Background
Parmalat (OTC:PLATF) is a multinational food group with origins in Italy, present in all five continents through either a direct presence or through license agreements in the products areas of milk, vegetable, fresh (yogurt, cheese, desserts) with global brands such as Parmalat and Santal, as well as other strong international and local brands.
My interest in Parmalat initially started as I read Third Avenue International Value Fund's most recent letters to shareholders (see here). There are several factors that make Parmalat a special situation potential:
- In 2003 the company collapsed with a 14bn euro hole in its accounts in what remains Europe's biggest bankruptcy (see here).
- Since its collapse, the stock is not widely held by Italian institutional investors, presumably because of the stigma of the earlier bankruptcy (see here).
- Since 2003, the company has built up a chest of financial assets worth €1,4 bn, through settlements of lawsuits against investment banks due to the fraudulent behavior uncovered that lead to the bankruptcy.
- In March 2011, Lactalis, a privately held French dairy company, announced it had taken control of 29 per cent of Parmalat, making it the largest shareholder after it struck a deal to buy out a trio of foreign activist funds who had been agitating for change at the group (source: FT.com).
- The Italian government, lead by finance minister Guilio Tremonti, is trying to preserve Parmalat´s Italian controlling ownership. Allegedly this is being closely monitored by the EU (see here).
- Other companies have been mentioned as takeover candidates, such as Pepsi Co, Danone, Intensa Sanpaolo and Ferrero.
Fundamental analysis of Parmalat group´s 2010 results
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The reformulated balance sheet shows the accumulation of financial assets and the reformulated income statement shows how these assets generate next to no returns. The other operating income in 2010 mostly consists of one-time gains, so NOPAT is a more appropriate measurement of earnings power. Return on NOA is low at 6,49% as profit margins for 2010 are 2,78% combined with a asset turnover of 2,33. This puts Parmalat well below the 14% line used in the DuPont analysis of M. Soliman (see here). Return on equity is dragged down by a relatively high amount of financial assets bearing low interests.
- For the per share calculations a conservative measure of shares outstanding was used, by assuming that all warrants will be exercised.
- Free cash flow yield on av. NOA was 9,09% in 2010.
- The calculation of goodwill seems to be quite conservative as DCF assumes growth rates of 1% and discount factors ranging from 8,3% to 11%.
Valuation
For the valuation there is no short term forecast. For the continuing value conservative assumptions were used, with growth rate of 2% and a required rate of return of 10%. As a comparison, in an analysis by Cheveroux in 2007 WACC was computed at 6,4% and revenue growth estimate was 4% (see here).
The estimation of long term profit margin was 4%, in line with the 2009 results. When compared with two similar dairy products companies, Danone and Dean Foods, margins seem to be persistent although very different between companies.
For NOPLAT the theoretical tax rate of 29.3% from the 2010 annual report was used.
The value per share from the conservative valuation was €2,15 but as seen in the sensitivity analysis it is highly dependent on the required return and profit margins. But due to the conservative nature of the valuation and a possible improvement in margin, the upside potential is considerable.
Cost reduction
The profit margin potential is important because Parmalat as other dairy companies produce relatively low profit margins (the median profit margin of the food products industry in the US in 1963-1996 was 4,4% according to Compustat data), as small incremental changes can have considerable effect.
Consider the 2010 results, if Parmalat had managed to squeeze out a cost reduction of just 1%, NOPAT would have been 24,4% higher.
A few outcomes
There are a few likely scenarios of how this situation will play out, most notably:
- Status quo: No change in controlling ownership and mediocre results prevail
- Change of focus: No change in controlling ownership, but management is able to change its focus from tying up loose ends after the bankruptcy to its operating businesses.
- Change in control: Hopefully, this would result in operating improvements.
- Takeover: Lactalis paid €2,80 for its most recent acquisition of shares (15,3% stake), so a takeover offer would most likely come at a considerable premium to current market prices (around $2,31).
- Allocation of FA: Independent of the scenarios mentioned above, at some point the financial assets sitting on Parmalat´s balance sheet will have to be put to work, be it returning it to shareholders, acquisitions or investments in current operations.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in OTC:PLATF over the next 72 hours.
