It is a truth generally acknowledged that public companies acting as holding companies for other public and private assets generally sell at a discount to their net asset value. The happy corollary is that when the holding company’s shares sell below the breakup value of its parts, the owners often try to close the gap – by buying up shares.
Consider George Weston Ltd. As far as I can tell, George Weston has been selling at a discount to its breakup value since I’ve been analyzing stocks, which is more than two decades.
Here is the math. Weston owns 187.8 million shares of Loblaw Cos. Ltd., and 21.7 million units of Choice Properties REIT. Combine their values at current market prices, and divide by the shares outstanding of Weston and one arrives at $110 per share. At the current share price of $113, investors are effectively paying $3 per share, or $450-million, for the equity value of the sole remaining business in Weston, the bakery and food division.
The problem is that the bakery and food business generated about $300-million in cash flow (or EBITDA, earnings before interest, taxes, depreciation and amortization) in 2014. This works out to a valuation of 1.5 times trailing cash flow. That valuation might be okay, if we were talking about Blockbuster Video and it was going to zero, but we aren’t and it isn’t – quite the reverse.
The public comparison to the Weston bakery and food business is Flowers Industries Inc., which trades at 12 times 2014 cash flow. That same multiple for Weston would imply a stock price greater than $130 per share, using the same methodology and numbers above.
But there are several other reasons why I own Weston for clients.
One, its brilliant 2013 acquisition of Shoppers Drug Mart Corp. The same delivery trucks can stop at Shoppers en route to the Loblaw store.
Two, the combined cash costs (costs of goods sold and selling, general and administrative expenses less depreciation) for 2014 for Loblaw Companies, including Shoppers, was almost $40-billion. Management estimates that the combined entity will only yield $300-million worth of synergies over time, including combined purchasing. I believe 0.75 per cent will turn out to be conservative. Just think about the waste in an organization with which you are or have been intimately familiar.
Third, more suppliers will be persuaded – or ‘voluntold’ – to reduce prices. Evidence of Loblaw’s new aggressiveness is already appearing in the form of complaints to the competition bureau. In fact, this trend tells me that Loblaw is doing a good job. Suppliers and employees have complained about Wal-Mart’s aggressive buying practices and labour relations for years. It’s the absence of complaints that signals corporate lethargy.
Clearly, Loblaw has seen the enemy – Wal-Mart – and is seizing the offensive, lowering prices to build customer loyalty. Instead of passing on price increases required to match food inflation, Loblaw is ‘eating’ some of the increase itself.
Fourth, Weston has now dropped below the magical 50 per cent threshold of ownership usually required for consolidation of a subsidiary. IFRS accounting rules allow companies to consolidate subsidiaries with less than 50 per cent ownership when the parent is deemed the ‘controlling mind of the business.’ During the conference call and subsequent public comments that followed the Shoppers acquisition, Weston management hinted at a desire to raise its stake of Loblaw Companies. True, no explicit promise or timeline was provided. But management did say that its intention was to look “actively at other ways to return capital to shareholders through dividends and share repurchase,” once the target for debt repayment was complete. For the record, prior to the acquisition of Shoppers in 2013, George Weston had owned 63 per cent of Loblaw Companies versus the current 45.5-per-cent ownership.
George Weston is a family business, and major decisions require the sanction of both Galen Jr. and Galen Sr., the current patriarch. They may decide there is no urgency in climbing above 50 per cent as Weston is the controlling mind of Loblaw Companies. But for me, with the business value far above its current share price, the logic of being long – the net asset value thesis– is compelling even without a share buyback.
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Gabriel Lowenberg is CEO and President of Lowenberg Investment Counsel, Inc. (LICi), an independent wealth investment management firm based in Ottawa, which owns George Weston for the benefit of its clients.