Bunzl Plc (OTCPK:BZLFY) is a compelling long-term investment opportunity with some powerful short-term catalysts for an immediate upside of at least 20-25% in our opinion. We will show the valuation and mis-pricing of this company by simple FCF (free cash flow) analysis towards the end of this article to prove our point. As value investors ourselves, we think FCF is the best measure of valuing any particular investment. As a matter of fact, the upside could even be greater under a blue sky scenario but we have remained conservative and have performed valuation using current metrics of the firm in this tough economic environment. Although the stock has done very well over the last 10 years, investors seemingly think of this company as a value play, while the company remains a growth story, as we shall demonstrate in this article. Thus the company is not being valued fairly and investors are seemingly ignoring the future benefits of recent acquisitions. With the market cap of 4.62 billion GBP, it is easy to see Bunzl as a relatively mature company; however, its growth hungry demeanor will surprise you. The company is a stellar performer in its field with a steady cash generative business while its long-term prospects remain excellent. Perhaps that's why Bill Gates' Cascade Investments LLC is the second largest shareholder of this company with a 5% stake currently worth about USD $375 million.
Bunzl Plc was founded in 1940 and is based in London, the United Kingdom. Bunzl Plc distributes non-food consumable products in North America, Continental Europe, the United Kingdom and Ireland, Australasia, and Brazil. The company supplies a wide range of consumable products such as food packaging, disposable tableware and catering equipment, cleaning and hygiene supplies, guest amenities, personal protection equipment, packaging and healthcare consumables to various customer markets including grocery, foodservice, cleaning and hygiene, safety, non-food retail and healthcare.
In addition, the company supplies cleaning systems, floor care items, hand cleansing products, hygiene paper, janitorial products, cleaning machines, mops, polishes, protective clothing, and washroom chemicals to facilities management companies, contract cleaners, and other industrial and healthcare customers.
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The company's Chairman "Philip Rogerson" has the following to say about the company:
"We continue to pursue our proven strategy of developing the business through organic growth, consolidating the markets in which we compete through focused acquisitions in both existing and new geographies and continuously improving the efficiency of our operations. We achieve our organic growth by applying our resources and expertise to enable customers to outsource to Bunzl the purchasing, consolidation and distribution of a broad range of goods not for resale. By doing so our customers are able to focus on their core business more cost effectively by achieving purchasing efficiencies and savings, freeing up working capital, improving their distribution capabilities and simplifying their internal administration."
Bunzl Plc is a leader in the market of distribution of daily consumables with consistent growth, stable operating margins and a very high return on invested capital. The company has been on acquisition binge for the last few years and thus remains a growth story. The company has more than 12,800 employees and operates in 27 countries and has a market cap of 4.64B GBP (about 7.5B USD). Bunzl Plc (ADR) (OTCPK:BZLFY) currently trades on OTC markets in the US with a recent price of $22.77 USD per share. (The shares traded at 13.99 GBP on London Stock Exchange (LSE) as of November 29, 2013)
The company had 2012 total revenue of 5.36B GBP (about 8.8B USD) and is projected to grow by 11% at the end of 2013, which would be a blend of organic growth and growth from acquisitions. An extremely important aspect of Bunzl's business is that it does not require any significant amounts of ongoing capital expenditures (capex). For example, in 2012, the capex was just 23M GBP on the operating cash flow of 265M GBP and majority of it was on IT and warehouse servicing. The company is spending majority of its generated cash on new acquisitions, which is very forward looking in our opinion. In spite of the fact that the company is in a growth mode, it has consistently grown its dividend since 2004.
Sources of Revenue:
The company derives 56% of its revenues from North America, 20% from Continental Europe, 16% from UK & Ireland and about 8% from the rest of the world. The profits follow approximately with the same ratios.
The company's strategy is based on three key areas of focus:
- Commitment to growth: organic
- Commitment to growth: acquisitions
- Continually improving operating model
The percentage of the revenue is distributed among its four major markets as follows:
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Recent Performance:
Please see below the highlights of the company's recent performance metrics:
- Revenue growth 11%
- Operating profit up 12%
- Operating margin up 10 bp
- EPS growth 10%
- Dividend per share increases 14%
Bunzl Plc has beaten the FTSE 100 index by 65% in the last 5 years (see chart below). The total 5 years return is a little more than 120%, which comes out to be around 17% CAGR. As a matter of fact, OTC shares in the US have fared far better in the last 5 years with a total return of 170%.
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Source: FT.com
The company's ROIC (return on invested capital) is a healthy 17.5%. Although the company has been on acquisition binge, the management has not lost the sight of operational efficiencies and organic growth. Therefore the company's management is intelligently focused on all areas of business and aspires to becoming a true global leader in its business.
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The company had net debt/EBITDA of 1.8x end of year 2012 and average working capital to sales at 9.6%. Operating cash flow in this case is almost equal to operating profit with the latter being 97% of the formal. The company deploys uniform reporting in all of its geographies. The company grew its dividend since 2004 at a CAGR of 10% over the past 8 years. The Board is recommending a final dividend of 19.4p in 2013, which brings the total dividend for the year to 28.8p, up 7% compared to 2012. Also the shareholders will again have the opportunity to participate in the dividend reinvestment plan.
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Well diversified sources of revenue:
Bunzl Plc is not your typical food distribution company but is a well diversified conglomerate. If you are comparing Bunzl Plc to the companies such as Sysco Corp (SYY), you are mistaken. Here is an exact breakdown of the revenue from each segment in the year 2012.
Below is the visual representation of the percentage of revenues from each segment:
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Bunzl Plc company is an astute buyer with increased acquisition activity as of late - the company made 13 purchases in 2012, with an investment of approx. 277M GBP, adding annualized revenue of over 518M GPB. In 2013, year to date, the company has had 6 acquisitions with a total capital outlay of 203M GBP for annualized revenue of 190M GBP. If the company can keep its current operating margins (6%) on these acquisitions, these are very impressive deals. Bunzl Plc is trying to become a one stop shop in all areas in which it serves its customers and has accomplished this with flying colors thus far, in our opinion. The company continually strives for excellence by investing in its IT infrastructure and modernizing its warehousing for operational efficiencies.
The company has a highly decentralized structure and each segment is operated as if it were an independent business unit. By having such a structure, each business is responsible for its own P&L (profit/loss) statement and management bonuses are based on achieving specific goals only. Furthermore, the executive management claims that each business unit CEO has on average 15 years of experience in their respective fields. The company keeps on pursuing its proven strategy of developing the business through organic growth, on consolidating the markets in which it competes through focused acquisitions in both existing and new geographies and continuously improving the efficiency of its operations.
Bunzl's acquisition strategy is to seek out those businesses which satisfy key criteria, including having good financial returns in resilient and growing markets, while at the same time providing opportunities to extract further value as part of the Bunzl Group. We believe the company has a business model for the 21st century where it delivers to its customer exactly what they need at the right time. The customers look upon the firm as a reliable resource which can deliver much needed products just on time. By outsourcing, Bunzl's customers are free to focus on their key businesses and not to have to worry about processes and other red tape. This is the value proposition that Bunzl brings for its customers and is well suited for today's business environment.
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Risks:
Every company, even if it is growing by leaps and bounds, comes with some risks and Bunzl Plc is no exception. Bunzl Plc (ADR) trades on a very thin volume of about 11,000 shares per day on average and this may cause a large gap in bid and ask spreads, especially during volatile times. Also if someone is trying to get out of a position (although this is more of a problem for institutional investors), it might take some time to be completely sold out of the position without causing any price gyrations in the marketplace. The institutional investors might want to consider buying directly through London Stock Exchange. (I can say with certainty that Bill Gates must have bought his 5% stake either through LSE or perhaps directly through the company but likely not through OTC markets).
Another concern is that since the company has consistently been acquiring other businesses, at times it must pay a premium to the book value of the acquired company which is recorded as the goodwill on its books. If Bunzl Plc overpays for an acquisition, it might have to record impairment charges in future which directly destroy the shareholder value. One prominent example of such a scenario occurred in 2011, when the company had to dispose of its Vending business altogether. Bunzl entered the vending sector, which is both more capital intensive and less resilient than other Bunzl businesses, in 1999 with the purchase of "Provend Group." At the time, Provend Group also included a large foodservice distribution business that expanded Bunzl's existing catering supplies operations. With passage of time, the company realized that its strategy is to focus its resources on areas where it has or can develop real competitive advantage; the Board concluded that the vending business was no longer a strategic fit within the portfolio of the company's businesses. The revenue of the business was just 33.2M GBP and in the same period the operating profit before intangible amortization was £ zero. Based on the estimated net assets disposed of, the company took a loss of approximately 55M Gbp.
The book value of intangibles at the end on Dec 31st, 2012 was 1.3B Gbp, which is a little high in our opinion. The intangibles included items such as Goodwill (£822M), Customer Relationships (£776M) and Amortization (£276M). The amortization of intangibles period varies from 10 to 19 years. This tells us that the company has paid significantly higher than hard assets of the businesses that it has acquired in the past. The positive takeaway in all this is that the brand name in any service business is the most valuable asset and being a customer, you are not going to outsource to an unreliable company. This tells us that Bunzl must have been acquiring quality businesses so as to keep its brand value intact.
Slowdown in each of its business segments unexpectedly is another concern. Americas and Europe are still in the recovery mode from effects of recession and economists widely believe that any hiccup in the recovery will send these economies into a tail spin, definitely bad for Bunzl. Furthermore, the company has to consistently integrate new acquisitions into its current systems and redundancy is a major issue (having two vice presidents for the same job is not a good thing). Having said that, the company has done a great job thus far of absorbing new acquisitions and giving them enough leeway to operate independently, so redundancy had been less of an issue as than one would otherwise think.
Competition:
In our opinion, Bunzl does not do a good job of highlighting its competition, so we had to dig deep in order to find few names in this landscape. Below is the chart that shows how well the company is doing in comparison to its competitors.
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As you can see above, the company fares well as compared to the competition if you do a broad comparison.
Bunzl's Recent Acquisitions:
Bunzl's latest acquisition is in Canada as it acquired Wesclean Equipment & Cleaning Supplies Ltd.
Based in Edmonton, Alberta and operating from 13 locations throughout Western Canada, Wesclean is principally engaged in the distribution of cleaning and hygiene equipment and supplies to a variety of customer markets. Revenue in the year ended 30 September 2013 was C$65 million.
Commenting on the acquisition, Michael Roney, Chief Executive of Bunzl, said:
"The acquisition of Wesclean is an important development for our business in Canada as it significantly expands our operations there in the cleaning and hygiene sector. The business has an excellent reputation for providing a broad range of products and services and should provide additional opportunities for us to develop further in this sector. We are pleased to welcome all their employees to the Group".
A table of other acquisitions throughout 2013 is presented below:
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Valuation:
Company is currently trading at P/E of 23.17 and forward P/E of about 18. EV/EBITDA is around 13. Let us start with the free cash flow analysis, which is the holy grail of value investing.
FCF (Free Cash Flow) Analysis:
Please see table graphic below for all values for FCF with different discount rates and certain other assumptions such as 10% earnings growth for the first 7 years since the company is due to benefit from its 18 some acquisitions in the near future. We assume a flat perpetuity growth of 3% in our FCF model after first 7 years.
With 8% FCF Discount:
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Applying higher discount rates gives the values as shown in below table graphic:
Now Bunzl Plc shares have been trading around USD $22.77 as of this writing. So there is an immediate upside if you were to purchase its ADR shares today. The company has a proven track record of generating free cash flow and increasing dividends so applying the above discount rates is more than justified and a discount rate above 8% is just a hedge for the margin of safety in our opinion. The recessions in Americas and Europe are not over yet and customers are still cutting back to save money. As things improve in Europe, Americas and the rest of the world, things are only going to get better for Bunzl Plc. Thus we remain highly optimistic about the future prospects of this firm. Furthermore, the company will realize additional revenues from its recent purchases going forward. The company has a track record of smoothly integrating newly acquired businesses, so we remain confident that recent acquisitions would follow the same pattern of flawless integration as past ones.
The company is still undervalued from a P/E ratio perspective. The management has given guidance that the company is expected to earn anywhere between $1.40 and $1.44 per share in 2013. The average P/E for the last 10 years is 17.1 with 23 being the highest and 14 being the lowest. So let's do a stress test on the share price using earnings guidance for 2013 with different P/E values as shown below. We come up with the following values for the company.
The stock is currently trading around 22.77 USD, so applying the most pessimistic values above provide a value ($19.60) lower than the current stock price and we shall discuss this under risk section below.
Catalysts for stock appreciation:
The following catalysts will allow the stock price to appreciate considerably in the near future.
- The company is wrongly categorized as a value stock while it truly is a growth story. The company is firing on all cylinders with new acquisitions and the best part is that company does it with its own cash without raising significant debt.
- Being a decent size company, the lack of zeal from Bunzl Plc to be listed on any major US exchange is astounding; however, this very fact gives it less visibility hence making it a good deal.
- The company derives a whopping 56% of its revenue from North America and yet has thin analyst coverage in the US. Since it is becoming more difficult to find bargains in the large cap universe in the US, we think investors would be looking outside the US for investment opportunities such as Bunzl Plc.
- The acquisitions that Bunzl Plc has completed thus far have yet to bear fruits, which would benefit the stock price.
- Bunzl Plc's (ADR) stock split in the ratio of 5:1 on Nov. 26, 2013, with a record date of Nov. 25, 2013 (Source: Citi's Depository Receipt Services). Although it does not fundamentally change anything about the company, the research shows that stock prices typically benefit from stock splits
Does Bunzl Plc present an asymmetric risk/reward opportunity?
We think so. Let's discuss why such is the case.
- First of all, company is rather wrongly categorized in investor's eyes who think of it as a value play with the market cap of more than £4 billion in the UK - and more than $1 billion in the OTC markets in the US; however, the company is actually a growth story. The company generates a healthy cash flow from its current business which it deploys to make further acquisitions. The discipline with which Bunzl has made acquisition deals in the past tells us that this company is an astute negotiator and avoids over-paying at any cost - a fact that creates tremendous value for the shareholders.
- The company's businesses provide a high and consistent cash flow, which helps fund future development and growth. The company seeks to maintain an appropriate balance between the higher returns that might be possible with higher levels of debt and the advantages and security afforded by a sound capital allocation. There were no changes to the company's approach to capital management during the year and the company is not subject to any externally imposed capital requirements.
Worst case downside risk(s):
- Just to give you an idea, since 2004, Bunzl Plc has announced 70 acquisitions with the capital outlay of £167 million and these deals have generated average annualized revenue of £263 million. Keeping in mind that the company has net margins of 6%, it means producing £16 millions of profits, which turns out to be healthy 9.5% return on investment (ROI). Since the company is acquisition savvy, we don't foresee Bunzl Plc making any gross errors of judgment or over-paying for its acquisitions which limits your downside risk. Worst come to worst, the company can stop its acquisition spree and start preserving cash for future years.
- The company is currently operating profitably in one of the toughest economic environments in two of its most important markets, i.e. Americas and Europe. The company grew its revenues from 4.2B GBP in 2008 to 5.3B GBP at the end of 2012, which is an increase of about 28%. Don't forget that this performance was achieved in one of the worst recessions in history and general consensus among economists is that things will get better. However, in case the US or Europe completely spiral down into a full blown recession going into 2014, Bunzl will have 300M GBP of cash to fall back upon. If earnings drop 10-15% going forward, the downside from current valuation is also in this 10-15% range (since company has minimal capex, its operating cash flow is fairly close to its free cash flow). Now look at the free cash flow analysis above and consider the lowest derived value (using highest discount rate), which is $29. Applying a discount of 15% to this value produces $24.65, which is still slightly above the current stock price. So there is enough margin of safety even considering a doomsday scenario.
- Considering an extremely pessimistic valuation and using the lowest P/E ratio that stock has traded in the last 10 years, we come up with a price of 19.60 USD, which represents approx. a 15% downside from the current stock price.
So we see an immediate upside of 20-25% (if not more) considering extremely conservative valuation above while the maximum downside comes out to be about 15% considering a doomsday scenario. Thus doing a fair comparison and weighing different real world scenarios in today's economic environment and looking at stellar past performance of the company, we are of the opinion that it presents a compelling asymmetric risk/reward situation.
Conclusion:
Bunzl Plc (ADR) is a fairly sized company that is undervalued by any measure in our opinion. We see a near term 20% to 25% upside with an excellent longer-term potential as acquisitions are settled and become a fresh source of revenue. The company has a stellar history of executing its strategy and integrating newly acquired businesses, a rare trait in our opinion. The management is focused on creating shareholder by giving a reasonable dividend even in the current growth mode as well as wisely spending on improving operational performance of the business. The company provides a good diversification from all of its segments and the revenue is derived from daily consumables thus providing a margin of safety if anyone of them slow down unexpectedly. The company has positioned itself in front of its customers as a reliable supplier on when and where needed basis. We are of the opinion that the company will continue delivering excellent results in the future by executing on its clearly defined strategies. Perhaps due to Bunzl's bright long-term prospects, Bill Gates remains long with his 16.5 million shares in the company.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in OTCPK:BZLFY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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