Clarifying Prosegur’s Structure – Prosegur Cash: That’s The Interesting Stock (OTCMKTS:PGUCY)

Spin-offs are always interesting situations for long-term investors, as sometimes the real motive to sell the business is the need for cash infusion. Companies sell assets that can be sold at a reasonable price. This means that many spin-offs hide good businesses, with clear trends and numbers. Obviously, we can consider the other way around: if the owner sells the business at a specific price, it means that the business is not attractive enough, or it may disappoint current buyers’ expectations. After all, the business’ owner possesses more information.

When we approach Prosegur Compañía de Seguridad (OTC:PGCSF) and its subsidiary Prosegur Cash (OTCPK:PGUCY), the investor does not need to position for either thesis. Below, we will sometimes refer to Prosegur Compañía de Seguridad as Prosegur Group, as the former is the parent company. Prosegur Cash’s spinoff in 2017 may have been a good move for Prosegur group – selling a mature business at a demanding earnings yield. Nevertheless, it is also true that Prosegur Cash is a consistent and reliable business, currently attractive after a 65% drop.

In this article, we explore and analyze three years of data for both companies, trying to better understand their context. The strong share repurchases in the parent company over the last 12 months may indicate that it is more attractive than its subsidiary. However, performance and trends show that Prosegur Cash is a more simple and interesting business for the long-term investor.

Short description of Prosegur context: business and 2017 IPO

Prosegur Compañía de Seguridad is the parent company of the group, which operates three main businesses: security services, cash transport and custody and alarm systems services. Cash transport and custody is basically the listed company Prosegur Cash, of which the parent company owns directly and indirectly 72.5% of shares.

This corporate structure is the consequence of the 2017 Prosegur Cash spin-off. Previously, all the business lines were 100% controlled by the parent company. After the sale of 27.5% Prosegur Cash shares by the parent company, investors had two different possibilities to invest in the Prosegur business.

Cash transport and custody has always been the most important business regarding profit contribution and cash generation, while the other two business lines have generated relevant revenue but no significant profits.

We can expect that the parent company will order high dividend payments from its subsidiary, as the rest of the Prosegur business is not cash flow positive. In other words, dividends from Prosegur Cash are financing projects and dividends of its parent company.

Accounting distortions in the group. Deconsolidation of the alarm systems business

One of the problems of Prosegur Group is the distortion of its accounting data. Prosegur Cash is considered a wholly controlled – not owned – subsidiary company, which means that 100% of Prosegur Cash accounts are added in the income statement, balance sheet and cash flow statement. Nevertheless, as we stated above, the parent company owns just 72.5% of Prosegur Cash. Therefore, an analyst that examines the financial statements of the parent company can be confused when estimating metrics such as revenue, EBITDA, operating profit, net income, financial debt, cash flow from operations and Capex.

Only “attributable profit” and “equity attributable to shareholders” are the accounts that already reflect the minority interests in Prosegur Cash. The rest of metrics should subtract 27.5% of Prosegur Cash contribution to the income statement, balance sheet and cash flow statement. If we make this adjustment, 2018 and 2019 net profits coincide almost exactly with the correspondent attributable profits of Prosegur Compañía de Seguridad. We obtain the same correspondence when we subtract 27.5% of the equity of Prosegur Cash from the group, obtaining almost the same figure as “equity attributable to shareholders”. Therefore, if someone wants to compare fundamentals of Prosegur Group with its market capitalization, it is required to make relevant adjustments downwards.

These complexities are manageable, it is just required to implement quantitative and clear adjustments. However, there are recent problems to follow the rest of the Prosegur Group business – excluding Prosegur Cash -, an important angle to choose what business is more attractive. In 2019, Prosegur Group signed a partnership with Telefonica to develop and transform the alarms business. This partnership consists in several basic points:

  • Telefonica bought half of the Prosegur Group alarms business in Spain. Now, the new entity is equally controlled by both companies. The main consequence is that the new subsidiary company is neither fully nor proportionally consolidated. This means that revenue, costs, balance sheet accounts and cash flow figures will not be initially included in the Prosegur Group financial statements. There will be just a profit/loss contribution at the end of the income statement and a financial investment recognized in the balance sheet – equity method. As a consequence, it will be more difficult to follow the success of the new business model.

  • The sale of 50% of the alarms business to Telefonica was not a cash transaction. The payment was made with Telefonica shares, which is a financially leveraged company in a complex restructuring. Besides, Prosegur Group has commitments to keep a stake in the Spanish telecommunications company. The exposure is about 49 million Telefonica shares or a financial investment of around €210 million at the end of June 2020 – more than 20% of Prosegur Group market capitalization. When the analyst evaluates Prosegur Group’s financial position, it is necessary to take into account that most of its financial assets – excluding cash and equivalents – are risky shares in another financially leveraged company.

  • The alarms business model changed dramatically. Telefonica is going to provide technological assets and its client portfolio to propel the business. At the same time, Prosegur Group contributes with its assets and scale to provide security services for the joint-venture. Both companies have a similar geographical distribution, which means that the partnership can be expanded to other markets – Latin America. This might become a success or a failure, which adds uncertainty – higher upside and downside risks.

Trying to reach conclusions about the rest of the Prosegur Group business is becoming harder. Transparency shrinks and additional risks arise in order to issue an investment thesis. On the other hand, none of these problems have to be addressed when analyzing Prosegur Cash.

Prosegur Cash was performing better before the Covid-19 crisis

Expectations for Prosegur Cash have been lowered in recent years, in spite of its stability and consistency in figures. Investors perceive cash services as a non-growth industry, limiting the expansion potential for cash transport and custody. In fact, we think that the price paid in the 2017 IPO was not attractive for buyers, as the earnings yield was not high enough. However, the current price is 60% lower even including distributed dividends – not reinvested – three years after. While the share price dropped dramatically, operating metrics have been stable until the Covid-19 crisis.

Revenue and operating profit have been flat and free cash flow has maintained relatively positive. Even in the Covid-19 crisis, we consider the business is holding up in an extreme environment for retail sales. Cash transport services are dependent on retail activity, which is the sector where cash is more widely used. Retail activity tends to be stable and not so cyclical as other industries, but the pandemic has created an extraordinary challenge for retail physical establishments.

In this context, Prosegur Cash revenue decreased only 13% in the first half of 2020. The surprise and fixed-cost structure of the business caused a 52% drop in operating profit. This may give a first bad impression, notwithstanding, it is necessary to remark that this business is still generating positive profits and relevant free cash flow in the worst crisis possible for physical establishments. It is reasonable to expect a recovery in retail activity and cash transactions in every market affected by lockdowns and restrictions. In fact, the annual comparison is starting to look better after the 3Q data, which showed an improvement compared with the 2Q results – 9 months 2020 operating profit -45.3% YoY versus 6 months 2020 operating profit -52% YoY. We will discuss the trends in card payments versus cash payments later.

More interesting is to compare the operating figures between Prosegur Group and Prosegur Cash. There are several obvious conclusions:

  • Prosegur Cash generates higher free cash flow than the whole Prosegur Group, excluding minority interests. In fact, free cash flow contribution from the rest of the Prosegur Group – excluding Prosegur Cash – is negative. This may indicate that alarms is still an incipient business that needs investment to grow, as it is recognized by management in earnings calls. The following table compares free cash flow between Prosegur Cash and Prosegur Group adjusted by minority interests:

  • Prosegur Cash generates almost all the profit in Prosegur Group, while security services and alarms have very low profit margins, or even non-existent. The following table compares Prosegur Cash operating profit with the rest of Prosegur Group – excluding 100% Prosegur Cash:

Prosegur Cash trends are not so bad as the share price is reflecting

It is understood that cash is becoming less relevant in developed economies, even in emerging markets. The percentage of cash payments over total payments is gradually shrinking, as other payment methods are growing strong. But it is important not to confuse the relative share of cash payments over total payments with the absolute quantity of cash payments. It is likely that cash payments are stable, while credit card payments are rapidly surging. Cash is not the payment method of the future, but it still has advantages for those in the informal economy and also in areas with low technological penetration. We cannot expect a quick collapse in normal conditions – after Covid-19 -, at most, a gradual slowdown over more than a decade.

Another risk that investors fear is the currency risk, as Prosegur Cash has a large exposure to Latin American economies. However, as this article in Seeking Alpha noted, devaluation usually coincides with inflation acceleration. Therefore, for the same basket of goods, it is necessary to exchange more notes, increasing Prosegur Cash revenue in local currency. Hyperinflation is at least partially compensated in the case of Prosegur Cash.

The cycle of products and the geographical trends are not as bad for the business as the share price reflects. Traditional services are shrinking in developed countries, but emerging markets still rely on cash for many consumer transactions. The exposure to Europe is not high, just 28% of revenue in 2019. Most of the operating profit came from Latin America in 2019 – €275 million from a total €304 million. Besides, in the last four years, it seems that Prosegur Cash is growing in the Asia-Pacific region. Being a strong company in a shrinking business allows it to strengthen in new market niches, as the whole demand is reducing and there are no new competitors.

Finally, another bright spot to compensate the decadence of cash is the introduction of new products and services. A few years ago, Prosegur Cash launched new products for small establishments – Smart Cash – , a smart safe box which automates cash management and simplifies the problem for the store operator. This safe automatically counts and deposits cash inside, but also transfers the funds to the owner’s bank account in 24 hours, even before the Prosegur Cash professionals collect the cash. Another interesting business line for the future is the custody digital assets. The company is applying its knowledge and leveraging its customer portfolio, adding new associated services. However, in contrast with Smart Cash, this business line is not yet relevant in terms of revenue.

As a result, these factors bring about great stability in revenue. Even if cash is shrinking as a payment method, all the trends put together in a real world business show no significant revenue reductions, as illustrated above. The exception is 2020, as a consequence of lockdowns and store shutdowns, but a return to normal is expected in the near future.

Prosegur Cash assessment

Prosegur Cash market capitalization is around €1.17 billion as of November 10, 2020. Net financial debt at the end of June was €838 million, 1.9 times the 2019 EBITDA. The company is generating positive free cash flow even in the midst of Covid-19 crisis. Free cash flow generation was negatively affected by relevant acquisitions in the 2020 third quarter, but it was positive for the first 9 months and quite high in the first half of the year.

2018 and 2019 profit figures are not a bad reference because the tax rate was higher than normal. Net income was near to €170 million in 2016, 2018 and 2019; being 2017 the only exception. With a net profit reference of €170 million, the current earnings yield of Prosegur Cash is an outstanding 14.5%.

We can expect relevant dividends in the future, as the parent company generates most of its free cash flow through Prosegur Cash. Notwithstanding, in the short-term, Prosegur Cash is making moderate share repurchases for its flexible dividend policy. Recent dividend distributions have allowed shareholders to receive shares instead of cash, while Prosegur Cash is backing those share distributions with share repurchases. The parent company has made higher share repurchases in the last 12 months. Nevertheless, the parent company is exposed to more uncertainties and businesses which still have to prove their profitability. Besides, when the parent company is repurchasing shares, it is also indirectly increasing its bet on Prosegur Cash – as long as it does not sell its stake in this subsidiary.

In conclusion, Prosegur Cash share price has been extremely punished by the market, while it is still a stable business with an extremely high earnings yield – also a high free cash flow yield. Decadent sectors do not bring new competition, this is the reason why these businesses can be highly profitable over a long period of time. The same conclusions cannot be reached for its parent company. As we explained above, Prosegur Group – Prosegur Compañía de Seguridad – is becoming more complex from many points of view, with more uncertainties and business lines still burning cash.

Disclosure: I am/we are long PGUCY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. As we have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned.

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