In the first part of our analysis we explained the business model of Delticom; now we would like to give you and inside in its valuation. But before we begin with the number crunching we would like to start with a short summary of the key takeaways of our first part:

- Some other Value-Investors think that the problems of Delticom are only short-term issues: EBIT-Margins will bounce back to their old highs.
- Delticom has a really light business model: everything is outsourced to third party distributors.
- No use of purchase power: Delticom uses a fixed premium on the purchase price of every tire, sometimes it uses a flexible mark up to account for seasonality and inventory management.
- No customer captivity due to long purchase cycles of over 4 years.
- No lock-in of fitting shops.
- BBE-Study assumes that the online market share will reach 15% in 5 years, e.g. 2020. In an overall saturated market. (You can see the development of 2014 here)
- Bad strategic behavior in the acquisition of Tirendo and bad own brand strategy (The tires get really bad reviews.)
- Too high ROCE and ROIC even with small EBIT-Margins, which we will explain in the hereafter

What do we mean with too high ROCE and ROIC, and why is the biggest advantage of Delticom also its weakest spot?

Many other investors think that Delticom is able to return to its old EBIT-Margins, but we don’t think so. Why? The answer lies in the Business Model of Delticom which is extremely asset-light. As you can see in the chart below, the Capital Employed of Delticom is 7,1 % of 2013 Revenues, relatively low in comparison to other companies, but for Delticom itself higher than in the year of 2006 (6,6%) and virtually sky-rocketed from its low in the year of 2010 (0,9%) where Delticom also has shown its highest EBIT margin (11,1%). The combination of high EBIT-Margins and low Capital Employed lead to an astonishing high ROCE of 276% in the year of 2010. Furthermore the ROCE was still high (51%) in 2013 where Delticom only had a EBIT-Margin of 3,6% and a Capital Employed of 7,1% of revenue. This high ROCE’s is also the reason why this business is so attractive for every competitor, if you cannot defend your turf with a big moat. As we don’t think that Delticom has a moat, we think that every time the EBIT-margins are high enough new competitor will enter the game.

So let’s come to our valuation of Delticom.

We have explained already that we don’t think Delticom has a moat and is a pure execution business only, so we use a discount rate of 10%. If we discount our Earning Power Value, assume an EBIT-Margin of 4% in the future and subtract the debt of Delticom we end up with a fair value of 16,62 EUR per share. This is not far away from our current trading price of around 17,5 EUR and is in our opinion quiet low for an evaluation without any future growth.

Delticom was able to growth its revenues by 17,7% p.a. over the last five years. If we now assume a growth of 8,8% in average over the next 5 years (10% in 2015 declining to 7% in 2018) which we think is quiet conservative, we end up with an N-EPV of 28 EUR per Share in the year of 2018 or an IRR of 13,7%. (Capital allocation is assumed to be stable: 43% dividends, 3% growth CAPEX, 2% change in NWC and no share repurchases.) If you than use the Growth Multiple of Greenwald to calculate the Terminal Value with a 3% growth rate, you end up with an N-EPV of 37,92 EUR per Share at the end of the year of 2018. Which is equal to an IRR of 20,1%.

We also used the approach of total Market size as an approximation but where not really satisfied with this approach. Therefore the reasonable share price of Delticom should be around 30 EUR which gives you a nice little upside. But if we think in our 3 pillars Model, we end up with a fair or cheap price but with neither a beautiful business, nor a management we would like to be engaged with. (You can inform yourself here and take a look at the insider trading)

We wish all of you a happy new year!

*Disclosure: No Position*

## Chris says:

Hello Nils,

I like your analysis. I share your views on Delticoms business model and the lack of an existing moat.

However, if you reach the conclusion that Delticom’s share price should be around € 30 at conservative growth rate assumptions, isn’t that more than just a little nice upside? Looks like more than 50% from current levels.

My point is, I agree with your conclusion (don’t buy), but I think the argument is much more around the uncertainty in the business model going that you described.

I think the valuation paragraph leads the reader to believe there is still some good money to be made even if it’s not a great business franchise. But is it really?

I’m glad I found your website. I’m quite impressed with the analyses you guys have published.

Regards,

Chris

## Nils Herzing says:

Hey Chris,

thanks for your response, and yes you are right. But for us it is difficult to come up with a fair price if we take the Management and Business Model into account. We try to be really strict and conservative with our investments. Normally we would like to buy at a N-EPV level with no growth assumed, so that we get the value of growth as a margin of safety.

Kind Regards

Nils

## Chris says:

Hallo Nils,

Ich verstehe…

Für Euch als Value Investoren die genau auf das Geschäftsmodell schauen und nach Economics Moats suchen könnte für 2015 die EQS Group interessant sein (falls Ihr euch das Business nicht schon angeschaut habt). CEO ist Der Firmengründer und hält mehr als 20% der Anteile. EQS spielt in einer schönen Nische und hat internationales Wachstumspotential…

Have a look

Gruß,

Chris

## Nils Herzing says:

Hey Chris,

in der Tat ist EQS eine sehr spannende Firma in einer tollen Nische mit einem guten Management, nur hat mich der Preis bis jetzt immer von einem Kauf abgehalten. Wieso denkst du ist es eine Aktie für 2015?

Bei Interesse können wir uns auch gerne mal an einer tiefergehenden Analyse blogen.

Liebe Grüße

Nils