I recently had a really good look at CTD to see what I was...

I recently had a really good look at CTD to see what I was missing.  The company has all the hallmarks of a great company - it has performed really well to date, screens really well for growth (revenue, EBIT, earnings growth), has an very articulate CEO and has some of Australians best growth institutional investors as shareholders.  

However as the analysis below shows - while the growth numbers look enticing the signs that this is a truly exceptional business (growing ROE, growing operating margins, strong organic growth) are still not showing up in the financials.  They may be coming but I think for my own money its hard to invest either on the hope that organic growth will appear in the future when it hasn't in the past (even if that is what management are saying), or building an investment case based on future acquisitions accelerating (something really out of the control of management as it is dependant on the share price and multiples staying high).  I'm not a shorter therefore this analysis is really meaningless to me as I simply sit out of the stock.

1. Per Share statistics:




If we look at the growth metrics - all of the businesses metrics are growing strongly.  Topline (revenue) growth of 29.32% over the past 5 years has matched by earnings growth (29.03%) and outpaced by cashflow growth (46.16%).  This far outstrips the growth of shares on issue (6.27%).  All impressive numbers.

However while the number of shares have only grown at 6.27% over the 5 years, shareholders equity has grown at 48.77% (which outstrips both revenue and earnings growth).  This rise in shareholder equity is either due to retained earnings building the capital base OR it is due to raising capital (at very high prices as we know the number of shares hasn’t increased as much).

The below analysis shows that CTD is growing its capital base by the later.  Around 80% of the new capital is raised from new shareholders.



The problem that this causes the business model is that future growth is dependent on the share price staying high and therefore being able to raise money at a high rate.  i.e. if hedge funds short sell the stock and the price drops (it could easily halve) then this will effect the actual business model. i.e. the fundamentals of the business ARE affected by the price of the stock (something which is out of the control of an investor or management).  

Another way of thinking about the valuation and to "price" the growth is to value the company on as a “sum of parts”.  Firstly, what is the value of the business as it is today (if it never acquired another business) and secondly what is the value of the "growth" - the growth being either organic growth or the continuation of the "roll-up" function of the business.  Mathematically the second valuation is the difference between the market valuation and the first valuation.  

Valuing the business as it is today:



Price / book:

CTD has clearly traded on superior price / book ratios to both FLT and HLO over the last 10 years.  HLO has had its own issues (franchisees) but FLT has been very successful over this period.  If we assume that CTD trades at a premium (but not too large a premium and model both 3x and 4x price / book the following are the results.  Assuming a market cap of $2.4b.



As you can see at 4 times book value the "growth" is valued at 36.01% of the market cap.
At 3 times book value the “growth" is 52% of of the market cap.  What is also important to notice is that irrespective of the market cap the “growth" valuation is at an all time high since listing.

PE Multiple:

At todays (2/10/17) share price of $21.89 this represents 40x 2017 earnings.  If we assumed that the business traded on similar metrics to FLT and model both 15x earnings and a more generous 20x earnings the following is the result:

   

Once again on a PE multiple it is clear that the market is assigning a large portion of the valuation to "growth".  This could be "organic growth" or it could be continuation of acquisitions "the roll-up function".  Given that this will need to revert to 0% over time the current valuation looks to either be pricing in much increased M&A activity over time or a lot of “organic growth”.

Organic growth:

A big part of the attraction of this stock is the “organic growth” story.  A large part of the investor presentations made by management are about explaining how much of the business is due to this “organic growth” and to back this up some of the best managers that focus on “organic growth” (Hyperion) have bought the story.
However despite this when I run the numbers on the acquisitions that have been made and sum them together there is very little (if any) organic growth as shown below.

The following table is a summary of all acquisitions undertaken since IPO. This  detail is provided by CTD in the notes under the “business combinations” section.

1. 
2. Once we know the above amounts it is now possible to reconstruct both the revenue and NPAT figures from the acquisitions (assuming there was no organic growth) as well as the 2012 prospectus financials and then compare it to the actual financial accounts.

There are a few observations that can be made from this.  Firstly and most importantly as you can see the 2012 NPAT plus cumulative purchased NPAT was actually larger than the actual 2017 result.  In my book this means that the business has produced NO ORGANIC GROWTH since 2012.  This is not to say that it wont produce it in the future but given that we have very little evidence of it I struggle to personally have an investment thesis for organic growth in a business that hasn’t produced any to date.  If the business was about organic growth I would expect the correlation with "purchased revenue and NPAT" to be much lower.  

There are a couple of small flaws in the above analysis (part year earnings) so another way I looked at cutting the data to analyse whether there was organic growth was to look at the revenue from “segment” point of view (CTD publishes regional revenue segment data in its notes).  Each year I have added the published revenue figures and then added the acquisitions with the difference being credited to “organic growth”.  Once again the below back-ups what my analysis above shows – very little organic growth.



My conclusion from this is that building an investment case on organic growth is problematic.  

"Growth from continual acquisitions"

If the business case for the margin investor isn't organic growth then it must be continually pricing "growth" as continuation of the acquisitions.  Now that the businesses has global scale and only 1% of the market in the US there is still a very long runway for it to continue down this track, so I wouldn't be game to say that this cannot continue.  
However what I will say is that an investment thesis built on continual acquisitions is predicated on the stock staying high (something completely out of the control of management).  While its impossible to time when the stock hits a roadblock and stumbles I find it far too risky a proposition to invest money into the stock at these levels knowing that my margin of safety (the value of the business ex-growth) lies about 50% under the current stock price.  

Smarter people than myself are invested in this stock but I thought it would be useful to balance the discussion on this thread with my view of the risks and barriers to investing in CTD.  Thoughts or opposition??