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White Falcon Capital FY 2022 Partner's Letter

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Investment, written pinch dice.

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Dear Partners,

While individual customer returns whitethorn disagree based connected their inception dates, consolidated capacity of each accounts for nan play ending December 30, 2022 is arsenic follows:

Q4 2022

2022

ITD*

White Falcon (net of fees)

2.52%

-9.26%

-10.62%

S&P 500 (CAD)

5.25%

-12.59%

-9.75%

MSCI All Country (CAD)

8.23%

-11.86%

-10.55%

S&P TSX

5.97%

-5.76%

-6.29%

*Inception day is Nov 8, 2021

What a year! It has been volatile but this carnivore marketplace has allowed america to upgrade nan value and valuations successful nan portfolio. In nan 4th quarter, nan portfolio was up little than nan marketplace arsenic nan higher weight successful exertion stocks weighed connected performance. This was negated by nan portfolio’s position successful commodity stocks arsenic good arsenic nan buyout of Maxar Technologies (MAXR) which was a apical 10 position. We added to exertion stocks successful nan 4th arsenic they were anemic owed to taxation nonaccomplishment realizations and money redemptions. We are presently afloat invested.

The capacity this twelvemonth has been a communicative of 2 halves. After a drawdown successful nan 2nd quarter, we were up 14.65% successful 2H 2022, owed to which partners, who started pinch america successful 2H person seen affirmative capacity successful their portfolios.

Currencies played a large portion successful returns this year. The US Dollar (USD) appreciated against nan Canadian Dollar (CAD) by 7.2% successful 2022 which helped CAD returns. In opposition to nan CAD returns reported above, successful USD terms, nan S&P 500 returned -19.4% while nan Nasdaq was down -32.8%. We had an mean of 40% of nan portfolio successful US equities during nan twelvemonth owed to which nan USD added astir 3% to yearly performance.

While we show different indices above, it is important to reiterate that White Falcon does not negociate against immoderate index. Our portfolio is an esoteric group of businesses wherever each institution is underwritten based connected expected returns and wherever consequence is managed by buying bully value and increasing businesses tally by competent guidance teams. As worth investors, we put pinch a separator of safety. We are cognizant of nan truth that ‘what’ we bargain and ‘how much’ we salary for it are nan only 2 factors we control. At nan portfolio level, we negociate exposures and support a operation of compounders, maturation and worth stocks arsenic good arsenic typical situations depending connected nan opportunity astatine hand.

We are playing nan agelong crippled but recognize that nan agelong word is made up of galore short terms. In this letter, we look backmost astatine nan twelvemonth and talk existent positioning. We besides coming a investigation study connected a caller finance successful Diversey Holdings (DSEY) successful nan appendix to this letter.

What went correct this year?

Half of nan portfolio had affirmative realized and unrealized gains for nan year. Out of these, EPAM Systems and Maxar were nan largest affirmative contributors to performance. In addition, our weight successful nan commodity sector, including nan precious metals hedge, produced important affirmative returns.

EPAM Systems (EPAM) is an IT services company. We initiated a position successful EPAM aft it sold disconnected erstwhile Russia invaded Ukraine. The interest was that EPAM had a ample portion of its workforce successful Ukraine, Belarus and Russia. Until then, EPAM had been a precocious value compounder whose banal value had gone up 10x successful nan erstwhile 10 years. It was a beardown institution that had travel crossed immoderate impermanent headwinds and our study (Q1 2022 letter) confirmed that nan risks are manageable. We bought nan banal astatine $210 per stock successful Q1 and sold astir a 4th of our position successful nan $400-450 scope successful Q3. EPAM remains a apical 10 position and closed nan twelvemonth astatine $330 per share.

Maxar Technologies provides outer images to nan defense and firm sector. The institution was going to motorboat its caller and improved Legion satellites but was faced pinch delays owed to which investors mislaid patience and sold nan stock. We saw a bully value institution beset by impermanent delays pinch beardown FCF disposable for little than 10x EBITDA and bought nan banal astatine an mean value of C$35 per share. In December, Advent, a Private Equity firm, announced that they are going to buy-out Maxar and return it backstage astatine supra C$70 per share. We sold our position and redeployed nan rate into different charismatic opportunities.

White Falcon has a position successful Gold/Precious Metals via royalty companies. These equities performed their domiciled arsenic ‘hedges’ successful a very uncertain macroeconomic environment. In summation to precious metals, our guidelines commodity (copper, oil) vulnerability besides added positively to returns.

What went incorrect this year?

The different half of nan portfolio that had antagonistic unrealized and realized losses and nan communal characteristics they had was that they were either exertion stocks aliases mini caps aliases both! The biggest mistakes successful this handbasket person been Farfetch (FTCH) and CopperLeaf Technologies (OTCPK:CPLFF).

Farfetch is nan largest scaled e-commerce level for luxury goods. In summation to being a marketplace, it has a level solutions business (think Shopify for luxury) arsenic good arsenic a ain brands division. Our gross and separator estimates for Farfetch turned retired to beryllium excessively precocious when, during an investor day, guidance lowered their guidance for nan business. The business should beryllium capable to do 20-30% EBITDA margins successful a mature authorities but that is not looking apt owed to little realized marketplace powerfulness and an inflated costs structure.

CopperLeaf Technologies is a package institution that provides determination analytics package to nan inferior industry. It is simply a precocious value institution that has not mislaid moreover 1 customer successful its history. With beardown portion economics, guidance decided to tally ample operating losses successful bid to turn and has deed nan cleanable large wind arsenic these companies are being severely punished successful this environment. While our investigation confirms that Copperleaf is simply a beardown institution (Q2 2022 letter), we were excessively early successful our purchases and underestimated nan volatility of a debased liquidity small-cap Canadian stock.

Other exertion positions specified arsenic Amazon.com (AMZN) and Converge (OTCQX:CTSDF) besides contributed negatively to performance. We person checked and double checked our assumptions and stay assured that nan marketplace will admit nan worth of these investments successful owed time. The Nasdaq has been nan worst performing scale successful nan banal marketplace and pinch it comes redemptions and taxation nonaccomplishment trading owed to which inexpensive keeps getting cheaper.

In Summary

What worked successful 2022 for White Falcon,

  • Investing successful bully value companies going done impermanent dislocation
  • Risk and position guidance really helped from a portfolio guidance perspective
  • Exposure to precious metallic royalty companies and to inexpensive guidelines commodity (copper/oil) companies which, we believe, person structural tailwinds owed to proviso constraints

What did not activity successful 2022 for White Falcon,

  • Investing successful business that were complete earning owed to Covid/lockdowns
  • Exposure to higher maturation and higher aggregate stocks

One of nan difficult things successful this business is learning nan right lessons. The bigger correction this twelvemonth has been buying agelong duration/technology stocks excessively soon. We started building positions successful Q2 while it would person been overmuch much advantageous if we had waited until Q3 aliases Q4. This is not a timing strategy but conscionable a realization that bigger nan bubble -> bigger nan bust. Having said that, it is important to mention that losses are portion of nan crippled - nan instrumentality is making less of them and keeping them small! It is important to mention that we person taken our losses wherever we mislaid condemnation and added to positions and lowered our mean costs successful businesses that connection charismatic risk-rewards.

How are we presently positioned?

Our underlying operational rule is that, arsenic agelong arsenic nan business is wrong our circle of competence, we put arsenic charismatic risk-rewards opportunities appear. In a normal marketplace environment, we are fortunate to find a fewer bully ideas but this marketplace situation has presented america pinch galore bully risk-reward opportunities. Our portfolio and your superior is invested successful precocious value companies that person been bought astatine important discounts to their intrinsic values.

“The prime is not betwixt worth and growth, but betwixt worth coming and worth tomorrow.”

- Howard Marks

As of December 30, 2022, we are positioned arsenic follows:

By Sector

Weight (%)

Technology

45.72

Commodities

28.92

Retail

9.60

Financials

5.90

Other

8.11

Total Equities

98.25

By Style

Weight (%)

Compounders

32.42

Value Now

32.40

Value Tomorrow

33.43

Total Equities

98.25

By MarketCap

Weight (%)

Large Cap ( > $20 bn)

38.51

Mid-Cap ( > $1 bn < $20 bn)

40.19

Small-Cap ( <$1 bn)

19.54

Total Equities

98.25

Out of each nan different ways of looking astatine nan portfolio, nan astir applicable measurement for america to look astatine them is Compounders, Value Now and Value Tomorrow. After that, nan businesses tin autumn successful immoderate assemblage and immoderate marketplace capitalization. Compounders are bully value companies pinch precocious returns connected capital, a agelong runway for growth, and tally by competent guidance teams. Value Now companies are nan emblematic worth investments disposable for debased multiples of existent earnings. Value Tomorrow companies are structural maturation businesses wherever nan banal whitethorn not beryllium inexpensive based connected this year's net but cheapens importantly pinch nan transition of clip owed to maturation successful revenues aliases margins aliases both. The comparative weight of these buckets, astatine immoderate 1 time, depends connected nan opportunity astatine hand. This year, we person allocated much to nan ‘Value Tomorrow’ bucket arsenic these businesses became cheaper. In galore cases, these are sticky package aliases ascendant marketplace businesses pinch a nett rate equilibrium expanse and a agelong runway of growth. If we person picked nan correct stocks past we person apt group White Falcon for precocious compounding capacity successful nan future.

There is an breathtaking summation to nan apical 5 positions. We added Advanced Micro Devices (AMD) during nan quarter. The different positions stay nan aforesaid - Precious Metals royalty basket, Converge, NU Holdings, and Amazon.com. AMD is simply a fabless semiconductor institution that, nether CEO Lisa Su, has been increasing structurally pinch nan spot marketplace and taking marketplace stock from competitors. It is absorbing that successful 2020/21, semiconductor stocks specified arsenic AMD were revered and deemed to beryllium structural winners owed to which they were fixed precocious multiples. Today, astatine 17-18x net (and these net person already been trim respective times), location is very small liking successful AMD arsenic investors interest astir further short-term revisions. We position AMD arsenic a structural grower pinch a cleanable equilibrium expanse and a awesome guidance team.

Earnings for portfolio companies were not arsenic affirmative arsenic past quarter. Technology companies person been slow to trim costs and that is hurting their bottommost line. We spot immoderate greenish shoots present and stay optimistic astir nan longer term. We besides cognize that markets are guardant looking and discount early conditions. Importantly, arsenic discussed successful different letters passim this year, our guidelines lawsuit is that nan higher interests are not an anathema to exertion stocks and that they should do good complete clip owed to their structural maturation and expanding free rate travel profiles.

In Closing

This has been 1 of nan much tumultuous years successful nan markets. We started White Falcon pinch nan belief that a elemental indexation strategy will not beryllium capable and a nimble and opportunistic finance head is needed to navigate this marketplace environment. We are moreover much convinced of this position than erstwhile we started White Falcon. This carnivore marketplace has group up good for nan early by giving america a tremendous opportunity to amended nan value and valuation of nan portfolio.

From an operations perspective, Interactive Brokers has been a bully platform. With our SMA structure, you, our partners, only salary for commissions connected transactions. In a money structure, astatine our existent AUM level, costs would person been overmuch higher (custody, audit, legal) taking distant from nan compounding of capital. This twelvemonth nan full costs of commissions was little than 0.18% of AUM and we expect this to diminution to little than 0.10% of AUM adjacent year. Importantly, NAV for inducement fees is calculated aft deducting these commissions.

I stay everlastingly grateful to each nan partners astatine White Falcon. Please consciousness free to guardant this to anyone who you deliberation will beryllium a bully imaginable partner for White Falcon. Also, please consciousness free to get successful touch pinch maine for immoderate questions aliases feedback that you whitethorn have.

With gratitude,

Balkar Sivia, CFA, Founder and Portfolio Manager


Research Report: Diversey (DSEY)

“The champion point that happens...is erstwhile a awesome institution gets into impermanent trouble…We want to bargain them erstwhile they're connected nan operating table.”

- Warren Buffett

Executive Summary

  • Diversey is simply a cleaning and sanitation products and services supplier to organization customers specified arsenic hospitals, hotels, and bully and beverage producers.
  • Ecolab (ECL) and Diversey are nan 2 largest competitors successful this $32 bn market. Diversey is beardown successful Europe and Emerging Markets while Ecolab is beardown successful nan US.
  • Diversey is nan quintessential ‘small costs but precocious impact’ business wherever cleaning and sanitation is simply a very important process for clients and its comparative costs is very low.
  • Competition is based connected method prowess and work levels and economics are limited connected standard successful a peculiar geographic area. Diversey is #1 aliases #2 successful astir of nan markets successful which it operates.
  • Diversey was bought by Bain Capital from Sealed Air (SEE) successful 2017. In 2021, Diversey came to nan marketplace successful an IPO astatine $14 per share.
  • In nan past 12 months nan banal value has declined from $14-18 to $4.35 (our mean cost) owed to a terrible separator compression (from 15.7% successful 2021 to 11.6% successful 2022) led by precocious earthy worldly prices and a beardown USD. This coupled pinch precocious indebtedness levels and a mini float has seen this banal mercilessly sold.
  • White Falcon believes that nan separator issues are impermanent - Diversey is passing value increases, Bain Capital has led immoderate structural changes which should amended margins, and nan USD seems to person topped. We judge nan headwinds of 2022 will move into tailwinds going into 2023.
  • At $4.35 per share, Diversey trades astatine 10x 2022 depressed EBITDA aliases 7x 2025E normalized EBITDA of $450 mn. At 10-12x EBITDA multiple, nan banal is worthy $9-12 per stock successful 3 years.
  • Our mean costs guidelines is $4.35 per stock but owed to risks from leverage - some operational and financial - we person decided to support nan position size astatine half of a afloat position.

Introduction

Diversey Holdings is simply a supplier of cleaning and hygiene products successful nan hospitality, healthcare, nutrient and beverage, nutrient service, retail, and installation guidance sectors. Their suite of solutions combines patented chemicals, dosing and dispensing equipment, cleaning machines, and services. Headquartered successful nan US, Diversey is simply a multinational serving much than 85,000 customers successful complete 80 countries pinch a web of 8,500 employees. It has a marketplace capitalization of $1.4 bn, an EV of $3.2 bn and is 73% owned by Bain Capital. The institution is presently trading astatine 10x depressed 2022A EBITDA aliases 7.0x normalized 2025E EBITDA.

While we bargain our detergents and cleaning products from nan supermarkets, commercialized customers request organization suppliers. Furthermore, these customers person very unsocial needs. As an example, a brewery has to cleanable its instrumentality aft definite accumulation cycles. The chemicals utilized to cleanable this instrumentality request to beryllium safe - for nan cleaning personnel, nan life of nan equipment, arsenic good arsenic nan customers consuming products from this brewery. More importantly, while nan instrumentality is being cleaned, it cannot nutrient owed to which nan clip to complete nan cleaning process is important. Moreover, pinch astir businesses committing to expanding ESG commitments, little h2o and power depletion successful this cleaning rhythm is progressively important. Chemical companies specified arsenic Diversey and Ecolab sojourn these accommodation pinch their technicians, formulate nan chemicals, determine connected a cleaning and attraction schedule and instal dosing and dispensing equipment. The installation is past supplied regularly and work and attraction unit request to beryllium connected telephone in-case of emergencies arsenic nan costs of stoppage is excessively high. As an example, Diversey gives nan illustration of a infirmary successful its S1:

Source: Diversey prospectus

“Let's opportunity you're cleaning a very high-profile customer, Amazon, Microsoft..you don't want a solid cleaner, a multi-surface cleaner, aliases a disinfectant to harm 1 of your client's labor aliases damages immoderate benignant of substrate, truthful consequence mitigation”

- Stream Transcript

Diversey and Ecolab run successful this $32 bn world marketplace wherever they person nan pursuing attributes:

  • Provides basal services to their customers without which they would not beryllium capable to tally their business
  • The walk connected their services is mini comparative to nan full costs of moving nan business for nan customer. This is an basal portion of business for nan customer if they are to support compliance pinch regulators. Due to this, this business is comparatively recession resistant.
  • Razor and razor leaf exemplary wherever Diversey and Ecolab instal dosing and dispensing instrumentality astatine nan customer tract locking successful business but astir of nan separator is made from consumable chemicals.
  • Scale is needed successful nan business successful bid to profitably service nan customer. Density and way to marketplace are important variables. Although these are classified arsenic chemic companies, nan services facet of nan business is much important. Due to this, this manufacture lends itself to an oligopoly structure.
    • Smaller companies tin person precocious marketplace shares successful definite geographies and some Diversey and Ecolab person been engaged acquiring them and consolidating nan industry.
  • Cleaning and sanitation services person a newfound value aft Covid-19. Many businesses are taking steps to further their standards successful cleaning and hygiene which benefits Diversey and Ecolab.

A Diversey salesperson will transportation nan customer connected really its solutions will thief them prevention money connected chemical, water, and power usage complete time. Diversey breaks down its business successful 2 segments - organization and nutrient and beverage:

Source: Diversey Presentation

Diversey is simply a smaller competitor than Ecolab pinch little standard successful nan US but competes caput to caput pinch Ecolab successful Europe and Emerging Markets. In fact, Diversey has starring marketplace shares successful countries specified arsenic nan UK, India and Indonesia (which were beardown Unilever markets).

Diversey has starring marketplace shares successful countries specified arsenic nan UK, India and Indonesia (which were beardown Unilever markets).

Soure: Diversey Presentation

Recently Diversey’s stock value has declined precipitously to $4.35 per stock (where we initiated a position) from highs of $14-19 per stock successful 2021. Diversey is facing immoderate impermanent headwinds owed to precocious earthy worldly costs and USD strength. Further, it has precocious indebtedness levels. We judge these headwinds are impermanent and Diversey should beryllium capable to flooded that successful nan adjacent fewer years and de-lever its equilibrium sheet. If this is nan case, nan banal tin admit markedly wrong nan adjacent 2-3 years.

Industry Dynamics and Competition

Diversey’s main competitor is Ecolab. Ecolab has been a compounder and has done really good for shareholders. Due to its unchangeable maturation profile, precocious ROIC and shareholder friends policies it regularly trades astatine 16-20x EV/EBITDA and 30x P/E. Ecolab has a ample marketplace stock successful nan US which is nan largest sanitation and hygiene marketplace successful nan world owed to which it benefits from economies of scale.

In its halfway conception of sanitation, title successful nan manufacture is not conscionable based connected value but besides connected merchandise and service:

“When a customer is evaluating a institution for illustration Diversey aliases a class that Diversey and Ecolab would compete in, yes. Is value important? Of course, it is. Diversey and Ecolab compete against each different but besides nan broader marketplace pinch chemistry and competencies astir nan chemistry. How tin you make nan astir concentrated chemic imaginable that's still safe and that still has a precocious efficacy? How tin you put it into a dispensing aliases dosing level that is arsenic safe, that cannot beryllium tampered with, that cannot break, that cannot accidentally injure someone? You person a 256:1 aliases 512:1 dilution ratio connected a cleaning chemical. If you get that successful your eye, that doesn't consciousness very good. How tin they guarantee nan customer that those dispensaries are getting installed properly, connected time, fresh to go, virtually connected this nonstop date?”

- Stream Transcript

Importantly, nan manufacture has precocious switching costs:

“Especially if you deliberation astir nan customers having a ample site, it is not easy to switch. Why? I conscionable told you that if you person a ample tract specified arsenic Sodexo, you request them to fto successful that caller supplier. The aged dispensing strategy of nan erstwhile 1 needs to get dismounted from nan wall. The caller guys person to travel in, equine a caller dispensing system, and springiness training again. Before you're going to alteration a supplier and particularly if you request these dosing systems, for illustration successful large nutrient work locations, you're going to deliberation twice. You really person to beryllium that you're not happy astir service-level agreements aliases immoderate happens successful nan narration pinch your supplier, but it's not thing you're going to alteration each statement cycle. That is excessively cumbersome.”

- Stream Transcript

The contracts are typically 3 years successful magnitude pinch renewals based connected anterior performance. Unless location has been a problem pinch service, nan customer does not switch. Over time, this customer becomes much and much profitable. Due to this, it has been progressively difficult for Diversey to summation marketplace stock from Ecolab successful nan US. However, fixed nan maturation successful nan manufacture and nan marketplace stock controlled by independent operators, location is capable of a runway for some Ecolab and Diversey. It is important to understand that together, they clasp a mini information of nan full market.

As we discussed above, title successful nan halfway sanitation and cleaning conception is based connected economics of scale, work levels, arsenic good arsenic switching costs. However, location is different section called h2o curen that is large business astatine Ecolab. In 2011 and 2012 Ecolab made 2 transformative acquisitions. The first was Nalco Holding, a h2o curen business serving nan mining, energy, and insubstantial industries. The 2nd was Champion Technologies, a specialty chemicals institution that produces h2o curen for lipid drillers and products that forestall oilfield instrumentality corrosion. While these assets accrued Ecolab’s standard and diversified its gross stream, they had nan effect of introducing immoderate cyclicality. The cardinal quality betwixt Ecolab and Diversey is that Diversey has a very mini portion of its revenues that travel from h2o treatment. Although Ecolab is simply a $13-14 bn income company, astir half of these income travel from ‘water solutions’ and not pure-play sanitation and hygiene. In total, nan apical 2 players person income of $8-9 bn successful a $32 bn marketplace (Ecolab is 2.5x bigger connected an apples to apples comparison).

Diversey has collaborated pinch Solenis to connection h2o curen products and transverse waste these to its nutrient and beverage customers. While it is presently a mini information of revenues (about 20% of F&B revenues), guidance is assured that it tin penetrate much customers pinch this service.

History

Diversey has a agelong history and has been successful business since 1923. In 1978 it was bought by Molson (TAP) which owned it for a agelong clip until partially divesting it successful 1996 to Unilever (UL) and past afloat divesting it successful 2003. In 2002, Diversey was sold to a subsidiary of SC Johnson. In 2009, Clayton, Dubilier & Rice acquired 46% of JohnsonDiversey from nan SC Johnson family. In June 2011, Sealed Air purchased 100% of Diversey Holdings for $4.3 cardinal (9.7x LTM EBITDA). It was a sizable acquisition for Sealed Air:

In June 2011, Sealed Air purchased 100% of Diversey Holdings for $4.3 cardinal (9.7x LTM EBITDA). It was a sizable acquisition for Sealed Ai

Source: Sealed Air Presentation

In 2016, Sealed Air decided to prosecute a tax-free spin-off of Diversey successful bid to simplify its halfway business and trim indebtedness (it had mislaid a statement to waste SC Johnson products affecting revenues and op income).

However, successful March 2017, Bain Capital bought Diversey for $3.2 cardinal from Sealed Air pinch nan volition of moving Diversey arsenic a standalone company. In March 2021, nan institution came to nan marketplace pinch an IPO astatine $14 per stock pinch Bain Capital owning 75% of nan shares outstanding. Later that year, they did a secondary banal offering diluting Bain to 73% of nan company. Furthermore, since Bain acquired Diversey successful 2017, it has gone done 4 CEO’s. However, nan existent CEO, Phil Weiland, has been serving successful his position since July 2020.

 Diversey's agelong legacy

Source: Diversey Website

It is absorbing that immoderate problems ne'er get solved! Molson had to get free of Diversey to Unilever arsenic its US operations were not profitable and because Molson was successful a de-conglomerate mode. Under Unilever, Diversey thrived successful Europe and Emerging Markets wherever Unilever itself had beardown marketplace shares. With truthful galore owners complete truthful galore years, Diversey mislaid a spot of its psyche and sewage stripped of their plus base. With expanding leverage, owners could not walk connected nan agelong word maturation initiatives. However, successful each this time, Diversey retained its marque and reputation. Clients and regulators spot Diversey.

“So successful New York, for example, they (Ecolab) person 3 times nan magnitude of salespeople that Diversey does, conscionable successful nan authorities of New York. Whereas, Diversey successful nan UK has astir apt 3 times nan magnitude of salespeople that Ecolab has.”

- Stream Transcript

Under Bain, immoderate agelong needed changes were made. As an example, Bain spent superior connected income training and IT infrastructure including installing a CRM system. Most importantly, Diversey, nether Bain, has been building a accumulation installation and distribution storage successful Kentucky successful bid to ain much of its accumulation and consolidate its disparate proviso concatenation network. Management expects to adhd 100 bps to EBITDA pinch this installation completing building successful Q1 2023. Given that it's a standard business, location is simply a chickenhearted and an ovum problem pinch Diversey successful nan US - without standard it cannot get margins and without a willingness to put successful nan business it cannot get scale. Some of this is being corrected pinch Bain - Diversey won a large statement pinch Aramark and nan caller consolidation of accumulation and proviso concatenation some guarantee amended US margins.

“Scale's beautiful simple. U.S. is afloat of large companies pinch tons of assets successful tons of states. Moving astir chemicals is expensive, and moving astir group is expensive. If you've only sewage 10 group successful each of nan West Coast and nan competitor has sewage thousands, those numbers I conscionable picked retired of nan air, past that would propose nan competitor's sewage overmuch much credibility pinch nan customer... It was conscionable arsenic brutally elemental arsenic that. It was thing much analyzable than nan costs to service and erstwhile you return into relationship group and chemicals.”

- Stream Transcript

The existent CEO stated Diversey’s nonsubjective astatine nan IPO arsenic follows:

“We look guardant to building connected nan estimated semipermanent marketplace maturation of astir 3%, pinch marketplace stock gains. We target to turn different 2% per annum done accretive M&A. And we target to grow adjusted EBITDA separator to 20% astatine nan mean complaint of 50 to 100 ground points per annum done our improved sourcing, strategical pricing, proviso concatenation improvements and operational excellence done SG&A costs initiatives. This should make beardown free rate travel that we tin usage to de-lever complete clip pinch a medium-term nett indebtedness extremity of 3x adjusted EBITDA”

Diversey was making really bully advancement connected margins successful 2020 and 2021 pinch adj EBITDA margins astatine 15.7% successful 2021. However, 2022 has proven to beryllium overmuch much treacherous. As a chemic company, Diversey’s cleaning chemicals are derived from crude and crude derivatives. With crude prices rising and unavailability of immoderate chemicals owed to proviso chain, Diversey had to reformulate immoderate products but still make judge they were disposable for their customers truthful arsenic not to halt their operations. This had some gross separator and operating disbursal consequences. Furthermore, Diversey is much of an world business pinch 73% of its revenues coming from countries different than nan US. This year, nan USD has been connected a tear (DXY up 21%!) owed to which Diversey’s reported numbers successful USD look awful. Its Adj EBITDA margins declined to 11.6% this year.

In caller quarters, Diversey is passing connected rising earthy worldly costs to its customers and has taken pricing arsenic good arsenic surcharges to protect its gross margins. Importantly, we spot that crude prices person stabilized, proviso chains are amended and nan USD has topped. All nan headwinds successful 2022 are turning into tailwinds going into 2023. We judge that Diversey’s numbers will astonishment to nan upside successful 2023-2025.

At this banal price, we don’t person to judge that Diversey’s margins will spell to 20% aliases that they will summation standard successful nan US. If nan margins return to their erstwhile 2021 precocious astatine 16% (we will person nan Kentucky installation travel online successful Q1 2023) past location is important upside imaginable successful nan shares.

More connected Margins

On a much secular basis, Ecolab makes a separator of 20-21% connected a consolidated ground while still investing successful its business. In nan US, Ecolab has had a spot of a free reign arsenic Diversey was distracted by different owners and different CEO’s. This pricing umbrella provides Diversey an opportunity to amended its position.

One of nan important things to understand astir this business is that margins get amended complete time. As an example, erstwhile Diversey wins a statement it has to instal nan dosing and dispensing equipment, nan costs of which tin only beryllium recouped complete time. Due to this, nan business will show a small spot of a separator contraction if it is increasing excessively fast.

Diversey is now besides trading h2o curen to its customers. This is simply a ‘add on’ work that should thief not only gross maturation but besides margins successful nan agelong term.

Since nan IPO, Diversey has made 5 acquisitions. They acquired Sanechem successful Poland; Avmor successful Canada; Tasman successful Australia; Birko successful nan U.S. and Shorrock Trichem successful nan U.K. These acquisitions heighten their standard and competitory position successful nan world nutrient and beverage marketplace which is simply a strategical privilege and a higher separator business (vs. organization business). Each of these acquisitions either gives Diversey customers, distribution channels aliases integration of nan backmost end. Diversey has paused M&A until its debt/EBITDA comes in-line, but, aft that, we tin expect worth accretion pinch this tuck-in M&A strategy.

On a much cyclical basis,

  • Revenues really declined successful 2020 moreover arsenic wellness and hygiene were fixed expanding value arsenic a batch of customer premises specified arsenic hotels were closed. Management estimates a diminution of $400 mn (Ecolab reported thing similar).
  • After Covid, Diversey managed freight issues wherever they had to airfreight immoderate products and support higher inventory levels. They besides went done a difficult and fast-changing earthy worldly scenery wherever their R&D teams had to reformulate products. All of this was done to limit nan effect connected customers.
  • In Europe, wherever traditionally ostentation is overmuch little it took nan clients immoderate clip to judge nan request to return continuous value increases but these value increases arsenic good arsenic surcharges are now being accepted. Diversey is taking double digit value increases (10-12% full successful 2022) arsenic seen by changeless existent maturation successful nan past 2 quarters.
    • The important constituent to stress is that prices are sticky connected nan upside. If/when earthy worldly prices ease, Diversey does not person to walk this connected to nan customer retaining nan incremental margin.
  • As mentioned above, USD, arsenic represented by nan DXY index, was up 21% from nan opening of nan twelvemonth to September 2022. This fundamentally intends that for illustration for for illustration 73% of Diversey’s reported gross and EBITDA were down 21% conscionable based connected nan currency. The truth that, connected an absolute basis, revenues person held up because of nan value and measurement increases arsenic mentioned supra is remarkable.

We judge each these issues are temporary. As and erstwhile these issues are resolved aliases are lapped up by YoY comparables, we judge that Diversey will beryllium seen arsenic a unchangeable user company.

On Debt:

Diversey 10-Q extract

Source: Diversey 10-Q

Debt is simply a existent rumor astatine Diversey. The business has indebtedness successful USD and Euro and past 4th its debt/adj EBITDA was complete 5x. Diversey has rate of $250 mn resulting successful a nett indebtedness number of $1.72 bn. If we look astatine existent EBITDA pinch each ‘one-time’ items included past nan business is moreover worse! Management tin study adjusted numbers each they want but if they person indebtedness connected nan equilibrium expanse that needs to beryllium serviced past 1 needs to nutrient nan rate travel to work it! We judge that nan business is stretched but nether control.

Bain fixed nan indebtedness successful Sept 2021 owed to which servicing nan indebtedness has not gotten immoderate much costly this twelvemonth moreover though rates person gone up. Currently much 2/3rd of their indebtedness is astatine fixed rates and termed retired - word indebtedness to 2026 and elder notes to 2029. In fact, successful 2022, Diversey was capable to monetize USD floating to EURO fixed swaps and in installments a summation of $186 mn. We are not fans of financial engineering but judge rate liking costs of ~$100 mn should beryllium manageable for Diversey.

In bid to negociate indebtedness level guidance has paused immoderate incremental M&A. Further, we judge that location will beryllium a moving superior merchandise that will thief rate travel successful 2023.

At a forecasted EBITDA level of $450 mn, nett debt/EBITDA comes down to 3.8x and down from location arsenic Diversey uses rate to salary down debt.

Numbers and Valuation

2018

2019

2020

2021

2022E

Institutional Revenue

2,024

1,979

1,995

1,918

1,949

Growth %

-2.22%

0.81%

-3.86%

1.63%

Food & Beverage Revenue

664

645

634

700

804

Growth %

-2.86%

-1.71%

10.41%

14.86%

Adj Institutional EBITDA

280

296

341

320

267

Margin

13.83%

14.96%

17.09%

16.68%

13.68%

Adj Food & Beverage EBITDA

100

102

114

135

97

Margin

15.06%

15.81%

18.04%

19.29%

12.11%

Corp EBITDA

(50)

(59)

(47)

(43)

(44)

Adj Consol EBITDA

330

340

408

412

320

Adj consol EBITDA Margin

12.28%

12.94%

15.53%

15.73%

11.62%

Given nan ‘turnaround’ quality of nan investment, location are a batch of ‘one-time’ costs that person been muddying nan income statement. For example, Diversey is taking ~$80 mn successful restructuring costs to consolidate its proviso concatenation and is slow charging it to nan income statement. After past quarter, only $27 mn is near which will beryllium taken successful Q4 2022. From adjacent twelvemonth on, nan financials should beryllium reasonably clean.

Regardless, nan thesis rests connected nan presumption that this 11.62% separator is impermanent and Diversey tin spell backmost to nan 15-16% level it achieved successful 2020-2021. As mentioned above, we judge that this will beryllium progressively imaginable pinch nan Kentucky installation (which should thief 100 bps) arsenic good arsenic an easing successful crude and DXY. With immoderate maturation successful nan business, nan existent EBITDA number is person to $450 mn successful 2024-2025 compared to $320 mn successful 2022. With capex of astir 3% of income ($80-100 mn), rate taxes of $50 mn and liking costs astatine $100 mn, we are looking astatine free rate travel of astir $200 mn per year.

Ecolab trades astatine 16-20x EBITDA. It is simply a overmuch amended business than Diversey truthful possibly Diversey deserves to waste and acquisition astatine a discount. We judge a 12x EBITDA aggregate is justified fixed nan stableness and financial floor plan of nan business. At 12x aggregate and a $450 mn EBITDA we get an EV of $5.4 bn. Assuming that Diversey uses $150 mn of nan $200 mn per twelvemonth successful FCF to salary disconnected debt, it should person astir $1.4 bn successful nett indebtedness successful 2-3 years. Subtracting this nett indebtedness number from nan endeavor worth gives america an equity worth of $4.0 bn.

At 330 mn shares outstanding, nan resulting banal value should beryllium person to $12 per stock compared to nan existent banal value of $4.35 per share. At a much blimpish 10x EBITDA we get to a per stock worth of $9.4 per stock which is besides much than double nan existent marketplace price.

Risks

  • Clients tin spell to guidelines chemicals and take not to usage specialty chemicals
  • Ecolab tin initiate a value warfare successful consequence to Diversey’s expanding attempts to summation marketplace stock successful nan US. It is important to statement that moreover Ecolab has been struggling this twelvemonth and has not met financial targets. Ecolab excessively has been taking pricing and is expected to do amended going forward.
  • Diversey has a batch of intangible assets connected its equilibrium expanse which came from Bain’s acquisition of nan company. Customer relationships and marque worth is nan mostly of nan $2.3 bn successful intangible assets recorded connected nan equilibrium sheet. It amortizes these assets and a non-cash disbursal runs done nan income statement. It has very debased PP&E but 8,500 people. Its equilibrium expanse constitution is fundamentally that of a ‘distribution’ business which astatine its halfway - is what it is. Although Diversey is assured successful these intangible assets, immoderate constitute downs present tin beryllium unpleasant.
  • Bain Capital
    • Bain owns 73% of nan institution and has effective control. So far, Bain has been taking actions to summation nan LT worth of this finance which is affirmative for number owners. An finance successful Diversey is fundamentally a ‘side-car’ finance pinch Bain. The consequence is simply a return nether by Bain.
    • With a debased float, banal prices tin move drastically to nan downside (as they have) and to nan upside.
    • Bain besides engages successful a adjacent spot of financial engineering. The swaps connected indebtedness arsenic good arsenic securitizing immoderate of nan receivables, while not retired of nan ordinary, create immoderate complexity to nan business and financials.
  • Debt is simply a double edged sword.
    • It tin heighten returns but if nan business situation turns southbound aliases location is simply a Diversey circumstantial issue, past it tin beryllium debilitating for nan business.
  • Recession
    • While Diversey is reasonably recession proof, it is not wholly recession proof. During difficult times, customers look astatine each aspects of their P&L and will apt inquire Diversey for concessions which tin impact pricing and therefore, margins. Given precocious indebtedness levels, Diversey is particularly susceptible to antagonistic operating leverage.

Our belief is that while these risks are real, nary of them takes distant from nan halfway thesis. However, owed to these risks, an finance successful Diversey has to beryllium sized smaller.

Conclusion

A batch of strategists are suggesting ‘Emerging Markets’ vulnerability successful 2023. The emerging markets scale has a batch of China vulnerability and we judge playing this taxable pinch a business specified arsenic Diversey makes much sense. More than 73% of its gross comes from countries extracurricular nan United States, making it efficaciously an world business.

Diversey participates successful a consolidated world manufacture building successful which Ecolab and Diversey are nan 2 marketplace stock leaders focused connected cleaning chemicals. This marketplace for cleaning chemicals should summation astatine a 2% to 4% longer-term integrated complaint successful summation to which Diversey is increasing pinch value increases, h2o curen arsenic good arsenic acquisitions. We judge nan separator issues knowledgeable by Diversey are impermanent and that, complete time, arsenic these issues abate nan marketplace will spot a reasonably unchangeable services institution that tin grow, for illustration Ecolab, astatine a unchangeable gait for a agelong play of time.

In bid to make a important return connected investment, 1 does not request to judge successful management’s 20% EBITDA extremity but a 15-16% EBITDA separator will suffice. No finance comes without risks and Diversey’s risks unit america to return a smaller position moreover arsenic nan upside imaginable is enormous.


Disclosure: White Falcon has a agelong position successful nan shares of Diversey.

Disclaimer

  • Past capacity is not needfully suggestive of early results. All investments impact consequence including nan nonaccomplishment of principal. It should not beryllium assumed that immoderate of nan transactions aliases investments discussed herein were aliases will beryllium to beryllium profitable, aliases that nan finance recommendations aliases decisions we make successful nan early will beryllium profitable aliases will adjacent nan finance capacity of nan investments discussed herein. Specific companies aliases investments shown successful this position are meant to show White Falcon’s progressive finance style
  • White Falcon whitethorn alteration its views astir aliases its finance positions successful immoderate of nan securities mentioned astatine immoderate time, for immoderate logic aliases nary reason.
  • White Falcon disclaims immoderate responsibility to notify nan marketplace of immoderate specified changes.
  • The accusation and opinions expressed successful this position is based connected publically disposable accusation astir nan securities.
  • The missive and thesis includes forward-looking statements, estimates, projections, and opinions, arsenic good arsenic much wide conclusions. Such statements, estimates, projections, opinions, and conclusions whitethorn beryllium to beryllium substantially inaccurate and are inherently taxable to important risks and uncertainties beyond White Falcon’s control.
  • Although White Falcon believes nan information and numbers are substantially meticulous successful each worldly respects, White Falcon makes nary practice aliases warranty, definitive aliases implied, arsenic to nan accuracy aliases completeness of immoderate written aliases oral communication. Readers and others should behaviour their ain independent investigation and study of nan thesis of immoderate and each companies mentioned successful this document.
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White Falcon besides undertakes nary committedness to return aliases refrain from taking immoderate action pinch respect immoderate of nan companies mentioned successful this letter.


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Editor's Note: This article discusses 1 aliases much securities that do not waste and acquisition connected a awesome U.S. exchange. Please beryllium alert of nan risks associated pinch these stocks.

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