Fazerles (4F6:BU): Is a 90% Price Drop Enough?

In 1993, Fazerles (4F6:BU) was formed to inherit the old wood-fiber plates (hardboard) plant.  The company is the largest hardboard manufacturer in Bulgaria.  The results in its best year, 2007, put Fazerles in second place among the largest exporters of hardboard in Europe, after the French Tarnais.

Fazerles has two wet-process production lines with a total capacity of 18 million square meters of hardboard per year.  They have been subsequently upgraded to increase capacity by 30%.  Hardboard is used in construction (for doors and to cover surfaces) and furniture.  Fazerles also manufactures wood and hardboard packaging for all sorts of products.

Around 85-90% of the company’s production is exported – 80-85% of it to Europe, the rest to Asia and Africa.

The major shareholder (58.6%) is the holding company, Fazerinvest.  So, as most Bulgarian companies, this one also has a control owner.  Other large shareholders are Leo Overseas (9.2%), a Cyprus offshore company, and several funds with stakes of 1-2%.  A pleasant surprise is management and directors’ holding of 2%.

Good Management

Apart from having skin in the game, management stands out on several other counts.  Most importantly, it has done a great job of navigating the company during the crisis.  It showed great foresight and attention to the international situation and expanded or scaled back, accordingly.  Debt was always used very sparingly.  Share count has been held constant.  Dividends were paid out in 8 of the past 10 years.  One final thing that never fails to impress me is the pertinent and down-to-earth tone of the management discussion and analysis section of the annual reports.

Here are some examples of good management at Fazerles.

The prices of basic inputs in the hardboard manufacturing process – wood fiber, fuel oil, electricity – have been rising sharply until 2008.  This increased manufacturing expenses by 10% in 2007.  In a demonstration of shrewd management, the company emphasized purchasing more wood waste.  Part of it was recycled and used in production.  The part that was not fit for any other use was utilized as an alternative energy source.  This way the company materially cut its fuel oil bill – one of its major expenses.

In addition to this, management has been making constant, targeted capital outlays to increase the efficiency of its machines and employees.  Currently, Fazerles has a no-waste production technology and effectively recycles not only its own waste, but also the waste of other wood processors.  As great and important as the ecologic effect of such capital expenditure is, the economic benefits are even greater by reducing the reliance on fuel oil.  Eventually, the company fully replaced fuel oil with biomass, cutting energy costs 5-6 times in the process.

Management also deserves praise for being realistic.  In 2007 – the best year in company history at the time, coming on the back of a record 2006 – management carefully considered the trouble brewing in the US and its importance for all other countries.  Based on this, the company was guided towards investing in solving potential future problems and cutting expenses rather than growth.  It is truly refreshing to see a management team that didn’t let success go to their heads.  It is also commendable that projections didn’t disappear during tough times – a normal occurrence in most annual reports.  Management had no problems predicating down years when the conditions on its major export markets granted it.

Management’s calls for caution were justified when, in October 2008, clients started delaying and cancelling orders.  Credit dried up and trade slowed down to a crawl.  As luck would have it, the planned shutdown of one of the two production lines for maintenance coincided with this sharp drop in orders.  So, management decided to keep it offline until conditions got better (not until 2011).  The orders were not enough even to fully utilize one production line.  Unfortunately, the cuts had to go deeper.  Almost 30% of the workforce was sacked.  All investment projects were scrapped.  Management clearly performed great under pressure.

Bad Economics

The most serious issue Fazerles faces now is that 90% of its wood fiber supply comes from state-owned forests (because the state owns 80% of all forests in Bulgaria).  In the heat of the crisis, management complained that negotiating with the State Forestry Agency, which saw “no market problems, no lack of buyers, no crisis,” was next to impossible.  Instead of reducing prices in the conditions of a severe, worldwide economic crisis, the agency increased the price of wood by over 20%.  This led the company to turn to Romania for supplies.  In 2009, a quarter of the wood fiber and wood waste came from Romania.

The 2011 export licenses allowed more wood to be exported and further exacerbated the problem by creating a deficit in the country, thus pushing prices even higher.  Management has been vocal about the years of consecutive 20-25% increases in the price of wood domestically.  In addition, last year’s winter was very harsh.  Roads were blocked and rivers were frozen, leading to the company’s supplies being blocked for 2 months.  These factors have been affecting sales and production in the past 4 years.

The two major problems ahead of Fazerles lie in Europe and Bulgaria.  First, the lack of business recovery in Europe holds the company back, because it exports 90% of its production.  90% of exports are to European countries – mostly to southern, i.e. troubled, countries.  Then, the poor government policies regulating wood sales and the government’s monopolistic position in the forestry business materially increase the cost of the company’s raw materials.

The company now operates between a hard place and a rock.  Europe’s troubles constrain demand while Bulgaria’s troubles limit supply, making it more costly and uncompetitive.

Valuation

Fazerles didn’t have a losing year in the past decade.

Between 2003 and 2008, when business was still going strong, Fazerles grew book value by an impressive 24% annually.  Sales growth was more moderate at 8%, but thanks to improved operational efficiencies this translated into over 60% annualized growth of the bottom line.

The period 2009-2012 went under the sign of the crisis.  After the sharp drop from BGN 27.4m (BGN 1 ~ €0.5) to BGN 14.5m in 2009, sales bounced back to BGN 22.2m in 2011.  However, they dipped again in 2012 – to BGN 17.8m.  As mentioned above, 2012 was particularly hard for Fazerles.  At the start of the year, the cold weather blocked roads and rivers, leaving the company without any supplies for two months.  Additionally, raw material prices kept going up.

Over the past 10 years, Fazerles earned BGN 16.3m.  However, two-thirds of this was due to two banner years.  The rest of the time earnings were way lower.  Since the business is closely related to housing and construction, it is likely that the cycle will turn when construction picks up.  But I am not too comforted by the fact.  I prefer businesses with pronounced consistency in results.  Wild swings and reliance on a few record years is not what I am after.  What is more important, I don’t like the fact that the company is very dependent on the government as a supplier and just dependent on South European countries as customers.  I find it hard to think of a worse set of external factors to be operating under.

The average earnings over the 2003-2012 period were BGN 1.9m.  However, I think the average year for Fazerles looks more like 2011 – with earnings of BGN 1.2m.  This is also closer to the average free cash flow over the 10-year period of BGN 1.3m.

The crisis took the market capitalization to a low of BGN 15m down from BGN 190m.  Nowadays, the company trades at around BGN 15m (now BGN 15.45m).  Despite the 90%+ price decline, I don’t think the company is a screaming buy.  The reasons are: the rising raw material costs; the dependence on the government as a supplier; the troubled markets for the company’s production; and the increasing competition domestically and internationally.

It is truly staggering that a hardboard business, hardly the most exciting or lucrative among companies, was trading for 35 times all-time-high earnings.  This just comes to show what levels of insanity the construction boom reached in Bulgaria.  It also shows why the SOFIX levels of late 2007 won’t, and shouldn’t, be reached again anytime soon.

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