What was cheap gets cheaper

Vianini Industria (VIN.Italy)

Price: €1.27 (11/8/11)

I posted about Vianini Industria previously, it was one of my first posts about international net-net's.  Since the post I'd kept my eye on it, but not very closely.  A few days ago I received a comment on the post which made me revisit the stock.  Here's the comment:

Mauro said...

Hi Nate,

it has been years since I'm following this stock and I've decided to buy it today...
now VIN is at 1.15,about €35mln in market cap. VIN holds now €30mln in cash, about €26mln in good stock shares(who are on their lows) and total liabilities about €7mln,so no debt... not to mention all the credits,physical assets that it owns.
In the June2011 semester report there's a little note saying that there's an additional €46mln in fixed assets which have been totally depreciated,thus not resulting on the book: about €11mln of these are buildings and land. With a very very conservative calculation,I think that this €46mln can have a value of around €10-15mln to add on the book...
with my analysis VIN's value is around €80-90mln,thus between 2.6-3.0 per share.

VIN is a deeply undervalued stock but should be considered because:
-the company is relatively stable and the losses it had are made by financial loss with it's stock portfolio
-the assets are tangible and very liquid
-in economic crisis people want to trade liquid stocks to get out quickly,so only the bigger ones...thus the small ones get dumped without much thought
-after years of inactivity the company is in work progress to install a huge solar power plant,thus a way to invest the huge cash it has and hopefully producing a decent income(and dividends)...and of course it will be more visible to investors.

My concerns when I looked at the company previously were the quality of earnings, and margin of safety.  I want to take a look at both of those items seven months later.

Asset Value

This is really the main driver for the investment, Vianini Industria is selling at an incredible discount to it's asset value.  Here is my net-net worksheet:

Right away the first thing that hits me is that the discounted NCAV is almost double the current price, this is rare.  What's even rarer is the composition of assets that the company has.  On the balance sheet €60m is in cash and publicly traded securities, liquid assets that could be sold today and fair value realized.  The securities are holdings in two companies Assicurazioni Generali SpA and Cementir Holding SpA, both Italian securities.

Taking this right off the bat we have a stock with €60m in cash and securities with €7m in liabilities (none of it debt), or a net-cash position of €53m against a market cap of €38m.  The company is selling at a discount of about 28% to the net cash value.  

What I really like about Vianini Industria is something Mauro pointed in the comment was that the company has some hidden assets.  The details are found on page 29 of the HY report in note 1.  The note discusses the property plant and equipment account, following the discussing of the balance sheet values is the following translated text, "The following are the values of tangible assets fully depreciated but still in use.

Cost                           30.06.2011

Buildings                          11,771

Plant and machinery         33,282

Industrial and commercial  2,509

Other assets                          340

Total                               47,902"

This is an interesting note, basically the company has €47m in assets that are being used to create cement products that aren't reflected on the balance sheet at all.  These assets consist of the the land the cement plants sit on throughout Italy and the cement facilities themselves.  Even though these assets don't have an actual balance sheet value they have a very real world value, these are the assets the company is using to generate it's non-financial returns.

In my net-net worksheet I only give these assets a value of about 10%, but that's probably on the low side.  In reality the assets are probably worth a bit more, my question would be who is interested in the properties and equipment.  I'm not sure how many other cement companies are operating in Italy that would be interested in swallowing the Vianini Industria operations.  Secondly the land appears to be in some very rural places, so I'm not sure if a ready buyer would emerge quickly.  Discounting 90% takes all of this into account and gives a wide buffer for error.

Overall on an asset basis Vianini Industria is very attractive, and selling at a deep discount.

Earnings Value

When I previously looked at this company one of the things that concerned me was that most of the company's earnings was from financial income, or dividends of holding companies verses operating earnings.  The operating earnings record is quite poor and very lumpy as seen below.

For the trailing nine months EBITDA is barely positive, and after taking a depreciation charge operating earnings are negative.  This was a big concern I wasn't able to overcome previously, but my thinking has changed some in the past seven months.

First and foremost I always want a stable margin of safety, the last thing I want to do is invest in a company that is destroying the margin with a large cash burn or terrible acquisitions.  I don't see either with Vianini Industria.  The operations of the company are very poor, but the difference is made up with dividends from other cement holdings.  In addition the company has a high amount of operating leverage, meaning if the cement market starts to have an upturn earnings could shoot up dramatically for the company.

The company currently has a backlog of about €8m in projects, with the possibility of €9 more in extensions.  The company also has started supplying cement to a new energy plant which Mauro mentioned and is mentioned in the HY report.  Taken together this is about another year or year and a half of earnings at the current pace before new works needs to be found.

I would prefer that the company earn a 15% ROE and have great operations but that's unrealistic considering I'm able to buy the assets for less than 50%.  With Vianini Industria I'm buying the assets, and my hope is that the operations aren't acting against me, which they aren't.  

Margin of Safety

The margin of safety for Vianini Industria is very obvious, the company has a large amount of liquid assets in excess of its market cap, additionally they have some hidden assets, and a business that isn't eating at the asset value.

I keep trying to think of the worst case scenarios for Vianini Industria in an attempt to kill the stock.

The cement business hits a downturn - This is already true, I guess it could be even worse and there is a complete stop to railroad construction in Europe.  I believe this is already priced into the stock, and additionally even at low levels of production the company is squeaking by and just barely covering costs.  Secondly most of the company's earnings don't come from the cement operations, they come from dividends of other cement companies.

Their equity cement holdings could eliminate their dividends - This is a risk, although considering the market environment and they fact they're still operating and able to pay a dividend currently I think it's probably fair to say they'll be able to continue in the future.  Even if the holdings cut their dividends 50% Vianini Industria will be able to record a profit.

All cement production in Europe ceases - This is truly the worst case scenario, Vianini Industria would be operating at a loss, and so would the equity holdings.  In this case if they didn't cut any staff or costs they have enough cash to survive a complete halt for five years.

The Caltagirone family takes it private or takes the cash and securities - This is probably the biggest risk, the family holding the company takes it private at some low multiple.  The family already has control of the company, and the company supplies the other family companies.  While this is a risk I see it as a unlikely risk.

If none of those scenarios play out the company has enough cash to weather a very long dry spell in the cement business.  I feel that I'm adequately protected against a loss by buying the assets at such a big discount, additionally once earnings turn around I think the stock could begin to rise quickly.

Why is it cheap?

There are some obvious reasons why Vianini Industria is cheap, and the reasons are pretty good, I'm just going to list them out.

• The company is 66% controlled by the Caltagirone family, only 33% of the float is public.
• The actual business is pretty bad, low margin, loss making, terrible return on equity.
• The stock has a small market cap, and is priced around €1, not much institutional interest.
• There are a lot of related party transactions with other family controlled companies, it's possible Vianini Industria isn't getting the best prices for their goods, or they are overpaying for materials and supplies.

All of the above reasons are perfectly valid, and if I was looking at Vianini Industria as an investment into the cement making business I would probably avoid it.  The key to this stock is that the value doesn't reside in the business, it resides in the assets, and the hidden assets.

The question I asked when looking at Vianini Industria is do I think that cement production will completely halt in Europe for five years?  That's my worst case scenario, and the scenario where this is a losing investment.  I don't think that will happen, I have an adequate margin of safety protecting my investment and the company has the resources to wait out the downturn.

Talk to Nate about Vianini Industria

Disclosure: Long a small stake in Vianini Industria looking to increase it over the next few days.