A cura di Morningstar
Symrise
Narrow-moat Symrise, a global ingredient manufacturer providing flavors and fragrances, is trading at a 15% discount to our EUR 70 fair value estimate. The company is about to start integrating its second large acquisition in 18 months, which will lead to longer-term higher margins and returns on invested capital. Switching costs explain Symrise’s moat, as nearly all business is bespoke. The complexity of the ingredient business, with its multitude of different formulations and raw material inputs, means that clients rarely change providers, making the business inherently sticky. Given the fragmented nature of the ingredient industry, there is scope for further consolidation. The ingredient industry is expected to grow faster than its end customers’ industries (food, beverage, personal care), given increased outsourcing of ingredients, combined with secular trends such as increased consumption of processed foods and high exposure to fastgrowth emerging markets.
Millicom International Cellular
Despite the decline in the stock due to the Colombian peso’s continued weakness, Millicom is still one of our Best Ideas. We expect the acquisition of UNE, the second-largest cable TV operator in Colombia, to enable Millicom to generate revenue growth even after currency declines in Colombia and other countries. We continue to expect the firm to generate organic revenue growth in local currency terms in excess of 6% for the next five years, the fastest growth rate of any of the European communication companies we cover. On an enterprise value/EBITDA basis, Millicom trades below 5 times our estimate of 2015 EBITDA, the lowest in our European coverage. The stock also yields in excess of 4%, a dividend that we believe is safe.
Fiat Chrysler Automobiles
The market continues to punish no-moat-rated Fiat Chrysler’s valuation unfairly, owing to incredulity over management’s five-year plan and a debt-laden balance sheet. Even though our Stage I forecast already includes significant discounts relative to management’s objectives, our EUR 15 fair value estimate is 50% higher than the market’s EUR 9 consensus price target. Additionally, this 5-star-rated stock currently trades at more than 50% below our fair value estimate. Management recently guided to revenue higher than EUR 111 billion for 2016 versus EUR 111 billion in 2015. Guidance for 2016 adjusted EBIT (before special items) is in excess of EUR 5.0 billion compared with 2015 adjusted EBIT of EUR 4.4 billion. Net industrial debt is forecast to be less than EUR 5.0 billion, down from EUR 6.5 billion at the end of the first quarter. In 2018, management’s updated five-year plan calls for revenue to reach EUR 136 billion, up from EUR 132 billion. Maintaining its profitability forecast at an adjusted EBIT margin of 6.4%-7.2%, the company now expects adjusted EBIT of EUR 8.7 billion-EUR 9.8 billion, slightly higher than the previous range of EUR 8.3 billion-EUR 9.4 billion. Additionally, updated plan guidance forecasts a net cash position in 2018 of EUR 4 billion-EUR 5 billion, slightly more than double the previous objective. Even so, we have not materially changed the Stage I forecast in our discounted cash flow valuation, resulting in our EUR 15 fair value estimate. Even though management has modestly raised its 2018 targets (for the first time since the company started publishing five-year plans in 2004) while our DCF model remains unchanged (and generates a EUR 15 fair value estimate), how much more so is the market discounting this stock if the consensus price target remains at EUR 9? In our opinion, this makes our case even more potent that the market has misunderstood Fiat Chrysler’s ability to increase revenue, generate cash, and repay debt. Our Stage I forecast peaks revenue at EUR 119 billion in 2018, while management’s plan forecasts EUR 136 billion. We also assume profitability that’s lower than company guidance. Our peak adjusted EBITDA margin is 10.7% in 2018, while management’s five-year plan guides to an EBITDA margin of 12.5%-13.3%. Even though Fiat Chrysler’s profitability is at the low end of the industry range, we think the market has missed the margin expansion potential resulting from a richer product mix, operating leverage in Brazil and China as new products launch, and the impact of demand recovery in Europe. We assume a midcycle normalized sustainable adjusted EBITDA margin of 10%. While the U.S. represents slightly less than 50% of total volume, Brazil and Italy are Fiat Chrysler’s largest markets outside of the U.S., representing just a bit more than 10% each. In 2015, demand for passenger vehicles was down in Brazil and Italy from the respective markets’ peaks by 36% and 37%. Consequently, we think it’s reasonable to assume a slightly higher midcycle margin of 10% relative to 9% in 2015.
The Swatch Group
Headwinds continue for the Swiss watch industry despite lapping the second year of declines in Hong Kong and China’s anti-gift-giving laws of 2013. Exports to Hong Kong, which is one of the main retail trading areas for Swiss watches, are still down. Apple Watch worries have subsided (for now), but as Swatch has just introduced a number of new products, from Sistem51 to its partnership with UnionPay in China, it remains to be seen if sales growth can be rekindled. Although other luxury companies’ stock prices have fallen first on worries over the macroeconomy in China and now further on Brexit, and the watch industry is more exposed to dollar related revenues than euro or pounds. We continue to prefer Swatch Group for both its discount to our fair value estimate and for the value of the portfolio of brands and technologies it holds. While the Apple Watch launch has underwhelmed, the amount of other fitness and smart devices coming to market is accelerating as sports and health companies enter the market. We believe long run interest in new wrist products will benefit the whole watch industry, especially for microbatteries and low power use where Swatch has significant knowhow. We are also of the opinion that Swatch’s partnership with UnionPay in China may be underestimated and that NFC payments are the one application for smartwatches that might catch on. Longer term, we believe new products and technologies could be growth drivers for the watch industry, and even though the United States is the largest single consumer, mechanical watches are still proportionately underpenetrated there. Swatch enjoys a dominant position as the leading manufacturer of watch parts, where there are high barriers to entry. Technologies will necessitate a further retail buildout for Swatch brands and enable increased automation in production, driving long-term margins. Currencies remain a risk to demand and profitability, but stabilization should work its way in consumer purchase decisions and cost and pricing strategies. While weakness in global equity markets creates uncertainty for high-end spenders and risk to near-term sales figures, a rebound in retail sales would reverse destocking and risk aversion at wholesale.
Danone
We are adding Danone to the Best Ideas list after raising our fair value estimate from EUR 65 to EUR 71. We are taking a more optimistic view of medium-term margins, particularly within the infant formula business. More broadly, we think Danone possesses strong secular growth drivers that should allow it to grow organically at a rate above packaged food competitors, and is trading at an attractive discount to our fair value estimate. Danone’s infant formula business is a growing, profitable business in which brand loyalty is fairly high, but acquisitions and a more capital-intensive process weigh significantly on ROIC. Economic development is a strong secular growth driver in this category, and if historical operating leverage ratios hold, we believe that at a mid-single-digit growth rate, Danone can expand its divisional EBIT margin by 400 basis points, closing its margin gap to Mead Johnson. This, we believe, is not appreciated by the market and is the source of the upside to our valuation.
Elekta
We believe Elekta is well positioned in the radiotherapy market, which has tremendous growth potential as improvements in technology, increasing awareness of the clinical benefits, and a favorable cost/benefit proposition should dramatically increase global adoption over the next decade. Further, we think Elekta carries a wide moat, based on a solid position in a market that is characterized by high barriers to entry, high switching costs, and strong intellectual property. This field has evolved into a duopoly over the past decade with virtually no new entrants, and the main two players (Elekta and Varian) have built durable franchises and are well positioned for growth.
Royal Philips We believe the market is undervaluing narrow-moat healthcare equipment manufacturer Royal Philips. The stock trades at 4 stars, a 23% discount to our fair value estimate of EUR 29 per Amsterdam-listed share and $32 for the ADR. Recently Philips Lighting shares made a successful debut on the Amsterdam Exchange as parent company Royal Philips raised EUR 750 million, prior to exercising the 15% overallotment option, in an IPO of the world’s largest general lighting business. As expected, the restarted sale process of the Lumileds unit had no significant impact on Philips’ separation process, as the Lumileds divestment is being pursued as an independent transaction, with an expected completion of 2016. We believe the breakup of the company has potential for shareholder value creation and improved capital allocation. We expect an enterprise value/adjusted EBITDA multiple re-rating due to operational improvements. Philips is currently trading at 7.9 times enterprise value/adjusted EBITDA multiple on our 2016 forecasts. We expect improving operational performance in 2016 for Philips’ HealthTech division and continuation of the strong performance of its Personal Health unit. For 2016, we expect modest sales growth and increasing margins as a result of operational performance improvements, mainly in the healthcare segment, benefiting from progress in ramping up production and shipments from the U.S. Cleveland manufacturing facility. Philips reported good first-half sales and profitability as personal health comparable sales grew strongly year over year and adjusted EBITDA margin increased 130 basis points. Diagnosis and treatment unit sales and margin improved in the quarter as well because of double-digit growth in imageguided therapy, mid-single-digit growth in ultrasound and low-singledigit growth in diagnostic imaging. However, more improvements are needed here to bring current low-singledigit margins to the long-term margin target of high teens. We expect Philips Lighting to return to positive comparable sales growth during the course of 2016, driven by an increasing contribution of LED lamps, luminaires, and systems and services, versus a diminishing proportion of conventional lighting. LED lighting sales grew strongly in the first half of 2016 and now account for approximately 50% of overall lighting sales.
RWE
In December, RWE management announced it would spin off its regulated grid infrastructure, renewable energy, and supply businesses into a new entity. RWE will keep its conventional generation, trading, and gas midstream businesses. Our EUR 18 per share consolidated RWE fair value estimate implies a EUR 3 per share valuation for legacy RWE and a EUR 15 per share valuation for the downstream spin-off. This means at current market prices, investors get the legacy generation business for free and they even get a discount on the downstream business. If RWE can ease concerns about nuclear decommissioning funding and energy markets incorporate greater value for conventional generation, we think the markets will recognize that the value of RWE’s parts is greater than the current sum of the whole.