Norway-based Orkla (PINK:ORKLY) has all the characteristics of a classic Contrarian special situation with a catalyst. At the time of our purchase, the company was viewed as an unwieldy conglomerate with activities in branded consumer goods (think a Scandinavia-focused Unilever), hydro power, aluminum industrial products (SAPA), specialty chemicals (Borregaard), solar (REC), and a significant minority interest in a privately-held paints and coatings business (Jotun). As if the aforementioned smorgasbord of activities was not sufficiently complex to discourage analysis, Orkla also had a portfolio of publicly traded securities and a collection of Scandinavian real estate investments.
Our interest in the name was piqued by a publicly announced plan to reduce the ‘diworsification’19 activities and refocus primarily on the branded consumer goods business. Despite being buried in what had been widely regarded as a poorly run conglomerate, the branded goods businesses has a history of maintaining long-standing, best-in-class brands and has shown that it can develop successful new products. Although Orkla lacks global brands, about 80% of sales are in the Nordic region, roughly 80% of sales come from products with #1 market positions, and about 70% of sales come from its ten largest product categories.
The catalyst for change in Orkla’s capital allocation strategy stems from action taken by the Chairman of the Board, Erik Stein Hagen, a Norwegian billionaire who made his fortune in the grocery business (which was, coincidentally, a big buyer of Orkla branded goods products). Mr. Hagen owns about 25% of Orkla, and since it accounts for a meaningful portion of his net worth, he has a vested interest in the success of the firm.
Mr. Hagen’s early restructuring moves included the appointment of a new CEO whose mandate is to improve the overall profitability of the branded goods segment. As of late, the business has exhibited the ability to earn EBITA20 margins of 10% to 12%, with capital turnover of 1.5x to 1.8x, resulting in pre-tax returns on capital employed of 16% to 21%21. While these metrics are above that of the average public company, management will be the first to tell you that Orkla is nonetheless performing below its global peers. Based on our discussions with industry analysts, competitors, and third-party advisors, we believe the refocused company has room to improve both operating margins and return on capital through various self-help initiatives, some of which have already been implemented.
We began purchasing Orkla in November 2011 on the belief that, net of conservative valuations for non-core businesses, we were purchasing the branded goods business at roughly 10-11x after-tax earnings, assuming no improvement in profitability. We viewed this price as offering a margin of safety22 in combination with optionality on improvement in the core business, accretive mergers & acquisitions, and an economic recovery that would allow a realization of non-core businesses in excess of our ascribed value. While the story has not yet completely played out, thus far, the plot is unfolding as we had hoped. Though the valuation is no longer as compelling as it was at our time of purchase, the current price remains sufficiently reasonable that we intend to stick around for the second half of the show.
While we wish there was more to be excited about in the portfolio today, we don’t just sit and wile away our time waiting for the door of opportunity to reopen. We spend our days (and many nights) researching businesses we’d like to own. We can’t tell you when that door will open, but it always does, which saves us from dislocating our shoulder (and the value of the capital entrusted to us) in a futile attempt to knock the door down.