Monthly Stock Idea Lab (MSIL) #3 - June 2023

2 July 2023

Welcome to the third edition of the Monthly Stock Idea Lab publication. My goal is to save you time by curating exciting value opportunities. I truly believe that just by honing in on better options, you can significantly boost your investment results. That means rejecting 90% of stocks, doing more work on the remaining 10% and rejecting 90% of those.

No matter how smart you are, you will struggle to intelligently predict which cryptocurrency will do better in one year (Bitcoin or Ethereum, for example). It is the same with dining out. If a restaurant offers only burgers and fish & chips, you cannot make a healthy choice there. Avoiding junk food is the first step to a healthier life. It is the same in investing: by staying away from the meme or thematic stocks (remember, Beyond Meat or Peloton), you make the first step in the right direction.

The simple way to check if you are consuming “junk food” as an investor is to ask yourself how confident you are about a company’s future cash flow and how much imagination you require to justify the current price. Some businesses are going through so many changes that it is hard to have any visibility about their FCF in the future. Others may have a more recurring business model, and their FCF is more predictable, but you would have to believe in an extraordinary future when all their projects succeed and no competitor challenges their positions ever to justify their valuation.

If the asset is not generating cash flow, its price will depend on what others are willing to pay for it in the future. So your decision to buy this asset today is based on the assumption that others will be willing to pay more later. It is a different game. Still possible to make money, but it is much harder. At least for me. The wealthiest people have owned real businesses, not speculated about future asset prices.

Billionaire Joel Greenblatt, the author of several best-selling books, put it well:

The common themes among the ideas in June’s MSIL are high insider ownership, with the founder or his direct heir playing an active role in the company. Generally strong business economics (high margins, high returns on capital, low debt) and attractive long-term growth prospects (I am taking a pause with commodity investments for now).

However, since most of these quality characteristics are easily identifiable by the market, you must make the second step: understand whether the price is right. All the companies I present today are experiencing some problems, and their stocks are trading below all-time highs (sometimes considerably so). So, no Nvidia or Apple stock today, as you have guessed.

To be clear, there is some negative momentum in the stocks from today’s menu. That means that their prices will likely be lower in the near term. Unless, of course, you have perfect timing skills and can successfully pick the bottom.

Think of this as a price we, value investors, have to pay to own good businesses, benefit from the compounding effect as they reinvest their earnings and capture additional upside from re-rating once the broader market realises that the problems were temporary.

Before I present this month’s ideas, let me make two observations regarding Biglari Holdings and Walgreen Boots, which I profiled in earlier editions.

You might remember one of the ideas in my last month’s edition was Biglari Holding, a company controlled by a 45-year US investor and businessman, Sardar Biglari. It turned out to be a highly controversial stock idea, with many people either in a “hate” or “love” camp (mainly in the former). A UK-based value investor Andrew Hollingworth, from Holland Advisors, compares the leadership style of Mr Biglari to that of Mike Ashley from Frasers Group (former Sports Direct). Biglari Holding is the biggest position in Andrew’s fund.

I have read more articles on Biglari’s background since the previous post and decided to wait for a lower price for now. While there may be some similarities between Biglari and Ashley, there is also at least one significant difference. Mike Ashley has built the retail business and has been growing it for 41 years after opening the first sport and ski shop in 1982. Sardar Biglari, on the other hand, is an investor who has only bought existing businesses. His primary skill is capital allocation. Integrity and trustworthiness are critical qualities of a capital allocator. But from what I have read so far, Biglari is far from Warren Buffett, given the complex remuneration structure he has created, not to mention his extravagant lifestyle.

Besides, the consolidated operating profits of BH businesses have not changed much, rising just 3% p.a. during 2009-22.

Walgreens Boots, another idea I presented in the first edition of MSIL, reported results this week which were below consensus expectations. Management also cut its full-year guidance. The stock fell 8% this week and is 17% below the price when it was first profiled in the March MSIL. I have not done more work on the company. Not being an expert on the sector, I cannot insist that the market has overreacted to weaker-than-expected results. There is definitely some negative momentum in the business. But…Walgreens has benefited from COVID by operating vaccination centres in its US retail chain. This has created a high base effect for future earnings. As some would say, COVID borrowed its growth from the future. Could the above-normal 2021-22 results drive recent weakness?

Walgreens’ new guidance for adjusted ’23 EPS is $4-4.05 (10% lower than the previous guidance and 20% below last year’s EPS). Still, the new guidance implies a PE multiple of just 7.1x. The company has also been the largest shareholder of another leading drugstore chain in the US, Amerisource Bergen. It initially owned a 30% stake, gradually reducing to 17% at the end of February 2023. The market value of this stake is $6.5bn, which accounts for over 26% of Walgreens’ market cap. This is a rough estimate, though, as Walgreens continued to sell its stake, and its effective interest and market value are likely a little lower now.

Walgreens stock has now reached the 2010 level. As the price of Walgreens continues to slide, it becomes a more interesting opportunity, in my view. I plan to do more research on this company and share my findings in the future (consider subscribing to receive regular insights and updates if you are not a subscriber yet).

One important observation is that you should not blindly copy ideas presented in this Monthly publication. Do your own due diligence. Consider this a healthy menu and just the first step, not a hot tip or investment recommendation.

Now let’s dive into this month’s stock ideas.

Ticker: ERF FP
Price: €58
Mkt Cap: €11.7bn
EV: €14.5bn

Eurofins is one of the world’s largest testing companies focusing on the Food, Environment, Pharmaceutical and Cosmetic sectors. Gilles Martin is the CEO and Chairman of Eurofins. He founded the company 36 years ago to provide wine authenticity testing. The tests involved using ground-breaking technology at that time called SNIF-NMR. That technology had been invented by his parents and their research teams at the University of Nantes six years earlier. It was the first time nuclear magnetic resonance (NMR) technology had been applied commercially for authenticity testing.

Mr Martin remains the company’s largest shareholder with a 32.8% stake.

Since its IPO in 1997, the company has increased its sales by 32% a year, on average, to reach €6.7bn in 2022, while its share price has compounded by c. 26%. Eurofins is a serial acquirer, with M&A being a critical driver in its growth strategy. The company has completed over 490 acquisitions. Its long-term objective for organic growth used to be 5%, but following consistent outperformance during 2010-21, management has raised its target to 6.5%, corresponding to the average organic growth rate during 2010-21.

Eurofins has benefited from the surge in demand for COVID testing in 2020-2021, which contributed €0.8bn, €1.4bn and €0.6bn to its revenue in 2020, ’21 and ’22, respectively. As a result, its performance in 2022 and forward guidance looks unimpressive.

Revenue in 2022 was flat at €6.7bn, while EBITDA declined by 20% YoY to €1.5bn. EBITDA margin dropped from 28.3% in 2021 to 22.5% in 2022.

As expectations have been coming down, the company’s share price has also corrected. It is now down -13% YTD and down -54% from its all-time high price reached in September 2021.

However, the business has continued to grow (by 5.8% in 2022, excluding COVID-related revenue). Going forward, Eurofins targets organic growth of 6.5% and overall revenue to reach close to €10bn by 2027 (with c. €250mn annual contribution from M&A). Its 2027 goals also include a 24% EBITDA margin and close to €1.5bn FCF (twice compared to its 2023 target of €700-750mn).

The past track record and strong alignment of interests between minority shareholders and the founder / CEO are the two points that attracted me to Eurofins. But there is more:

• There are secular demand drivers such as improving living standards globally, the rising share of the older generation, demand for safe and environmentally friendly products.

• The sector is still highly fragmented.

• High barriers, including R&D and customer trust, limit competition.

• Customers prefer to work with reliable suppliers and want to avoid taking the risk of going with a new provider, given potential negative consequences. As a result, established laboratories enjoy high recurring revenue.

• Customers are not price sensitive. The cost of a test is marginal compared to their overall cost structure. But getting the necessary certificate and approval is critical for the overall success of their business. Hence, companies like Eurofins enjoy strong pricing power.

• Testing companies also enjoy scale effects as specialised laboratories operating under one brand are more valuable to customers who prefer one-stop solutions rather than dealing with individual providers. Stand-alone laboratories have high fixed costs, so additional revenue that comes from cross-selling goes right into the bottom line.

The only main issue that stops me from buying Eurofins shares is valuation. While the stock is down a lot, it is still priced at about 5.4% FCF yield. FCF number does not take into account the capex that the company spends on upgrading its sites. The net FCF is also lower because of M&A spending by the company, which generates about 70% of the company’s overall growth. The company’s share count has also been rising over time (+38% since 2008).

If the company’s business model is somewhat similar to Amazon or Costco (“scaled economy shared”), then applying traditional metrics like PE or FCF yield to value Eurofins would be wrong. I plan to spend more time understanding Eurofins’ business model and its competitive advantages before making the final decision.

Ticker: HWDN LN
Price: £6.42
Mkt Cap: £3.5bn
EV: £3.2bn

This idea was shared with me by one of the Hidden Value Gems newsletter subscribers. Thank you!

The original thesis was written by Bonsai Partners (you can Google their Q1 2023 Investor Letter).

I have yet to check all the points about Howdens. I should note, though, that this company has come up more than once on my radar, which suggests that it has probably passed the quality filters of more than one value investor.

Howdens sells kitchens in the UK, but it has a differentiating model which allows it to gain market share and achieve better financial results than traditional furniture retailers. The business generates about 60% gross margin and earns ROIC of about 30%.

The company has no financial debt (just lease liabilities) and a cash position of £308mn.

It trades at less than 10x trailing earnings, having paid a 3% dividend yield in 2022 and with a 7% buyback yield.

The company was founded in 1995 by Matthew Ingle, who currently owns c. 5%. He has learnt the kitchen business from his family. His grandfather was the founder of a leading kitchen manufacturer at the time (Magnet).

The unique feature of Howdens is that it focuses on tradespeople, those who install kitchens, rather than in-house sales or distributors. As a result, the company saves on marketing expenses since tradespeople are happy to recommend it to their customers. They do it because Howdens maintains a vast network of small depots (> 800) across the country, meaning that 85% of their trade customers are within 5 min drive of their local store. Other benefits for installers include delayed payments, exceptional service, a tiered discount programme (the more you install Howdens kitchens, the more your earn), and fast availability (no need to order and wait a month for an item to be delivered).

Howdens products are considered high quality and great value for money. So, installers take little risk when offering customers Howdens kitchens.

Investing in long-term relationships with tradespeople is much more beneficial than acquiring end customers. Homeowners buy kitchens once or twice in their life, while installers are always busy.

Additional growth drivers include expansion in France, digitalisation, vertical integration and expansion in quartz countertops (which can represent 20-40% of the total kitchen value).

My main concern is the economic recession and the slowdown of the UK housing market. COVID support and record-low interest rates boosted house demand benefiting suppliers like Howdens. I plan to do some stress-test analysis to see what could be the worst-case scenario and downside risks.

Ticker: ICE
Price: $113
Mkt Cap: $63.3bn
EV: $73.3bn

Exchanges have natural advantages that make them attractive businesses. There cannot be many places for people to transact, so exchanges are enjoying monopoly positions, similar to toll roads or bridges. Such businesses benefit from network effects as more participants create more liquidity, attracting even more participants. They also benefit from inflation in the long term or at least provide some hedge against the devaluation of the currency. In times of stress, trading activity picks up, which boosts exchange revenues.

Of course, with many nuances, things do not work precisely the same way in the real world.

The founder of ICE, Jeff Sprecher, remains its CEO and Chairman with a 1% stake in the company (5.2mn shares worth c. $0.6bn). He has grown the business through a series of transactions, demonstrating good capital allocation skills. The book value per share increased tenfold from 2007 to 2020 (then stagnated), while EPS increased by 3.7x.

Its reported EPS peaked during 2017-21, averaging $4.4. Last two years, EPS was at $2.6. However, there were some one-offs in the past, including gains from selling businesses in 2021, write-downs in 2022 and other non-core expenses. Adjusted for that, EPS continued to grow, reaching $5.3 in 2022 ($5.1 and $4.4 in 2021 and 2020, respectively).

The company generated $3.6bn of operating cash flow in 2022 ($3.1bn in 2021), while its capex was $225mn and $179mn in the same period (the company also capitalises its software development costs in the amount of $260-270mn a year which should be added to cape).



The market is concerned with the mortgage segment, which will likely underperform in a period of high-interest rates. However, this is a temporary issue and will be resolved eventually.

The stock is not optically cheap, though, trading at about 22x adjusted earnings (’22). The business has superior economics and secular growth. I plan to dig deeper into its business model. I also want to read the annual reports of their competitors, including CME Group, NASDAQ, and LSE, to see how ICE is trading relative to peers. I think selling trading data is a new important driver of growth and margins for many exchanges, and I would like to understand where ICE stands on this.

Ticker: KER FP
Price: €506
Mkt Cap: €62.9bn
EV: €65.2bn

Kering is a leading global luxury goods company headquartered in France. Its portfolio includes brands like Gucci, Saint Laurent, Bottega Veneta, Balenciaga and many more.

It was founded by Francois Pinault as a timber trading company in 1962, eventually becoming a luxury goods conglomerate under the name PPR (Pinault-Printemps-Redoute). Pinault’s son, Francois-Henri, became the company’s CEO in 2005 and has transformed the business from a complex holding company into a modern enterprise with transparent financials and shareholder returns policy.

Pinault’s family holding company, Artemis, is the largest shareholder of Kering, with a 41.7% stake. Moreover, Artemis has been regularly adding to its position during 2022 and selling put options (meaning that it was happy to buy the stock at a lower price and earn a premium if it doesn’t fall).

Kering is trading at about 16x PE - considerably lower than its peers, such as LVMH, Prada or Hermes, which are trading at 30x and higher.

The main reason for the valuation discount has been Kering’s over-reliance on a single brand, Gucci, which, in turn, relied heavily on China. Recently, neither China nor Gucci has performed well, which slowed down the overall growth of the business.

For comparison, Kering’s like-for-like revenue growth in 2022 was 9%, while LVMH delivered 17% organic growth in the same year. Kering delivered overall revenue growth of 15% last year compared to 23% at LVMH.

Some of its big brands, like Gucci and Balenciaga, have experienced problems recently. Gucci’s designer, Alessandro Michele, left the company in November 2022. His flamboyant designs attracted younger shoppers from New York to Beijing, driving remarkable growth for the brand. However, more recently, the growth has come to a stall, with critics pointing out that the older, wealthier consumers prefer products that are unlikely to go out of style. Michele was replaced by little-known Italian designer Sabato De Sarno.

Balenciaga was under fire for several of its ad campaigns with children. Its designer, Gvasalia Demna, has also left the firm.

The critical point for the investment thesis of Kering is whether the recent problems are temporary and whether the company’s underlying strength has been preserved. I am inclined to say Yes, but I need to do more work on the company. Other sceptics also point out that Chinese consumers have primarily driven the growth, and now that China is entering a slower growth phase, the sector would expand much slower. There are also concerns that the concept of luxury is more popular with the older generation, implying weaker future growth.

A critical driver for the sector has been M&A. Deals have historically worked well in the industry as large established companies helped small brands with distribution and advertising. Kering has just announced a new deal: acquiring luxury fragrance Creed (€250mn revenue in 2022). The price has not been disclosed; some media reported that potential consideration was €1-2bn.

The company distributes about 50% of its normalised (“recurring”) net earnings as dividends, accounting for 50-90% of its FCF. The dividend for 2022 came at €14/share (3% yield). The company also purchased about 2% of its shares during the past year.

Ticker: PARA US
Price: $15.9
Mkt Cap: $10.5bn
EV: $24.2bn

Paramount is one of the few stocks that Berkshire Hathaway has been buying for almost a year now. While the total value of its investment in Paramount is small ($2.1bn) relative to Berkshire’s overall equity portfolio ($328.1bn as of Q1 ’23), this investment makes Berkshire the largest shareholder in Paramount (15.3%).

The second largest shareholder (excluding ETFs) is National Amusement, the media holding of Sumner Redstone, who passed away in 2020. The fund is now run by his daughter, Shari Redstone, who is also the chairperson of Paramount’s Board of Directors.

National Amusement owns 77.4% of Class A shares (ticker PARAA), the only shares with voting rights. Class B shares (ticker PARA) have no voting rights. National Amusement’s economic interest is 9.8%.

Shari Redstone has also been buying shares of Paramount directly on the open market. Her latest transaction was on 16 May 2023, when she purchased 165,000 Class B shares at an average price of $15.06. She now holds 577,064 shares directly.

In simple terms, the company combines cash-rich but declining traditional TV channels and fast-growing but cash-burning streaming content. There is also a film studio, Paramount Pictures, but its contribution to the consolidated P&L is relatively insignificant (13% of total revenue in 2022).

Through a series of M&A transactions, Viacom acquired CBS in 2000, then the two companies split in 2005 and then, following several attempts and lengthy negotiations, merged again in 2019.

Some well-known traditional channels in North America and internationally include CBS, Paramount Media Networks, Nickelodeon, MTV, Channel 5 (UK), and Telefe (Argentina).

The two main streaming services are Paramount+ (paid) and Pluto TV (ad-supported, free to watch). The company also runs Showtime, part of paid subscriptions in certain markets. Management is integrating Showtime into its premium subscription, Paramount+.

Paramount reported consolidated EBITDA (or OIBDA, as it is often referred to in the media business) of $3,276mn in 2022. Consolidated profitability continues to decline from $5,132mn in 2020 to $4,444mn in 2021 and $3,276 in 2022.

However, the main driver behind this has been mounting losses in the Direct-to-Consumer segment (Streaming), which increased from $(992)mn in 2021 to $(1,819)mn last year.

The traditional TV Media segment delivered a solid OIBDA of $5,451mn. It was lower than the previous year, mainly due to a one-off boost from broadcast rights to the Super Bowl in 2021.

On top of that, Paramount owns a publishing business, Simon & Schuster, which it tried to sell to Penguin Random House (a subsidiary of Bertelsmann) in 2020 for $2.3bn. The deal did not go through on anti-trust grounds. The business has been de-consolidated and treated as discontinued operations. It remains profitable, with operating earnings of $248mn and $13mn in 2022 and 2021, respectively.

Unsurprisingly, Reuters reported earlier this year that Paramount was looking to sell the business again for $2-2.5bn.

Assuming the Streaming business has zero value (losses will not run forever) and deducting the $2bn valuation of the publishing business from the EV of Paramount ($24.2bn), we get $22.2bn value attributable to the core TV and Film studio segments. The two segments earned $5.7bn OIBDA in 2022, which puts Paramount (ex Publishing and ex Streaming) at 3.9 EV/EBITDA multiple.

I think further consolidation in the streaming sector should be expected. Most players are burning FCF, which is not sustainable. With the rising cost of capital, this behaviour could change earlier than later. Business Insider published an article last month noting that Netflix had considered buying Paramount in the past.

At the latest Berkshire shareholder meeting this year, Buffett was asked the question about Paramount, and he said that there should be fewer companies or higher prices for the streaming industry to break even. This suggests to me that he also expects the sector to consolidate in the future.

I have not had a long and successful experience with media stocks (I once owned Viacom after I saw it in the Magic Formula Screen run by Joel Greenblatt). I am also concerned by Paramount's leverage (net debt of $13.7bn in Q1 '23). So, I am cautious on Paramount but plan to do more work in the near term. My view could change if the share price continues to drift lower.