (namely Lebanon and Angola - driven by out of control inflation in these economies) that may have also led to the derating in 2018 are hardly significant now, as Portugal represents the large majority of current EBITDA (+70% in 2020). Construction is booming in the country and if anything one should expect significant growth in earnings over the next year or two.

A re-rating to historical EBITDA multiples at which the market previously valued the Semapa stub (~3-4x average EBITDA of €90m) would yield c. 30-40% upside to the current Semapa price. If it were to trade at peer multiples of 6x, the upside would rise to ~60% (see Exhibit 2 for a sensitivity of the share price to these assumptions). To invest you need to believe in the narrowing of the current conglomerate discount, but this seems to be what the main shareholder and management are motivated to achieve, judging by the recent tender and commentary, and you only need to believe in a return to the historical discount for the company to be mispriced.

Besides this potential upside on the stub, I believe we are also getting a reasonable price for Navigator in the market. The company is trading at 7.8x its 2019 EBITDA (itself depressed relative to 2018 levels due to a downturn in the paper sector), slightly below the average 8.0x multiple for the last 8 years, for a business that has been able to grow above GDP throughout the last ten years with average returns on equity pre-2020 of c. 15% and ~80% conversion to cash flow. The company does suffer from the overhang of the long term decline in demand for its key product, office paper, but it is diversifying into the tissue market as well. It also stands to benefit from the booming price of paper pulp in recent months, as it produces the material in excess of its consumption needs and sells the rest to the market.

RISKS. Although I believe the large discount to the sum of the parts offsets the risks to holding Semapa, it is worth highlighting them:

1.  Exposure to the Portuguese construction sector (70% of Secil EBITDA);

2.  Potential for further deterioration of the economies of Lebanon, Tunisia, and Brazil and/or further currency devaluations (30% of Secil EBITDA).

3. The decline of office paper (70% of Navigator’s sales) may occur faster than expected, preventing firm from diversifying its operations in time.

4. Governance – management has at times seemed to disregard the interest of minority shareholders in favor of the family – e.g. biased support of the Sodim bid. I believe this is the main risk, not least because management could decide to attempt a dilutive equity raise to take the company private (as occurred in another Portuguese company recently - Sonae Indústria). The rpesence of large institutionals with significant stakes, however, lessens this risk.

EXHIBITS

Catalyst

• Actions by management and controlling shareholder directed at narrowing conglomerate discount (namely a new tender at a higher price or a corporate simplification)