Monday, July 16, 2012

Grenobloise d’Electronique et d’Automatisme - Toll Collection


Grenobloise d’Electronique et d’Automatisme (GEA) is, at its core, a manufacturer of highway toll collection systems. It is a small, family-owned business headquartered in Meylan, the village near Grenoble where I spent the substantial share of my gap year.

GEA’s products are installed in 80% of tolled highways in France and the company has used this track record to develop close subcontractor type relationships with some of France’s major infrastructure companies – Vinci, Bouygues, Thales, Egis, Albertis and Eiffage.

This relationship building has had two benefits: GEA has been contracted to install and maintain ticketing and collection equipment for parking lots/garages owned and operated by these companies; and GEA has followed these companies in their work abroad, installing toll collection systems in more than 30 countries around the world.

This is GEA’s financial history in the past 7 years:




The results before 2008 are poor; the results after 2007 are somewhat special. The question, therefore, is: what happened? 

GEA’s Annual Reports and regulatory filings attribute the improved performance to a reorganization of the manufacturing process instituted in 2006. This seems to me an  unlikely, or incomplete, explanation for the kind of performance improvement seen over the last four years. GEA actually makes its own products and if it has discovered a  manufacturing process that can triple its asset turns and earn 100% returns on its operating capital, it would be far better off licensing that discovery to Toyota and Boeing than it would be installing machines in parking garages in Nimes -- especially as the improvements seem not to have cost anything to institute. 

A better explanation lies in the increasing proportion of international work, and of service contracts, in GEA's revenue mix. 

It is likely that GEA's domestic revenue earns ~40% gross margins, while its international work -- as a subcontractor to a large infrastructure firm that itself charges cost-x-multiple to its clients, and is therefore price insensitive -- earns ~60% gross margins. In addition, service work earns 100% gross margins and requires no operating assets. Together, these two trends would explain a substantial share of GEA's performance improvement over this time period, as shown below:


The remainder may well be explained by the performance improvements that GEA's management cites, especially in its management of working capital.

That, then is the first proposition: GEA's performance depends on the share of revenues derived from international work and from maintenance services.

The second proposition is that international and maintenance work is likely to constitute an ever larger share of GEA's revenue mix, partly because the market in France is saturated, and partly because tolls roads are a growth business worldwide, as shown in this graphic prepared for one of GEA's competitors, the Austrian company Kapsch Traffic Control:


As a result, I think it reasonable to expect that GEA's future will resemble 2008-2011 far more than it will resemble 2004-2007. 

Turning now to valuation. At the low end, I capitalise operating profit over the last seven years at 10% to get the value of the enterprise, and add net non-operating assets to arrive at the value of equity, as below:


At the high end, I capitalize average operating profit over the last three years -- "the new normal" -- at 10%, and add net non-operating assets at arrive at the value of the equity:


In both scenarios, I use 10% as the appropriate discount rate because GEA has no debt, and is largely dependent on others for its revenue. 


Growth seems probable and the incremental value of that growth, not accounted for here, would be a bonus. Kapsch Traffic Control, mentioned earlier and with similar margins as GEA, is trading at an EV/EBITDA multiple of 10x, implying that GEA's shares would be worth €155. 

Disclosure: I have a position in GEA

7 comments:

  1. hi,

    i believe that there is always a reason for companies to trade at certain PE range or what some call their signature PE. the reason for this is that investors generally do a very good job at valuing a company especially insiders that holds large chuncks of it.

    the question that investors put forward regarding the future of any investment, in terms of what warren buffett like to put it:

    is there a 'moat'
    where is its 'durable competitive advantages'

    those two add up very well to drive growth that continue to plough earnings higher year by year.

    GEA has benefited from its close 'connections' in France but the market is matured. its growth driver must come from outside. to understand the game of international services provider that deals with goverments and infrastructure maybe we can compare it to another company side by side. maybe we can get a better picture.

    what about having a look at this service provider: SERCO GROUP PLC

    which do you think has a stronger 'moat' and 'durable competitive advantage'?
    at current prices which has a steeper margin of safety?

    warren use to say high PE doesnt have to mean expensive or even low PE has to be consider cheap.

    where will the growth come from and sustainable margins too.

    just wondering what you think?

    cheers

    ReplyDelete
  2. This

    "i believe that there is always a reason for companies to trade at certain PE range or what some call their signature PE. the reason for this is that investors generally do a very good job at valuing a company especially insiders that holds large chuncks of it."

    directly contradicts this

    "warren use to say high PE doesnt have to mean expensive or even low PE has to be consider cheap."

    don't you think?

    I'm with Warren.

    ReplyDelete
  3. I'll look at Serco Plc and thanks for the comment/question.

    ReplyDelete
  4. An interesting look at a really cheap stock. I had a couple of questions and one remark.

    1) I wonder whether the improvement in margins is really largely driven by operating leverage; more sales on fixed costs. Certainly the number of employees has not increased much over the years - and the productivity has soared (+100,000 sales/employee). Fixed assets have also remained steady. I'm not sure I buy the argument gross margins are higher internationally than in France.
    2) I can't get my head around why so little PP&E is needed - when apparently they manufacture most items themselves and outsource little. Also don't they own any of their own land or buildings? Ideas?
    3) What is your take on the advance payments (11.6m). Should these be deducted from cash or not?

    ReplyDelete
  5. Thanks.

    1) That's certainly a plausible hypothesis and I agree with it in part. Gross margin has crept up 100 bps, though, so it seems to me that there must either be some pricing gains happening for one reason or another and/or a higher service mix. And, after accounting for increased delivery of services, one is still left with an unexplained gross margin improvement. I don't have a definitive answer but in my long ago, largely forgotten experience of international infrastructure projects, some subcontractors' billings are so small relative to the total cost of the project that they can afford to pad a lttle without anyone minding too much.

    2) It's a real mystery. There's virtually no PP&E on the books, they don't lease. But there's no cumulative depreciation of PP&E that I could find, so its possible that they have already entirely depreciated their owned property.

    3) The advance payments are deferred revenue, and therefore a free loan to be repaid in product and service rather than cash. I don't see any reason to treat this differently than an insurance company's float or a retail company's gift cards.

    By the way, there is a French blogger who sees GEA differently and his thoughts are worth reading: http://valueinvestingfrance.blogspot.com/2012/09/gea.html

    ReplyDelete
  6. Thank for the prompt reply. Your point about smaller sub-contractors being able to gain some extra margin is a good one. You see this regularly at companies whose products are both important and a relatively small part of COGS; they invariably enjoy good margins. Just not sure this is the case with GEA. I would think that GEA would enjoy higher margins in F than abroad - better utilisation of fixed costs, leverage of installation network, large market share, etc. I admit to some surprise that the service revenues aren't higher than they are - they have grown, but you'd think with a much higher installed base they'd actually be higher. And, indeed, higher service revenues ought inevitably to lead to higher margins.

    I'm sorry you also don't have a satisfactory explanation for the absence of fixed assets. I just don't understand how you produce so much with so little. Others apparently worry at the sustainability of the business at current margin levels (e.g. valueinvestingfrance). Given the roads are there, replacement demand is clear, and GEA's huge F mkt. share they do have an advantage of some sort, if not a moat. I do worry that I'm missing something though. 1.4m in MFA to generate 60m+ in sales is just not a normal relationship.

    As to advance payments, the float aspect is clear. BUT, what is that float worth? Is it worth the nominal value of cash? It is it for example, an opportunity benefit; no need for expensive external financing, etc.. Given the excess of cash this doesn't seem the case for GEA. Besides which this feels great in theory but less so in practice. Buffett invests his float. GEA can't really. Thus in practice it is almost certainly parked in a very safe but low interest account. This is worth something. But probably well short of its nominal value (ie 1 EUR = <1 EUR) given current interest rates. If the amounts were smaller this might not be an issue but it is not an inconsequential amount (c. 1/6 th of the current sh. price). I'd like to assume this was not an issue, but fear it is.

    Thanks for your work and your thoughts!

    ReplyDelete
    Replies
    1. I hear you.

      RE: MARGINS & TURNS

      You're puzzling over the same issues that I had to confront when I was first considering this business.

      Let me see if I can break down some of my thinking at the time:

      1. In the first half of the prior decade, GEA was operating with under 1.5 million in PP&E but generating half the revenues that is now. The return on net tangible assets was low (~4%) and that, too, was a mystery: a business in that line of work, i.e. specialized equipment, facing that industry structure, with the relationships that it enjoys, should be earning circa 30% to 40% returns on net operating assets.

      2. In the second half of the decade, revenue grows by a factor of 1.5x, the margins expand by 100 bps, and, given that one doesn't need to build another factory to churn out approx 20% more units (20% volume x 10% expansion in gross margin = 50% increase in revenue,the fixed assets now turn over 43x rather than 23x -- that's operating leverage.

      3. So, the real curiosity is not about the second half of the decade, but the first half.

      Asset turns at 23x suggests a low volume, high value product. The cost of equipping a lane for dual manual/automatic electronic toll collection is circa EUR 80K (see here: http://ntl.bts.gov/lib/jpodocs/repts_te/7223.pdf , for example), and that suggests the manufacture & sale of about 440 units per year.

      Can one or two machines a day be manufactured in a space valued at EUR1.5m, net of depreciation? I think so. (As an aside, low volume, high value may also explain the high carrying cost of the inventory; the inventory is 4x the PP&E).

      4. So, if the first half of the decade can be explained in that way, then understanding the second half is not too problematic: instead of 440 machines, its 520. Same space, faster production process. Faster selling cycle so that inventory rises at a slower rate than revenues. Margins improve, services increase, and it all adds up to a plausible plot.

      That's the story I told myself then, and I was comfortable enough with it. I don't think that I've encountered a more plausible hypothesis since.

      RE: VALUE OF THE CASH

      1. Well, the company authorized a share repurchase program that sets the floor at EUR 61 for the next 18 months ("We may buy 118K shares and spend no more than 7.2 million").

      2. In the worst case scenario, the next decade is exactly like the past decade, and GEA just sits on the cash for 10 years. In which case, the cash is worth 35 instead of 39, and GEA is worth 80 million, or EUR 67. Which, of course, is where we are now.

      I think it's important to note the business is operated by its owner rather than by an agent. He's been at this for a while and hasn't yet done anything ill-judged. Every decade has been better than the last, it is in the right industry at the right time, it has locked up its domestic market, it has close relationships with customers who carry it to emerging markets. I think it would take some imagination to see the stock fall from this level.

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