“In the end, what counts in investing is what you pay for a business – through the purchase of a small piece of it in the stock market – and what the business earns in the succeeding decade or two.”
Warren Buffett – 2010 Letter to Shareholders
A series of fortunate events over the last year or so has provided patient, opportunistic investors with the ability to take a longer view, with an extraordinary opportunity to purchase a wonderful business at a cigar butt price.
With a FCF yield of 14%, a dividend yield of 1.6%, the ability to generate ROIC/ROE north of 20% on a sustained basis – as well as to meaningfully grow both sales and margins in both the short and long-term – we feel an investment in the century old Brink’s Company (BCO) offers investors not only tremendous downside protection, but the chance to earn 100%+ over the next few years as the market comes to its senses and awards this high quality business with a much more appropriate valuation.
The Brink’s Company is a provider of secure transportation, cash logistics and other security-related services to banks and financial institutions, retailers, government agencies, mints, jewelers and other commercial operations around the world. The company was founded in 1838, has operations in more than 50 countries, and is based in Richmond,Virgina.
Services include cash in transit armored car transportation and automated tell machine (ATM) replenishment and servicing – global services includes arranging secure long-distance transportation of valuables – cash logistics includes supply chain management of cash and guarding services, including airport security and – secure data solutions which includes transporting, storing and destroying sensitive information.
A Favorable, High Probability Outcome In An Uncertain Environment
Considering today’s environment and the myriad of risks/headwinds that still face both the public and private sectors of our economy, we think it makes sense to look for investments with certain defensive characteristics that will likely do well under any reasonable future outcome.
With that in mind, the Brinks Company fits this bill beautifully, as it possesses numerous attractive qualities that taken together go a long way towards ensuring a positive outcome regardless of what the future has in store for the general equity market as whole. As we see it, the combination of Brinks (1) fortress balance sheet (2) incredibly attractive valuation, (3) stable, high return, relatively recession/inflation resistant business model, and (4) dominant competitive position, in an industry with solid secular growth prospects, make for a rather attractive combination in today’s uncertain world.
Again, we feel that owning a stable, high quality, low debt, cash cow business that dominates it’s markets is ideal at the moment, both because Brink’s ability to cope with the effects of an economic downturn, and/or temporary business problems is as good as it gets, and because they have the financial strength and flexibility to (1) capitalize on the weakness of their overleveraged competitors and (2) reward existing shareholders through pursing value accretive growth initiatives, buying back stock, and/or increasing dividends, whatever the macro environment looks like going forward.
Additional reasons to get excited about Brinks in today’s environment revolve around the fact that the multitude of temporary problems that have plagued results over the last year or so are firmly behind them and operating momentum is poised to improve. We feel that an operational inflection point has been reached, and that after a tough 2009 Brink’s is finally on the cusp of returning to its historical modus operandi of consistent, mid single digit organic revenue growth, solid FCF generation, and sustained returns on equity and capital of 20%+.
Why is it Mis-priced?
In our experience, any time the historical performance of a company doesn’t give a particularly good view of what the prospective performance of the business is likely to be, there’s an outsized chance the market will mis-price the opportunity in question – typically such situations are created when a business is in the midst of a major change in their corporate organization or their capital structure, and where the implications of the changes are not well understood. Unsurprisingly, the late 2008 spin-off of their home security division created a similar situation, where the implications regarding its effects on BCO’s margins and revenue/operating income growth were (and still are) not well understood.
In addition history has taught us that periods of economic turmoil and/or periods where a business is experiencing temporary (but fixable) problems, tend to create opportunity as well. Again, last year’s economic meltdown and the unusually difficult conditions it created for Brink’s higher growth, higher margin division coupled with a rapidly rising dollar, and a variety of non-recurring charges created exactly the type of conditions that tend to cause the market to misprice even the highest quality businesses on occasion.
So with the above in mind it should be no surprise that when all of the above happen simultaneously, some truly “pinch me I must be dreaming” opportunities can result, and luckily for us, that is exactly what happened. The result was, in our opinion, the type of heads I win, tails I can’t lose opportunity that all of us value investors live for.
With that said, let’s digress for a moment and discuss the implications of the spin and why it is we feel that it lead to a permanent improvement in BCO’s already outstanding business model. Essentially it boils down to the fact that the spun-off home security business required significantly more cap-ex than the core cash and logistics divisions – therefore, the separation naturally embedded a meaningful amount of margin expansion and operating momentum for the core biz post-spin, as less cap-ex, means less depreciation, which means higher margins and an ability to grow revenue/operating income at a faster clip going forward.
Yet, this favorable underlying dynamic has been temporarily masked, as the series of negative events that converged last year created a “perfect storm” of operational headwinds that is just now reversing itself. Below is a quick review of the issues the company dealt with over the last 12 months…
(1) Political instability in Venezuela caused the company to suffer a large currency conversion loss, as management was forced to repatriate cash from its Venezuelan subsidiary (they ended up taking a charge of roughly $22 million). Additional concerns regarding the SEC’s classification of Venezuela as “highly inflationary,” and the accounting and tax implications that would flow from such an outcome didn’t help much either. It’s not too much of a shocker that institutions decided to pass on a business dealing with issues involving a socialist dictator.
(2) A strong dollar negatively impacted results as roughly 80% of BCO’s operating income is derived internationally.
(3) A deeply underfunded pension following the market meltdown of ’08, early ’09 caused management to contribute $150m in the third quarter of last year.
(4) Unusually weak demand for the transport of diamonds and other valuables depressed results for the company’s higher margin value added service division.
(5) Competitive pressures in one of the company’s larger segments (Europe)temporarily depressed organic growth and operating margins
We feel that in light of the above issues, the fact that Brinks was able to once again grow its revenue (admittedly a meager 1%) in what can only be described as an absolutely terrible economic environment, is an impressive testament the quality of this business.
High Quality Business
The Brink’s Company is the very definition of a great business. It possesses a deep moat and a variety of durable competitive advantages that should keep it ahead of its competitors for years to come. In our opinion, it is one of those rare businesses where investors can have significant conviction that not only will this business be around, it will almost certainly be worth considerably more 5, 10, 20 years from today.
It is financially strong, relatively recession resistant, with a multi-decade track record of consistent organic revenue growth and above average profitability. Better yet, due to the durability of its moat and the power of the secular tailwinds that drive its various business units, it doesn’t require a 150 IQ and much of an imagination to see that it its operational results should continue to be stellar for a long, long time to come.
Again, attractive characteristics of Brink’s business include….
• Recurring Sales
• Scalability at low cost
• High returns on invested capital
• Stable, high margin cash flows
• Durable, structural competitive advantages
Attractive Growth Prospects
We believe that Brinks has an extremely attractive growth profile, which over the long-term, should mirror world-wide nominal economic growth and lead to consistent revenue gains in the mid single digits on a sustained basis (at minimum). Maybe we lack imagination, but we are not sure how the global economy can grow over time and not require the services that Brinks business provides.
Shorter-term we expect margin and revenue growth to come simply from the normalization of business conditions. In addition we expect the company to continue to use their cash to pursue strategic acquisitions (especially now that the pension overhang issue is gone), and to some extent from the continued rapid growth of their higher margin CompuSafe proprietary cash management system, which we believe will continue to gain traction with struggling retailers in the today’s environment.
Longer term, growth will be primarily driven by growth in the international economy, which will naturally drive steadily increasing demand for cash-in-transit and cash and logistics services. Growth opportunities in countries like China, India, Brazil, etc. where demand is still in a very early (nascent) phase is significant, and should in and of itself deliver revenue growth to the company in the mid to high single digits over the next 5+ years. Historically mid to high single digit revenue growth was driven simply by the general increase in cash in circulation and rising demand for cash logistics that is a natural extension of economic growth, we expect the same going forward.
A quick discussion on the multiple growth drivers that underlie BCO’s future is worth discussing in our opinion, both to get a better feeling of just how long a runway they still have in front of them, as well as to get a better idea of the power and durability of the secular tailwinds at their back.
The primary factors that have, and should continue to drive revenue growth (and the company’s prospects) over the next 3, 5, and 10 years are as follows:
• Growth in global cash in circulation
• Growth in retail banking bank expansion (worldwide)
• Proliferation of ATM’s (worldwide)
• Growth in CompuSafe product cycle
• Weakness in the U.S. Dollar
Growth Driver #1 – Growth in the amount of cash in circulation worldwide is, and should remain, a growth business. Some mistakenly worry about the continued rapid growth in credit and debit cards and its effects on the amount of cash currently in circulation. Deeper analysis reveals this concern to be baseless, as plastic has been proliferating for decades, and yet the amount of cash in circulation continues to grow 15-20% annually.
Growth driver #2 – We feel that steady growth in the amount of retail bank branches around the globe should continue far into the future. Perhaps understandably, many think that turmoil in the banking industry over the last few years, wide spread bank failures, and/or consolidation in the industry, might be a bad thing for Brink’s business (as banks represents Brink’s single largest customers worldwide). Once again though, this view is mistaken as none of those issues/problems have any real effect on the actual number of retail bank branches according to decades of relevant statistics. In fact, the problems of the last few years might end up causing the number of retail branches in the developed world to actually grow, as banks return their focus to retail banking and more traditional lending. Anyhow, in the U.S. and Europe the number of retail branches tends to remain remarkably stable year in and year out regardless of whether or not bank A or bank B owns it (or whether Bank A or B owns a ton of toxic waste on its balance sheet), and any problems/turmoil in the industry short of systemic meltdown shouldn’t be a major impediment to growth in either the short or long-term. Obviously, BCO should continue to benefit from further growth in the international economy/developing world (Latin America, Asia, Central and Eastern Europe, etc.), and the natural growth in the number of bank branches that such growth will require.
Growth driver #3 – Another revenue driver that has been (and should continue to be) a significant tailwind for Brinks over the last twenty plus years is the continued proliferation of ATM’s around the world, which we expect to conservatively grow at a mid single digit rate over time.
Growth Driver #4 – Growth in the adoption of CompuSafe should drive the top line as well over time. CompuSafe is a closed loop system for retailer’s that helps them detect theft and manage cash. It is a higher margin, value added service that essentially helps them increase’s their operational efficiency by helping them to dramatically improve their working capital turns (a significant value proposition in good, but especially tough times). CompuSafe is still in the early stages of its adoption cycle (and is notably only a small portion of the company’s current revenue), but it has grown rapidly since its introduction (38% yoy) and will likely continue to for quite awhile as competition is weak and the addressable market is large.
Growth Driver #5 – Continued weakness in the U.S. Dollar looking out longer-term is highly probable in our opinion. Considering the huge amount of credit creation, quantitative easing, and dollar printing taking place at the moment (both in the U.S and around the world) and the second order effects of these policies – such as rising interest rates and/or the declining purchasing power of the dollar, it’s worth noting that BCO is a business that not only has pricing power, but that also earns roughly 80% of its profits globally, so it’s a natural inflation hedge.
Dominant Competitive Position
BCO absolutely dominates its industry. It has the strongest balance sheet and the best margins relative to its rivals, a globally recognized brand, and is hands down the market leader in each of its business segments. Brink’s unmatched financial flexibility, not to mention their superior size/scale, the breadth and depth of their service offerings, and global footprint, taken together, should ensure that their dominance will continue for the foreseeable future.
It’s worth mentioning that there are significant barriers to entry in this business due to training requirements for personnel and the need to have a sophisticated back office that can sufficiently track and secure the goods they transport, as is the importance of a trusted brand. Obviously, its multi-decade history of consistently generating ROE/ROIC north of 20% is another, and probably the best, indicator of the strength and durability of its competitive advantage.
For those who worry about the macro-situation (I know we do), it’s important to keep in mind that a double dip would almost certainly be a good thing for Brink’s in the long run, as their unlevered balance sheet and ability to generate large amounts of excess cash in recessionary environments will ensure that their already ridiculously strong competitive position will get even stronger if such an outcome ever came to fruition -The ability to selectively pursue accretive acquisitions and other strategic growth investments around the world, but in particular in China, India, Brazil, Russia, and other fast growing developing markets – while their competitors are hampered by significant debt burdens – is a powerful competitive advantage in the near to medium term that we feel would only strengthen their already dominant competitive position further. Notably, management has said that they have actually been stealing share as of late from competitors due to clients concerns regarding their rivals leverage levels (which average north of 3.5x).
Brink’s current valuation of roughly 5x normalized FCF – which notably assumes 0 growth – is stunningly cheap on an absolute basis and relative to (1) other business service companies with similar organic growth prospects and returns on capital, (2) to the 10 yr treasury, or (3) the S&P. Amazingly the current valuation assigns absolutely no value to BCO’s premier franchise or its significant growth potential.
This is simply too cheap for a financially strong, relatively recession resistant, competitively entrenched business with a strong brand and a multi-decade track record of consistently generating returns on equity/capital in the 20% range. After all, this business generates stable, high margin cash flows that are so consistent and durable that we don’t feel its outlandish to compare their reliability to a AAA bond.
If we assume no growth, and assign a much more rational (but still arguably too conservative) multiple of 10x BCO’s EV/OpFCF, that would peg BCO’s intrinsic value at roughly $50 per/share or roughly double the current price. Again, this is almost unjustifiably conservative in our opinion for a business that consistently generates such robust FCF and ROIC year in and year out.
The bottom line here is that it’s hard to imagine a way in which one could lose money looking out a few years paying the current price, regardless of what the future holds. We can say with pretty strong conviction that the current share price is very well supported by current cash flows and that any future market turbulence short of complete meltdown should not erode that value…i.e. that the odds of permanent capital loss are incredibly low. As a rule of thumb we like to look for opportunities where we can build conviction that, looking out 3 years or more, there is an 85% probability that the price of the investment in question will be higher than it is today. This is one of those investments. Seriously, what are the odds that there will be less bank branches, ATM’s, and cash circulation worldwide in 5 years than today? A review of history would say 0, we wouldn’t go that far but our guess wouldn’t be to far off. What are the odds of a competitor displacing this company over the same time period? We can’t pin point it exactly, but we can say very, very low.
Stock Price = $26.04
Shares Outstanding = 47.50
Market Cap = $1236.90
Net Debt = $198.60
Excess Cash = $143m
EV = $1289.50
Normalized EBITDA = $350m
Maintenance Capex = $120m (70% of Capex according to management)
OpFCF = Normalized EBITDA – Maintenance Capex = $350 – $120
EV/OpFCF = $1289.50/$230m = 5.6x
MF Earning’s Yield = LTM Operating Earnings/Enterprise Value or 13.2% ($170.3/$1289.50)
MF Return on Invested Capital = LTM Operating Earnings/MF invested Capital or 16.68% ($170.3/$1026.10)
To reiterate, Brinks operates in a secular growth industry with tremendous tail winds at its back. If history is in any sense indicative of the future, this is a business that should easily be able to grow for as far as the eye can see. Consider for context, that Brink’s is a business that’s revenue has declined less than a handful of times over the last forty years and that has actually grown revenues through every single recession over that period (for example yoy revenue growth was 1% in 2009 and 11% in 2008). Brinks grew its revenue and operating profit 10% and 26% respectively over the last 5 years.
Companies that trade at roughly 15% Free Cash Flow yields are typically businesses in decline without any real hope of growth in the future. For a growing, competitively entrenched business of this quality to trade at a similar valuation makes no rational sense.
Strengthening Dollar – A rapid rise in the dollar would be an obvious negative, as it would dampen Brinks operating income. We feel that this is something to watch in the short to medium term as a double dip scenario, Greek contagion, PIIGS problems, or any other of the very real macro worldwide risks that could potentially come to fruition over the next few years would likely lead to a flight to quality similar to what was experienced last year. One can always go long the Powershares DB US Dollar Index (UUP) to hedge out this risk if preferred.
Pension Plan – A dramatic drop in asset prices would be a negative, but managements recent 150m contribution should go a long toward minimizing the risk of any dramatic increase in the funding gap becoming an issue at any point going forward. Notably, the pension will not require any additional cash contribution until 2012 at the earliest. As it stands, the pension should actually provide a tailwind to BCO’s earnings as the tax treatment of the contribution is set to ensure the pension will actually be accretive to earnings over the next few years.
Continued Weakness in BCO’s higher margin, value added services division – . We find this risk highly unlikely to be a significant issue as we feel that last year’s unusual weakness was driven by retailer’s fears of being stuck with unsold inventory. There are numerous bits of evidence that the destocking phase is over and that retailers are once again rebuilding inventory. Our expectation is that with destocking behind them and both the American and European economies stabilized (at least for the moment), diamond/jewelry shipments will continue to rebound over the next few quarters as inventory restocking resumes, and the global economy begins to grow again (or at minimum treads water). That’s not to say that we think activity will approach the levels of the last couple of years, but simply that activity will return to a reasonable level.
Improving operating performance – as margins and revenue’s normalize at some point over the next couple of quarters/ year, we think the market will re-rate the company with a much more appropriate multiple on much higher profits as they come to understand the true economics of BCO as a standalone company.
Accretive buybacks, a dividend increase, and/or the announcement of a value accretive acquisition
Continued insider buying – chairman Michael Dan purchased a quarter million dollars in stock in the open market a few weeks ago. We feel that its not a stretch to take this as a sign that he realizes how drastically undervalued the equity is as well as an indication that he believes the value of his franchise is firmly in tact. Additional purchases of size may awaken many on the street to the magnitude of BCO’s mispricing
Potential buyout – considering its valuation, unlevered balance sheet, and qualitative characteristics, we wouldn’t be shocked to see it get bought out by a financial buyer, especially now that the capital markets are alive and well again.
In light of what we feel are less worse economic fundamentals, persistent structural credit risks, and a general market that is pricey enough to be uncomfortably dependent on a sustained economic recovery and continuing record profit margins – we feel that an investment in The Brinks Company offers a rather optimal balance between risk and reward in today’s environment due to the quality of its business and an unrealistically low valuation that seems disconnected from reality, as it discounts an outcome that we feel is incredibly improbable. Better yet, if such an unlikely outcome actually came to be, our losses would be disproportionately small.
To put it a little differently, we feel it is pretty hard to lose by allocating capital towards a well run, financially strong business with fantastic economics, a widening moat, attractive secular growth prospects, and favorable near-term operating momentum at a price that implies the opposite (i.e., a no moat, low return business in terminal decline). By purchasing a wonderful business at a cigar but price, investors (1) minimize the odds of permanent capital loss, while simultaneously ensuring that they have (2) an incredibly high probability of generating substantial gains on their invested capital at some point over the next few years, and (3) that such gains will come largely irrespective of the status of the continuing economic recovery, or lack thereof.
So again, if what counts in investing is what you pay for a business relative to what it earns in the succeeding decade or two, then in investment in Brinks in our opinion will be difficult to beat.
Disclosure: The author has a position in The Brinks Company (BCO). This is neither a solicitation to buy or sell any securities. All information provided is believed to be reliable and is presented for information purposes