An even better French small cap: Precia Molen

"It isn’t exactly cheap. But it’s a good value." - Walter Schloss

For all the fear in Europe I'm finding good value, but not screaming bargains.  My dream is finding companies like Precia selling for less than NCAV, but the only place that exists right now is Japan.  Instead of once in a life time bargains the European situation is making good companies cheap, Precia Molen is one of those.  This company almost forced itself upon me, I received some comments and emails praising it after my post on Gévelot, it appeared on the list of comparables for Gévelot, a list Geoff Gannon created, and a trusted investing friend recommended I look at it, how could I not?

What they do

The easiest way to describe Precia is that they enable customers to weigh things.  They build scales and scale systems that range from small scales a laboratory might use to a scale system used at a truck weight station.  The scales I find most fascinating are their continuous scales.  A scale of this sort is installed onto a manufacturing assembly and will constantly evaluate volume or product weight.

A distinction I feel I need to make about their product is it's geared toward high usage applications.  They don't just make scales that people use to weigh things, they make scales that are integral in a customer's process.  In a manufacturing setting if a scale is broken a machine won't know when to stop filling packaging.  If a scale breaks in a lab researchers won't be able to conduct experiments.  I don't say this to mean that Precia has a moat, I don't think they have any sort of competitive advantage at all.  But I want to point this out because their product is a necessity.  A client will find a way to replace their product if it breaks, they can't defer replacement until times get better.  This is important because scales that are used often will eventually wear out no matter how well built they are.

Why invest?

I want to try to get back to the idea that a suitable investment thesis can fit on the back of a napkin, and present that with each post.  Here is my stab at a napkin thesis for Precia Molen:

A company that's been consistently growing profits the past ten years while steadily growing book value deserves to trade above book value with a P/E higher than 7.8 and a EV/EBIT higher than 3.6x.

Additional factors:

• 43% of the market cap is composed of cash.
• Debt is 21% of equity and interest is covered 38 times.
• The company pays a growing dividend, past six years growth rate is 11.2%
• Earnings growth rate for the past 10 years is 17.9%
• ROIC of 17.12% and ROE of 13.4%
• Expanding into India, Morocco, Brazil and Romania.
• Management repurchased shares 

Earnings power

Most of my thesis rests on Precia's earning power, a company with their earnings power and growth shouldn't be trading at the level they are.  The question I first asked was is their business under pressure such that earnings are about to drop off a cliff?  The answer to this question comes from the company themselves, here's what they said:

The macro outlook is cloudy in Europe, but Precia believes that 2012 should be similar based on current demand.  This could obviously change at any time, but this is better than what Gévelot's management said, they said they were feeling the pressure and doing their best to react.

I put together a little spreadsheet showing earnings, earnings per share, and the growth rate for the past ten years.

The reason I did this was I wanted to see if a slowdown in earnings growth was leading to their undervaluation.  Often a company that is consistently growing will be punished by the market when growth slows.  I think this spreadsheet shows pretty well that while earnings have grown solidly it hasn't been a straight line, and each year hasn't blown out the last like Apple does.  The results have been lumpy, but lumpy in the right direction.

One thing that always makes a deep value person like myself nervous when looking at a company like Precia is I want to see where the cash is going.  Are shareholders being rewarded by purchasing and holding onto this company?  I created two graphs to show that I believe that's the case with Precia.

The first graph shows the equity value per share growth since 2006:

This graph shows the cumulative growth per share in assets, dividends and intangibles:

Risks

A lot of the reason this company is cheap is it happens to be located in the wrong spot, in Europe where business is set to seize up and everyone will be living on the streets soon (well at least if you read US media).  Looking beyond the hype there are a lot of headwinds facing companies over there, reduced demand, and increased financing costs to name two.  I really thought this over for Precia, how will this company fare?  Will I be looking back in two years wishing I would have just had cash and avoided the investment?

I took a step away from the headlines and thought about Precia's business and clients.  I have no reason to believe Precia's scales are of anything other than average quality.  The fact remains they're used often and they're high volume products.  Putting something heavy on top of a scale day after day will eventually wear the scale out no matter how well it's manufactured.  If these scales are integral to client processes the clients will be forced to upgrade no matter what the financial situation is.  They might pressure Precia to reduce their prices, but they will eventually need to upgrade their scale.  If not through Precia through a competitor.  Based on my experience with manufacturing companies if they have someone build out a system for them in almost all cases they will have that same company service it, and if the system lasts they'll have the same company replace it as well.

I should mention here the company isn't immune, they took a write down in the beginning of 2011 over their Irish operations.  The goodwill impairment was small around €300,000, but they were still impacted.

Final Thoughts

I read a fair amount about Precia, read through their annual report and looked back at their history asking myself "why shouldn't I invest?"  I couldn't come up with a good reason.  This isn't the cheapest investment I've ever found, but if the company executes in the future in a similar manner to how they have in the past I think this is a very good value buying almost exactly at book value.  I was initially disappointed that I wasn't finding quality net-net and cheap book value stocks in Europe.  Then I realized that if I fill out a portion of my portfolio with companies like Precia Molen at very reasonable valuations I will do fine over time.  This isn't the sort of investment that's going to return 75% in the next year, but I think in five or ten years I'm going to be very satisfied.

Talk to Nate about Precia Molen

Finding more information
Ticker: PREC.France
Website: http://weighing.preciamolen.com/
Annual reports: here
Reports in English (summary versions): here

Disclosure: Long Precia Molen