1. The company
Derichebourg (XPAR:DBG, Financial)
As of Jan. 21, 2019:
No of shares: 163.9 million
Free float: 52.8%
Share price: 3.95 euros
Market cap: 655 million euros
Derichebourg’s share price declined by more than 50% over the course of 2018 to 3.95 euros per share and the price level as of January 2019 seems widely undervalued. One major factor seems to have caused this sharp drop: the troubled environment faced by its recycling activities in the second half of 2018 due to tariff wars between the U.S. and China, and the U.S. and Turkey. Nevertheless, the company maintained its Ebitda in line with the prior year. The share price has the potential to double over the next 12 months.
1.1 History
Derichebourg started in 1956 in the metal recycling business under the name of Compagnie Française des Ferrailles (CFF), which began trading on the Paris stock exchange on April 23, 1963. In the 1970s, CFF set up plants directly at steel mills to recycle production waste at the source through onsite treatment of residues from blast furnaces and steel mills. In the U.S., CFF founded Portsmouth Metals Export, a site dedicated to supplying ferrous metals from European factories, at the port of Portsmouth in 1975. It acquired its first shredder in Oklahoma City in 1979 and a second shredder in Houston Texas in 1982.
CFF grew over time in France by taking over Novafer (1977), the French foundry Afficuivre (1979), Nord-Affinage (1979), Sicaworms (1981) and Metalinor (1987). In the 1990s, CFF became the world leader in the shredding sector. At the same time, international operations became a major driver of the group’s development, including the large-scale export of its metals to India, Turkey and Egypt in particular, and international trading in ferrous metals for Southeast Asia and Latin America.
In 1996 Daniel Derichebourg became the majority shareholder of the group and chairman of the company. He conducted a strategic shift and vast restructuring plan for a new start. By 2005, the group's revenue had reached 1.7 billion euros, a rapid increase since the beginning of the decade, and it employed more than 3,000 people. On Jan. 3, 2005, CFF Recycling and Penauille Polyservices announced an agreement to create a major player in services to industries, with revenue of more than 3 billion euros and on July 3, 2006, Daniel Derichebourg was appointed chairman of the Penauille Polyservices Group.
The current Derichebourg Group was formed on July 18, 2007, from the merger of the CFF Recycling Group and Penauille Polyservices Group, both of which were chaired by Derichebourg. The resulting group became a global operator in environment and environmental services for businesses and regional or local governments worldwide, offering recycling and recovery activities, as well as sanitation, security, energy and temporary staffing services. Derichebourg, the main shareholder, still controls the company, with the Derichebourg family owning more than 50% of the voting shares.
1.2 Activity (brands and business model)
Derichebourg is a global operator at the international level in environmental services to businesses and local and municipal authorities. Its global sales were 2.9 billion euros in the last fiscal year, with operations in 14 countries and over 300 locations worldwide.
Its activities can be divided into two separate branches: the Environment division and the Multiservices division. The Environment division includes the recycling activities and services to municipalities and represents around 72% of the global sales (2.1 billion euros), with 10,810 employees in nine countries. The Multiservices division includes services for industries, buildings, tertiary sectors and urban maintenance and accounts for around 28% of the global sales (0.8 billion euros), with 28,598 employees in eight countries. Both share the same basic values and common ambition: serving mankind while protecting the environment.
Derichebourg aims at: protecting the environment and its resources through recycling operations of waste, generated by industries, communities and individuals; making urban environments cleaner and improving their residents' quality of life through services to local and municipal authorities; and optimizing professional environments through offering a wide range of services to businesses and local and municipal authorities that enable them to outsource all transferable services and thus focus fully on their core business.
1.3 Strategy
Derichebourg pursues a strategy around the deleveraging of its balance sheet and has achieved a ninth consecutive year of reducing debt in 2018.
The group typically adjusts its capex on a yearly basis such that it amounts to 50-60% of its Ebitda. In terms of dividends, the group’s policy is to pay shareholders if overall performance allows, which is quite common in family-owned businesses. For fiscal year 2018, the same dividend as the year prior (2017) was paid.
The management of Derichebourg is confident in the growth perspectives of both the Recycling and the Multiservices businesses:
- The OECD foresees a 100% increase in raw materials needs within the next 40 years.
- There are growing regulation pressures in order to develop recycling of industrial waste globally, which should act in favor of its Recycling branch.
- There is a clear outsourcing trend ongoing, which should help its Multiservices branch.
- Nearly all the growth in the global steel production comes from the EAF (Electric Arc Furnace) process, which is favorable for recyclers like Derichebourg.
- Environmental regulation is expected to create new markets for Derichebourg.
The group intends to further increase the use rate of its industrial equipment and to reduce transportation costs by moving sites closer to where waste is produced. The ultimate goal is to continue to vertically integrate the business by further developing specialized processing lines like floating of zorba, aluminium refineries, stainless steel waste blend preparation and aluminium profile shredding and to feed these specialized facilities using the group’s own tons.
Another notable fact is that Derichebourg maintains a low inventory at all times thanks to its real-time IT monitoring system, which helps the company weather downturns in metal prices and be more resilient than competitors.
Furthermore, a share buyback program for 2019 has been approved and is in the process of being implemented. The terms and conditions of this program include a maximum buyback amount of 10% (or 16 million shares) at a maximum price 20 euros per share, spanning a duration of 18 months.
2. Management
The key management positions are held by three members of the Derichebourg family and others:
Daniel Derichebourg, chairman and CEO
Abderrahmane El Aoufir, deputy CEO (non-member of the board)
Bernard Val (member of the board)
Matthieu Pigasse (member of the board)
Boris Derichebourg (member of the board)
Thomas Derichebourg (member of the board)
Compagnie financière pour l'environnement et le recyclage (member of the board represented by Ida Derichebourg)
Françoise Mahiou (member of the board)
Catherine Claverie (member of the board)
2.1 Compensation
The deputy CEO and two members of the board, Boris and Thomas Derichebourg, received variable compensation for their 2017 to 2018 activities of 400,000, 13,000 and 13,000 euros, respectively. This corresponds respectively to 138%, 2% and 2% of their fixed annual incomes.
2.2 Company’s ownership
The following shareholders own shares of the group:
Compagnie financière pour l'environnement et le recyclage (CFER, member of the board): 40.1%
Financière Derichebourg: 0.04%
Employees: 0.96%
Float: 58.88%
It has to be noted that CFER held more than 50% of the shares until the past year (2017). In 2016 and 2017, the float held 40% and 49% of the shares, respectively. However, CFER still maintains the majority of voting rights (56.7%).
3 Company’s operating performance
3.1 Operating performance
Derichebourg recorded solid revenue growth but Ebitda stalled and net earnings declined in 2018:
Derichebourg SA reported an increase of 6.8% in revenue to 2.92 billion euros for its last fiscal year ending Sept. 30, in line with its target, which was revised downward in November 2018.
Meanwhile, Ebitda was stable (-0.3%) at 202.1 million euros but lower than consensus of 210 million euros, or 6.9% of the the revenues from 7.4% of revenues for the previous year. This was due largely to a strong contribution from the services to municipalities, which saw an increase in revenues and in current Ebitda (8.1 million euros).
The group benefited from several amortizers in order to maintain current Ebitda in line with the prior year, such as its resilient business model in recycling and improved performance of its services activities (Household Waste Collection and Multiservices). However, Recycling activities faced a troubled environment in the second half of the year, due to tariffs war between the U.S. and China, and the U.S. and Turkey.
The below chart shows the resilience of Ebitda when ferrous scrap prices drop and the improvement of Ebitda as soon as ferrous scrap prices go up, which can certainly be attributed to its rigorous low inventory management policy.
Ebit declined by 21.4% to 96.3 million euros in 2018 from 122.5 million euros at the end of the previous year. The group took advantage of its resilience in 2018 to end some old litigation cases, which had a one-off impact of 17.1 million euros on 2018’s Ebit.
3.2 Financial situation
The strength of Derichebourg’s balance sheet will increase the company’s resilience in a downturn.
Consistent deleveraging over the last nine years:
Net financial debt has decreased from more than 900 million euros in 2009 to less than 100 million euros in 2018 (85 million euros) and by 11% in the last fiscal year.
Net financial debt-equity is around 47% as of Sept. 30.
Ebit covers more than 11 times the interest payments, close to the highest level in 10 years.
The current ratio is reasonable (0.94).
The return on equity (ROE) stands at 15.1% as of the end of fiscal year 2018 and compares favorably to the industry (median 6.88).
The company has long-term prospects: It is a leader in the core business of metal recycling and develops recycling activities in other areas. The company has embraced the rising environmental themes and is well exposed to the high-potential sector of waste management recycling.
The company is stable and understandable:
The group’s book value has increased by 8.3% per year over the five last years.
Derichebourg is a leader in its core business.
It has a clear business model in a sector that has a lot of potential.
Moat: low inventory at all times, protecting it from price downturns and extreme cyclicality.
The company’s shares can be acquired at an attractive price:
Price to intrinsic value is 0.44 (projected FCF intrinsic value 8.93 euros)
The margin of safety is 13% (fair value 4.53 euros based on DCF valuation)
Low historical price-earnings ratio (9.9)
Low historical price-book ratio (1.39)
Low historical P/S (0,22)
See section "market valuation of the company" below for more details.
3.3 Market valuation of the company
The share price stood at 9 euros at the start of 2018 and collapsed over the last 12 months. As a result, the price-earnings ratio declined sharply from 18 to the current level of 9.9, which looks reasonably cheap and well below its median of 13.68.
Similarly, the price-book ratio appears very cheap and is now at 1.29, down from the highs of late 2017 (3.5).
Despite a challenging second half of 2018, the company managed to maintain Ebitda at a robust level, slightly down from 2017. Its intrinsic valuation based on projected free cash flow remains close to 9 euros, the book value per share shows an upward trend and the debt-equity ratio is now at the lowest in 10 years.
With all these elements factored in, it seems there is ample room to the upside and little to the downside.
4. Risks
The first risk one can identify is the possibility of an escalation in trade wars globally, which could negatively impact the profitability of Derichebourg. This risk is real and quite likely to materialize, but this risk is already largely priced in.
The introduction of customs barriers leading to a segmentation of international trade might have consequences on prices and volumes of recycled materials processed by the group.
These exogenous risks can not be controlled by the group. The low inventory policy, which is performed by the group, is likely to limit the impact of occurrence of such situations, as well as the policy to preserve unit margins. As one can see on the below chart, Derichebourg has an inventory-revenue ratio below its European counterparts, which allows it to remain resilient in price downturns.
The sectors that consume the products sold by the recycling activity of the group (iron, steel and metallurgy) are considered cyclical. A slowdown in these cycles is likely to affect profitability of the activity.
The European and Turkish steel sectors depend on the strength of domestic steel consumption in China. When this consumption weakens, the pressure of Chinese exports at low cost increases and competes with European and Turkish steelmakers.
Another identified risk is that the first client of the environment services activity represents 15% of turnover of this activity, and the top five about 32%. Financial failure, or the reduction of commercial ties with one of these customers would be likely to affect the group's results.
The group's practice is to systematically include reserve clauses in its contracts property, and for large exports to obtain prepayments before unloading the goods. Similarly, a policy of diversifying the customer base is likely to reduce this risk, and this has actively been tackled by Derichebourg: The logistical framework (in particular, accessing ports) necessary for this diversification is ongoing.
It remains true that the business predictability rank of Derichebourg is very weak and the company has lost money several times over the past 15 years. Nevertheless, this is in large part due to the cyclicality of its business. We believe the combination of its long-term strategy based on the stabilization and deleveraging of its balance sheet, its low-inventory management policy, the launch of a substantial share buyback program and the currently low share price put the odds in the favor of a share price appreciation.
Disclosure: The author owns shares of Derichebourg at the time of writing.
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