With all the chatter in the media concerning the "taper" and the "shadow banking system" in China, it is understandable that retail investors are growing nervous about owning stocks. I expect that volatility will likely ramp up this summer, as investors reevaluate their holdings and don't want to be caught with their proverbial pants down when the tide invariably goes out. Volatility, though, should be viewed as a creator of investment opportunity: to buy high quality businesses at cheap(er) prices.
I look for equities that are little known and/or out-of-favor and try to understand why they are unloved. Then, I look to the competitive positioning of the business and determine if they have sustainable competitive advantage. Lastly, I like strong management who are taking steps to erase discounts ascribed to the businesses equity, generally in the form of catalysts that aren't fully priced into the stock: asset sales, spin-offs, restructuring activities, among others.
Take Orkla (OTCPK:ORKLY), a Norwegian conglomerate currently undergoing a business strategy transformation amid considerable uncertainty, including an executive shakeup when its former CEO was ousted in April 2012 due to a disagreement with the controlling shareholder, Stein Erik Hagen, who beneficially owns about 25% of the company.
Orkla has historically been viewed by the market as an unwieldy conglomerate/industrialist (and rightfully so), with a variety of disparate assets under its corporate umbrella. As such, Orkla currently operates in a number of industries (consumer staples, paints/chemicals, electric utilities, solar panels, aluminum, real estate and manages a considerable investment portfolio), but Mr. Hagen and management has communicated to the market the strategic future of its business: to be the number one pure play, consumer brand/staple company in the Nordic region, focused on growing cash generation from its strong portfolio of consumer products.
To me, this is the number one reason why the name trades at a discount: it's extremely difficult to value because of all the moving parts and disparate businesses (which management is clearly trying to clean up).
But Mr. Hagen is turning Orkla into a Warren Buffett type target, a boring, but understandable and best-in-class business with strong brands and market positions. With Berkshire Hathaway's (BRK.A) (BRK.B) recent acquisition of Heinz for $23 billion, the underlying value in Orkla's consumer brand division only becomes more apparent.
While Orkla's strategic vision is easy to understand, valuing its current business is quite difficult which is likely one reason it trades at a discount to underlying value (in my opinion). A number of recent acquisitions and asset disposals make the task harder.
This analysis will place most weight on the Consumer Brands business and Orkla's 42.5% interest in Jotun, a leading manufacturer of paints and powder coatings. Orkla has indicated its long-term commitment to Jotun, and I surmise will take control of this business in the future. The rest of the assets owned and operated by Orkla are considered non-core, and I expect they will be liquidated over the next 3 years or so.
Branded Consumer Goods (Core Asset; 100% ownership)
Orkla is Scandinavia's leading consumer brands, with #1 or #2 market positions in a number of product categories, including home & personal, confectionary & snacks, foods and food ingredients. You can think of Orkla's consumer branded business similar to that of Proctor & Gamble (PG).
In 2012, Orkla closed a few strategic transactions in this segment, including its acquisition of Reiber and Sons and Jordan. From a valuation perspective, Orkla's consumer brand unit should do about 30 billion NOK in sales in 2013, or about $4.8 billion. Based on price to sales multiple of comparable companies, including General Mills (GIS) (1.8), Proctor & Gamble (2.5), Danone (OTCQX:DANOY) (1.6) and Kraft Foods (K) (1.6), a reasonable (and very conservative) multiple to apply to Orkla's food business is 1.5, valuing it at about $7.2 billion.
Jotun (Core Asset; 42.5% ownership)
Jotun is a leading manufacturer of paints, coatings and powder coatings. In 2012, Jotun generated 11.3 billion NOK in sales and 1.2 billion NOK in operating profits in 2012. Currently, Orkla accounts for Jotun as an equity method investment; that is, Jotun's sales and expenses are not posted to the income statement. Rather, Orkla's pro rata share of the income less any dividend distribution is accounted for in a single line item on the income statement, and Orkla carries its investment in Jotun on the balance sheet.
Management has made it clear that it would like full control of Jotun. Therefore, if, and when, Orkla acquires control, the consolidated financial statements will look quite different, particularly with far higher top line revenues. That, in itself, may be causing obfuscation with respect to the valuation of Orkla as well.
At any rate, one comparable for Jotun may be PPG Industries (PPG), which trades at a 1.4 times sales. If we apply the same multiple to Jotun's sales, we get a value of approximately $1.2 billion for Orkla's share of Jotun. This will be materially higher if, and when, Orkla is able to acquire the rest of the business, including a control premium.
Sapa (Non Core; JV announced 50% ownership with Hydro Norske)
As part of Orkla's divestment strategy, it announced a joint venture with Hydro in October 2012, whereby Orkla contributed its extruded and welding aluminum businesses to the newly formed 50/50 the JV. Because Orkla's contributed a bigger business, it received a 1.8 billion NOK (~$300 million) balancing payment in Q1 2013.
The combined business generated NOK 47 billion ($8 billion) sales and NOK 1.9 billion ($323 million) EBITDA in 2011, representing an EBITDA margin of 4%. In addition, the JV expects to create NOK 1 billion in synergies and a leading market position in Europe and North America, with a strong anchor in certain emerging markets including Vietnam, Brazil, Argentina and India. I don't have any special insight into this business, other than it will lead to a cash windfall to Orkla when its share is IPO'ed in the open market. The JV agreement allows either party to IPO their shares after 3 years.
Certain analysts believed the Sapa JV could be worth $2.5 billion at the time of the deal, valuing the unit at .33 times 2011 sales. Given the difficult economic environment with respect to the commodity markets, the low multiple of sales appears like a decent approximation of value. Since I don't have a unique insight into Sapa, I'll value Orkla's 50% share at $1.25 billion.
To make matters more complicated, there was a piece of the Sapa business that was not contributed to the JV, the rolled products division called Sapa Heat Transfer which generated NOK 3.9 billion in sales in 2012.
Sapa Heat transfer is a leading global manufacterer of rolled aluminum solutions for the heat transfer industry, with a worldwide market share of 21%. Management has indicated it is looking for a buyer for this business as well. Again, I don't have any unique insight into the value of this business, but I expect it could be worth up to $500 million, or roughly 0.75 times 2012 sales and 10 times 2012 operating profits, since it has better margins than the Sapa JV.
Hydropower (Non Core; 100% ownership)
Yet another set of businesses controlled by Orkla are hydro electric power plants and related assets. In 2012, the business generated 812 million NOK (~$140 million) in sales and 208 million NOK (~$35 million) in operating profits. I value this business at 2 times sales and 8 times operating profits, or $280 million.
REC (Non Core; 15.6% ownership)
Orkla owns a 15.6% share in solar panel maker REC, which it is trying to dispose. Because it represents minimal value, I will do a straight market valuation approach to this asset and because it is a listed asset. REC currently trades on the Oslo exchange for 4.8 billion NOK, or about $770 million, or which Orkla's share is $115 million. Let's call it even at $100 million.
The Share Portfolio (Non Core, 100% ownership)
As part of Orkla's conglomerate itch over the years, it began an investment management business, using excess assets to build its Share Portfolio, with a mandate to buy securities of undervalued Nordic companies.
Management has indicated it will liquidate the Share Portfolio by mid 2014 as part of its narrowed strategic focus.
The market value of the Share Portfolio is around NOK 3.6 billion ($576 million) and is expected to be liquidated by mid 2014.
In addition, Orkla holds an interest in various real estate assets around Norway. It is carried on the books at 1.8 billion NOK ($288 million).
As of the latest quarter, Orkla reported 5.4 billion NOK in net interest bearing debt, or around $876 million.
Like other European conglomerates and/or holding companies I have featured recently (including Groupe Bruxelles Lambert and Vivendi), Orkla pays a nice dividend. Of course, the financial media sites like Yahoo Finance omit this information.
No matter, value investors don't mind digging further. For you curious (or cautious) readers, go to the investor relations site here, and rest assured that Orkla will send you a dividend check each year (if one is declared, of course). They may even distribute a special dividend when some of the non-core assets are sold, as they have done in the past.
With a steady dividend throughout the financial crisis and resultant malaise in Europe, the continued shareholder remuneration in the form of cash dividends is a testament to the financial strength and operating model of Orkla.
In addition, Orkla intends to maintain its current dividend of NOK 2.50 per share throughout the transition to a consumer branded company, funded by operating profits and cash flow from non-core asset sales.
The NOK 2.50 dividend represents a 5.1% yield at current prices, so investors are paid to wait while management restructures the business.
Conclusion: Price <<< Value (By A lot)
The market says Orkla is worth $8.0 billion. I think its worth closer to $11 billion right now (about a 37% discount), with more upside as Orkla grows its consumer staple empire in Scandinavia and paint/chemical operations globally.
Even better, if the market continues to get upset with the "taper" and the Chinese "shadow banking system", it is unlikely Orkla will experience significant value deterioration considering the defensive industries it is exposed to and because it operates in fiscally healthy nations.
In fact, I think investors will ascribe a higher multiple to the "new Orkla" when the conglomerate discount dissipates from restructuring activities, leading to the market viewing Orkla as a pure play consumer brand company.
Will Orkla trade lower if volatility rachets up? It is certainly possible. But if investors indiscriminately sell Orkla out of fear of the macro economic concerns, the disparity between price and value will only grow wider, and considering all the catalysts in place, an even more compelling investment opportunity.
Additional disclosure: I bought shares at $8 on June 25. I will add to the position if it declines further.