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Berendsen provides textile cleaning and supply services in Europe. Berendsen’s textiles include uniforms for customers from fire fighters to doctors, road workers and chefs. Berendsen provides mat for facilities and linens for hospitals, hotel, restaurants, etc.
The company operates in 15 countries throughout Europe. Most of its business comes from the U.K., Germany, and Scandinavia. Berendsen purchase textiles and then rents them to customers. They then maintain and launder these textiles periodically.
3 Layers of Durability
I think Berendsen is among the most durable businesses I know. Berendsen’s durability has 3 layers.
First, I think in 30 years, people will still need uniforms and linen. You must stay close to customers to collect, launder, and deliver textiles regularly. So, there’s no threat from low cost providers in China.
Second, the local nature of this rental business means Berendsen’s durability is equal to its customers’ durability. Most customers are service providers like hotels, hospitals, and fire departments. So they will stay in Europe forever.
The third layer comes from diversification. Berendsen serves customers from 180 plants. Each plant stays close to a major center of commercial activity and serves customers within a radius of 100 km (62 miles). So, if something happens to a plant, it has less than 1% impact on the company.
Wide Local Moat from Economy of Scale
I think Berendsen has a wide moat thanks to economy of scale. Local scale is important as the management mentioned Berendsen has the highest return where it has density and scale. Local scale maximizes plant utilization and asset turnover.
Also, it’s costly to collect and deliver textiles to customers. Distribution cost is 20% of Berendsen’s sales. A new competitor without local density may have to spend 30% of sales on distribution cost and therefore make little profit.
High plant utilization and good profit margin allow Berendsen to make about a 25% pre-tax return on net tangible assets.
It’s impossible for a new competitor to enter a local area where Berendsen is already big. A competitor must sign contracts with a lot of customers to gain scale. Berendsen has 250,000 contracts around Europe. That’s close to 1,400 contracts per plant. And these contracts last 1 to 3 years. Assuming that a competitor can sign up a new customer whenever a contract expires, it still takes at least 3 years to build up scale. That competitor will surely lose money during the ramp up period.
Capital Allocation Creates Value
Berendsen is really a capital allocation story. The company changed its name in 2010. It was formerly The Davis Service Group. The Davis Service Group acquired Berendsen in 2002. Davis was originally a car dealership in the U.K. They entered the textile rental business through the acquisition of Sunlight Services in 1987.
The company entered and exited different businesses over time. They made a lot of acquisitions. But on average, they created value for shareholders. Since 1998, Berendsen compounded sales and EBITDA by 6.5% and 6.1% respectively. They achieved that by retaining only half of free cash flow. So, Berendsen effectively made 1a 2% return on investment over the period.
A Perfect Candidate for Defensive Investors
The share price is not cheap but is relatively good. At 995 pence per share, the market cap is now £1,650 million. Net debt is £476 million. So, EV is £2,126 million. Berendsen made £146 million EBIT last year. EBIT grew 13% in the first half of 2013. But based on 2012 number, the EV/EBIT ratio is 14.6. That’s about 5% after-tax earnings yield.
A 14.6 EV/EBIT ratio is too high for most companies. But for a predictable company like Berendsen, long-term investors can still make an adequate return.
Berendsen’s growth is tightly related to GDP growth. The company targets 1-2% organic growth ahead of GDP growth. That makes perfect sense given that there’s a huge market potential from customers who have never outsourced. So, organic growth can be 3-4%.
Berendsen makes 25% pre-tax return on net tangible asset. So, they need to retain less than 20% of earnings to grow sales by 3-4%. Therefore, at today’s price, investors can expect about a 7-8% return.
Berendsen won’t actually return 80% of earnings to shareholders. Berendsen historically returned 50% of earnings. They made bolt on acquisitions. I expect those acquisitions to create value as proven in the past. Berendsen usually acquires small competitors that are family-owned. The reason for sales of those businesses is usually generational shift rather than economic factors.
So, I don’t think it’s aggressive to expect Berendsen to grow sales by 6% in the future as they did in the past. Along with today’s 3% dividend yield, the expected return would be 9%.
Investors should also keep in mind that earnings can grow slightly faster than sales. I think margins tend to increase over time in this business. That didn’t happen in the past at Berendsen. But the company is focusing on improving margin in the near term. So, margin expansion can be a nice surprise.
Berendsen is not cheap, but it’s among the most predictable businesses I’ve ever seen. It’s a perfect candidate for defensive investors. At today’s price, I wouldn’t buy the stock. However, Berendsen is definitely among my top candidates.
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