Codan Ltd

Codan Ltd. (CDA.AX, CODAF) is a 50+-year old Australian company with three electronics-based business segments:

  • radio communications (30-40%)
  • metal detection (50%+)
  • mining technology (5-10%)

The numbers in parenthesis represent relative share of total revenues in the past few years. In FY 2015, the segments did $65m, $70m, and $5m in revenues, respectively. All dollar numbers in this post are AUD, unless otherwise stated. As of today the conversion rate is 1 AUD = 0.75 USD.

For a company with less than 400 employees, it has an enormous (150 countries) global footprint. Its customers include aid and humanitarian organizations like the UN, mining companies, security and military outfits etc.

One of its competitive advantages is its “ability to be profitable in challenging countries and geographies“.

Financial Performance

I snipped the following table from the 2015 annual report

codan2015

Before 2010, EPS were below $0.10/share. It nearly tripled over 2011-2013 to a record $0.26 in 2013. In 2014, revenues and EPS fell by 50% and 80%, respectively – driven by lower gold detector sales.

What caused this steep decline? Gold prices reached a high plateau around 2012-2013. This drove up demand leading to a blockbuster 2013. However, Chinese counterfeiters (who illegaly sold Codan branded detectors) stepped in to absorb the demand, cutting into Codan’s business. Simultaneously, gold prices declined from their high point. The combination lead to a brutal 2014.

Since 2014, management appears to have worked off some of the excess inventory, and developed new detectors, which  are harder to counterfeit. The income statement appears to show growing signs of improvement. Revenues and earnings in 2015 were better than 2014, but still depressed below the 2011-2013 period. Further improvement appears underway for FY 2016: NPAT guidance of $20m is up from 12.7m in 2015). CapEx has been somewhat high the last couple of years due to new product development, but indications are that this will ease in the near future. This should improve net margins back to historic levels of about 15%.

Let’s step back and look at the company over a longer historical time frame (say 10 years). It is immediately obvious that the company has been consistently profitable with no down years (yeah, not even 2008-2009). The average ROE has been in the 15-20% range. The addressable market is quite large (for example radio communications is about $1B, growing at 10-12%), and Codan can deploy free cash flow at attractive rates of return. The company pays a rich dividend (~50% payout ratio, >3% yield currently). Given the ROE (15%) and reinvestment rate (50%), one would expect normalized growth rate to be .15 * 0.50 = 7.5%/year without any heroic assumptions.

The debt ratio (labeled “gearing” in the table above) has hovered around 25%. In Dec 2015, the net debt was $40m (servicing cost about ~$3m/year), which seems reasonable for a company with $20m in net income this year. The amount of intangible assets is somewhat large (~40%, more than $80m), but that number has been relatively steady.

Valuation

In 2016, the company is expected to earn $20m. The number of shares is 177m – therefore FY 2016 EPS is expected to be $0.11/share. These earnings understate normalized earnings, due to heavy capex in the last couple of years.

A growing, consistently profitable company, with reasonable debt levels might trade at 12-15x earnings. This implies a share price between $1.32-$1.65. The midpoint is $1.49.

Alternatively, one can use the formula for a growing perpetuity, with a discount rate = 15%, growth rate = 7.5%, and cash flow to equity of $0.11 to get an approximate NPV = $1.58/share.

Currently, shares trade at about $1.13, providing a nearly 30% margin of safety.

Personal Backstory

I bought a tiny stake in Codan Ltd in the second half of 2014 (CODAF), after reading writeups by Shadowstock and Investing Sidekick for USD 0.71/share. At the time of the purchase 1 AUD ~ 0.92 USD, so my basis was AUD 0.77/share.

Given the 3.5% dividend yield and share price appreciation of about 50%, I should be a happy camper, right? Unfortunately, the USD has grown stronger by about 20% in this time period taking a large bite out of my profits (1.50 * 0.80 ~ 1.20 – 20% appreciation in USD).

Furthermore, the US-listed shares (CODAF) trade very infrequently. It is quite common to see an entire month go by without any volume. In contrast the CDA.AX shares have a more liquid market ($100,000 trades every day). The two quotes are usually not in sync: for example today CDA.AX trades at $1.13, while the last trade of CODAF was USD $0.56 (=0.75 AUD).

Given the intrinsic value, the dividend, and the growth/operational improvement prospects, holding Codan for a couple of years more should provide a reasonable rate of return.

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