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Natuzzi: Hidden Italian Gem?

October 06, 2013 | About:
Chandan Dubey

Chandan Dubey

97 followers
Current Price: $1.81

Shares Outstanding: 55 mn

Net Cash: €27 mn

Working Capital: €174 mn

LT Debt: €5.3 mn

EV: €107 mn

FCF: -€16 mn

History: Founded in 1959 by Pasquale Natuzzi, Natuzzi S.p.A. designs and manufactures a broad collection of residential upholstered furniture. With consolidated revenues of EUR 468.8 million in 2012, Natuzzi is Italy's largest furniture manufacturer. The Natuzzi Group exports its innovative high-quality sofas and armchairs in five continents under separate brand names, Natuzzi Italia, Natuzzi Editions (only for the North American market) /Leather Editions and Softaly. Natuzzi S.p.A. has been listed on the New York Stock Exchange since May 1993. The Company is ISO 9001 and 14001. (taken from annual report)

Valuation: The company is incredibly cheap on several metrics. It has a net cash position of €27 mn, and a book value of $6.78. In fact, the company’s current assets minus total liabilities stands at €99.8 mn according to the HY 2013 report. This means that you get all the company’s lands and factories for free. The carrying values of these assets are given below.

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Key Figures:

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Management: The company is chaired and run by the founder Pasquale Natuzzi. He is 72 years old and also holds 55% of the company. The Natuzzi family, together, holds 60.1% of the company. Annamaria Natuzzi, the daughter of Pasquale Natuzzi, holds 2.6% of the company and is also on the management. She is responsible for defining group strategy. She has been working for the company since 1980, starting as Production Manager.

Since 2011, the family has purchased 793,086 shares (approximately 1.4% of the shares outstanding) at an average price of $2.4 per ADS.

From its humble beginning in 1959, the founder Pasquale Natuzzi has managed to make it the largest Italian furniture manufacturer with reach in 123 countries. It has 314 galleries, and eleven factories worldwide -- seven in Italy and four abroad (China, Brazil and Romania).

The company boasts of being one of the largest investor in research and development in the furniture industry. The CEO personally manages the research and development facility located in Italy. This facility houses 120 professionals and is dedicated to designing furnitures and studying worldwide trends. The company has invested more than €420 mn in brand repositioning and development since 2002.

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Business: The company uses three raw materials, wood, leather and fabrics. The interesting dynamic is the pricing of leather. It does not depend on the demand of leather but on the demand of Beef. The leather manufacturers have no control over the demand of beef and hence the price of leather is difficult to predict.

Leather is bought mainly in Europe, wood from Romania and fabric exclusively from Italy. The group controls 92% of the raw materials and semi-finished products and hence is guaranteed ultimate quality at most competitive prices. The furniture is handmade by expert craftsmen.

The group principally operates in a niche area of the furnishing market: leather upholstered furniture. This is a fancy word for leather padded/covered furniture. The group is a leading player in this market and 95% of the sales come from this segment.

The company competes with global as well as local players in this segment. The competition is intense and can be on quality, brand, price and service. This will be discussed in more detail under the “Risk” heading.

Financial Strength: The company’s balance sheet has been getting worse with time. The longer the recovery takes, the worse the situation will be. The company lost around €16 mn last year.

Currently, with nearly €25 mn in net cash, the company still has more than a year to wait for the market to recover.

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The company has €67 mn in cash and €5 mn in long term debt.

Risks



Even though the company operates in the niche market of upholstered furnitures, it faces intense competitive pressures from both local and global manufacturers. Even without worrying about the changing consumer tastes and fashion, there is ever present risk of losing market share.

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The group’s main markets are in the US and Europe -- which are very different in terms of competition. The market is Europe is highly fragmented while the market in the US has a number of large companies. Some of these companies have much larger financial resources.

On the cost of labour front, Natuzzi is ill suited to compete with the manufacturers in Eastern Europe and India. These countries have much lower manufacturing costs and subsequently the competition in the lower priced segments have increased significantly in the last few years. If the price of raw materials increases, Natuzzi will find itself limited in pricing its products and hence may face decrease in profit margins.

The group has had significant benefits from government incentive programs for under-industrialized regions of Southern Italy. These have been in the form of tax benefits, subsidized loans and capital grants. It has also received support from Chinese, Romanian and Brazilian governments. There is no reason to believe that these grants and supports will continue in the future.

In the past, the group has also benefitted from workforce reduction programs. Unfortunately, these are not popular with the Italian government. The group plans to fire 1,726 employees -- which is the government has blocked as of yet.

CIGS is a temporary lay-off program pursuant to which government funds partially cover the cost of salaries of workers who are laid off or whose hours are reduced. The Company’s participation in this program is set to expire on October 15, 2013.

As of the date of this Annual Report, the Company is currently engaged in negotiations with the
relevant Italian government authorities on the potential extension of its participation in the CIGS program, but a final agreement has not been reached, and as such no change has been made in the Company’s one-time termination benefits reserve. The Company’s objective is to achieve greater flexibility in its cost structure, increase its competitiveness and hasten its return to profitability in response to the current business environment. The Company can provide no assurance as to the outcome of these negotiations. (annual report)[i][/i]

Italian labour laws require companies to pay termination indemnity to their employees. The group has an aggregated termination indemnity of €25.7 mn and sales agent termination indemnity of €7.4 mn. It is not known when these will be payable because it depends on when the employees are terminated.

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While the company has a lot of cash, nearly all of it is in the Chinese subsidiary. This cannot be repatriated without incurring withholding taxes. If the management decides to move cash from China by a dividend distribution, it will have to pay 10% withholding tax and then income taxes of 27.5% in Italy.

The group has unsecured lines of credit totalling €48.3 mn. The group uses these for short term liquidity needs during the course of its day to day business. As of Dec 2012, the company had €26.9 mn of bank overdrafts. These are payable on demand in a very short term and can be terminated without any advanced warnings. If this happens, the company may have to borrow money on unfavorable terms.

Bottom line: The company is very cheap, and you are getting the long term assets for almost free. The problem is the business which is suffering. The company can survive for a while but the situation will get uglier with time.

Steven Romick once said in an interview that good things happen to cheap stocks. But this is not my cup of tea. There are too many risks involved here.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 3.6/5 (14 votes)

Comments

batbeer2
Batbeer2 premium member - 10 months ago
I think Natuzzi is very interesting.

The seats and sofas they sell may be tied to the housing market (late cyclical). They may be be one of the few still standing.

I like to see how the US division performs this year. If that does well, that may be a good sign for the EU operations next year. For now, I'm watching this one from the sidelines.

Thanks for the article!
cdubey
Cdubey premium member - 10 months ago
@Batbeer2: Thanks for commenting. What do you think about the risks I mentioned ? Cash mostly in china, losing money, labor problems, and worsening balance sheet ?
batbeer2
Batbeer2 premium member - 10 months ago
Cash mostly in China => this means they are doing well in China. That's good. Housing market elsewhere has been not so good in recent years. A small part of their business has generated all that cash. In the past, the rest of the business also generated lots of cash. To the credit of Pasquale, a lot of it was returned to shareholders (including his own family).

Losing money => Not good

Labor problems => They've had that for 50 years; nothing new

Worsening balance sheet => Last time I checked they were a bit lower on cash and a bit lower on debt as well. Smaller balance sheet but not worse. Maybe less good.

If you forced me to bet I'd say it's up next year. I'm not betting though; just watching and learning. This may be the housing stock that got away. Everyone has been bidding up USG and MHK. This may have been overlooked.... for now

Do not forget they have an extensive retail network. This is not just a manufacturer; they have their own shops. They also have significant brand recognition. Quick, name me one other sofa maker from Europe

...


Just some thoughts.
cdubey
Cdubey premium member - 10 months ago
@Batbeer2: As much as I would like that, the extra cash is not entirely from profitable chinese venture but factory relocation expense paid by the local chinese government. Here is the relevant section.

The Chinese plant owned by the Group was subject to an expropriation process by local Chinese

authorities since the plant was located on land that was intended for public utilities.

Negotiations involving the expropriation process began in 2009 and were concluded in 2011. The

agreement setting forth the payment of compensation for the expropriated plant was signed with Chinese authorities on January 26, 2011. As compensation for this expropriation, the parties agreed upon a total indemnity of Chinese Yuan (CNY or RMB, hereafter) 420 million, which is equivalent to approximately €46.7 million based on the Yuan-Euro exchange rate as of December 31, 2011. The Company collected the full amount of the indemnity payment from the local Chinese authorities in 2011.

batbeer2
Batbeer2 premium member - 10 months ago
So they are doing well in China ;o)

I remember a few years ago the bear case for Natuzzi was "the Chinese competition will produce cheaper". I would argue, with that stash of cash, Natuzzi now has a meaningful advantage in China.

Again, just watching this one.... and learning.
batbeer2
Batbeer2 premium member - 3 months ago

Natuzzi has done very well since your article.

Nice work!

Please leave your comment:


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