France: Caustic Elections and Undervaluations

I’m checking out a few ideas in France these days. Unfortunately, it seems Frederick Hollande will be the next President. I say unfortunately because his election will likely amplify the drop that French stocks are experiencing. There are real risks to France’s overall economy – a public sector that is bloated and largely unpaid for, high taxes and social charges that will have to increase to close the budget deficit, and high labor costs that reduce the competitiveness of industry. These, combined with Hollande’s socialist proposals, have spooked investors out of the French market. However, sometimes it pays to look where others are not, and occasionally real value can be unlocked.

One such value play I am looking into currently is Catering International – traded as CTRG on the Euronext Paris. This is a company that handles food catering, but specializes in doing so in hostile terrains. The company’s services are almost 100% employed by the oil and gas (64%) and mining sectors (35%). Of especial interest is the large presence in North and Central Africa (51%).

North and Central Africa will become increasingly important resource centers this century to quench the hunger for development coming from a fast-growing Asia. New fields, with relatively simple geology (compared to complex U.S. oil domestic oil plays) are being discovered in Africa, which will lead to expanding oil exploration. As U.S. and European oil companies move in to exploit these resources, they set up work camps for the workers from overseas. Often companies will have to pay high salaries and throw in special services to tempt workers to leave their native countries – special services like catered food by Catering International.

In addition, the company has just started operations in Iraq and Peru – both oil plays. Iraq is just beginning the opening up of many new fields that have been closed off because of lack of sufficient technology and nearby violence, so the potential for growth in this region is strong, as long as the American troop draw-down continues and new battles do not break out. Peru has small absolute resources, but a history of good production, so Canadian oil companies are jumping on the opportunity. After Argentina’s recent takeover of national oil reserves, companies may be re-evaluating exploration in South America, but so far international exploration and production companies seem will to pursue the risk to reward ratio offered by Peruvian deposits. These could be a source of new growth going forward into the new year.
The company says that from the last half of 2010 on, the African mining sector has been providing much of the company’s growth. Mainly this growth has occurred in four countries – Sierra Leone, Burkina Faso, Equatorial Guinea, and the Democratic Republic of Congo. Let’s take a look at what minerals this growth is dependent on:

1. Sierra Leone – Diamonds

2. Burkina Faso – New gold mines opened up here in 2009. This was the first time that a large scale gold mine has operated in this country.

3. Equatorial Guinea – While this country derives most of its export revenue from oil, there are also important mineral resources here as well – such as bauxite (aluminum), gold, and diamonds.

4. Democratic Republic of Congo – This country is also a huge oil producer, but also has vast copper resources. The other major minerals here are diamonds and cobalt. Rio Tinto has just opened a new gold mine in 2011, so this may be a new source of growth for Catering International.

So we can deduce that CTRG’s growth has been tied to price increases in diamonds, gold, aluminum, copper, and cobalt, along with high oil prices. As long as these five resources remain highly priced, the risks to CTRG’s business model are minimal.

I will certainly have to do some more research on the finances, but at a glance it seems to have grown revenue at 35.7% for 2011. The number of contracts signed nearly doubled for 2011, going up from 280 to 509 total. This company is growing at a phenomenal pace, and it isn’t using debt to do so – its debt-to-equity sits at 3%.

That last part is crucial – any European companies that rely heavily on debt to grow may have a tough time wading through the Euro credit-crunch.

Management is generating a 23% ROE, a number made more meaningful by the low debt.

Operating margins took a big dive from all time highs of 9.3% in 2008 to 7.3% in 2009, and still have not recovered – it is currently hovering around 8%. This margin level has been maintained even as revenues rise.

The business model does not require large-scale capital expenditures, so the company can cover its own growth and turn more than 50% of its operating cash into free cash flow. It has been using its free cash for paying a dividend and paying back debts, but now that its debt is almost eliminated, it may be a candidate for a dividend increase. This would be a big plus, as its current yield of 1.3% is not too tempting on a pure income basis.

The company had a record backlog of orders, worth 260 million euros, which is about equal to the company’s entire 2011 revenue of 266 million euros. So, assuming all of the backlog comes through, the company can expect to at least maintain current levels of earnings, if not grow them more.

Really, this is a growth stock, that seems to be bucking the general trend of the French economy, and of the Euro-zone economy in general. Its primary trends rely on the commodity consumption in emerging markets, the inflation of the dollar and other developed world currencies, and exploration trends in oil and gas and mining, which are all fairly independent of the European credit crunch. And at a P/E of 16.4 and a growth rate above 35%, its got a PEG of .47. That makes it a pretty attractive GARP stock.

It might go down with the rest of France for the near term, so there is still plenty of time to do some research and maybe wait for the price to drop a little more, but don’t let those macro-trends overshadow great micro-economic stories.

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