Today I would like to give you an update and final valuation of our Sto AG analysis. Last time we wrote that: “We can see that Sto AG is benefitting strongly from the trend towards renovating building facades with a view to saving energy and the new laws which implies new energy standards for houses. This is by far the most reliable and practical way to save fossil fuel – it does not require the wind to blow or the sun to shine.” And that the company has a long history of innovations which are driving out the great understanding of the market and the needs of the craftsmen at the construction site. This is also the root of the company’s direct sales approach to the craftsman and construction companies.
For this reasons we would like to show you how the industry itself has developed over the last years and if Sto has only profited by this development of the industry or if Sto is an outstanding player in the industry of heating insulation.
In the following chart you can see the change of the market size of heating insulation in m². You can observe a high volatility in the chart, which is clearly linked to the construction boom of the late 90’s and the years after 2005.
We think that this chart is rather meaningless, because of the fact that you only see the m² of installed heating insulation in Germany, but the companies didn’t charge their clients for m², they charge the money for m³ of heating insulation. For this reason we have built another chart with the development of the thickness of the heating insulation. In the next chart you can easily observe that the thickness of the heating insulation has a strong upward trend in terms of average thickness in mm.
Whether you then multiply the mm of the year 2004 and the constructed m² you get to see the produced and installed m³ of heating insulation, which was 30.690.000m³. In the year 2012 you can observe an average thickness of 125mm and 40,1 Mio. installed m² which leads us to 50.125.000m³, an increase of nearly 60% in only 8 years.
For this reason we think that Sto has visibly profited from the trend in heating installations, and the increase in profits over this time is not only linked to the fact that they are a good company. As a conclusion of the moat research we think that Sto is a good company with a medium size moat which is linked to its understanding of the customer and the direct sale approach, but furthermore Sto has profited from a good macro environment.
Value of Earnings
In our last post we have stated that we can see on Sto’s balance sheet that it consists to 2/3 of short term assets and these short term assets consist to more than ½ or roughly 215 Mio. Euro out of cash. An interesting fact is that the amount of cash more than doubled over the last 5 years and we can assume that the company does not need all this cash for its ongoing operations. A further interesting fact is that Sto was able to reduce its debt completely and after that establish a net cash position over the last 10 years. Cash is only of value to an investor if he can get rid of this cash. The question which an investor should ask himself is, what Sto will do with the new money which will be generate over the next years, because they can’t reduce their debt a second time. This is a big question mark in this valuation!
Because of the fact that we assume that we will not have any access to the cash pile of Sto, we think that the return on equity is a good estimator for the owners earnings, but it has a clear downward trend over the last years and is now around 14%, (because of the high cash pile). The price target of our cash flow model is around 180€ per share and the Graham formula give us a value of 230 € whereas our model give us a fair value of around 191€ and without any future growth 170€ per share.
The SE & Kgaa problem
We think here is the main problem which we have with Sto, because of the fact that the Stotmeister family tried to push the VZ shareholders out of the company several times. The last move of the family was to change the status of the company from AG into a SE & KGaA, where the VZ shareholders lose several rights. [We previously wrote: The Sto Management GmbH is in charge of Sto SE & KGaA, furthermore the GmbH charge a fixed fee of 4% of the total assets plus several expenses to manage Sto. This management fee would produce annually costs of 28 Mio. Euro with an upward trend which wipe out nearly half of the annual net profit. But we had made a mistake due to the fact that it is not the total assets of Sto SE&KGaA which is the basement of the redemption, instead it is the equity of the Sto management Gmbh which is today 1 Mio. Despite this calculation mistake our concerns are still valid because of the fact that you it will be very hard to influence the assets and the several expenses of the Sto Management GmbH.] You can check this problem on page 41 of this pdf: http://www.sto.de/media/documents/investor_relations/hv/2013_2/10471-12_00318_SVER_Umwandlungsbericht_unterzeichnet_mit_Anlagen_26042013.pdf
Some shareholders have already sued Sto and got right on the first instance of the German law, but we think that the Stotmeister family will try to push out the VZ shareholders again. You can read the court decision here: http://www.sto.de/media/documents/investor_relations/meldungen_2013/AHM-20131220-Klage-stattgegeben.pdf
As a conclusion we can say that Sto is a good company, with a mid-size moat and a fair price of around 180-190 Euro. But we will not invest in Sto, because of the fact that we can’t trust the management and that we will see future actions against the VZ shareholders. Furthermore we have a problem with Styrofoam itself and the fact that we think the moat will shrink over time because more and more insulation manufacturers rush in the market and try to move in the high priced area, where Sto mainly sells its products.
Merry Christmas to all of those who celebrate!