Portfolio update #7: Apranga Group Upside Potential?

Ok, a lot to talk about. So let’s begin.

Apranga Group business

Apranga Group (ticker: APG1L) is a Nasdaq OMX Baltic listed company that sells clothing in Baltic states. Group develops its own retail concepts: Apranga, Aprangos galerija, City, Mados Linija. Group also operates stores in Lithuania, Latvia and Estonia under the franchising agreements with Zara, Burberry, Hugo Boss, Emporio Armani, Ermenegildo Zegna, Max Mara, Mango, Massimo Dutti, Bershka, Pull and Bear, Stradivarius, Zara Home, s.Oliver, Promod, Orsay. You have probably heard some of those.

In brief and extremely simplistic way: Group rents commercial areas, pays salaries for its 2000+ employees and hopes the sentiment in consumer spending would increase or at least be stable. Because it is exactly the consumer spending in microeconomics of Baltics that drive the business.

Personal notion on APG1L in the past

I have been watching this stock closer for the last 4 years now. Investors likewise have been long alert of any early signs of recession, but years pass and S&P500 just keeps hitting new all time highs. From microeconomics standpoint clothing (Group’s target clientele is middle – upper and luxury class) is not a necessity good, which means if consumer spending would slow down, Apranga Group might be one of the first stocks to feel direct effects in their income statement as opposed to say utilities or telecommunication sectors, which are considered defensive and more stable during economic downturns.

Apranga stock is a typical dividend cow – business is large, stable, valuations are above market average and main factor influencing price movement had been dividend yield. Take a look at the price chart below:

It’s not hard to see the pattern. From the start of 2014 till the May of 2018 price ranged from 2.43 to 3 € per share, while dividend yield ranged around 5% and it was a great speculative asset, however I did not participate in any of these price waves, primarily due to the nature of Company’s business and economic cycle. I like it when even if you miss the market timing, you are still backed by company’s fundamentals.

Reasons behind recent price correction

As you have noticed from the price chart above, recently Apranga Group stock price has escaped its long 4 year range and at the time of writing is traded at 2.06€.

Major Shareholder MG Baltic scandal

We could start at the end of 2017, when Lithuanian media was boiling with corruption (or bought political influence to be more specific) scandal where main actors were MG Baltic (major shareholder of Apranga Group) concern’s vice president Raimondas Kurlianskis and liberal party’s leader at the time Kęstutis Masiulis. If you want to read more, just type “Masiulis MG Baltic” in duckduckgo and you are good to go. This is indirect, but associations with corrupt major shareholder’s management still moved the price average lower.

Growth

In recent years company struggled to grow organically. It seems, as if retail market is saturated, competition is tight and e-commence space is even worse. It struggled to grow – yes, but it did not contract yet. We will see this in financial analysis section.

Growing expenses

Baltic Countries have been showing a strong economy growth in the last several years and this calls for salary increase:

And we know ECB will likely hike up interest rate by the end of 2019, if not sooner. Commercial real estate leasing agreements are usually indexed with inflation. That’s one major thing I forgot to mention while discussing Baltic Horizon Fund. This means, that leasing expenses will also likely to accelerate in upcoming years.

This adds up to a total increase in COGS (costs of goods sold) which squeezes the bottom line and hence – dividends.

Liquidity

Occasionally major shareholders take the role of market maker in APG1L quote and provide liquidity through UAB Minvista, which is one of major shareholders. Those deals distort the picture of trading statistics. With those in mind, quarterly trading volume for 2016-2018 Q3 looks like:

However more troubling is the order flow of Apranga Group shares as few investors are willing to buy at this range. This screenshot was made on 2018.10.04 trading session.

And this sort of buyer/seller disbalance can be observed in most of recent trading sessions. Seems troubling, until we get to financials.

Apranga Group Financials

Balance Sheet

Over the last 3.5 years there were no significant changes to balance sheet:

Few things worth noting from Apranga Group balance sheet :

• Debt/ Equity is 0.402 – finances are being managed conservatively;
• Financial Debt/Debt 0.061. Which means there are virtually zero expenses on borrowing;
• 2.44 Current ratio means there’s enough debt liquidity to cover short term liabilities, however;
• quick ratio, which subtracts inventory stands at 0.43; which might require some additional liquidity;
• although Apranga Group is a well recognized retailer, especially in Lithuania, intangible assets amounts to only 0.4% in Shareholder’s Equity;
• At 2.06€ share price, P/tBV ratio is at 2.23. For the last 4 years P/tBV has been floating in 2.5-3 range.

Let’s take a look at Income statement.

Apranga Group Income Statement

The weather this summer was extraordinary good. While agricultural business has suffered substantially, Apranga Group’s shops were also experiencing a decreased number of shoppers. CEO Rimantas Perveneckas admitted this earlier this week. In the same interview he noted, that 4th quarter is most important for clothing sector. However we have a full data for trailing twelve months for 2018 H1. So let’s look at some charts and tables.

In linear fashion recent years looks like this:

Yes, that is above 20% Return on Equity, growing revenues and stable, I would call it – profits.

As mentioned above, due to hot summer, 2018 H1 wasn’t really successful for the company. Net profit for 2018 H1 decreased to 2 144 k€, while in 2017 H1 it was 4 272 k€. Group also is reconstructing 10-17 stores in 2018. Investments (capex) are planned to amount to 5-10 M€.

Apranga Group Dividends

Calculated at closing price of ex-dividend date (after daily correction, so a conservative estimate), dividend yields were as follows:

While at 2,06€ and 0,17 dividends the yield is already 8,25%. This is highly speculative at this point, as we saw a significantly weaker first half of 2018.

Cash Flows

Group’s Cash flows graphically:

Mentioned 5-10M€ investments for 2018 in reconstruction of Group’s stores fits right in. Free cash flow (FCF) is healthy and provides opportunities to pay dividends which Apranga did for a number of years.

My favorite FCF/Market Cap indicator at 2.06 price stands at 10.71%.

Portfolio update

I’ll be honest with you. I’m not particularly happy with this purchase. I have been monitoring price development closely for the last month. For 8 trading sessions 2,14 seemed like a strong support. I saw the market depth, but expected the price to break below sooner. And on the same day that I entered at 2,14, it closed below that. Murphy’s law?

It’s been a long time since I used MACD, but this right here looks like a nice divergence:

Anyway, current Baltic Equities portfolio composition:

Conclusion

Company is well established in Lithuanian market. It entered Latvia and Estonia markets later. It could be seen from 2018 H1 report, where Lithuanian market is showing a stagnation, whereas Latvia and Estonia shows conservative growth.

Final results for 2018 will highly depend on last quarter. In 2018 H1 report management gives a turnover guidance for 2018 of 231 M€, which is 3.6% more than revenue for 2017. However pressure from expenses side is increasing.

Nevertheless, Apranga Group is a stable giant in this comparably tiny market of Baltic Countries, with a long track record of excellent corporate governance and dividend payments. Where are risks, there are opportunities as well. My stance is that market is overreacting at this point. I intend to stay in a position no longer than for a year. Will see how this goes.

To make God laugh, tell Him your plans. – Writers of Amores Perros

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This is not a financial advise. Read my poorly written disclaimer. Other Wonders in Baltic Equities market are here.