Value in France – Who Would have Thought?

Nowadays France is better known as the country which has managed to take incomprehensible, anti-growth, anti-sanity, bureaucratic policies, layer them on top of existing, mind-numbing socialist stupidity and have their citizens think it all as ordinary as chocolate cake.

It’s enough to induce a guy to reach for Xanax, if just to quell the anxiety. It was obviously enough for Gerard Depardieu to become a Russian… which is saying something!

It is therefore with much surprise that Brad told me this afternoon about a company he has on his radar… a French company.

Let’s dig deeper and take a look.

Veolia (VIE) is a French company involved in utility and public transportation businesses. They provide drinking water, waste management services, manage and maintain air conditioning systems, and operate road and rail passenger transport systems. Veolia is yet another one of Europe’s “deep value” large cap stocks.

Given the chart above, it doesn’t take much to work out that it is highly unlikely to be crowded on the long side, and certainly isn’t popular with the investing public. As a result Veolia isn’t expensive – that’s for sure. The big question is, just how cheap is it?

  • It trades below book value (0.86)
  • Its price to sales is a mere 0.3x.

Perhaps these low valuations have been warranted up until now, as earnings at Veolia have collapsed over the last 6 years due to the global financial crisis and European debt crisis. Take a look at the following chart:

2Veolia – Price to Book Ratio (Red) and Operating Income (Yellow)

However, what has happened in the last 6 years is history. The “million dollar question” is what will the next 6 years bring? It appears that the long term downtrend in earnings estimates has been broken. Analysts are starting to factor in a turnaround in the fortunes of the company. Earnings estimates have begun to rise after enjoying a continual downtrend since the end of 2007.

3Veolia – 12 month Forward EPS Estimates

As with most large cap deep-value situations, what is required is lots of time for the turnaround to occur. Perhaps the “secret” to investing in deep-value situations isn’t so much the view about the underlying investment, but rather how that view is applied.

One way of applying this view is via ultra-long term warrants trading in Europe. A warrant is similar in most aspects to an option. On most large cap stocks in Europe one can get warrants with an expiration of December 2020. I think that these are great instruments to apply long term views as they provide ample time for a turnaround to play out, and they mentally encourage investors to not think about what will happen to the stock within the next 6.5 years, but rather to where the stock price is likely to be at expiration of the option (December 2020).

These ultra-long term warrants bring in a different dimension of diversification/risk to a portfolio. Many investors think of diversification as spreading risk over a number of positions/assets. Few look at diversifying risk by going across varying time frames. As an example, what happens to Veolia in the next 12-24 months may well have little to do with what happens to it in 6.5 years time!

Another aspect to these long term warrants when applied to deep value situations (in this case Veolia) is where the stock price will be in 6.5 years time has little to do with where the market will be at that time. This is because the stock price is so depressed, and there is such negative sentiment towards it, that if something “less worse” than expected occurs to the company within the next 6.5 years the stock is likely to advance materially higher.

Of course warrants do have drawbacks. These mainly relate to more practical aspects, such as:

  • On which platforms can one trade the warrants
  • How to get bid/offer prices
  • How to determine whether or not the option is expensive or reasonably priced.

For many retail investors these practical aspects are overwhelming, perhaps this is why very few actually bother to trade them. In doing so they forgo huge potential gains with relatively little risk.

Brad is sending trading ideas like the above to our Capex Asymmetric Trader members on a weekly basis. You can learn more on how to profit from long-term, low-risk, big payoff value trades here.

Have a good weekend!

– Brad and Chris

“Value investing is at its core the marriage of a contrarian streak and a calculator.” – Seth Klarman


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