Subdued FY18 results reflect market trends

Scherzer & Co 18 April 2019 Update
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Scherzer & Co

Subdued FY18 results reflect market trends

Asset management

Scale research report - Update

18 April 2019

Price

€2.42

Market cap

€73m

Share price graph

Share details

Code

PZS GY/PZSG

Listing

Deutsche Börse Scale

Shares in issue

29.9m

Last reported net debt at end FY18

€23.7m

Business description

Scherzer & Co (PZS) invests its funds mainly in domestic equities. PZS looks for companies that are unknown or unloved, and special situations. The focus is on special situations, where the downside is perceived to be limited. In addition, it acquires value stocks, mainly below book value. These stocks need to demonstrate strong business models.

Bull

Strong management, well known in the market.

‘Hidden’ NAV kicker through special compensatory rights, albeit with binary outcomes.

Well diversified portfolio with attractive risk/return pattern, built over a number of years.

Bear

Dependent on market environment.

Still relatively small.

For the strategy, market size is limited.

Analyst

Milosz Papst

+44 (0) 20 3077 5700

Scherzer & Co’s (PZS) NAV declined by 12.6% in FY18 and a further 1.3% in Q119. The company increased its income from dividends and writing options, but significant write-offs in the portfolio and a relatively high tax burden resulted in negative EPS of €0.03. Consequently, the company will not pay a dividend, compared to a DPS of €0.10 paid from FY17 profits. PZS’s portfolio of extra compensatory claims (ECS) increased to €103.8m (€116m including Allerthal-Werke and RM Rheiner Management) in FY18, mainly due to the addition of €8.4m attributable to PZS’s stake in Oldenburgische Landesbank.

Negative EPS on write-offs and taxes

PZS reported negative EPS of €0.03 in FY18 vs positive EPS of €0.26 in FY17. The loss was caused mainly by net unrealized losses (€9.7m vs €2.9m in FY17) – reflecting negative developments in German equity markets in H218. Two sizeable disposals from PZS’s ‘old’ current assets led to a high tax burden of €1.6m (FY17: €0.03m), which should diminish in time due to regulatory changes. The company reported a profit on realized transactions of €9.4m (-27% y-o-y), further assisted by a 44% y-o-y increase in income from dividends at €2.6m, and reduced personnel expenses.

NAV performance in Q119 below broader market

While PZS’s NAV performance in FY18 (-12.6% in total return terms) was ahead of both the MDAX (-18%) and SDAX (-20%), it did not rebound in Q119 (-1.3%) despite these indices showing a positive c 15% return. During FY18, PZS has not seen any significant ECS rulings, but expanded its portfolio by €10.6m to €103.8m in tender value (€116m including ECS held by portfolio companies). With the recent minority squeeze-out in Linde (21% of PZS portfolio at end-March 2019), the ECS portfolio could increase by a further c €21m. While the outcome and timing of such claims is uncertain, they provide a potentially strong ‘NAV kicker’.

Valuation: Slight premium to NAV

PZS has long traded at discounts to NAV to the tune of 15% but, following positive catalysts, eg the successful sale of FIDOR Bank in 2016, its shares are now trading broadly in line with NAV. An additional stock driver could be the pending AXA ECS case. The latest valuation report by the auditor indicates potential income for PZS of €18.8m or €0.63 per share from the case. Importantly, NAV does not include any income from potential ECS profits.

Consensus estimates

Year
end

Revenue
(€m)

PBT
(€m)

EPS
(€)

DPS
(€)

P/E
(x)

Yield
(%)

12/17

18.8

7.9

0.26

0.10

9.3

4.1

12/18

12.4

0.7

(0.03)

0.00

N/A

0.0

12/19e

6.2

5.4

0.18

0.05

13.4

2.1

12/20e

6.4

5.6

0.19

0.06

12.7

2.5

Source: Scherzer & Co, Refinitiv consensus based on two analysts as at 11 April 2019.

Edison Investment Research provides qualitative research coverage on companies in the Deutsche Börse Scale segment in accordance with section 36 subsection 3 of the General Terms and Conditions of Deutsche Börse AG for the Regulated Unofficial Market (Freiverkehr) on Frankfurter Wertpapierbörse (as of 1 March 2017). Two to three research reports will be produced per year. Research reports do not contain Edison analyst financial forecasts.

Financials: Valuations weigh on results

PZS reported a net loss of €0.9m (vs €7.9m profit in FY17), which translates to EPS of -€0.03 (vs positive €0.26 in FY17). The loss was mostly driven by lower market valuations, as well as a higher tax expense at €1.6m compared to €0.03m in FY17and a five-year average of €0.5m. Consequently, PZS will not pay a dividend, compared to a DPS of €0.10 paid from FY17 profits.

Income from financial instruments of €12.1m was down 32% y-o-y mainly on lower disposals of assets classified as non-current (Scherzer differentiates assets depending on the expected holding period), which contributed €2.6m (down 68% y-o-y). The corresponding expenses related to financial instruments were 45% lower y-o-y, which resulted in an overall net result on financial instruments of €9.4m (down 27% y-o-y). Net gains on the portfolio (both current and non-current) remained the main income contributor at €6.6m (FY17: €10.5m). Importantly, PZS was able to realize a profit on writing options at €2.7m (FY17: €0.8m), which constituted a certain offsetting factor in an adverse stock market environment.

PZS posted an EBIT of €0.9m (down 89% y-o-y from €8.2m). However, this was largely the result of net unrealized losses on the portfolio at €9.7m (FY17: €2.9m). These losses were partially offset by lower personnel expenses at €0.7m (FY17: €2.7m) as a result of lower bonuses to management and employees, as well as higher dividend income from the portfolio at €2.6m (FY17: €1.8m).

According to the management, the higher than average tax burden in FY18 came from two significant disposals from the current portfolio of assets that were bought before 2017. The gain on disposal of shares is exempted from income tax up to 95% of value since 2017. Prior to that, only shares acquired with the intention of long-term holdings (booked in fixed assets) were tax-exempt. Taxation will apply to any disposals of assets in the current portfolio that were bought before 2017. PZS does not disclose the amount of such assets, but the tax burden should diminish over time.

Following the decline in personnel expenses and broadly stable other operating expenses, PZS’s expense ratio (measured as a percentage of average NAV during the period) declined to 1.7% in FY18 vs 4.8% in FY17. Despite the significant decrease in Q418, average NAV in FY18 was 6% higher y-o-y, also contributing to the lower expense ratio. Net debt decreased slightly to €23.7m (down 2% y-o-y), but as PZS’s equity was down as well, the net debt to equity ratio increased slightly to 42% from 40% at the end of last year.

Exhibit 1: FY18 results highlights

€000s, unless otherwise stated

FY18

FY17

y-o-y

Income from financial instruments

12,132

17,819

-32%

Expenses related to financial instruments

(2,727)

(4,937)

-45%

Result on financial instruments

9,403

12,882

-27%

Other operating income (excluding value adjustments)

69

30

127%

Personnel expenses

(688)

(2,686)

-74%

Other operating expenses

(716)

(976)

-27%

Income from dividends

2,586

1,801

44%

Unrealized gains (losses)

(9,742)

(2,883)

283%

D&A

(18)

(11)

70%

EBIT

907

8,161

-89%

Other interest and similar income

113

80

42%

Interest and similar expenses

(317)

(297)

7%

EBT

703

7,944

-91%

Income and other taxes

(1,558)

(43)

N/M

Net profit for the period

(855)

7,911

N/M

EPS (€)

(0.03)

0.26

N/M

Source: Scherzer & Co accounts, Edison Investment Research

PZS’s NAV decreased during FY18 by 12.6% in total return terms including the €0.10 dividend paid. The company still managed to outperform the German small- (SDAX) and mid-cap (MDAX) markets, which declined 20% and 18%, respectively. However, since the end of 2018, German equity markets rebounded significantly, gaining 15% to end-March. At the same time, PZS’s NAV went down slightly by 1.3%. PZS’s NAV progression (ex-dividends) is shown in Exhibit 2. One of the contributors to this was the weaker performance of shares in GK Software.

Exhibit 2: PZS’s NAV per share and share price comparison (€)

Source: Scherzer & Co accounts

The NAV progression does not fully reflect the ECS portfolio. On the one hand, earnings realized from successful closures are reflected in the NAV, and the returns are at least partially reinvested in the portfolio. On the other hand, ECS held currently are not included in NAV. Having said that, the outcome and timing of monetisation for potential claims is uncertain. During FY18, Scherzer generated €12.7m in new ECS, of which the largest squeeze-outs were Oldenburgische Landesbank (€8.4m) and Buwog (€2.8m), bringing the total value of the ECS portfolio to €103.8m at end-2018 (FY17: €93.2m). During the year, two cases were closed and yielded a minor profit of €0.1m based on an ECS value of €2.1m (Edison estimate). Following the recent squeeze-out at Linde, the ECS portfolio could expand by further c €21m. Also recently, Zeal announced its intention to acquire Lotto24 in exchange for its own shares (PZS holds a 0.63% stake in Lotto24 valued at c €2m).

Portfolio developments

The main portfolio components weighing on PZS’s NAV development in FY18 and Q119 were GK Software and freenet, which made up 23% of the portfolio at the beginning of 2018 with their combined share declining to 16% at end-2018 (and remaining at the same level at end-Q119).

GK Software share price declined 40% during 2018 and further 4% in Q119. The company offers software solutions for international retail chains. In 2018, GK Software revenues increased to €103–106m (preliminary) from €90.5m in 2017. It developed on the US market winning three new customers. On the other hand, the company moves further away from achieving its target of reaching 15% EBIT margin by 2020. In 2018, EBITDA decreased to €3–6m (FY17: €8.8m) on the back of product development costs. The company calculates its adjusted EBITDA margin in the range of 8-11%.

Freenet is a German telecommunications and web content provider. PZS holds a 0.2% stake in this €2.6bn market cap company. Freenet’s share price declined 45% in 2018, but rebounded subsequently by 13% in Q119. The company met its FY18 guidance on EBITDA and free cash flow. In recent years, it has made several acquisitions, including Media Broadcast (100%), EXARING (50.01%), Sunrise Communications Group (24.95%) and Ceconomy (9.15%).

Linde became PZS’s largest holding in January 2019 and subsequently its weight in PZS’s portfolio increased further amid purchases in recent months. Following the merger with Praxair, the company (as a new entity called Linde plc) is the world’s largest industrial gas company with a market cap close to €36bn, with Linde being one of its subsidiaries. Subsequently, Linde plc performed a squeeze-out on the minority shareholders of Linde with the price at €189.46 per share, finalised on 10 April 2019. We estimate that the cash inflow from this transaction could amount to c €21m for PZS.

Exhibit 3: PZS’s top 10 holdings list

Company

% of total
(Mar 19)

% of total
(Dec 18)

% of total
(Dec 17)

Opportunistic/safe

Linde

20.99%

10.83%

N/A

Safe

GK Software

10.19%

11.38%

13.72%

Opportunistic

freenet

5.37%

5.07%

9.10%

Opportunistic

Audi

4.92%

5.15%

3.73%

Opportunistic

Allerthal-Werke

4.43%

4.41%

4.88%

Safe

Horus

3.76%

4.39%

4.02%

Opportunistic

Mobotix

3.37%

3.38%

2.92%

Opportunistic

AG f. Erstellung billiger Wohnh. in Winterthur

2.96%

3.24%

N/A

Opportunistic

Weleda AG PS

2.55%

N/A

N/A

Opportunistic

N.N.

2.22%

N/A

N/A

Total top-10 holdings

55.97%

55.83%*

54.17%*

Source: Scherzer & Co, Edison Investment Research. Note: *Includes holdings not in top 10 as at end of period.

Valuation

The most recently reported NAV stands at €2.28 per share as at end-March 2019. In the past, PZS’s shares traded at prices below the stated NAV. The share price appeared to be a function of the net asset value minus the capitalised management costs, which were c 10% of revenues. As such, the average discount to NAV before 2016 was c 15%. Since the successful Schering ECS ruling in 2015 and subsequent newsflow, the discount has declined and the stock now trades slightly above the last reported NAV at €2.42. This suggests improved acceptance of potential gains resulting from the ECS portfolio. There is no visibility of future gains, which may explain why PZS has been trading well below market averages in the past five years based on the P/E ratio.

Exhibit 4: Comparable market P/E ratios

 

P/E (x)

2014

2015

2016

2017

2018

2019e

2020e

DAX

16.6

22.0

19.0

14.6

12.9

13.1

11.9

MDAX

20.0

19.2

28.8

17.6

13.4

18.4

16.4

SDAX

30.9

28.0

23.5

23.4

13.8

17.5

14.9

Arithmetic average

22.5

23.1

23.8

18.5

13.4

16.3

14.4

PZS

11.9

9.2

13.6

10.0

loss

13.0

12.3

PZS discount

47%

60%

43%

46%

N/A

20%

14%

Source: Bloomberg as at 10 April 2019, PZS reports, PZS forecast is Refinitiv consensus based on two analysts. Note: P/E ratios based on year-end prices.

Asset management company valuations are commonly based on asset value, which can be demonstrated by the price to book (P/BV) value. We have looked at the development of P/BV ratios over time, and a decline in PZS’s discount to market has been apparent since 2015, and reached 17% at end 2018. Since 2017, PZS has traded at a premium to its equity value per share.

Under PZS’s reporting standards, NAV development is not fully reflected on the balance sheet. While a decrease in the market price of portfolio is reflected through write-offs, the increases are recognized on disposals. The company can only report positive value adjustments by reversing write-offs, and in effect the book value of the portfolio cannot exceed the initial investment.

Exhibit 5: Comparable market P/BV ratios

 

P/BV (x)

2014

2015

2016

2017

2018

2019e

2020e

DAX

1.7

1.7

1.7

1.9

1.4

1.5

1.4

MDAX

2.1

2.3

1.9

2.1

1.6

1.7

1.6

SDAX

1.9

2.0

1.7

1.8

1.6

1.6

1.5

Arithmetic average

1.9

2.0

1.8

1.9

1.5

1.6

1.5

PZS

0.8

0.8

0.9

1.3

1.3

1.1

1.0

PZS discount

58%

60%

49%

32%

17%

33%

33%

Source: Bloomberg as at 10 April 2019, PZS reports, PZS forecast is Refinitiv consensus based on two analysts. Note: P/BV ratios based on year-end prices.

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This report has been prepared and issued by Edison. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

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General disclaimer and copyright

This report has been prepared and issued by Edison. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the Edison analyst at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2019 Edison Investment Research Limited (Edison). All rights reserved FTSE International Limited (“FTSE”) © FTSE 2019. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd who holds an Australian Financial Services Licence (Number: 427484). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

Neither this document and associated email (together, the "Communication") constitutes or form part of any offer for sale or subscription of, or solicitation of any offer to buy or subscribe for, any securities, nor shall it or any part of it form the basis of, or be relied on in connection with, any contract or commitment whatsoever. Any decision to purchase shares in the Company in the proposed placing should be made solely on the basis of the information to be contained in the admission document to be published in connection therewith.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document (nor will such persons be able to purchase shares in the placing).

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

The Investment Research is a publication distributed in the United States by Edison Investment Research, Inc. Edison Investment Research, Inc. is registered as an investment adviser with the Securities and Exchange Commission. Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a) (11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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