The Security Securities

by: Veni Vidi Emi

I've covered the security sector over roughly 14 articles during the past two weeks.

In this article, I summarize the top-down reasons the industry is interesting and I outline the verticals covered and their players.

A brief coverage of each company situation is given with a link to investigate further.

For investors that do not want to read 14 independent articles, this summary is a great way to orient yourself.

Over a period of time, I have attempted to gain an understanding of industries that fulfill either structural or fundamental desires. The waste industry was my first foray into an industry that has structurally stable demand (albeit slightly procyclical). Another industry that has been a permanent fixture of western society and will continue to be so is our need for safety. Safety can be for personal or commercial use, but in the end, the demand boils down to a primal urge. Security comes in many forms. It can be the protection of our children, the safety of our workforce, the transportation of valuables, or things as simple as entry systems that keep out unwelcome visitors. One thing is certain, an ounce of prevention is almost always worth a pound of cure.

There are a wide-range of verticals to protect valuables and this is an overview of a certain subset. This article attempts to outline:

  1. Why To Invest

  2. Places To Invest

  3. Players and their competitive positions.

  4. Further sources of information.

Why Safety Is A Good Place To Invest

Besides being a fundamental human need, I believe that safety is inherently investable for the following reasons:

  1. Good Place In The Value Chain

If you consider a traditional supply-chain you have the companies that allow access to raw materials, usually these are quite commoditized businesses. The process through which the material is treated is often commoditized at will. Manufacturers at both component and equipment levels can be differentiated.

But generally, the suppliers to industries make for the great business models. When a war is being fought (commoditized markets) be the arms dealer (differentiated supplier). It is best when the arms dealer provides mission-critical services. Safety is certainly mission critical.

2. Low Price Competition In Certain Areas

Almost per definition, the safety market is focused on the safety and reliability of services and products. Faulty equipment can lead to interruption or worse yet - death. While price competition is relatively intense in the manned security space (due to low capital requirements), most other areas focus less on price and more on reliability.

3. Not Likely To Be In-sourced

The waste industry handles something most operators produce, but which is not within the scope of their operations - so they are almost forced to outsource it.

A few global players can attempt to in-source it through scale, but the operations are generally so distinct from their own that hiring competent managers and allocating capital becomes a drag on performance.

The same is true for security services. Why keep a high-cost IR function, hiring officers, and the actual manned security along with systems integration capabilities? In general, the manned security space and others can be compared to call centers. Companies could handle the operations themselves, but why dilute the expertise and focus of a company to perform a commoditized service?

4. Opportunity For Local Economics of Density

Unlike call centers, the demands are for local services. A requirement for local services often results in economics of density. Consider a home-alarm response team or even general manned security. Training and retaining a material amount of personnel requires proper utilization. The alternative is less-trained part-time guards but specialized guarding and other services obviously require proper employees. In collecting cash from retailers, for example, the major costs such as wages, fuel, and armored truck depreciation all quite heavily depend on how close the customers are, not how many there are. On the equipment side, there are no economics of density.

5. Change Afoot Leads To Potential Alpha

Events & trends such as increased technological adoption, the death of cash, digital stores of value, and post 9/11 replacement cycles make for interesting (but not necessarily complex) cases that could reward intelligent investors.

6. Stable, Often Contractual, Demand Leads To Low Cost Of Debt

The stable demand for security services, whether cash transportation or manned security, results in spectacularly low interest rates on debt. Securitas can finance their debt at ~120 basis points for 7-year maturities. Even Latin American firms can often finance at under 200 basis points for multi-year maturities. In a competitive market, a low cost of debt does not always amount to good returns on equity, but with economics of density, economics of scale, brand importance, and other movements, the competitive pressures are decreased. Low competitive price pressures coupled with a low cost of debt usually results in shareholders reaping the benefits.

7. Emerging Markets Play

Safety and reliability is a trait often associated with a society seeing middle-class growth.

As countries like China enter the western world. Their mass-transit systems must acquire access systems, their valuables must be protected, and 21st-century technology must be integrated into company security. While far-east players like Secom (OTCPK:SOMLF) dominate certain fields, many other spaces are still open for western companies.

8. Organic Growth Globally

In my experience, most management teams aim for 5% organic growth. Most achieve at least 3% organic growth per annum. From the US to Europe, this is the trend. Emerging markets aren't the only high performers. We are increasingly entering a more security-obsessed world; from terrorism to corporate espionage, the world is growing more aware of the issues it faces on the security front.

That was my initial list of reasons that the security market is interesting. The security market is a relatively broad name. Let me specify the companies I have covered and where I see value.

The Verticals: Access Solutions: Manned Security, Cash-in-Transit, Safety Equipment, Safes & Vaults, and Much More.

There are a LOT of safety-related verticals. It would be difficult to name all the different spaces you can provide safety. Do bomb shelters count? Aerospace & defense? Private security firms?

I must admit that the following list is more the product of rough borders and related industries than all-encompassing omnipotence of all verticals that provide safety. The goal has been to hit most of the major "key investment reasons" outlined above while maintaining a clear connection to providing safety.

The verticals are, in no specific order:

Access Solutions:

The vertical can also be called "electromechanical, technological, and mechanical solutions to keeping places off-limits to certain populations". I think access solutions generally flows off the tongue better.

Access solutions range from incredibly safe doors to entrance systems for gyms, mass-transit ticket checks, hangar doors for commercial enterprise, or simply locks for residential homes.

The market is seeing +3% organic growth, and oftentimes double-digit growth in places like China for certain verticals. The market has a large aftermarket component (recurring revenue), is consolidating, and traditionally sees operating margins in excess of 10% (i.e. profitable).

The key players I've covered include:

Assa Abloy (OTCPK:ASAZF): The largest player in the access solutions space. Consolidated the space over 10 years ago and currently outsizes the closest competition by more than 2x. Swedish company, but has recently faced trouble in emerging markets. Has a unique hangar-segment. Article link.

Allegion (ALLE) is the stock on this list with the most coverage. The company is roughly a third the size of Assa Abloy. They have exceptional margins and exceptional growth, we investigate why. Article link.

Dormakaba Group (OTC:DRRKF): The runner-up to Assa Abloy in terms of consolidating the global space. We look at Dormakaba and their special presence in China along with potential margin expansion. Article link.

NAPCO Security Technologies (NSSC): A niche provider of security products to the North-American market. Includes access solutions, but NSSC is also a play on replacing landline safety messages through their proprietary Starlink Connect offering. Article link.

Manned Security:

Manned security is exactly what it sounds like. Employees that provide security from malls and shops to embassies.

The space has the advantage of not being capital-intensive, which unfortunately fosters some intense price-competition on margins. Disregarding the margins, the space is quite attractive on ROE and stability. I usually analyze the space as an arbitrage between labor costs and value offered as a consolidated entity. That paradigm results in two views: The key in manned security isn't margins. Margins in this space include a lot of pass-through revenue.

Imagine an ice-cream shop that made an absolutely delicious lemon sorbet. So good that customers gladly paid $3 per scoop, ensuring tremendous gross margins. The shop has a tremendous value-offer, as reflected in the margins.

However, to sell the lemon-sorbet, the shop also has to sell an ice-cream cone at basically no margins. Since guests usually like to mix flavors they will also require scoops of normal-tasting strawberry. All-in-all, the total cost of the ice-cream cone might come out to $6. Three dollars originate from a greatly value-adding product while the rest is almost pass-through revenue. Now compare a shop only selling lemon sorbet with no cones and no other offerings to one selling everything, including the expensive lemon sorbet. Which has a greater offering? Despite the higher gross and absolute margins on the "only lemon-sorbet shop", it is clear to see that they offer less of a value proposition to customers. The key in manned security is understanding whether the corporate entity adds a layer of value that five men and a homemade badge-design won't. Does the brand, unique offerings, access to proprietary products, hard-to-acquire domain knowledge, or something entirely else provide a substantial benefit when hiring these firms? That is the goal of all manned security analysis in my paradigm.

With that said, I cover:

Securitas (OTCPK:SCTBF): The world's largest manned security provider, based out of Sweden. With a focus on introducing technology, the company is growing their presence in the sale of technologies. Securitas is transitioning into a company that adds more of a value-layer to their labor arbitrage. Article link.

G4s (OTCPK:GFSZF): The world's second-largest security provider, based out of the UK. With a clear path to expanded profitability through a much-needed recapitalization and an ambition to compete with Securitas. G4s has an idiosyncratic cash-in-transit division that makes up a fourth of EBIT. G4s has less of a value-adding layer, but a clearer catalyst for intermediate-term growth. Article link.

Cash-in-Transit - CIT:

Cash-in-transit is an opportunity to bet on the future of cash. Besides the coverage of G4s business unit, I cover the cash-in-transit market through: Prosegur (OTC:PGCSF): The Latin American cash-in-transit player. Lat. America is the world's most attractive CIT market in terms of organic growth and suggested longevity. We cover the company attempt to enter new markets. I am bearish on corporate strategy, bullish on geographic exposure. Article link.

The Brink's Company (BCO): The leading global player in terms of geographic exposure. Operating as a duopoly across several countries, BCO is attempting to grow their CIT business even further. Brink's diversified geographic exposure, corporate strategy, and a few other things make them the easiest top-down bet on cash. Article link.

Loomis (OTCPK:LOIMF): A Swedish CIT stock. The biggest CIT operator in the United States and much of Europe. Has a large cash-management segment which the company is developing upon. I dislike the geographic exposures, but I am enamored with the corporate strategy. Potentially the highest quality player in the space on a long time-scale. Article link.

Idiosyncratic Companies:

There are a few companies that clearly provide security products, yet do not seem to fit neatly into a category box. These are just as interesting, but as a result of their unique position, my comprehension of their competitive landscape is somewhat decreased. That statement does not count for Gunnebo, which simply operates across too many segments to be properly placed.

MSA Safety (MSA) builds safety equipment for dangerous industries. Most analysts have been bearish as the stock rocketed. We look at the company through a new lens with a focus on replacement cycles and operating leverage. Article link.

Sensys Gatso (OTC:SEFCF) is as niche a play as it comes. The company invented the speed-camera in different iterations. A recent merger has led to the company attempting to enter more high-tech markets. Article link.

Gunnebo (OTC:GBOGF) is the most confusing amalgamation of access solutions, cash management, vaults & safes, and even electronic systems integration to enter the pile. It offers 4 different segments of safety exposure at lower than market prices but has recently underperformed. We identify the reasons for underperformance and conjecture on the future. Article link.

How To Start & Other Articles I've Written

Look over the verticals and find one that catches your eye.

For qualitative investors, I'd recommend the manned security space. As mentioned my paradigm is very much based on a qualitative understanding of each firm. A start could be my article comparing the investment merits of G4s versus Securitas.

For dividend-growth investors, I would recommend the CIT-space where the payout ratios are often high and the organic growth rates are often expected to be material as well. Loomis pays out 40-60% of their net income as dividends. For growth investors, I recommend the access solutions space. All the stocks are aiming to grow in their own ways. Dormakaba is a good business to research for emerging market exposure, while Allegion and NapCo is a good bet on American institutional spending (such as school safety). To understand the differences between each company I recommend looking at their geographic exposures and comparing them to my outline of recent trends in the space. Otherwise simply read what catches your eye and feel free to contact me personally with any further questions.

If you have any other security & safety companies not mentioned, then please comment their names below!

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in LOIMF, SCTBF over 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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.