SFFYF - Signify: A 'Melting Ice Cube' Worth Considering

Summary

• Investors are told to avoid melting ice cube-type companies as they are likely to lose value as their sales decline.
• There are situations where a company can be well managed through the decline, and if the valuation is low enough, it can still make sense to invest.
• We believe Signify is in one of these situations, where the company is managing costs and cash flow in a very smart way, and the valuation is very undemanding.

Signify NV (PHPPY) is a Netherlands-based firm that provides lighting solutions, particularly LED based, and was formerly known as Philips Lighting. Many investors have shunned the company due to its lack of growth, resulting in the company having a very undemanding valuation.

Value investors often use the metaphor of a "melting ice cube" to describe a company whose value is likely to decline over time. This can happen for a number of reasons, such as changing market conditions, increased competition, or technological disruption. Some of the signs that a company might be a melting ice cube include declining sales, shrinking market share, or profit erosion. While we believe Signify might be a melting ice cube, particularly when looking at revenue, it is still possible that the valuation is attractive enough for an investment to work out alright. Warren Buffett likes to call melting ice cubes that are cheap enough to warrant an investment "cigar butts", saying that some companies still have a little bit of value left that can be had almost for free. He uses the strategy less often now, but it was one of his main strategies early in his career.

We believe Signify sales are unlikely to grow very much in the future, probably not even keeping up with inflation. Still, it is a melting ice cube worth considering for a number of reasons. For starters it is expected to melt at an extremely slow pace, meaning there are probably still many years for investors to receive returns from the company. The company has also been good at extracting increased earnings from the existing revenue. The most important reason, however, is that the company is being managed intelligently as a business in decline, meaning that management is using a large part of earnings to buy back shares and pay dividends, instead of trying a heroic attempt at becoming a growth business again through expensive acquisitions.

Financials

Despite the revenue headwinds, profit margins have remained relatively stable, and the company continues to make a healthy operating margin. We believe this reflects good and realistic management of the company.

Growth

Revenue is lower than it was in 2016, despite the company completing some acquisitions . We find the company's acquisition strategy reasonable, as it is focused on the following three areas: luminaire companies that come to the market for consolidation, technology companies with strong know-how in connected lighting systems, and platforms for services. In any case, as can be seen in the second graph, the average quarterly year over year growth has been slightly negative. We would therefore classify Signify as an extremely slowly melting ice cube.

Looking forward analysts expect extremely modest growth that might not even exceed inflation. As can be seen in the table below, YoY growth for 2023 is expected to be ~0.14%, and growth in 2024 to be only ~2.05%. Analysts expect this low level of growth to persist for the rest of the decade, which given the company's circumstances is a reasonable assumption.

Importantly, the company is almost done phasing out conventional lighting, which was a major headwind. LEDs now make up more than 80% of sales, and Connected lighting & Growth platforms make up about a quarter of sales.

Despite the stagnant revenue, the company has managed to increase earnings per share in a meaningful way.

Balance Sheet

While Signify carries significant debt, its leverage remains reasonable, and it has been able to retain an investment grade credit rating. The leverage ratio decreased from 1.7x at the end of Q2 22 to 1.5x at the end of Q3 22.

The company has a reasonable amount of liquidity, with a €500 million committed multi-currency revolving credit facility that remains undrawn, and ~$460 million in cash and short term investments. Its total long term debt is ~$2.1 billion.

ESG

Something many investors will appreciate is that the company is considered a sustainability leader. It is part of the Dow Jones Sustainability Indices, and has a well defined sustainability plan.

Valuation

Shares are trading at very cheap valuation multiples, as can be seen in the graph below. At a ~7x p/e ratio we believe shares are very reasonably valued.

The company pays a dividend which is currently yielding ~4.4%, and which is very well covered by the earnings and cash flow of the company.

What's more, the company has been increasing the dividend, even if the increases have been relatively modest in recent years. The graph below shows dividends in Euros for the native shares ( SFFYF ). For the ADR shares ( PHPPY ) that would be half the amount as the ratio DR/underlying is 2:1.

Risks

There are a few risks worth considering, especially the stagnant revenue of the company which is unlikely to keep pace with inflation. The company also has a considerable amount of debt, and its Altman Z Score is ~1.90x, which is below the critical 3.0 threshold.

Conclusion

Investors are told to avoid melting ice cube companies as they are likely to lose value as their sales decline. While this is generally true, there are situations where a company can be well managed through the decline, and if the valuation is low-enough it can still make sense to invest. We believe Signify is one of this situations where the company is managing costs and cash flow in a very smart way, and the valuation appears attractive enough to at least warrant consideration. For the time being we are adding the shares to the watch list, and will consider them if the valuation becomes even more attractive in the future. We are rating shares as a 'Hold' but we think they are not too far from a 'Buy', and we would like the shares more if they were yielding above 5%.

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