Wilhelm Wilhelmsen Holding, the Bear Case

In my first post on W. Wilhelmsen Holding published yesterday, https://hammerinvesting.wordpress.com/2015/03/18/wilhelm-wilhelmsen-holding-quality-at-bargain-prices/, it was established that the stock is exceptionally cheap right now, based on both Price/Book and Price/Earnings.

Why is it cheap? The Bear Case
This question ought to be the main focus when we dig into the fundamentals of a company, which on the surface appears to be especially cheap. There is always the risk that it is a value trap and that the market knows about things that we don’t. As we slowly peel the onion that is the company and get closer to the core of it, reasons will start to appear. The main question is if those reasons are rational or not.

So far I have spotted the following possible reasons:

• Antitrust investigations
• Uncertainty about contract renewal
• Fear of increase in local car production?
• Conglomerate discount
• Shipping market discount
• Norwegian market discount (following the current oil crash)
• The founding family controls more than 50%
• Dividend payout ratio is low (12%)
• No share buyback
• Cyclical, low liquidity, boring

Let’s look at those one by one.

Antitrust investigations
WWASA and three Japanese competitors are all being investigated for price fixing from 2008-2012. The investigation started in the fall of 2013 and has already led to fines from Japanese authorities. Two Japanese competitors have also been fined by US authorities and it is expected that WWASA will be fined as well. It is also expected that the EU, Canada, Mexico and Chile will seek to fine the major of players in the industry. This creates uncertainty in the market. But it can also be a source of opportunity and lead to mispricings if that fear is irrationally overblown. WWASA expects a clearer overall picture on this issue during 2015.

Having spoken to analysts who have followed the process more closely, the expectation is that the total fines for WWASA will be in the USD 100-120 million range, and USD 200 million being a worst case scenario, in their opinion. Translating those numbers to the balance sheet of the holding company means a reduction of between USD 70-140 million in equity. If that turns out to be the case the effect will be in the 0,02-0,03 range in terms of Price/Book, ie. it will jump from 0,49 to 0,51/0,52 – still a far cry from P/B 0,84 of 2013 and 2012. In other words, while a serious matter, this alone cannot be the reason for the heavy discount – if we suppose investors are rational.

The liquidity position of WWASA is solid enough to counter fines of this size. On top of that WWASA has a 12,5% share in the logistics company Hyundai Glovis, and that share is currently worth approximately USD 1 billion. So if things get tough, they can sell a portion of that.

Uncertainty about contract renewal
Eukor, which is 40% owned by WWASA, has a contract renegotiation with Hyundai and Kia coming up in 2016. Eukor currently transports 60% of Hyundai’s and Kia’s exports and there is uncertainty whether this will continue or whether it will drop into the 50% or 40% range. WWASA has stated that they expect volumes to remain the same. Perhaps the market views this as overly optimistic.

Fear of increase in local car production?
I have not been able to find information on whether there is a trend in this direction currently. But if it is indeed the case, or if it happened in the future, it would result in a smaller market, so it is a potential threat to keep in mind and to look out for.

Conglomerate discount
There has always been a discount compared to a sum-of-parts valuation in WWI. As I wrote in the first part of this analysis, I don’t completely agree with it, but it will probably stay that way in the foreseeable future. Should the company decide to spin off some of their holdings, this will come down and the share price will go up.

Another reason for the discount might be a very simple one. Both WWI and WWASA consist of a myriad of companies and joint ventures, which makes it harder and more time consuming to analyze. Perhaps many potential investors stay away for that reason. However, none of those two reasons address the increasing discount gap.

The general shipping industry has been hit hard
The Baltic Dry index, which measures the transport activity of commodities by sea, is at an all time low – due to a combination of overcapacity and declining demand. As a result of that many players in the shipping industry are struggling. However, WWI’s main operations are in the car carrier and high & heavy markets, which are both unrelated to Baltic Dry. The revenues for the Ship Service part of the group has declined slightly – but profits are up and EBIT-margin a healthy 10%. However, these numbers are relatively small compared to the overall numbers for the group.

You could argue that if the market is viewed to be in a slump now and the current P/E is at 3,4 what happens to the share price once profits start to really take off?

Norwegian market discount
Norway is to a very large extent synonymous with the oil and shipping industries. As both have witnessed brutal declines recently some investors in the region may have withdrawn funds from the overall stock market out of fear regardless of the industry that the individual companies are in. A lot of stocks on the Oslo stock Exchange are traded at historically cheap prices. For some the fear is warranted, for other much less so. I believe the latter to be the case for WWI.

The founding family controls more than 50%
Some investors don’t like to be at the mercy of one group controlling 50%+ of the outstanding shares. However, it is very well documented that founding families tend to be more focused on long term value creation than your average CEO. And generally speaking, you get rewarded handsomely for owning shares in family owned businesses. However, there is also another side to this story and that is that the company (Tallyman), which controls the majority of shares in WWI, is owned by about 15 family members, I am told (as a side note, many of those are on this list of Norway’s richest people, among them the group CEO, Thomas Wilhelmsen: http://www.dn.no/nyheter/naringsliv/2013/10/18/her-er-norges-1000-rikeste). What happens if there are disagreements with regards to the overall strategy within that group. Can it hamper decisive action?

Low dividend payout ratio
WWI is expected to pay out NOK 3 to shareholders in May and NOK 2 in November, this equates to only 12% of earnings (3,3% dividend yield). Compare that to the more normal 50% payout ratio of other companies. I think this is one reason why WWI is usually cheap compared to its earnings power. In the current low interest environment the market is hungry for dividend yield so I have no doubt the share price would explode if the company suddenly decided to payout 50% of its profits. Very unlikely to happen though. The company does not strike me as one that changes its strategies to satisfy the market.

No share buybacks
If the primary aim of a company is to increase shareholder value one expects that company to invest its profits in ways that maximizes the return. New capex investments might be expected to produce a return on investment in the 10-15% range. However, there is another low hanging fruit waiting to be grapped now that the company’s asset are for sale at only 49 cents on the dollar and that is to buy back its own stocks. If Price/Book were to increase to the more normal (but still cheap) levels of 2012 and 2013 the stock would increase by about 70% in value. That seems like a no brainer investment to make. And personally, I would much rather see this happen than increased dividends.

I don’t believe it will happen though. The company has no history of doing so and it may prefer an organic growth strategy. If that is the case, perhaps the stock market is punishing the company for preferring empire building rather than shareholder maximizing initiatives.

Cyclical, low liquidity, boring
I don’t care in what shape or form they present themselves but I like value propositions. Paying much less than the expected value of an asset is all that interests me. But many investor groups need an investment to fit into a certain box in order for them to invest and in many ways WWI doesn’t fit the bill.

Dividend investors tend to be defensive and shy away from businesses that are cyclical in nature, which WWI certainly is.

Institutional investors want a minimum of liquidity otherwise their very buying and selling will move the price too much to be worth it for them. On many days the volume in WWI is less NOK 1 million, which is surprising for a company of this size.

Gamblers want bigger day-to-day movement than WWI provides, being in a mature business segment and with a low gearing ratio and solid balance sheet. The later also scares away growth oriented investors.

Personally, I am indifferent to those reasons. I just want the gap between price and value to be huge. I also don’t mind volatility from year to year as long as value is created and compounded over time.

Bear Case conclusions
Of the above mentioned 10 possible reasons for the discount, I believe the first three are somewhat rational. I am the most uncomfortable with the second and third reasons as I find those the hardest to assess both in terms of the likelihood of them occurring as well as the possible impact they can have. The rest are not really rational in my book.

I hope there are skeptical investors out there  who would like to share their thoughts if they have found holes in my analysis or have additional information or questions/thoughts to bring to the table.

You can read the third and final part, the Bull Case, here: https://hammerinvesting.wordpress.com/2015/03/23/wilhelm-wilhelmsen-holding-the-bull-case/