The individual investor should act consistently as an investor and not as an speculatorBenjamin Graham
Miquel y Costas has always been the kind of company that most value investors have purchased in the past. It is prudently financed, well managed and has always cared shareholders. Recently, its Market price dropped from €23,55 to €15,72 and I would like to check if current price is a good entry point.
For those that do not know Miquel y Costas, the company has historically produced special papers for the tobacco industry. Additionally, in the last decade, and due to a declining number of smokers, Miquel y Costas decided to invest in a different growing line of business: special papers for food & beverage, industrial use and high porosity papers. In the following graph, we can see the evolution of net sales by LOB:
Because they are very different markets, we further analyze each of them separately.
This industry has been dominated by Schweitzer-Mauduit International (SWM) with a 36% market share according to its latest 10-k report. This figure makes SWM the largest producer of paper for the tobacco industry. In the following graph, we can see how the market is distributed among competitors:
As it can be seen in the previous graph, this is market dominated by few companies – the 75% of the market is captured by four– where Miquel y Costas has approximately 8% of the whole market.
As we previously stated, tobacco industry is a very mature sector. For that reason, it is worth considering if the Spanish producer has any chance to prosper in this market. As you may know, in such businesses, economies of scale are extremely important. For that reason, we want to compare Miquel y Costas ans SWM in terms of sales and profitability.
SWM has only reported two official market share figures: 35% in 2008 and 36% in 2016. Thus, the variation in those eight years lead me to think that market shares have remained stable. So, in this stable scenario: has Miquel y Costas reduced its difference with SMW?
As it is reflected on the previous graph, Miquel y Costas has increased its net sales figures for the tobacco paper market and have shortened its difference with SWM in terms of sales about 5% in five years. Thus, the following question arises: Can Miquel y Costas grow in a foreseeable future? To answer this question, we have plotted the EBITDA margin for both companies. As it is reflected in the following graph, Miquel y Costas can produce at a lower price than its main competitor and makes more money for each euro invested in assets:
After this, we can say that it is plausible that Miquel y Costas can compete on this line of business due to its lower costs and higher returns. Nevertheless, it must be highlighted that tobacco papers is a declining market. For that reason, it is extremely important the efficiency and the ability to increase margins over time.
The second line of business that Miquel y Costas has invested in, is special papers for industrial usage. Here, its competitors are different: Glatfelter as the largest competitor, Purico and Alhstrom among others. Not all of them produce the same sort of papers. Accordingly, Miquel y Costas and Glatfelter have been compared only in those markets where they produce the same products (Single Serve coffee & Tea, Technical Specialties, Composite Laminated, Special papers and Engineered Papers).
Firstly, we have started with a graph that represents Miquel y Costas net sales over Glatfelter net sales. We plot this metric in order to see the evolution of the relative size of both companies in term of net sales.
As we can see, the difference among both companies in terms of net sales have been reduced, specially in the last three years. Because what matters are both the future and economies of scale, we have calculated the EBITDA margin for Miquel y Costas and Glatfelter:
Contrarily to what happens with tobacco papers, Miquel y Costas has lost money in this market in 2013, 2014 and 2015.
One explanation for this poor result can be found in the fact that Miquel y Costas does not know how to exploit this opportunity and, as a consequence, it cannot compete against Glatfelter. If this hypothesis was true, prices would be declining. Hence, I also wanted to check evolution of production prices for the Spanish company. In the following graph we can see how, for the last ten years, prices have been pushed upwards. Consequently, a lack of competitiveness may not be the reason.
What can be seen in the previous graph is that cost per ton has been greater than its cost per ton for 2013, 2014 and 2015. A second explanation can be found in the fact that the Spanish company has not reached its optimal production for the invested assets and faced higher costs for those years. To check this, we can compare annual production for industrial papers, assets allocated to this market and the ratio of tons produced divided by total assets:
Here, we can see how the annual production has been increased (Tons), how Miquel y Costas has been investing in this market (Assets) and how the ration of Tons over assets has been diminished. It can mean that:
- The company is overcoming a learning curve.
- It has a margin to increase production and earnings.
- Miquel y Costas can improve its profitability.
We have analyzed Miquel y Costas in both market it participates. As a summary, here I leave a SWOT matrix that highlights the most important facts gathered so far:
Key accounting policies and potential red flags
Accounting principles always allow corporate management a certain discretion when making estimations, recognizing assets and liabilities as well as income and costs. Thus, financial analysts should check that financial reports truly represent company economic reality.
After reviewing Miquel y Costas accounting principles, I have summarized the main factors that could potentially distort financial statements:
After checking those accounting principles, financial situation and cash flow statement, I can consider that financial reports of Miquel y Costas accurately represent its financial and economic situation. Nevertheless, an analyst should be skeptical and double check this topic. Some authors use financial ratios in order to spot potential red flags. For that reason, I have used four of them.
By dividing trade receivables by sales, we can see if trade receivables maintain a relationship with sales or, by the contrary, the company is being aggressive when recognizing sales.
Secondly, we have taken into account inventories over sales to detect if the company is piling up inventories. As we can see in the following graph, Miquel y Costas is not doing it significantly:
Thirdly, a potential investor should check if the relationship between operating earnings and cash flow from operations is stable or improving. In the following graph we can see how this ratio has decreased over the last eleven years. After checking the Cash flow Statement, I found out that the accounts that have a stronger impact on this ratio are “change in working capital” and “other adjustments”. The first ítem can be broken down into two groups: inventories & trade receivables and short term investments. Since a piling up of inventories and receivables could be a problem in the future, I have compared them against sales figures. The result is that they keep a stable proportion with sales figures. Thus, the explanation is found in the fact that the company has been increasing short term investments.
Finally, since management can change depreciation and amortization policies in order to manage earnings, we have plotted the relationship of this variable with depreciable assets. We can see how this relationship has been stable over the selected time frame:
Valuation is a very important discipline in the investment world because it can set the difference between an investment opportunity and an overvaluation.
The method employed here to value Miquel y Costas has been:
- Firstly, I have adjusted Income Statement to better reflect its economic reality.
- Secondly, earnings have been normalized for a 10-years period.
- Thirdly, three scenarios have been created with three different growth rates.
As a result, we get a range of the intrinsic value of this analyzed stock:
I have analyzed Miquel y Costas in both lines of business it compete. I have pointed out the stability of the tobacco paper market as well as the opportunity to grow in industrial papers. Taking into consideration that management did a great work in the past, the low leverage and the fact that the company produces enough cash to pay capex, interest and repay debt, it looks like a good opportunity.
Nevertheless, this is not a risk-free investment, so ee should track performance in both markets and the ability to generate cash.
By no means this is an investment recommendation (none of my articles are), so each one should conduct a deep analysis or pay for profesional advice.