Saturday, July 20, 2013

Contrarian Investing in practice...

Post inspired in a comment of user magno11 in financial portal

In a previous post we mentioned a style of investing called Contrarian Investing.

According to the definition in Wikipedia, Contrarian Investing is “In finance, a contrarian is one who attempts to profit by investing in a manner that differs from the conventional wisdom, when the consensus opinion appears to be wrong.“

In this post, rather than explaining it in detail, we will try to follow a contrarian analysis to find a good investment. You can find plenty of web and book resources about Contrarian Investing.

So, let's try it.

First of all, look at a market that normal investor never would go at this moment, what about South Euro area, Italy, Portugal, Spain, Greece, Cyprus...

At first sight, Cyprus would be the worst one, but we are talking about investment with risk, not gambling... And there is a corralito de facto for Cypriot euros, .

So, maybe the next in bad state is Greece, and what do we have in that market?? Well, the overall index has not done bad this year, but it includes all risks, so lets look at some good companies in it, mostly those undervalued...

To not bore you with long analysis, I propose to analyze directly one of the sectors with bad reputation, which normally are those that perform better..., in this case, a tobacco company, Karelia Tobacoo, KARE:ATH.

This company's last closing price was 145.05 €, but, according to some it may be 50% undervalued, that is, it may reach, in 2 – 3 years time, double price.., let's see the data:

This company exports 80% of its production, (15 billion cigarrettes), that means that, in worst case of Greece exiting the euro, costs will do down (currency devaluation), increasing profits.

In Greece it has 10% marketshare, (3 billion cigarrettes), but it is leader in Bulgaria, 20% and it is performing an active international expansion.

In 2009 they started launching new products and expanding in duty free markets. Earns per share rose 16% in last 5 years with 10% increase in sales.

In 2004 it sold 15 billion cigarretes, same amount as in 2009, however operating profit went up 30%, but transferring increases in taxes and inflation to final price.

Getting more market share in other countries is a very good signal, because normally tobacco consumers have a lot of fidelity to their brands..

Now lets do the numbers using latest published data, price evolution and other economical facts.

Company Valuation

Analyzing the enterprise value, as market cap + debt – cash, that is 420M – 150M, that is, 120 million euros.

EBIT = 56 M.
Free cash flow = EBIT – capex
EV/EBIT = 4.2 x pret-tax
EV/FCF = 4.3 x pre-tax
ROTE, Return on tangible equity =56/260-60-150+70=46%
EBIT margin = 9%
ROIC=56/236=23% pretax

If we compare this numbers with similar companies, for example Imperial Tobacco, it has a ROTE, of 31%, (just 25% including goodwill).

EV/ebit = 11.3 x, that is 3 times Karelia Tobacco.

Analysing the stock price, it shows a clear primary trend up, since 2012.

Moreover, this company has given its employees 1.8 Million € in bonus last december, from 400 to 1400€ extra depending on family charges per employee.., which shows an economically healthy company with motivated employees.

And last but no least, new limits in tobacco advertising is good for small companies, because it reduces the gap between big companies, that can spend huge amounts in TV ads, and small ones.

So, if everything sounds that good, why is the share so cheap..


Of course, there are risks, but a good analysis of them will be the key to a good contrarian investment. What are those risks?

Well, these days, anything with the word Greece in it is considered as a bad investment. Basically the media do not use to publish subtle details...

There is also a risk of task increasing on tobacco, but we have seen in the past that this cost can normally be transferred to final price, how much before people leave smoking?.

Management team is a family, Karelia family, and normally funds do not like family managed companies, however, in 2009, when many strategic decisions had to be taken, they did really well.

Other risk is the little free float, just 150.000 shares out of 2.76 million in total.

And, one strange thing, the big amount of 120 million € of cash with 400 million € of market capitalization. Why did they not buy shares back in 2012 with PER was 4???

So, what must happen for the stock to double price??


The company looks very good, could it be bought by another (big) one??

Maybe, spending those free 120M in dividends, or buying shares back???

Maybe a big hedge fund does same calculations, or reads this post and buys all free float shares???

These things are not likely to happen, but just simple expected growth may produce a very good return.

Finally, here 3 possible growth scenarios in next 4 years:

1.- Share price 202€, 7% yield in 4 years.
2.- Share price 354€, 24% yield in 4 years.
3.- Share price 489€, 34% yield in 4 years.

As a disclosure,  please do not consider all these as a buy/sell recommendation, it is my first approach to Greek markets, and  it would require deeper analysis and, even better, some local information about this company in Greece.

This exercice is just an example, how to find jewels dismissed by the media, and so by the crowd.., in countries, sectors or companies that the crowd dismisses.., and there is where money can be made.