Investment Analysis: Fleury Michon

Share Price: €30 (July 11th 2012) Number of shares: 4,387,757 Market Cap: €132M EPS: 3.13€ / Div: 0.91 Trailing P/E: 9.6 EV / EBITDA: 4.5 P/Book: 0.81 P/Tangible Book: 1.20 ROE: 8% Debt/Equity: 1,01 Current ratio: 1.18 Valuation: DCF method: €28.3 Tangible book value: €25 Net-net: No Reco: Hold, negative short term outlook

Presentation of the activities:
Fleury Michon is a French company which prepares and sells cooked pork meat, surimi and prepared meals to supermarket outlets Fleury Michon operates 8 production facilities in France (including one currently in construction), one in Canada and another one in Slovenia. The French major outlets division (“GMS”) provides with 86% of revenues. Fleury Michon is the leader in France with a 27% market share in prepared meals, 24% market share for surimi and 11% for cooked pork meat.

2011 Key Figures (€M): Sales: 644 EBITDA: 54 CFO: 29 FCFF: -20 Net Income: 13 Equity: 161 Assets: 510 Financial debt: 163 Cash: 54

Strategic analysis:
5 Porter’s forces:
Bargaining power of suppliers: Bargaining power of buyers: Threat of new entrants: Threat of substitutes: Competitive rivalry:

Low because Fleury Michon is a very large buyer for pork producers. Very high because of the high concentration in distribution in France. Low because of the tight margins and high capital requirement: it is already a mature industry in France. High. High even if the strength of its brand helps.

Of course, vertical integration would make no sense to Fleury Michon (both forward and backward integration). Also, the French market is saturated. Remains three ways to add value to shareholders: 1. Improvement in production efficiency 2. Horizontal integration in foreign countries 3. Share buyback when market conditions are favorable

Hopefully, the management came to the same conclusion and undertook each of these three steps.

Mehdi MEZIANE, Asset Management & Equity Research.

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Financial Analysis:
Evolution of Sales, Net Income, ROE and Debt ratio:

We can notice the steady growth of sales, the relative stability of net income and return on equity and the recent increase in debt-to-equity ratio.

Dupont Analysis (ROE Analysis):
ROE = (NI/EBT) x (EBT/EBIT) x (EBIT/Sales) x (Sales/Assets) x (Assets/Equity) ROE = 0.56 x 0.91 x 0.0397 x 1.26 x 3.16 ROE = 0.02 x 1.26 x 3.16 ROE = 8 % NI = 13,042 (€k) EBT =23,260 EBIT = 25,564 Sales = 644,592 Assets = 509,666 Equity = 161,234

As the Dupont analysis shows, the most critical part in the ROE breakdown is the EBIT/Sales ratio of 4% which leads to a very tight net margin of 2%. This tight margin mainly comes from the cost of goods sold which represents almost 50% of revenues, employee charges represent 25%. As we can see, Fleury Michon net income is highly dependent on commodities prices, pork bellies coming first. A 1% increase in COGS would result in a 13% decrease in net income if selling prices were not adjusted. Alternatively, if main commodities prices were to go down by 8%, net income would double. However, the selling price should offset the variations in commodity prices on the long run and the net profit margin should reverse to its mean.

Mehdi MEZIANE, Asset Management & Equity Research.

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CFO: +29M CFI: -66M CFF: +31M FCFF: -20M Adjusted FCFF: 16M

Figure 1: Pork bellies price in France ("Marché du Porc Breton")

As the above chart shows, the average price increased by 5.6% in 2012 compared to 2011 prices. This price level puts a huge downward pressure on 2012 operating margin. It seems that Fleury Michon share price does not reflect this recent surge in price levels.

Cash Flow Analysis:
The FCFF for 2011 is negative (-€20 M) which should have been a red flag if we did not consider that this was due to the exceptionally high fixed capital investments made this year for €60M. Adjusting the fixed capital investment requirements for a longer term perspective yields a positive FCFF of €16 M on the low range. As shown in the statement of cash flow, the investment outflow is covered by both cash from operations (CFO) and cash from financing (CFF) by issuing debt in similar proportions. The remaining €5.6M decreased the cash position.

Balance Sheet Analysis:
Intangible assets: €51M LT tangible assets: €200M LT Financial assets €28M Current assets: €229M (includes cash and equivalents = €54M) LT Financial debt : €124M LT Total liabilities: €154M ST Financial debt : €39M Current liabilities: €194M Equity: €161M

There is no short term liquidity issue given the current ratio of 1.18 and a strong cash position (€54M). LT debt increased by 40% from €88M to €124M in 2011 in order to finance fixed capital investments (mainly the production facility located in Cambrai, France).

Mehdi MEZIANE, Asset Management & Equity Research.

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Governance:
Ownership:
    Family shareholders: 69.3% Public: 19.8% Treasury stocks: 6.4% Employees: 4.4%

Board of Directors:
The board of directors is composed by 11 people and is renewed by third every year:    4 representing the family owners (among them the chairman of the board of directors) 5 totally independent members, elected for their expertise 2 representing employees shareholders

As we can see, corporate governance is considered seriously. The board of directors is independent and aligned with shareholders interests.

Insider Trading:
  Magdelena Philippe, member of the board of directors: Sold for €272K in 2011 SHCP (represented by Gonnord Yves, member of the board of directors): Bought for €638K in 2011

Share Price: (compared with French index CAC 40)

Figure 2: Estimated Beta : 0.42

Mehdi MEZIANE, Asset Management & Equity Research.

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Fair value estimation:
Using the discounted cash flow model with a 9% discount rate (cost of equity estimated using the CAPM model) and considering a sustainable growth of 5.6%, we estimate the fair value to be around €28.3 per share.

Conclusion:
We consider Fleury Michon to be a good company, well managed and working in its shareholders interests but operating in a competitive environment. The current €30 market price per share seems fair but does not allow for a margin of safety and our recommendation is then to hold. Everything else being equal, we would consider buying if the price was to fall below €25.

Author: Mehdi MEZIANE, Independent Financial Analyst and Portfolio Manager. Contact: mehdi.meziane8@gmail.com

Disclosure: The author of this analysis owns shares of Fleury Michon. This analysis includes personal opinion and should be considered as such. The author should not be held responsible for any financial losses incurred following decisions based on this analysis as well as for the accuracy of the figures presented.

Mehdi MEZIANE, Asset Management & Equity Research.

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