Viscofan: A Great Business, But I'm Still Waiting For A Fair Price

Summary

• Viscofan does everything right, and is being rewarded with a superior valuation.
• The company appears to be priced for perfection, and I'm waiting for a lower share price before initiating a long position.
• Despite a substantial FCF increase in 2018, the free cash flow yield will still be less than 5%.

A few years ago, I discussed Viscofan (OTC:VSCFF) here at Seeking Alpha. I like the company's business model (it's making artificial casings for sausages, which are more appealing for consumers than using the intestines of pigs which is the traditional way of "casing a sausage"). As you can see on the next chart, Viscofan's share price has remained pretty stable throughout the past few years, but the company remains pretty expensive (on both an EV/EBITDA as well as a free cash flow yield basis).

Source: finanzen.net

As Viscofan's main market is the Bolsa de Madrid, I would strongly recommend you to trade in the company's stock there as the liquidity is much better. Viscofan is trading with VIS as its ticker symbol, and the average daily volume is 104,000 shares. The current market capitalization is approximately 2.5B EUR. As the company reports and trades in Euro's I will use the Euro as base currency throughout this article.

Sausage casings. Source: financial report

A strong result in 2017 despite higher capital expenditures

2017 was a pretty good year for Viscofan as the emerging regions (especially Brazil) are pushing the total revenue higher: up 6.5% to 778M EUR. Unfortunately there was some pressure on the company's margins as the EBITDA increased by just 3.5% due to a higher amount of 'net purchases' and personnel expenses as these both expenses increased faster than the revenue did. The situation isn't alarming, as the EBITDA margin remains very robust at 27.1% (compared to 27.9% in FY 2016) with the full-year EBITDA coming in at approximately 211M EUR.

Source: financial statements

Viscofan was also hit by the Euro-Dollar exchange rate and instead of reporting a 3M EUR FX gain in 2016, it now had to include a FX charge of 8.5M EUR in its FY 2017 results. That's why the pre-tax income fell by 6.4% and the net income fell by 2.4% to 122M EUR, or 2.61 EUR per share.

Fine, but let's have a look at the cash flow results, as these tend to provide a better overview of how a company is really doing.

Viscofan reported a total operating cash flow of 157.3M EUR, but this includes a 21.8M EUR working capital investment, whilst it also takes a 28.5M EUR tax payment into consideration. However, this 28.5M tax largely consists of the tax paid in 2017, but due on the 2016 results. For FY 2017, the income statement shows a total amount of 23.3M EUR as taxes due. After adjusting the operating cash flow for these two elements, we end up with approximately 184M EUR as adjusted operating cash flow.

Source: financial statements

The total amount of capex was almost 112M EUR (excluding acquisitions, which aren't really capital expenditures), and this results in a free cash flow result of 72M EUR or 1.55 EUR per share, indicating

2018 will see a substantial increase of the company's free cash flow

Not only did we see a substantial acceleration of the growth in the fourth quarter (which makes me wonder if FY 2018 started with the same momentum), Viscofan is also guiding for a much lower capex of just 75M EUR in FY 2018.

This lower capex, combined with the guidance which includes a higher operating income, bodes well for 2018. Let's run the numbers. Viscofan expects a 4-6% revenue increase and a 2-5% EBITDA increase. If I would now remain relatively conservative and use a 3% growth rate for the adjusted operating cash flow, we would see an adjusted operating cash flow of 189M EUR this year.

After deducting the 75M EUR the company expects to spend on capital expenditures, Viscofan is essentially guiding for an adjusted free cash flow result of 114M EUR, and that's a substantially better result than this year. The expected FCF/share increases to 2.45 EUR, for a free cash flow yield of 4.65% based on the current share price.

But I'm still not impressed with the valuation…

Whilst Viscofan is doing everything right (it's investing in growth and expansion at the right time), has been taking care of its own balance sheet (I would expect Viscofan to have a net cash position by the end of this year), but I still think the company is a bit too expensive considering the free cash flow yield is less than 5%. Using a DCF calculation assuming a 2.5% increase of the operating cash flow in the next five years before falling back to a conservative eternal growth rate of 2% results in the following calculation and numbers:

The WACC is relatively high due to the high equity ratio on the balance sheet (approximately 75% of the balance sheet consists of equity). I admit I have been conservative in my assumptions in the DCF calculation, but even if I would apply a required free cash flow yield of 6.25% based on the expected free cash flow in 2020, I'm ending up with a share price of 44 EUR/share (further discounting this to today's fair value would be in line with the 36 EUR in the DCF calculation).

I like the business, but would think a share price in the lower 40's might be a better entry point. This does NOT mean Viscofan is a 'short'. It's just a great business which currently isn't available at a fair price as the company is relatively expensive based on a free cash flow yield (4.6%), a DCF calculation (1.5X DCF fair value) and EV/EBITDA (approximately 12).

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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.