This will be the final summary of our Vetropack series. Here are links to the first two parts:
We want to start by giving you the most recent numbers (http://www.vetropack.com/htm/presse_detail_3.htm?id=159). The revenue growth was in line with our expectations, just as the decrease in EBIT matched our prediction quite closely. As we have said before, we estimated an average 2.5% revenue growth in the short term. We need to add that all calculations have been done in reporting currency, which is CHF. Most profits occur in EUR though, as one of our great readers has remarked in a comment previously. But it is even more important how the cash is pooled. The CFO has told us that the cash pool that is used for investment is also kept in EUR. So we converted our DCF model. We have made the following assumptions, using the most current numbers:
- Revenue growth of 2.5% in the short term, 2% in the long term
- 10.1% CAPEX / revenue
- 0.63 operating expenses / revenue
- 0.17 average cost / revenue
- 0.09 average depreciation, amortization / revenue
As Bruce Greenwald likes to say, if there is not much change in market share over time and the leaders stay the same, it is likely that there are some kind of competitive advantages or high entry barriers. Vetropack’s share has remained unchanged over some time now. We have mentioned how far glass can be transported and how the geographical structure could create an oligopolistic market (see our 2nd part). We need to keep in mind that Vetropack only makes up about 7% in the European glass industry and is susceptible to pricing power of bigger competitors like O-I and Verallia. But it is crucial to look at each country separately. In each Croatia, Austria and Switzerland, the companies market share is over 50%. In the links from our last post you can see signs that output of high-volume products (with lower margins!) elsewhere is rising, a segment that generates more than half of Vetropack’s revenues.
But let’s talk about the company’s potential now. The key to success is the goal of full utilization. That means turning plant efficiency to a maximum. According to our research, at 75% of capacity, the break-even point is reached. At full capacity, it should enable a 35% EBITDA-margin. So efficiency is crucial and expansion can be costly. For cost minimization, the melting tanks could be expanded during each repair process which would be about every ten years. Momentarily, Vetropack is running at full capacity while small competitors can usually not stand the pressure for long. That explains the high cash conversion cycle, because the company has built up inventory, primarily in Switzerland and Austria. The Cash Conversion Cycle went from 242 days in the year of 2008 to 389 days today, which is an average increase of 9% pa.. So it takes the company a long time to generate money out of its production.
The market overview given by the hardened glass patent holder shows the position of the glass consumption in different countries. This is also where you can see the growth potential of the emerging economies. The Czech Republic already has high glass demand compared to its gross national income, but Slovakia, Ukraine and Croatia could deliver valuable growth in markets where Vetropack has a more dominant position than in Austria and Switzerland. The Swiss-Austrian home market should be rather satisfied, the management confirmed that they do not necessarily expect demand growth there.
The hard glass production itself might put Vetropack in a nice position for production and distribution, but we do not think that there will be long-term advantages without owning the patents. Bucher Emhart Glass could be the one profiting by selling its technology to all market participants. That is probably going to happen as soon as hardened glass appears to be profitable, obviously that also depends on oil prices and therefore the break-even point with PET bottles, but also environmental policies or restrictions that could come. We prefer not to put too much value in the eventuality of the hardened glass turning around the market. Here is (again) a comparison to similar manufacturers.
(numbers for Vidrala and O-I from gurufocus)
So, do our numbers confirm our general opinion? Sometimes, it is necessary to change an opinion, especially in the case you have been too enthusiastic about an investment idea. Yes, for our conservative assumptions, the company is still slightly undervalued (price goal of 1887 CHF). But it offers by no means a margin of safety great enough for further investment. The P/B of 1.07 is not exactly a value-alarm-sign, even though the competitors trade at much higher P/B (O-I 3.65, Vidrala 2.4). The detailed researched has shown that there are visible, but not strong oligopolistic structures in the emerging markets, while the home market is rather competitive, forcing the company to build up inventory in order to maintain full utilization. O-I and Verallia will be able to play the game of raising volume in the home market for some time. Smaller firms will not be able to stand the pressure, to Vetropack’s advantage is its very small financial leverage. In the best case it will be able to buy smaller competitors cheaply in distress, as it has done before. So while the emerging market looks promising, the home market is fairly uncertain. We will follow our strategy of holding Vetropack, because there is still an upside to our estimated intrinsic value.
What I have learned from analysing Vetropack is quite a lot, to be honest. I have not had such a long researching and reviewing process before. I definitely learned to double-check everything. I also learned how valuable it is to ask the management the right questions. Finally, I have learned to be more reluctant when I feel enthusiasm and compare several sources for financial reporting numbers. There is still a lot to learn, but I have noticed how much I am looking forward to it.
Disclosure: Long VET at time of writing.