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Summary

  • Coloplast is the only stock that passed the stock screening process for my "sustainable portfolio" with distinction.
  • The company's focus on intimate healthcare provides a unique angle on healthcare as investment theme.
  • A track record of 19 consecutive years of increased dividends would make it in the categories used by David Fish a Dividend Contender on a DKK-basis.
  • Coloplast sports a strong balance sheet with no interest-bearing debt at all.
  • The business has been growing revenues organically at a rate of 6 to 7% per annum in recent years and impresses by converting an increasing share of its revenues into cash.

There are two types of criteria that I used to select the stocks for my 'sustainable portfolio': Must-have and nice-to-have criteria. My three must-have criteria are:

(1) Sustainability

You can think of a number of definitions of what 'sustainability' actually means. For me the test consists of one question: Does the company in question create value for today's customers as well as for future generations, or would they be better off if it goes out of business? Note that ultimately the benefit to future generations will decide about the company's prospects.

(2) Unique role in portfolio

Each holding in my portfolio must be linked to at least one of the four trends discussed here. Plus, it must provide a unique angle on the respective trend.

(3) Non-corrupt environment

The companies that I invest in must have their headquarters and primary listing in countries that are 'clean' or 'very clean' according to Transparency International's Corruption Perceptions Index. Investing is difficult enough for mom-and-pop-investors like me so that I prefer to participate only in markets that are unlikely to be rigged.

Apart from these minimum standards there are a number of nice-to-have criteria that helped me to narrow my potential holdings further down. The most important ones are summarized below:

(4) Track record of distributions

Although I am not a dividend growth investor, I appreciate that dividends of certain companies are among the very few reasonably predictable metrics in the world of investing. This predictability is very welcome for me as risk-conscious retail investor who decided to hold individual stocks rather than funds. Therefore, I am among those who screened David Fish's invaluable list of companies with 25+/10+/5+ straight years of higher dividends for suitable stock picks.

(5) Low level of debt

Being no accountant, I take a rather archaic view on a company's financials. Any investor's biggest concern is that the company he is invested in files for bankruptcy before he can exit. The less likely this worst case, the better. There are two metrics that are important for a clean 'bill of health': The first one is debt load. My comfort zone ends at a total debt to total capital ratio of 70% (exceptions apply for holdings from the financial service space where a higher level of liabilities can be inherent to the business).

(6) Strong cash flow

The other metric is liquidity. The first level here is operating cash flow, where I would normally not accept any cash drain. Ideally, I like to see a sustainable double-digit OCF to revenues percentage.

While I understand that free cash flow can be a more volatile metric given the infrequent nature of capital expenditures in certain industries, I still like to monitor FCF as well in order to have confirmed that the company is actually able to service its debt and to see how well its distributions are covered.

(7) Major stake held by (founder) family

In many of the better run companies that I know a (founder) family is holding a major stake. There may be no empirical proof for this link, but I do believe that it is beneficial to any business to have owners who are committed for the long-term and who know that they and their successors will continue to do well if the company is doing well.

(8) 'Stripes'

For mom-and-pop investors it is a fact that there are many people out there who spend significantly more time researching the companies they are interested in than they could do themselves. Some of them publish on Seeking Alpha others publish their findings by means of rankings or ratings. While it is important to remain cautious with regard to secondary sources, I do take note of some of them -- in particular, when there are a number of different voices commending a company. This is how companies can earn 'stripes' in my screening process.

A word on valuation

One of the most common criteria in stock selection is missing on my list: current valuation. I appreciate that finding undervalued stock picks may be the ultimate in investing. My view on this discipline is ambiguous, though, and there are a number of reasons for why it is not a priority to me:

  • I doubt that I have the ability to identify undervalued stocks (by definition this must be true for most investors actually).
  • I want to keep the turnover of holdings in my portfolio low, which means that I am prepared to hold a stock through both, phases of over- and undervaluation. Through such a cycle the value will be created by means of rebalancing which I consider to be the possibly less-effective, but foolproof version of value-investing.
  • The total number of holdings needs to be manageable with the current number of 18 looking about right to me. I cannot keep adding potentially undervalued stocks to my portfolio without losing control.

Having said all that, I do pay attention to how my holdings are valued in relation to FCF, earnings and book value and I use this as a rough guidance when adding to my positions. In most cases I can see why some of my holdings enjoy higher valuation multiples than others. This is also true for the one stock that passed my stock screening process with distinction: Coloplast (OTCPK:CLPBY).

To get a better understanding of a business, history is often a good starting point -- in particular if you are interested in sustainability. In 1954 the Danish nurse Elise Sørensen invented a plastic, adhesive-backed ostomy pouching system that should allow stoma patients like her sister to live a more normal life than it was possible in those days. Eventually she found in factory owner Aage Louis-Hansen and his wife Johanne (who was a nurse as well) business partners who would produce her innovative system on a large scale. For this purpose Coloplast was founded in 1957.

Today Coloplast describes its business as 'intimate healthcare'. They sell products that help patients who

  • had a stoma surgery (business area Ostomy Care),
  • suffer from incontinence (business area Continence Care),
  • need wound dressings or special skin treatments (business area Wound & Skin Care)
  • suffer from urological disorders (business area Urology Care).

In the FY 2012/13 that ended on 30 September 2013 Coloplast generated revenues of 11,635m DKK and showed an operating profit of 3,672m DKK (31.6% of revenues). The market cap is 17.3bn USD. Its geographical focus is on Europe (67% of revenues), but the company's current growth is mainly driven by emerging markets and the United States.

Let's see why I consider Coloplast the blueprint of a stock that I want to own.

(1) Sustainability

Does the company create value for today's customers as well as for future generations, or would they be better off if it goes out of business?

No ambiguity here: Coloplast is developing and producing aids that are definitely of great help to people -- today and tomorrow.

Further, Coloplast pursues numerous initiatives in order minimize the environmental impact of their activities throughout the whole product life cycle by aiming among other things at

  • Using less raw materials such as crude oil, aluminum and silver
  • Reducing energy consumption in the production process
  • Shifting to more efficient modes of transport in their logistics chain.

(2) Unique role in portfolio

Coloplast adds a unique angle on healthcare to my portfolio, which is a key investment theme that I want to capture. Even beyond the holdings in the small universe of my portfolio Coloplast is unlike other businesses. Reuters recently wrote there would be few direct competitors to Coloplast and at least in terms of listed competitors this is a fair statement. Peers would be companies like Smith & Nephew (NYSE:SNN) or C.R. Bard (NYSE:BCR), that are also active in Wound Care (Smith & Nephew) and Urology Care (C.R. Bard). However, these are Coloplast's smaller business areas and stand only for 13% respectively 10% of total revenues (Ostomy Care: 42%, Continence Care: 35%).

(3) Non-corrupt environment

The company's primary listing is on the Copenhagen Stock Exchange. Coloplast is also headquartered in Denmark. Denmark tops Transparency International's list of the world's least corrupt countries together with New Zealand.

(4) Track record of distributions

In the categories set out by David Fish Coloplast would be a Dividend Contender. After normalization for stock splits and special dividends they have been increasing their pay-outs for 19 consecutive years now (this is on a DKK-basis -- I understand that David Fish uses a strict USD-basis). The current dividend yield is 1.6% (2.3% including last year's special dividend).

(5) Low level of debt

Coloplast sports a very strong balance sheet. The total debt to total capital ratio is at 28% with no interest bearing debt on the balance sheet at all. It is the company's policy only to take on interest bearing debt to pay for acquisitions.

(6) Strong cash flow

Coloplast has been growing revenues organically at a rate of 6 to 7% pa. in the past five years. At the same time they managed to convert an increasing part of their revenues into cash. In the FY 2007/08 OCF to revenues was at 16% and FCF to revenues at 8%. In the FY2012/13 Coloplast has converted 11,635 mDKK of revenues into an OCF of 3,136 mDKK (27%) and a FCF of 2,699 mDKK (23%).

Unsurprisingly, distributions to shareholders have been covered by the company's cash flow with a comfortable margin. In 2012/13 some 55% of the FCF were paid out to shareholders including a special dividend. In previous years the pay-out ratio was less than 25%.

(7) Major stake held by founder family

The Louis-Hansen family is owning 45% of the shares and 68% of the voting rights in the business and they are not likely to sell any time soon.

(8) 'Stripes'

In a business that was started by a nurse and that serves patients with indeed intimate health issues high ethical standards should apply. Coloplast is widely recognized as an outstanding corporate citizen. Among other things the company

  • Is named on the World's most Ethical Companies list
  • Ranked 67th on the 2013 Global 100 list of the Most Sustainable Corporations in the World
  • Ranked 12th on the 2013 The World's Most Innovative Companies list.

Coloplast's credentials are increasingly appreciated by the stock market. In 2013 the stock's total return was 33.4%. 2014YTD it is up by an impressive 19.8% (all on a EUR-basis).

In summary I do feel comfortable to recommend any investor who applies similar stock selection criteria as I do, to take a close look at Coloplast. At the same time I would like to point out that this article provides by no means financial advice of any kind.

Source: By All Criteria That Matter To Me, Coloplast Is The Ideal Stock