Name: Construcciones y Auxiliar de Ferrocarriles
Country: Spain
Ticker: CAF
Shares: 3,428,075
Price: €352 (Dec 14)
52 week range: €332-€417
Market Cap: €1.23 billion
Revenue: €1,725 million
P/E: 9.88
Div: 2.98%
Sales growth: 16.5% (five-year)
EPS growth: 31.14%
Dividend growth: 32%
1 The Company:1.1 Business: The company manufactures railway vehicles — high speed, locomotives, regional trains, commuter trains, electric motorcars, metro unit trains, light rail trains — you name it, they manufacture it. To get a better sense of the business, look at some of the projects they have completed:
Apart from manufacturing, not surprisingly, the company also offers maintenance, overhaul and upgrades of the vehicles and the components therein.
1.2 History
The company traces its roots back to 1860 when Domingo Goitia, Martàn Usabiaga and José Francisco Arana established a company whose main activity was puddling furnaces (a way to make iron and steel) and cylinder rolling. The company CAF itself was founded in 1917 with around 1,600 employees, and the main business was freight car production. A significant event happened in 1954 when CAF took over Material Móvil y Construcciones (MMC), a manufacturer of long-distance subway trains. In 1969, CAF created its R&D unit, increasing the competitiveness of the company and at the same time improving its in-house technology.
1.3 Home market
The company is based in Spain and constructs most of the equipment in Spain, then ships and assembles it where it is required. It has 11 factories in total, including one each in Brazil, the U.S. and Mexico.
The company has become a global player in construction of railway systems. In 2001, the company had sales which were half in Spain and half outside (32 million pesetas each). But in 2011 it sold €435.29 million in Spain and €1.28 billion outside.
1.4 Segments
The company divides its sales into three segments: railway, rolling stock and components, and concession. The concession business has been discontinued in 2011. So, we only need discuss the other two. The railway segments represents most of the sales. The rolling stock is mainly repair and upgrade of the vehicles.
1.5 Growth
CAF benefited from the railway investments in Spain during the 1990s. It has leveraged the strong position it enjoys in the home market to become a company with broad technical know-how and an ability to manufacture any type of rail vehicles.
It has been able to capture market worldwide and has become a major player globally. The revenue and the order backlog has grown at a very fast rate. In the last five years, the growth in revenue stands at compounded 20%.
In itself, this is no mean feat — but the order backlog has been going up quite nicely too. They are up a compounded 13%. The company has revenue of nearly €1.7 billion and a backlog of €5 billion. This is nearly three-year's worth of revenue right there.
Furthermore, as you see from the picture above, most of the growth has been in the exports. The company is getting a larger share of its business from outside Spain. It is heartening to see that it has been able to succeed in competing on the larger stage.
1.6 Profitability
The company has been able to maintain a stable operating as well as net margin (7-12%). The figures for the last five years can be seen from the chart below.
2 Financial Situation
All of the company’s debt is financed by banks. The company has a total of €242 million in loans. Let us look at the interest expense and the operating income of the company in relation to the debt.
* including interest expense
The financial cost in 2011 sticks out like an eye-sore. Sadly, the annual report of 2011 does not give clear reasons for why that is. I sent them an email and am expecting a reply. Given the LT debt has not increased too much, the cost is definitely not from interest expense.
The interest cover is more than 6 in the most recent year and has been significantly higher in the previous years. I do not see the company having any trouble paying the interest on its loan.
Following is the timeline for its loan payments.
Given an operating income which is 8 times as large, the company should not have any problems in meeting its covenants. Furthermore, there is a significant margin of safety here. Financially, I see the company to be quite strong.
3 Management
I started reading the shareholder letters from 2001. The then chairman José Maràa Baztarrica Garijo is now chairman and CEO of the group.
The way the company has made strategic acquisitions to bring itself to the forefront of railway manufacturing gives me a lot of confidence in the management. The company has a clear goal of becoming one of the most competitive global manufacturer of railway solutions and the track record of the management is quite good. Look at the following two charts:
The board of directors received €1.3 million in compensation. There is no pension of life insurance obligation to the company. Since the senior management is part of the board of directors, their remuneration is included in the above figure. This is quite cheap. Getting such a management with such a small amount of money is a great deal. I would have liked to know as to how much each manager earned, but the annual report is short in this regard.
The management believes that the employees should have a significant stake in the company. As the company is not allowed to keep any treasury stock, they came up with a workaround. A new company/fund called Cartera Social S.A. was formed. This company would by shares of CAF and sell it to the employees at a discount. This way Cartera will make loss and it will be absorbed by CAF.
The scheme was implemented in three stages. The first began in 1994 when Cartera bought 632,000 shares of CAF at a cost of €26.9 million. The second was completed by acquiring 210,150 shares in 2005 at a cost of €14.3 million. And the third in 2007 with acquisition of 171,747 rights at €50.7 million. In total, Cartera owns 1,013,897 shares of CAF, which is equal to 29.56% of the company.
Since Cartera sold the shares to the employees at a discount, it incurred losses of €49.6 million so far. This has been recognized in full in previous years already. The majority of the rights which are not yet sold to the employees belong to the last phase in 2007. As a result of this, there is a €17.6 million asset recognized in Non-Current Financial Assets - Loans and Receivables.
The following is the list of significant shareholders of CAF.
4 Risks
I don’t see a lot of risks to be honest. There is a significant macro shift toward upgrading the existing infrastructure of many countries and cities. For example - in India the government is building new metros in Delhi, Calcutta, Bangalore and there are plans to add other towns on the list.
The company is also financially very sound. The only problem I see here is that all of the long-term debt is funded by bank loans. Banks are not a very good lenders as they might try to pull their money out if there are signs of trouble with the world economy. I am sure that CAF will have thought of such a situation but given that the LT debt is less than twice the operating income, I don’t see a lot of reason to worry about.
Obviously, if the governments start cutting on infrastructure, the company will suffer in the short term. This risk might delay the significant capital gains we are salivating for.
5 Valuation
Without going into a lot of juggling with numbers, we can agree that getting such a fantastic growth along with a very good management is worth more than 9xFCF and 8.2xP/E. Paying 12xFCF should be fair for such a company. Which means that the company is undervalued in the range of 30%.
6 Conclusion
If that did not convince you, read the article above.
I am going to buy the stock in the next few days. I will probably start a position with five shares and add from there, if the price continues to fall.
Country: Spain
Ticker: CAF
Shares: 3,428,075
Price: €352 (Dec 14)
52 week range: €332-€417
Market Cap: €1.23 billion
Revenue: €1,725 million
P/E: 9.88
Div: 2.98%
Sales growth: 16.5% (five-year)
EPS growth: 31.14%
Dividend growth: 32%
1 The Company:1.1 Business: The company manufactures railway vehicles — high speed, locomotives, regional trains, commuter trains, electric motorcars, metro unit trains, light rail trains — you name it, they manufacture it. To get a better sense of the business, look at some of the projects they have completed:
- In 2005, they supplied 12 high speed units to Turkish Railways.
- Quite recently, they supplied 8 units for the new metro link from New Delhi to its international airport. Each unit is made of 6 cars and each has a 25 Kv AC traction unit.
- The company has designed or designing metro unit trains for cities around the world. For example - Barcelona, Madrid, Istanbul, New Delhi, Algiers, Hong Kong, Caracas, Sao Paulo, Santiago, Rome.
Apart from manufacturing, not surprisingly, the company also offers maintenance, overhaul and upgrades of the vehicles and the components therein.
1.2 History
The company traces its roots back to 1860 when Domingo Goitia, Martàn Usabiaga and José Francisco Arana established a company whose main activity was puddling furnaces (a way to make iron and steel) and cylinder rolling. The company CAF itself was founded in 1917 with around 1,600 employees, and the main business was freight car production. A significant event happened in 1954 when CAF took over Material Móvil y Construcciones (MMC), a manufacturer of long-distance subway trains. In 1969, CAF created its R&D unit, increasing the competitiveness of the company and at the same time improving its in-house technology.
1.3 Home market
The company is based in Spain and constructs most of the equipment in Spain, then ships and assembles it where it is required. It has 11 factories in total, including one each in Brazil, the U.S. and Mexico.
The company has become a global player in construction of railway systems. In 2001, the company had sales which were half in Spain and half outside (32 million pesetas each). But in 2011 it sold €435.29 million in Spain and €1.28 billion outside.
1.4 Segments
The company divides its sales into three segments: railway, rolling stock and components, and concession. The concession business has been discontinued in 2011. So, we only need discuss the other two. The railway segments represents most of the sales. The rolling stock is mainly repair and upgrade of the vehicles.
1.5 Growth
CAF benefited from the railway investments in Spain during the 1990s. It has leveraged the strong position it enjoys in the home market to become a company with broad technical know-how and an ability to manufacture any type of rail vehicles.
It has been able to capture market worldwide and has become a major player globally. The revenue and the order backlog has grown at a very fast rate. In the last five years, the growth in revenue stands at compounded 20%.
In itself, this is no mean feat — but the order backlog has been going up quite nicely too. They are up a compounded 13%. The company has revenue of nearly €1.7 billion and a backlog of €5 billion. This is nearly three-year's worth of revenue right there.
Furthermore, as you see from the picture above, most of the growth has been in the exports. The company is getting a larger share of its business from outside Spain. It is heartening to see that it has been able to succeed in competing on the larger stage.
1.6 Profitability
The company has been able to maintain a stable operating as well as net margin (7-12%). The figures for the last five years can be seen from the chart below.
2 Financial Situation
All of the company’s debt is financed by banks. The company has a total of €242 million in loans. Let us look at the interest expense and the operating income of the company in relation to the debt.
| Items (in € thousands) | 2011 | 2010 | 2009 | 2008 | 2007 |
| Equity | 671,370 | 561,479 | 473,271 | 382,023 | 304,330 |
| Cash | 86,214 | 55,705 | 81,727 | 116,714 | 24,212 |
| LT Debt | 242,171 | 240,565 | 187,577 | 160,349 | 161,232 |
| Operating income | 164,783 | 156,644 | 145,272 | 91,869 | 86,191 |
| Financial costs* | 26,627 | 2,102 | 1,110 | 1,272 | 609 |
| Financial income | 9,620 | 11,473 | 6,287 | 17,135 | 8,527 |
| Interest cover | 6 | 75 | 131 | 76 | 143 |
The financial cost in 2011 sticks out like an eye-sore. Sadly, the annual report of 2011 does not give clear reasons for why that is. I sent them an email and am expecting a reply. Given the LT debt has not increased too much, the cost is definitely not from interest expense.
The interest cover is more than 6 in the most recent year and has been significantly higher in the previous years. I do not see the company having any trouble paying the interest on its loan.
Following is the timeline for its loan payments.
Given an operating income which is 8 times as large, the company should not have any problems in meeting its covenants. Furthermore, there is a significant margin of safety here. Financially, I see the company to be quite strong.
3 Management
I started reading the shareholder letters from 2001. The then chairman José Maràa Baztarrica Garijo is now chairman and CEO of the group.
The way the company has made strategic acquisitions to bring itself to the forefront of railway manufacturing gives me a lot of confidence in the management. The company has a clear goal of becoming one of the most competitive global manufacturer of railway solutions and the track record of the management is quite good. Look at the following two charts:
The board of directors received €1.3 million in compensation. There is no pension of life insurance obligation to the company. Since the senior management is part of the board of directors, their remuneration is included in the above figure. This is quite cheap. Getting such a management with such a small amount of money is a great deal. I would have liked to know as to how much each manager earned, but the annual report is short in this regard.
The management believes that the employees should have a significant stake in the company. As the company is not allowed to keep any treasury stock, they came up with a workaround. A new company/fund called Cartera Social S.A. was formed. This company would by shares of CAF and sell it to the employees at a discount. This way Cartera will make loss and it will be absorbed by CAF.
The scheme was implemented in three stages. The first began in 1994 when Cartera bought 632,000 shares of CAF at a cost of €26.9 million. The second was completed by acquiring 210,150 shares in 2005 at a cost of €14.3 million. And the third in 2007 with acquisition of 171,747 rights at €50.7 million. In total, Cartera owns 1,013,897 shares of CAF, which is equal to 29.56% of the company.
Since Cartera sold the shares to the employees at a discount, it incurred losses of €49.6 million so far. This has been recognized in full in previous years already. The majority of the rights which are not yet sold to the employees belong to the last phase in 2007. As a result of this, there is a €17.6 million asset recognized in Non-Current Financial Assets - Loans and Receivables.
The following is the list of significant shareholders of CAF.
4 Risks
I don’t see a lot of risks to be honest. There is a significant macro shift toward upgrading the existing infrastructure of many countries and cities. For example - in India the government is building new metros in Delhi, Calcutta, Bangalore and there are plans to add other towns on the list.
The company is also financially very sound. The only problem I see here is that all of the long-term debt is funded by bank loans. Banks are not a very good lenders as they might try to pull their money out if there are signs of trouble with the world economy. I am sure that CAF will have thought of such a situation but given that the LT debt is less than twice the operating income, I don’t see a lot of reason to worry about.
Obviously, if the governments start cutting on infrastructure, the company will suffer in the short term. This risk might delay the significant capital gains we are salivating for.
5 Valuation
| Items | 2011 |
| EPS | €42.64 |
| Revenue | €1.7 billion |
| Op income | €164,783 thousand |
| Cap ex | €30,561 thousand |
| FCF | €134,222 thousand |
| Market Cap | €1.23 billion |
Without going into a lot of juggling with numbers, we can agree that getting such a fantastic growth along with a very good management is worth more than 9xFCF and 8.2xP/E. Paying 12xFCF should be fair for such a company. Which means that the company is undervalued in the range of 30%.
6 Conclusion
| Industry | Railway engines and buggies for metros, high speed, light rail, locomotive etc. |
| Current price | 9xFCF, 8.2xP/E |
| Revenue Growth (5Y) | 16.5% |
| EPS Growth (5Y) | 31.1% |
| Share dilution | 0% |
| Management compensation | €1.3 million, no options rewarded |
| LT Debt | €242 million |
| Equity | €671,370 thousand |
| Goodwill+Intang | €30,799 thousand |
| FCF | €134,222 thousand |
| EPS | €42.64 |
| Share price | €352 |
If that did not convince you, read the article above.
I am going to buy the stock in the next few days. I will probably start a position with five shares and add from there, if the price continues to fall.
