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Value Investing

Lindt & Sprüngli – Buying with caution!

Value Investing

Chocoladefabriken Lindt & Sprüngli is a Swiss-based manufacturer of premium chocolate. With seven premium chocolate brands, the company is most active in Europe and America. The company recently increased its sales activities towards Russia, China, Japan and South Africa. Recent results show double-digit revenue growth rates in emerging markets accompanied with increased operating margin on the group level.

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Upside Potential

Strong, internationally recognized brand

The company´s two core brands “Lindt” and “Ghirardelli” enjoy iconic status in Europe (Lindt) and the Americas (Ghirardelli). Both brands are associated with premium chocolate. Customer recognition results in impressive sales numbers despite a stagnant overall confectionary market. Taking a look at the current annual report, sales have increased YoY by 5% with significant double-digit growth in emerging markets. Group-wide sales are expected to increase by 6-8% p.a. mid- to long-term.

Product Quality

Lindt & Sprüngli have established their cocoa farming program (in Ghana) focusing on traceability, training & monitoring and quality improvement activities. In the end, the company is able to maintain highest quality standards in their commodities while providing local farmers with beneficial long-term contracts.

Focus on untapped growth markets

Major outtake from the current annual report is Lindt´s focus on major confectionary growth markets. Russia (+24%), China (+33%), Japan (+58%) and South Africa (+20%) achieved impressive YoY sales growth.
In China for example, chocolate desserts are still very uncommon. Young, middleclass Chinese from major metropolitan areas begin to familiarize with western café and dessert culture, increasingly buying premium chocolate as gifts for business partners and family. With stronger awareness towards western cuisine, chocolate sales are anticipated to increase strongly in the long-run.
Lindt´s selected growth markets are characterized by a large sales volume paired with relatively low per capita consumption (see figure below). In all markets, local cuisine and especially dessert culture is shifting gradually towards European customs, offering huge potential for producers with strong international brands like Lindt.

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Red Flags

Improvable capital allocation

Along with Lindt´s success within the last 20 years, the company has entered into several capital transactions which may not be beneficial for shareholders. Most recently the company has announced a new share buyback program, aiming to repurchase stock worth CHF 500 Mio. With a trailing P/E ratio of 39,9 (10Y avg. P/E of 33,4) and trailing P/B ratio of 21,1 (10Y avg. P/B of 15,5) the stock is not really cheap on any statistical basis. With significant growth potential in emerging markets existent, the money would be better invested in operational expenditures than in tactical share price engineering.

Another worrying fact is Lindt´s current development of its own Chocolate Competence Center in Kilchberg, Switzerland. The project, covering a R&D facility, a chocolate museum and the world´s largest chocolate fountain is estimated to cost shareholders CHF 80 Mio. until completion in 2020. Although the building features R&D infrastructure and serves a marketing purpose, the question arises if the company is erecting a monument for itself.  Rather than focusing on increasing shareholder value, money would be better invested in growth markets.

Ernst Tanner: who can fit in his shoes?

The biggest red flag arises with the gradual resigning of Ernst Tanner. Currently serving as executive chairman, he has handed over the role of CEO in 2016 to the company´s long-time CFO Dieter Weisskopf. Tanner is inseparably linked with Lindt´s success since taking over the role as CEO in 1993. Tanner has transformed Lindt & Sprüngli from a troubled takeover candidate to a worldwide recognized brand with strong operational efficiency. He is attributed the marketing genius behind Lindt´s success and the question remains if his successor will be able to fill his shoes. Only time will tell!

Investment rationale

Despite two minor and one major red flag, the company will be able to capitalize on its strong brand in the mid-term, especially in fast growing emerging markets. In the long-term, new management will have to prove if it can fill Ernst Tanner´s shoes and continue Lindt´s success story.
Chocoladefabriken Lindt & Sprüngli remains a buy recommendation with an investment horizon of 5-7 years.

 

Sincerely Yours,

Value Investing

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