Tuesday, September 18, 2012

Precia SA -- Measuring instruments



Precia Molen ("Precia") is a supplier of instruments that measure, weigh, count, and dose in contexts where exactitude matters a great deal – pharmaceuticals, chemicals, agro-industry, mining, construction, railroads, and many others. Its instruments “weigh anything from a grain of wheat to a sea-going vessel”.  

In support of the design, manufacture, and marketing of these instruments, Precia provides a number of pre- and post-sales services: instrument selection advice, application engineering, pre-installation visits, calibration and commissioning, on-site training, repairs, spare parts, and so on.

Industrial weighing is important, and in some circumstances mission critical: imperfect weighing of pig iron will cost someone a lot of money; imperfect measurement in flavors and fragrances will lead to the manufacture of unusable batches; imperfect measurement of pharma dosages may cost lives. 

What matters most, therefore, is not going to be price, but service and reputational quality. 

This means that measurement instrumentation is a business suited to specialists – in established markets, one can’t easily buy in to the business: one has to wait a long while before a reputation is built, distributor relationships forged, service personnel reach appropriate levels of excellence and reliability. 

For incumbents, therefore, gross margins should be very high, and corporate financial health – operating margins, return on capital, cash conversion -- should follow from that. As the incumbent's business grows, overhead should constitute a smaller share of costs, replacement parts and services should constitute a larger share of revenues, and the return on incremental investment should therefore outstrip ROIC.

Like so:






Precia is currently yielding 18% and is worth approximately 135 – without growth, just doing maintenance business and servicing its current client base.



In recent years, however, Precia has sought to expand internationally, i.e. beyond the European Union. International sales now account for 34% of sales and 31% of profit.

While the company has identified Brazil, Australia, Indonesia, and Eastern Europe as promising markets for its products, its activities in these markets is still embryonic. 

Those international markets in which it has already established a presence, however – India and Morocco, in particular – are growing at 14%, helping to drive overall revenue growth by 4.5%. The client list of Precia's India subsidiary is illustrative of the potential:


It's not out of the question that international sales (and profits) will constitute 50% of both revenue and profit within three years. In fact, it seems unlikely that it won't: India alone contributed 2.8 million to revenue in 2010, 3.65 million in 2011, and is on track for something like 4.55 million in 2012. Brazil is a similar opportunity to India, in terms of both size and market characteristics. 

Barring exceptional events, therefore, one can peer into Precia's future:



If one assumes that an ex-cash P/E ratio of 1.77x is unreasonable for a quality business, one can envisage two paths to share price appreciation by 2015 -- via multiple expansion and via growth in earnings power:


Precia, then, has all the characteristics of the kind of investment that I have had success with: a solid competitive position, a clear pathway to growth, increasing economies of scale, a clean balance sheet,  free cash flow generation, significant insider ownership, and a history of increasing payouts. It is the safest way that I can think of to earn annual returns of 25% or more.

I am in debt to Nate at Oddball Stocks for the lead. His recent post on every stock he's ever written about is a treasure chest.

Disclosure: I have a partial position in Precia and intend to accumulate more shares in the near future.

11 comments:

  1. Hi Red,
    very nice analysis. It is definitely a nice stock whose business is nice and boring but which has a nice moat. The share has already increased by 33,71% since the beginning of the year what would your entry point be?
    Their gross margin is growing nice and steadily which always a good sign. Do you have a look at the historical ROE?
    Once again, many thanks for your analysis. It is definitely an under the radar company which is also a nice company!
    Cheers
    Jeremy

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  2. Hi Jeremy,

    I was fully invested and only recently sold a position in another stock. I'm hoping use funds from that sale to accumulate a full position in Precia at prices below 75. I've already started buying but, as you may know, this is a fairly illiquid stock and building a reasonable position may take some time.

    I'm more interested in return on incremental investment ("RONIC") than I am in ROE. In fact, I only really ever calculate ROE for financial companies. There is so much excess cash on Precia's balance sheet that I can tell that the ROE will be somewhere in the 11% to 13% range and will be improving over time. The underlying business, however, earns 20% on the cost of the assets required to operate it. And. more importantly, its returns on capital are increasing with scale -- i.e. proportionately less reinvestment is required to support a larger volume of business.

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  3. Wow, that's a great tip. One does not normally find a company with such excellent growth prospects yielding 18%. I like the emerging market connection too (provided China does not go kaput).

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  4. Hi Red,

    Very nice writeup.
    Tell me please, how did you come up with the decision of how much cash is necessary for the company's regular operation, which of course had a mark on your ROIC (I think you left about a third of the cash in the working capital).

    Thanks,

    Michael

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    Replies
    1. Hi Michael,

      Noncash net working capital for the years 2008-2011 was 18.5, 16.1, 17 & 19.7. in other words, Precia requires 80 days of noncash working capital to conduct its business, plus or minus a day.

      Now, unless a company has a negative working capital cycle, I sometimes want to err on the conservative side. We know, from Mckinsey studies etc, that the average business requires cash on hand equivalent to 2% of revenue. That's one way of doing it. In the case of Precia, I have simply excluded the marketable securities from the working capital calculation. We know that cash & equivalents was 9% of revenue in 2008 and we can probably extrapolate from that that anything above that is certainly excess cash.

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  5. I had heared the new that in Holland one of the offices was declared bankrupt.
    check http://www.curatoren.nl/fo/insolventie/209071/precia-wpl-bv-h-o-d-n-precia-wpl-wpl-industries/
    There's no information about this but i know lawyers are involved in financial claims

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  6. Indeed, in Feb 2012 and reported in the Semiannual report a few months back. Thanks for the comment.

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  7. Are you still following? It seems international sales have not taken off as expected, but the opportunity is still there, and the shares still appear cheap (EV/EBIT at about 5.5).

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  8. This is one I follow quite regularly.

    GEA, another stock I wrote about at the time, has similar characteristics but trades 3x EBIT and offers a better yield.

    It's possible that Precia's last two acquisitions haven't been accounted for in share price but my sense is that they have. 50%+ payout policy would make allthe difference but I don't know how to handicap that.

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  9. I took a quick look at GEA. Certainly looks cheap, but what is the plan for the massive amount of excess cash? If Google Translate has not betrayed me, it looks like there's a buyback in place, but it's not being used. The company is starting to look like a cash box with a business attached.

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  10. There are materials in English and the excellent blogger "caque "keeps up to date with GEA here
    http://valueinvestingfrance.blogspot.com/

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