KKOYF - Kesko: Why You Should Be Buying This Finnish Mixed Trading Business

2023-10-11 21:03:13 ET

Summary

• Finnish company Kesko offers a rare combination of solid dividend yield, growth potential, and stability.
• Kesko is one of the largest players in Finland in groceries, building/tools, cars, and luxury cars.
• The company's financial success, market-leading positions, and attractive valuation make it an appealing investment opportunity.

Dear readers/followers

I've been reviewing Finnish company Kesko ( KKOYF ) ( KKOYY ) for a number of years, investing and rotating it successfully the last time it "came around" and was undervalued for some time. Now, I believe that time has come again, as the company has dropped below a native price of €18/share. It's nowhere near as appealing as when I bought it at €12/share, but am at a high degree of conviction that despite pressure, this is not a share price we will easily see again given that the company is substantially better than it was a few years back.

In this article, I'll update you on Kesko as an investment for the medium to potentially long-term - because this company can, as I see it, fulfill several roles in your portfolio.

It can be a solid dividend payor with over 6% yield - but it can also provide growth and stability. Such a combination is very rare on the market, and that is why I believe Kesko presents such a great opportunity to investors.

Let me show you what I mean. We have the latest results to consider, and I'll go into some of the more interesting fundamentals here.

Kesko - Finnish Upside with great yield.

Finnish companies aren't that popular investments in the USA, and it's hard to blame investors here, given that the Finnish population is smaller than many American states. It's a small country, judging by the number of people - even smaller than Sweden.

However, even smaller countries need basic operations.

What do I mean by basic operations?

I mean things like groceries, building/tools, cars, trucks, and luxury cars.

That is what Kesko does and is.

It's one of the largest players in Finland for all of these things. This might sound incredibly weird as a sort of "mix" for a business, and it is - but that's the sort of upside you can get when you start digging into these smaller countries.

The last time around I invested in Kesko I was able to generate returns of over 170% in less than 2.5 years - and my investment here was not small.

So as of this time, I'm almost fully invested once again in Kesko - both in my corporate and in my consumer investment accounts.

I made the decision today, to update you on Kesko Oyj because I believe:

1. Finnish companies deserve more coverage on SA
2. This is a great company, and as of going below €17/share, it has once again become an interesting investment potential.

So a "trading company" is what the company is. Much like the Swedish company ICA, which was taken private over a year ago, Kesko was formed when four wholesaling companies merged during the early 20th century (1940), and has grown like a weed since then. It's the Scandinavian model for growth, and whenever this model is publicly listed you better pay attention. That was the main reason I invested in Swedish ICA when it was still public (it was taken private not that long ago).

The company is the second-largest grocer in all of Finland in terms of both market share and sales. The company's role includes the purchasing of FMCG, selection management, logistics, and the overall development of chain concepts and the ever-growing store network. The company also plays cooperation with VV-Auto and Konekesko, to be the main driver of both sales and leasing of some of the most popular car brands in Europe.

The fact that a single player has managed to enter these vastly different fields, and has done so successfully for decades should be of immense interest to any investor. Please note that Kesko is market-leading in food service, car trade, and the biggest in all of northern Europe in the building/tech trade, and manages sales revenues of over €15B per year.

The main areas of operations are Finland, with ancillary operations and representation in Norway, Sweden, and the Baltics.

Instead of showing you straight out and doing just that, I ask you the serious question how you could not be interested in this? We're talking food and daily products - products for infrastructure, building, and vehicles. Things that is needed on a daily basis in society.

The only thing Kesko could do to become more attractive would be to open a few power plants and start owning utility networks - and I hope they don't go that way.

The company serves both B2C and B2B customers, with B2B at about 40% of sales. It's an ecosystem that, once you understand it, is incredibly attractive in terms of its mix of wholesale and retail.

What previously was a diverse mix of betimes-confusing brands has been gathered into a small number of "flags" which the company has been pushing for years here. KodinYkkönen, Anttila, Musta Pörssi, Konekesko, K-payta, VV-Auto, K-Rauta/Rautia, and various "K-brands" have all been moved to 1-4 brands under each segment.

I've already covered in previous articles, like this one , that the company is a financial success - the financial success being seeing non-stop growth in operating profit for the last 10 years. Further growth in Finland at this point is unlikely to be far above the rate of inflation. When a company reaches this sort of size, comparable to businesses like Axfood ( AXFOF ) in Sweden.

Growth will now mostly come through expansion, and for a business like this, that presents a risky proposal. The latest results for 2Q23 show a few new moves the company is doing though.

First off, Kesko is expanding to Denmark. Not super thrilled about this. The Danish market is tricky, even if it's just the building trade - we'll see how that goes.

Otherwise, results in 2Q were....okay considering the macro we're in. Kesko reported a slight net sales decrease as per the guidance, but only 10 bps - so more of a rounding error than anything else. However, operating profit was down. This peaking trend is likely also the reason why the company has moved from over €30/share down to below €18/share - which of course is a development I very much welcome given that I sold above €30/share.

ROCE/other return KPIs remain at a very solid level, even if they're not as stellar as they were a year back during 2Q22. Also, the company has a very strong financial position coming out of this record period. Like most companies in the trade, Kesko has pushed much back into the organization in the form of investments into logistics, M&A, growth, and working capital improvement.

Lease liabilities are up, and Kesko moves up in debt by 0.5x to EBITDA - but from a level of 0.2x - and 0.7x net debt/EBITDA for interest-bearing debt isn't something that I am concerned about at all. Not for a company like this. 2Q23 operating cash flow is up from YoY, and the company now manages close to €1.1B of operating cash flow on an annual basis.

The overall picture for Kesko as of 2Q23 is a lessened profitability, but still very solid indicators despite this if we look at a longer-term perspective. The headwinds and major risks here come in the form of rising inflation and interest rates, with solid construction activity, albeit a decrease in parts of northern Europe especially in the new construction sector.

Sales decreases were both in B2B and B2C technical trade. The grocery trade, unsurprisingly, was the major driver of earnings here, as it remains the less volatile portion of the company.

Overall, I am not bothered by these impacts and trends and would look at the company's valuation as follows.

Kesko - The safety is massive, as is the upside

Kesko is pretty rare here in terms of what it offers. It's a grocer that trades at 12x P/E, which is a clear discount to me, even though the future trends and forecasts imply only an upside of around 1% per year on average until 2025E. The company is coming out of a construction-fuelled earnings boom, with normalization expected in 2023E to the tune of 16% lower adjusted EPS, but a dividend growth of less than 5% despite this to where the current 6.5% yield is not only safe but well covered at a 70-80% payout ratio. The company is then expected to improve, and on the basis of full reversal to a 19-20x P/E premium, this is the midpoint annual upside.

This is a product of the extremely attractive yield as well as a very low, comparative valuation for the business. Even if the company trades lower, say at 13-15x P/E, which would put it significantly below most grocers, we're still at a 20%+ annual upside.

There is very little downside to this investment at €16.17 or around, or anywhere below €17/share. That's why the level of €17/share is an important marker for me, and as soon as the company dropped below it, I started pushing in the capital at a somewhat accelerated pace. My positions are now above 2% each, and I have room to fill them up more if I want to.

It's important to point out at this time that FactSet analysts underestimate Kesko at 40-45% of the time for the past 10 years. Kesko has been able to vastly outperform in some cases the forecasts and expectations - and I would expect the outperformance to forecasts to continue, or at the very least forecasts to be met here.

Kesko is best invested in the native KESKOB shares on the Helsinki stock market. This means you want an international broker like IBKR to go in here - the ADRs are somewhat thinly traded.

Current valuation estimates come to a low of €12.5 to a high of €23/share. I would maintain here my Kesko share price target of €22/share, higher than the current €19/share average of the 5 analysts, but 3 analysts of those 5 are still at a "BUY" or equivalent positive rating here.

I believe Kesko represents one of the better potential investments in the grocery sector at this time. With its recently adopted quarterly payout model, this is an almost-NA sort of investment from that perspective as well.

Here is my updated thesis for Kesko.

Thesis

• Kesko is one of the more interesting grocers in Scandinavia, with its unique combination of cars, grocery, and building trade. I view this combination as inherently attractive, and Kesko as a proven, profitable manager of this mix with the ability to generate above-market returns and attractive dividends. The current yield for the company is above 6%, and I view it likely to stay at that level on a forward basis. Current dividend estimates are even for an increase.
• Based on this, I give Kesko a conservative share price target of €22/share, though the company could easily go as high as €25-€28/share again once its new initiatives and structure are realized.
• Due to that, this company has a double-digit upside, a high yield, and is at a very attractive overall price level.
• I maintain my "BUY" rating for Kesko here, as of October of 2023.

Remember, I'm all about:

• Buying undervalued - even if that undervaluation is slight and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
• If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
• If the company doesn't go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
• I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them (italicized).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside that is high enough, based on earnings growth or multiple expansion/reversion.

I believe the company fulfills all of my targets and criteria here, making it an attractive "BUY".

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