As I explained in a previous post, Viscofan is one of the best examples of value creation. Its return on capital, as a result of its competitive advantage, allows the company to compound capital in the long run. In addition, the company has almost no debt, and the capital allocation has been very successful in the past. The management is committed with the objective of creating value to its shareholders, among which, highlights the holding company Corporación Financiera Alba. Therefore, Viscofan is a high-quality company, as I showed here.
Being a high-quality company is a necessary condition to be a good long-term investment, however not sufficient. The other crucial element is valuation. Buffett said that “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”, although buying a wonderful company at a high price is, for sure, a bad investment.
Therefore, it is important to deepen in the valuation process, besides the quality of the company. Viscofan generated almost €800 million revenue in 2017, with a positive trend in the last years. The expected growth rate for the casing industry is around 5%, so we can accept this rate for Viscofan’s revenue growth, assuming constant market shares, although the Spanish company is the leader of the market, with better ability to gain share with respect to its competitors. The operating margin was 20% in 2017. Nonetheless, we can expect a little fall in the following years as a consequence of the increasing competence, mainly coming from China. With these figures, assuming normalized capex, the free cash flow generated is above €100 million, and it is expected to remain constant in the following years due to the expected increase in effective tax rate and investments in working capital, that is going to offset the increase in revenues.
On the other hand, considering an expected yield of 2% for the Spanish 10Y Bond, and a risk-growth premium of 2% (as historical averages), we obtain an exit FCF Yield of 4% for 2020. The present terminal value, therefore, is €2.4 billion that, added to the present value of cash flows for the following three years, gives a total enterprise value of €2.7 billion. The considered discount rate is 8%. Given the net debt and the number of shares, the share value is €57, against the current share price of €52.
So that, for this valuation, the potential upside is 10% (with a margin of safety of 9%). However, if the market price recognized the value in 2 years, the compound annualized growth rate (CAGR) would be 5%, while if it occurred in 3 years, the CAGR would be 3%. However, we must be conscious that companies generate value over the years so the expected CAGR for the following years would be larger.
On top of that, it is important to analyze the implicit multiples of the valuation. First, with a net profit of €122 million, the P/E ratio would be 22x. Nevertheless, although it seems a high multiple, we should consider that this year’s profit includes a non-recurring loss of €8.5 million as a consequence of foreign exchanges. Regarding enterprise value multiples, we are assuming an EV/EBITDA of 13x and an EV/EBIT of 17x, equivalent to the industry averages, according to Damodaran. The normalized EV/FCF is 25x.
This valuation assumes a FCF growth rate of 0% for the first three years, and a 3.4% perpetual growth rate, slightly above the global economy’s growth rate due to the competitive advantages and the good dynamics of the sector.
Finally, every good valuation should include a sensitivity analysis. We have studied the sensitivity of the share value to two different numbers: WACC and Exit FCF yield, which are the two most uncertain inputs in the valuation process. The discount rate (WACC) doesn´t affect very much the valuation. Approximately, as WACC increases 100 basis points, the value decreases 1%, so an error in WACC estimation in a certain quantity is directly equivalent to the error in the valuation, though in a very small amount. The exit multiple, however, affects a lot the valuation. With a FCF Yield above 6%, the stock would be worth 40€, while if it were 2%, the value would be three times greater. Thus, the exit FCF Yield is the key element in our valuation.
In summary, Viscofan is a great company, in a growing industry, with exposure to the worldwide economy. The main risk of the company is the competitive environment, but the scale and product portfolio are robust enough to adapt to it, and even to take advantage. The price, though, is not as attractive as a value investor would expect to buy the stock. In other words, the margin of safety is not big enough. Yet, it is a company to include in the watchlist so that, if the price drops, we can have a good investment opportunity.