Dear readers/followers,
I cover Kesko (OTCPK:KKOYF) on a fairly regular basis nowadays because the company makes for what I consider to be a very attractive investment with a good long-term upside in a sector that Is extremely conservative – groceries (and some trading). Some of the company is building trade and automotive – and this is not conservative or non-volatile as such given the correlation to automotive and construction, but grocery certainly is.
In this article, I’ll update for Q1’24, and show you why Kesko represents a very solid long-term investment with good upside potential. And while it looks for that upside valuation potential, you’re still getting paid a dividend yield of 6% that is extremely well-covered at this time – and you’re also not paying and sort of massive premium for owning the second-largest grocer in Finland.
Risks? Sure, there are risks. But major ones? I wouldn’t say that this is the case, no.
Let’s dig into what Kesko can offer you, and why I consider this company a business with a significant upside.
Kesko – Why the company is such a great business
I have been beating the drum for this company for quite some time. Kesko is market-dominating, or at least among the top 3 in Finland in everything that it does, and in most areas, it’s #1 or #2. It’s a mixed lay on groceries, Building/Tech trade, and Cars, as odd as this mix may sound.
Sales are split fairly favorably – with cars, some of the most volatile, at less than 12%, with trade and groceries at 60/40 of the remaining split. Also, do not miss the fact 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 well over €15B per year.
The company has store representation not only in Finland but Sweden as well.
Kesko’s dividend and earnings tradition speaks for itself -as does the current valuation. The company trades with the native ticker KESKOB in Finland and currently trades at a valuation of between 13-14x P/E normalized, depending on where you look at the EPS. This is compared to a 20-year average of about 17.5x, so you can see that the company is actually quite cheap from a historical context – and for a reason.
The company is in the midst of a Buildings/volatile-correlated earnings slump which is likely not to drive things down in 2024E as well, and which has driven yield up to over 6.25% at this particular time. This is despite very conservative fundamentals and a long-term leverage of less than 44% in terms of LT debt/capital.
The appealing fact lies in that the company is a business that very rarely misses estimates, that is in a conservative business, and that over the longer timeframe, is likely to grow. You are able to be part of that growth story here, and make a great deal of money through yield and potential capital appreciation – provided, of course, the company doesn’t face or encounter issues.
The best that can be said for 1Q is that the quarter was “good considering the market and macro” – and this is usually cause to go “deeper” here. Yes, company cost efficiency was good, but sales nonetheless went down 5.5%, with a significant decrease in operating profit and a margin decline from 4.5% OM to 3.6%.
kesko IR (kesko IR)
ROCE was down, but still at a decent overall level. The company continues to invest internally, with two properties acquired that expand the company’s network of shopping centers. Also, the company’s move into Denmark is now in full swing.
The M&A of Davidsen in Denmark has “cracked open” this market as of February 2024. Other investments the company has made include a new shared logistics center, expected to be completed in 2025.
There was a rare drop in grocery trade sales on a sequential basis, but growth on a YoY basis, and less-than-inflation growth on a TTM basis. The company describes the sales as good despite a competitive situation. The positive is the company’s online sales share, which grew by almost 20%. Kesko also is losing some market share at this time, though the pace of this decline has slowed down and almost stopped. Consumption is somewhat polarized – price is key, but value convenience, and quality continue to be important. Customer receipts and flows grow thanks to good campaigns and ads.
Overall, the company, however, expects a weak set of results for the year, in line with a relatively weak cycle. At least for the building trade, which saw quite significant declines in line with the current overall macro.
Kesko IR (Kesko IR)
The construction cycle is weak across all operating countries – net sales and operating profit are impacted as well. Deliveries are down, and the timing of Easter had a net negative impact of €3M. The energy crisis saw record sales – so difficult comps are another reason for the decline – but a multitude of factors came together here to bring about a single-digit operating profit for the quarter. This also includes the ongoing integration of the recently-acquired Elektroskandia Norway, which is set to bring positive impacts at the onset of 2H – so about now.
The company is converting K-RAUTA into K-Bygg, and this is going as planned in Sweden. A few loss-making K-Rauta stores have already been closed, with conversions planned for the year-end period.
Further margin decline and operating result decline in the solar power products.
Kesko IR (Kesko IR)
Meanwhile, the car trade is ironically enough (given that it’s typically far more volatile) showing good profitability. Net sales were down slightly, but operating profit was at a relatively good overall level. The company’s order book for new cars grew compared to the end of -23, and new car orders exceeded market levels – as did used car sales, with continued market share gain for the company’s car trading segment. Positive development was also seen in service sales with continued growth in service, repairs and spare parts, and the EV charging business.
For the full-year outlook for the entire company, Kesko gives a sober picture. The grocery trade is expected to remain stable despite margin pressure, and inflation is overall expected to decline in -24. Profitability is expected to remain good, though the company does not give exact OM targets – leading me to forecast a low of 3.8-4.4%, lower than the previous year and more or less in line with current results.
Building and technical are tough nuts to crack. It’s likely to continue to decline due to the heavy impact on residential construction, while declines also in infrastructure, renovation, and building construction are expected to be smaller, but still non-trivial.
A turnaround is expected in -25, with increased profitability as a result. The car trade is expected to fall short of the 2023 level, but still grow in used and service segments. Profitability is expected to be good, but short of 2023.
This comes to an operating profit estimate to around €700 at the high end, down around €20M as of 1Q – and this is mostly related to construction.
Not exactly a worrying, but still a sobering forecast with some valuation-related impacts.
Kesko valuation – The company is attractive for the long term, and the long term is what I invest in.
Finding a longer-term upside for this company is not hard. The question becomes if that upside is enough for you. As I have told you before in other articles, I invest about 70-85% of my portfolio in what I would consider income-generating dividend stocks at low valuations. Kesko is one such stock. I do not expect Kesko to make me rich – I already am. Kesko gives me above-market return rates for the capital I invest, and that is what I am looking for.
The combined yield of 6.2% coupled with the fact that Kesko is a 17-18x premiumized company, currently trading at normalized 13.7x, means that I view the company as meaningfully undervalued at this time.
Even a forecast for a lower premium of around 16.5x brings about market-beating rates of return above 16% per year.
F.A.S.T. graphs Kesko Upside (F.A.S.T. graphs Kesko Upside)
During the “right” environment, this company can easily go over €25/share again because it has been in the past (and not that long ago). My conservative PT of €22/share represents a 2026E 16.5x P/E, and I consider this to be a very valid and likely scenario (Paywalled FAST graphs link).
Also, I want to mention that Kesko more than often – 42% of the time with a 10% margin of error – beats estimates by more than 10%. They in fact beat estimates every single year since 2019. This year is the first time that estimates have not come in as good or better than expected since 2018. So while we are in a slump, this slump does not worry me. That is also why Kesko represents 1.5% of both of my portfolios, and why I am not averse to adding more to these positions.
Kesko is also a quarterly dividend payer, which is rare in Europe, but which should enhance appeal somewhat to international investors.
My investments in the grocery trade are numerous. Kesko is one of the largest of these, but far from the only one. During the last year, I have increasingly moved capital and new cash into things like utilities, grocery, and other very “basic” things in preparation for what I see as a problematic and volatile market. This volatile market has arrived. I still do invest in a lot of other things, including IT and software – but my investments in these things are comparatively small.
Instead, I focus on these basic things because the purpose of my investment portfolio is singular – to ensure my own financial well-being and monetary growth over time. I’m at a level where taking excessive risk is not something I’m all that interested in.
For that reason, Kesko is a good example of a safe investment for me, and I give the company a continued “BUY” here.
My thesis for the company is as follows.
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 6.2%, 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 – though I expect this to take 2-5 years.
- 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 June of 2024.
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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