Monday, January 20, 2020

"Compounding" at Fagron intrinsic value based on Benjamin Graham Defensive analysis

Here is an analysis of Fagron using the methodology of Benjamin Graham, the father of value investing as explained by John Reese and Jack Forehand in The Guru Investor.

I don't know much about the company except that it is literally a compounder (it mixes drugs: ) In investing a compounder is a business where profits are reinvested to grow the company (and or Earnings Per Share through share buybacks) which is especially interesting if the company earns high Returns On Capital Employed. 

Fagron recently agreed to pay the US government a fine of $22m (or 30 cents per share) in connection with an industry-wide investigation into pricing.  

SECTOR: [PASS] FAGRON is in the pharmaceutical sector, which this methodology accepts. Technology and financial stocks were considered too risky to invest in when this methodology was published.

SALES: [PASS] The investor must select companies of "adequate size". This includes companies with annual sales greater than $340 million. FAGRON's 2018 sales of 473 million passes this test. Sales are increasing.

CURRENT RATIO: [FAIL] The current ratio must be greater than or equal to 2. Companies that meet this criterion are typically financially secure and defensive. The current assets are €233 million and current liabilities are €198 million. FAGRON's current ratio of 1.2 fails the test.

LONG-TERM DEBT IN RELATION TO NET CURRENT ASSETS: [FAIL] For industrial companies, long-term debt must not exceed net current assets (current assets minus current liabilities). Companies that meet this criterion display one of the attributes of a financially secure organization. The long-term debt for FAGRON is €350 million, while the net current assets are  €35 million. FAGRON fails this test and debt has recently increased. 

LONG-TERM EPS GROWTH: [FAIL] Companies must increase their EPS by at least 30% over a ten-year period and EPS must not have been negative for any year within the last 5 years. Companies with this type of growth tend to be financially secure and have proven themselves over time. FAGRON made losses in recent years and fails this test.

Earnings Yield: [FAIL] The Earnings/Price (E/P) ratio, based on the lower of the current E/P or the E/P using average earnings over the last 3 fiscal years, must be "moderate", which this methodology states is greater than 7%. Stocks with high E/Ps are more defensive by nature. FAGRON's E/P at the moment is only 5% and fails this test.

GRAHAM NUMBER VALUE:  [FAIL]  The Price/Book ratio must also be reasonable. That is the Graham number value must be greater than the market price. FAGRON has a Graham number of √(15 x €0,7 EPS x 1,5 x €3,1 Book Value) = €7

Conclusion: FAGRON is difficult to evaluate. It belongs in what CharlieMunger calls the “too hard pile”.  Investor Waterland recently sold at EUR 16,20 at the current price of EUR 20,56 that might be a good idea? Then again the business seems to be doing well. 

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