Madeco SA Financial Analysis

8/14/2019 Madeco SA Financial Analysis

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One risk factor, however, is inflation, which peaked at over 9% in 2008. Yet it is my

opinion that this was largely caused by the speculative run-up in copper prices, of

which Chile is a large exporter.

Because of the current interest rate climate, equities were chosen as the target

asset class to invest in. In particular, I wanted to find a company in Chile that had

been harmedby the recent run-up in copper prices. I figured that as Chile was a

large producer of copper, there surely had to be manufacturers in Chile that had

been squeezed by the recent price surge. I therefore started looking at


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Once these figures were arrived at, the DCF matrix could be computed (UK 30 Yr

Gilt at time of writing, 4.60%):DCF Matrix Growth Rate: 1.50% 1.75% 2.00% 2.25% 2.50% 2.75%

UK30yr Gilt: - - - - - -

4.00% 330,943,303.01 367,714,781.12 413,679,128.76 472,776,147.15 551,572,171.68 661,886,606.01

4.25% 300,857,548.19 330,943,303.01 367,714,781.12 413,679,128.76 472,776,147.15 551,572,171.68

4.50% 275,786,085.84 300,857,548.19 330,943,303.01 367,714,781.12 413,679,128.76 472,776,147.15

4.60%266,889,760.49 290,301,142.99 318,214,714.43 352,067,343.62 393,980,122.63 447,220,679.74

4.75% 254,571,771.54 275,786,085.84 300,857,548.19 330,943,303.01 367,714,781.12 413,679,128.76

5.00% 236,388,073.58 254,571,771.54 275,786,085.84 300,857,548.19 330,943,303.01 367,714,781.12

5.25% 220,628,868.67 236,388,073.58 254,571,771.54 275,786,085.84 300,857,548.19 330,943,303.01

5.50% 206,839,564.38 220,628,868.67 236,388,073.58 254,571,771.54 275,786,085.84 300,857,548.19

All figures are in GBP. At the end of trading last Friday, Madeco SA had a market cap

of GBP237,146,341.50. Therefore, a margin of safety could also be computed.Marginof Safety Growth Rate: 1.50% 1.75% 2.00% 2.25% 2.50% 2.75%

UK30yr Gilt: - - - - - -

4.00% 39.55% 55.06% 74.44% 99.36% 132.59% 179.10%

4.25% 26.87% 39.55% 55.06% 74.44% 99.36% 132.59%

4.50% 16.29% 26.87% 39.55% 55.06% 74.44% 99.36%

4.60% 12.54% 22.41% 34.18% 48.46% 66.13% 88.58%

4.75% 7.35% 16.29% 26.87% 39.55% 55.06% 74.44%

5.00% -0.32% 7.35% 16.29% 26.87% 39.55% 55.06%

5.25% -6.97% -0.32% 7.35% 16.29% 26.87% 39.55%

5.50% -12.78% -6.97% -0.32% 7.35% 16.29% 26.87%

The red box could be considered the worst case scenario from a DCF perspective,

and yellow box is what I consider most likely given the conclusions of the Pro Forma

financial statements (target long term growth rate: 2.46%).

The following details my analysis and assumptions for the Pro Forma Financial

statements. The actual statements, as well as the restatements for the previous

three years, are attached at the end. Following the forward projections is my

discussion of the Management as well as potential risk factors.

Brass Mills Unit Between 2006 and 2008, the brass mills unit languished under the increased

competition from PVC and CPVC piping. In plumbing circles, there is a

healthy debate between the benefits and costs of PVC and CPVC piping as

compared to copper pipes. To summarize, the benefits of CPVC and PVC

piping include:

Low cost and price stability over time

Less subject to on-the-job theft

Ease of installation

Because it is not metallic, CPVC will never pit, scale, or corrode

CPVC can maintain drinking water even when the Ph of the water

source falls below 6.5

CPVC is more energy efficient than copper due to its improved thermal

insulation properties

On the other hand, the benefits of copper piping over PVC and CPVC include:

Long term durability; much sturdier (can even set in concrete)

Historic use ensures compliance with building codes in the United

States and other countries


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Copper piping much more durable on the jobsite (CPVC pipes are

subject to cracking if stepped on or not handled carefully; CPVC must

be stored properly to prevent UV degredation)

Copper piping more versatile: used for portable water supply,

drain/waste/vent applications, natural gas supply, high pressure steam

applications, etc. Copper is biostatic, and therefore doesnt support bacterial growth

PVC and CPVC are likely to melt or break in a fire or earthquake (Chile

experiences earthquakes often)

In a final analysis, it appears that both pipes offer benefits and costs in

certain applications. In my opinion however, the languishing profitability of

the Brass Mills unit can largely be traced to the skyward ascent of copper

prices over the past three to five years:

Of course, since 2008 copper prices have plummeted, from a high of in

excess of $4 per pound (as traded on COMEX) to $1.25 per pound last fall.

While there has been a rebound in copper prices since the November low

(now trading at around $2.5 per ton), many posit that this is due to

stockpiling from Chinese firms that seek to take advantage of the current

price environment. All in all, there is still a marked overcapacity in the

copper mining industry, as evidenced by the excess inventory that the

industry still needs to work through:


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While it is perhaps unknowable where copper prices are headed in the

medium term, itis my opinion that the historically high price of copper seen

over the past three years was an unsustainable anomaly. The switch from

the more durable (and some say, vastly superior) copper pipes to PVC and

CPVC piping should be seen, therefore, as a price-driven rather thanpermanent phenomenon. To this end, it is foreseeable that the Brass Mills

unit rebound nicely in 2009 and into the future, although one should be

cognizant the commodity price risk faced by Madeco SA.

The dynamic of a price-driven product substitution hurt the copper mills unit

two ways: falling volumes and squeezing margins. Over the past three years,

the Brass Mills units sales declined considerably:

Both PBS and the coins unit faced plummeting demand, although the coins

units fall was a bit more spectacular (the coins unit has a more discrete

rather than continuous sales dynamic sales are usually done by bidding for

contracts, and many contracts were lost to companies that blend copper with

other, cheaper metals). And yet, even more dramatic was the units declining

margins:Year: 2008 2007 2006

Gross Margins: 4.069% 6.324% 14.525%

Year: 2008 2007 2006

Sales Volume (w/o coins) 17,209.00 20,511.00 26,400.00

Implied price per ton 5.17$ 5.47$ 5.29$


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Using the average over the past three years, the implied price per unit is CLP

3.41 million per unit in Chile and Argentina, CLP 2.64 million per unit in the

more price sensitive Peruvian market, and CLP 3.03 million per unit for their

exported goods. Using these implied prices, it is estimated that Revenues for

the Flexible Packaging unit will increase .60% in 2009, 5.31% in 2010, and

6.77% thereafter. Margins were assumed to be equal to the average of theprevious three years.

Madeco SAs flexible packaging plants are currently running at 92% of

capacity in Peru, 89% in Chile, and 86% in Argentina. Therefore, unlike their

other units, it is likely that the flexible packaging unit will have to expand

their capacity in the future. To this end, it is assumed that over the next

three years and into the future, the units SG&A, Capex, and interest charges

will start at their three year average and growth by the long term growth rate

in revenues, i.e. 6.77%.

Profiles

The profiles industry is at a crossroads, as PVC profiles are starting to replacethe more traditional aluminum profiles. Unlike the debate between copper

and PVC pipes, PVC profiles offer obvious advantages over aluminum ones.

In addition to being cheaper, PVC profiles are also drastically more energy

efficient. To this end, the aluminum profiles industry in Chile faces two

competitive challenges: firstly, it is coming under direct attack from the PVC

profiles industry. Secondly, local producers face intense cost pressures from

Chinese competitors.

Madeco SA has responded to the Chinese threat by focusing more on

distribution, and importing the aluminum profiles from China. Madeco has

also invested heavily in PVC profiling; the unit had just come online in 2008

and almost immediately grabbed 11% of the Chilean market share (the rest

of the market is serviced by imports, uniquely positioning Madeco SA to take

advantage of this expanding market).

At first glance the Chilean aluminum profiles industry appears to be in

decline. Yet under a closer examination, it seems not that the industry is

contracting but rather that its makeup is shifting:

2006 2007 2008

Size of Market - - -

Size of Total Market 19,190.00 19,280.00 19,700.00

Size of PVC Market 1,390.00 17,300.00 2,700.00

Size of Aluminum Market 17,800.00 1,980.00 17,000.00

Therefore, for the purpose of this analysis it is assumed that the overall

profiles market contracts by 1% in 2009, and expands by 1.325% per year

(the three year average, 2006-2008) thereafter. Yet one could also expect

that the makeup of this market radically shifts: from a base of 13.72% of the

market in 2008, it is assumed that this share to grow by 30% year over year.

Furthermore, as Madeco SA is uniquely positioned to take advantage of the


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lack of domestic competitors in the PVC profiling industry, it is assume that

Madecosmarket share in this industry experiences a phase of supernormal

growth, expanding by 30% per year until reaching 20% of the market in 2011.

After Madeco had been experiencing a rapidly dwindling market share in the

Aluminum profiles industry (falling from above 70% of the Chilean market to

67% in 2006, dropping to a low of 60% in 2007), their shift in strategy causedthe unit to rebound a bit in 2008. It is assumed that this modest rebound

continue, growing by 1.67% per year. In sum, the estimates for the units

forward looking revenues are as follows:

2009 2010 2011 Thereafter

Size of Market - - - -

Size of Total Market 19,503.00 19,761.41 20,023.25 1.33%

Size of PVC Market 3,476.02 4,578.70 6,031.18

Size of Aluminum Market 16,026.98 15,182.71 13,992.08 -

Market Share - - - -

PVC Market 11.55% 15.02% 19.52%Aluminum Market 61.00% 62.02% 63.05% -

Implied Volume - - - -

PVC Profiles 401 687 1,177

Aluminum Profiles 9,776 9,416 8,823 -

Combined Volume 10,178 10,104 10,000

Implied Price - - - -

PVC Profiles 4.38$ 4.38$ 4.38$ -

Aluminum Profiles 3.41$ 3.41$ 3.41$ -

Revenue - - - -

PVC Profiles 1,758.48$ 3,011.21$ 5,156.38$ -

Aluminum Profiles 33,337.72$ 32,108.98$ 30,085.14$ -Total Revenue 35,096.21$ 35,120.19$ 35,241.52$

Growth Rate of Revenue: 0.068% 0.345% 0.345%

The interest expense, depreciation, gross margin, and SG&A for the unit are

all assumed to continue at the average level of the past three years.

Non-operating Items

The Government Fines, Interest, and Other Taxes, the Depreciation of the

Unused Argentinean Assets, the Asset Rental Income, and Madecos writeoffs

are all assumed to be the average level of the past three years.

While Net Working Capital usually increases along with revenues, it seems

unlikely that Madeco SA will add to their net working capital given their large

cash balance. It seems far more likely that the company will decrease this

figure, but the figure is conservatively estimated to remain constant.

Taxes are assumed to be 17%, the going corporate tax rate in Chile. The

Nexans dividend is assumed to be taxed at 25% in accordance to Frenchtax


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laws. In addition, the Nexans dividend is valued at an exchange rate of 602

CLP/EUR, its 10yr high.

Management

While a deeper analysis of the management is necessary, I feel that given the

recent restructurings, Madeco SA is repositioning itself in a healthy manner. Thesale of the Wire & Cable unit brings up three questions: first, why did Madeco decide

to sell off the unit? Second, why did Madeco then decide to take a large position in

Nexans? And finally, why has Madeco SA decided to hold such a large cash position

in a low interest rate environment?

My answers to these questions are largely speculative. To answer the first and

second questions, Madeco SA may have thought of the Wire & Cable business to be

a good one (as evidenced by their growing earnings), but decided that the

investment in further capacity that was needed was either outside of their area of

expertise, or perhaps financial position. Nexans is a global leader in the Wire &

Cable industry, and had a cash position requisite to buy the unit and make the

necessary capital expenditures. Yet Madeco SA also took a large equity position in

Nexans, possibly to partake in the growth of the Wire & Cable industry in the form of

Nexans large dividend, which is EUR 2/share. Lastly, Madeco now has the cash

necessary to invest in other areas of their company, such as increasing the

operational efficiency of their Brass Mills unit (a stated goal in their 2008 annual

report), or by increasing the capacity of their Flexible Packaging or PVC profiles

units.

Furthermore, the decision to distribute 76% of the proceeds of the Wire & Cable sale

in the form of a special dividend proves, in my opinion, the rationality ofmanagement. While there are areas for which Madeco SA certainly has room to

invest, the manufacturing business in Chile is not a high growth industry, and

carrying a cash balance any larger than Madeco currently has would not be in the

best interests of the shareholders. It is my opinion that this rationality stems from

the fact that Madeco SA has one large majority shareholder, the Quienco Group,

which holds 47.7% of the company and has significant influence of the board of

directors.

Risk Factors

Madeco SAs annual report carries a far more detailed summary of potential riskfactors, but in my opinion there are three of which are primary concerns.

Firstly, and most importantly, due to the low percentage of ADR ownership (roughly

8%) and the high cost of complying tothe U.S. GAAP, Madeco is discontinuing their

ADR program. Therefore, unless one can speak Spanish with fluency, it will be

difficult to obtain further information about the company from this point forward.


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Madeco SA will still be traded on Chilean exchanges, but will unfortunately no longer

issue financial statements in English will accordance to the US GAAP.

Secondly, as seen from the performance over the past three years, the profitability

of the Brass Mills is highly susceptible to changes in the price of copper. It is my

belief that what we had seen in commodities in 07-08 was an unsustainable bubble,but there are those that believe otherwise (e.g. Jim Rogers supercycle theory).

Many people seem to have accepted the narrative that demand from a growing

China would raise commodities prices indefinitely whilst forgetting that the

production of commodities ca expand. Yet one can also not forget that commodities

prices seem to always rise upwards toward the end of a business cycle; therefore,

the effect that this has on the Brass Mills unit must be watched closely.

Lastly, Madecos investment in Nexans represents 18% of Madecostotal assets.

While Madeco has very little leverage, the same cannot be said of Nexans, which

has a D/E of 1.65. This situation should be watched closely, however, one positive

data point is that Frances SWF recently made an investment in Nexans equaling 5%

of the French Wire-makers capital.


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Estimated Net Change in Working Capital w/o Restructurings: 506,000,000.00$ (2004-2005)

Nexans Dividend, A/T (@ current mkt price of 765 CLP/EUR): 2,947,882,500.00$ Note: tax rate on French Dividends =25%Nexans Dividend, A/T (@ 10yr low of 602 CLP/EUR): 2,319,771,588.00$

Owner Earnings, 3yr average: 7,317,534,035.78$Owner Earnings, 3yr average (GBP): 8,273,582.58$

Mkt Cap (GBP): 237,146,341.50$

Exhibit 2: ValuationDCF Matrix Growth Rate: 1.50% 1.75% 2.00% 2.25% 2.50% 2.75%

UK30yr Gilt: - - - - - -

4.00% 330,943,303.01 367,714,781.12 413,679,128.76 472,776,147.15 551,572,171.68 661,886,606.01

4.25% 300,857,548.19 330,943,303.01 367,714,781.12 413,679,128.76 472,776,147.15 551,572,171.68

4.50% 275,786,085.84 300,857,548.19 330,943,303.01 367,714,781.12 413,679,128.76 472,776,147.15

4.60% 266,889,760.49 290,301,142.99 318,214,714.43 352,067,343.62 393,980,122.63 447,220,679.74

4.75% 254,571,771.54 275,786,085.84 300,857,548.19 330,943,303.01 367,714,781.12 413,679,128.76

5.00% 236,388,073.58 254,571,771.54 275,786,085.84 300,857,548.19 330,943,303.01 367,714,781.12

5.25% 220,628,868.67 236,388,073.58 254,571,771.54 275,786,085.84 300,857,548.19 330,943,303.01

5.50% 206,839,564.38 220,628,868.67 236,388,073.58 254,571,771.54 275,786,085.84 300,857,548.19

Marginof Safety Growth Rate: 1.50% 1.75% 2.00% 2.25% 2.50% 2.75%

UK30yr Gilt: - - - - - -

4.00% 39.55% 55.06% 74.44% 99.36% 132.59% 179.10%

4.25% 26.87% 39.55% 55.06% 74.44% 99.36% 132.59%

4.50% 16.29% 26.87% 39.55% 55.06% 74.44% 99.36%

4.60% 12.54% 22.41% 34.18% 48.46% 66.13% 88.58%

4.75% 7.35% 16.29% 26.87% 39.55% 55.06% 74.44%5.00% -0.32% 7.35% 16.29% 26.87% 39.55% 55.06%

5.25% -6.97% -0.32% 7.35% 16.29% 26.87% 39.55%

5.50% -12.78% -6.97% -0.32% 7.35% 16.29% 26.87%

Exhibit 3: Flexible Packaging, Estimated Growth in Revenues


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Chile 32,967.00 33,791.00 34,636.00 2.50%

Argentina 100,980.00 103,505.00 106,092.00 2.50%

Peru 25,134.00 25,764.00 26,407.00 2.50%

Market Share - - - -Chile 33.62% 35.32% 37.11% 5.06%

Argentina 7.58% 8.21% 8.90% 8.33%

Peru 57.03% 56.07% 55.13% -1.68%


Chile 11,083.24 11,935.09 12,852.57 -

Argentina 7,657.41 8,502.70 9,441.19 -

Peru 14,332.81 14,445.25 14,557.03 -

Export 9732.6 10024.578 10926.79002 9.00%


Chile 3.41$ 3.41$ 3.41$ -

Argentina 3.41$ 3.41$ 3.41$ -Peru 2.64$ 2.64$ 2.64$ -

Export 3.03$ 3.03$ 3.03$ -

Revenue - - - -

Chile 37,793.85$ 40,698.67$ 43,827.26$ -

Argentina 26,111.78$ 28,994.21$ 32,194.47$ -

Peru 37,838.63$ 38,135.46$ 38,430.55$ -

Export 29,489.78$ 30,374.47$ 33,108.17$ -

Total Revenue: 131,234.04$ 138,202.80$ 147,560.45$ -

Growth Rate of Revenue: 0.60% 5.31% 6.77% 6.77%


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Exhibit 4: Profiles, Estimated Growth in Revenues

2009 2010 2011Thereafter


Size of Total Market 19,503.00 19,761.41 20,023.25 1.33%

Size of PVC Market

3,476.02

4,578.70

6,031.18

Size of Aluminum

Market

16,026.98

15,182.71

13,992.08 -

Market Share - - - -

PVC Market 11.55% 15.02% 19.52%

Aluminum Market 61.00% 62.02% 63.05%-


PVC Profiles 401 687 1,177

Aluminum Profiles 9,776 9,416 8,823 -

Combined Volume

10,178

10,104

10,000


PVC Profiles

$4.38

$4.38

$4.38 -

Aluminum Profiles

$3.41

$3.41

$3.41 -

Revenue - - - -

PVC Profiles $1,758.48 $3,011.21 $5,156.38 -

Aluminum Profiles

$33,337.72

$32,108.98

$30,085.14 -

Total Revenue

$35,096.21

$35,120.19

$35,241.52

Growth Rate of

Revenue: 0.068% 0.345% 0.345%


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Sales - - - Growth

Brass Mills 88,909.00 88,909.00 88,909.00 -

Flexible Packaging 131,234.04 138,202.80 147,560.45 6.77%

Profiles 35,096.21 35,120.19 35,241.52 0.35%

Total Sales: 255,239.25 262,231.99 271,710.97

Growth Rate of Total Sales -0.30% 2.74% 3.61% 3.61%

Cost of Goods Sold - - - GrowthBrass Mills 80,643.13 75,994.97 75,994.97 -


Profiles 27,067.41 27,085.91 27,179.48 0.35%

Total COGS: 216,341.00 210,787.00 191,534.00

Gross Income - - - Growth

Brass Mills 8,265.87 12,914.03 12,914.03 -


Profiles 8,028.79 8,034.28 8,062.04 0.35%

Total Gross Income: 39,663.00 36,595.00 41,115.00

Gross Margin: 15.49% 14.79% 17.67%

Brass Mills 9.30% 14.53% 14.53%

Flexible Packaging 21.34% 21.34% 21.34%

Profiles 22.88% 22.88% 22.88%

SG&A Expenses - - - Growth

Brass Mills 6,493.00 6,493.00 6,493.00 -


Profiles 4,959.33 4,959.33 4,959.33 -

Total SG&A Expenses: 17,230.37 17,621.54 18,039.20

Depreciation - - - Growth

Brass Mills 2,607.67 2,607.67 2,607.67 -


Profiles 1,723.00 1,723.00 1,723.00 -

Total Depreciation: 9,020.33 9,337.82 9,676.81

Operating Income - - - Growth

Brass Mills 631.87 5,161.94 5,031.62 (0.10)


Profiles 1,346.46 1,351.95 1,379.70

Total Operating Income: 17,727.90 22,920.88 23,929.35

Interest Expense (Income) - - - GrowthBrass Mills 192.33 192.33 192.33 -


Profiles 705.67 705.67 705.67 -

Unallocated (note: consolidated) 1,333.33 1,333.33 1,333.33 -

Total Interest Expense 4,263.88 4,401.48 4,548.40

Ongoing Non-Operating Items - - - -

Government fines, taxes and interest (378.67) (378.67) (378.67)

Asset rental income 153.50 153.50 153.50

Depreciation of Unused Agentinian Assets (838.67) (838.67) (838.67)

Obsolescence and Writeoffs (606.67) (606.67) (606.67)

Income Before Taxes 13,238.86 18,294.23 19,155.78 -

Net Income 10,988.25 15,184.21 15,899.30

Growth Rate of Net Income 38.19% 4.71% 4.71%

Capital Expenditures - - - GrowthBrass Mills 1,141.00 1,259.09 1,389.41 10.35%


Profiles 1,579.00 1,579.00 1,579.00

Total Capital Expenditures 9,197.74 9,754.37 10,352.92

Nexans Dividend, A/T (@ 10yr low of 602 CLP/EUR): 2,319,771,588.00$ 2,319,771,588.00$ 2,319,771,588.00$

Net Change in Working Capital -$ -$ -$ -$

Owner Earnings 14,575,954,707.91 18,532,766,024.25 18,988,292,414.69

Growth Rate of Owner Earnins 27.15% 2.46% 2.46%

Madeco SA Financial Analysis

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