Prosegur: Should Have Remained A CIT Pure Play

| About: Prosegur Cia (PGCSF)

Summary

Prosegur is a Lat. Am. Cash-In-Transit Company attempting to diversify operations.

The attempts to enter new verticals seem to be in either unattractive or unattainable markets.

Prosegur isn't a short yet, but if the core business begins to see a decline that might change.

Prosegur is a clear avoid, given the existential risk over a long time-frame and doubtful corporate strategy.

Prosegur De Securidad (OTC:PGCSF) started as a Cash-In-Transit company. To readers who haven't read my G4S (OTCPK:GFSZF) article or are simply unaware: Cash-in-transit is the business of moving cash from one place to another, primarily from government institutions to bank ATMs.

The sector is a strong one. There are only a few global players, and the margins are higher than pretty much any other security-based work. There is a large amount of trust implicit in the relationship. Both switching and searching costs are usually high and entail career risk. The economics entail that each geography is generally "owned" by one or two operators that dominate the market. The market broadly follows a "General Electric" Jack Welch model where a player is in the two or quits.

The sector is great because the industry dynamics are consistent across countries. In the waste sector, landfills are much more important in the US than they potentially are in Brazil or Europe, but cash transportation is almost always "the same" across the globe. There are some fixed-asset charges, but in general, the business is extremely cash-generative and stable.

The only geographical difference is really the amount of cash users. The so-called death of cash has been a theme for some time, but that is mostly in extremely developed countries and China (due to its weird economic progression timeline).

In fact, cash volumes are still growing in many Latin American and African countries. Prosegur has a very strong position in Latin American Cash-in-transit and has used it to generate impressive results. So, depending on your view relating to the fintech/payment status of developing nations, Prosegur de Seguridad could have been a great pure play speculation on CIT services. In fact, Latin America has been "the jewel" geography of peers such as Brink's (NYSE:BCO).

I am inclined to say that cash volumes have a moderately strong "remain" case in many parts of Latin America for the near team. The stock could reasonably have traded at 15-20x earnings had management paid out capital from the cash-generative business while stoking organic growth. Cash volumes in Latin America are almost bound to decline over the next 30 years, but organic volumes would have plenty of space to grow till a technological inflection point was reached.

Unfortunately, Prosegur has decided to redeploy capital into three projects. One is reasonable (at best), two seem to be quite wasteful of shareholder cash.

For now, Prosegur still generates more than 76% of its EBIT from CIT and pays a dividend, but management's capital allocation, combined with a ~22x earnings multiple, pinpoints Prosegur as an 'avoid' or a potential short if you are bearish on cash use across the world.

A Critique of Management's Capital Allocation; 1 Good and 2 Bad

Besides the Cash-in-transit business Prosegur has two divisions and a new project.

The overall critique of branching out is that cash-in-transit offers very little in terms of synergies besides "knowing about security".

In a favorite book of mine, Billion-dollar Lessons by Paul B. Carroll, a story is briefly mentioned where a home construction company entered the bookcase business "since every home needs a bookcase". While actually fairly ingenious, given the right price and execution (in my opinion), the acquisition and initiative failed horribly because there were no real advantages or synergies that joined the operations.

It is much the same with Prosegur. The customer relationships are usually limited in scope (not necessarily depth as touched on above), the distribution channel doesn't allow for pushing extra products, and few people think that moving cash from one place to another is the height of technological sophistication. In short, there is little cross-selling, expertise, synergy, or even brand name associated with Cash-in-transit to the best of my knowledge.

The business is idiosyncratic in a sense. It has some capital intensity usually not associated with manned security (which is basically a spread-trade on labor with low investment needs). It also has heavy labor costs and a reliance on personnel.

The Good; Alarms Seem To Be Working

One business which Prosegur decided to enter was the alarm business. The business generated €213 million in sales in FY17. It has experienced good organic growth and a consistently growing amount connections. Churn is moderate at 10.2%, but the business seems to be generating very consistent income.

Profitability is somewhat lacking at an EBIT margin of 4.5% and income of "only" 10 million which obviously implies that the alarm section is fairly immaterial when it comes to valuation.

It does showcase that management is competent at entering new verticals, which weakens a potential short thesis.

The Bad Market; Security Services

Those familiar with my work on Securitas (OTCPK:SCTBF) and G4S will know that the manned security business is intense and price-competitive which requires technology and innovation.

Even worse, the big players are heavily investing into technology integration and utilizing their scale to bully smaller players such as Prosegur.

To add salt to the wound, Latin America is a notoriously low-margin market for manned security across all major players.

My coverage on G4S outlined that their Latin American market margin was roughly 4.1%. The margin of Prosegur is currently 4.0%. While a Prosegur Security bull thesis might've been that margins would expand to the global median of ~7%, it initially seems to me that the margins can only be enhanced by offering more capital intensive services with more cyclicality.

Prosegur seems to have grown the business well, with good organic growth, but the business is (as mentioned) fairly commoditized and subject to great amounts of price competition.

The Overly Optimistic; Cyber-security

Cyber-security is an insanely competitive arena. The multiples are high, the growth is expected, all the major players are investing billions, and there has never been as much focus on the area as now with GDPR.

While the Prosegur business is certified and has invested heavily into "operation centres", it seems entirely unrealistic that a high-level trucking company would have an edge in the cyber-security market.

Worse yet, the company is attempting to develop their own cyber-security tools.

There is always the chance that Prosegur has hit a goldmine and will develop the leading protection against cyber-crime, but from where I stand, it looks to be an extremely over-optimistic entry into a market where the company has no real experience.

The company is currently acquiring companies (such as Dognaedis Lda S.A. for 1.5 million Euro, Evolium group for €1.6 million) with cash from the CIT business instead of distributing the cash back to shareholders.

Why Prosegur Might Not Be a Short (Yet)

While I am not exactly thrilled by the capital allocation practices of the Prosegur management team, there are three key reasons that Prosegur is not yet a short.

First of all, the company has tremendous financial stability post its extremely beneficial financial restructuring. Prosegur put out debt at a rate of 1.2% with over 7-year maturities.

Source

Secondly, the management team has shown some skill in growing their business effectively, and that should never be under-weighted. The 50.1% motivated shareholder might have something to do with the great governance, or perhaps, the company is simply innovative. I have no wish to bet against a competent management team with a cyber-security lottery ticket.

Third, and most importantly, the Latin American cash market has not begun to turn negative. If this begins to occur within the next 3-4 years, the short thesis might trump all previous arguments in favor.

There is simply no reason that a company with declining volumes in their core business should sell at 22x, but for now, we await the downturn in Latin American cash.

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.