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Sonae SGPS (SON PL)

Sonae SGPS is a family conglomerate from Portugal that owns:
- the largest chain of hypermarkets and supermarkets (Food Retail) and retail outlets (Specialised Retail) in Portugal, with an international expansion strategy,
- a 50% interest in Sonae Sierra, a company dedicated to the management and promotion of shopping centers.
- a stake of 53% in Sonaecom, a national telecommunications company.

Holding company controlled by the Azevedo Family (53%). The bulk of the family’s wealth is tied to the company. Sonae SGPS is the biggest portuguese private employer (40.000+ employees).

THESIS

Food Retail business (their biggest business):
- Has a 25% market share and growing even in an awful consumer confidence environment. Stable business.
- They have a very loyal and stable customer base. 85%+ of sales are associated with loyalty card.
- They were the first food retailing company in Portugal with most of their hypermarkets located in city centers.
- All of their hypermarkets and supermarkets are in shopping centers which gives them traffic from shoppers from other stores in the malls. People in Portugal go to shopping malls for all their shopping and they are open until Midnight.
- Its wider variety of products makes it the first choice for one stop shoppers (70.000+ SKU’s).
- 29% of sales in own label products.
- They have the biggest logistic operations in Portugal with more than one distribution plant, unlike competitors, which makes them more cost efficient.
- Their margins are higher than peers compared to well run local competitors, such as Jerónimo Martins and DIA; 6,3%, 4,3 %, and 1,9 % respectively.
- 78%+ of stores (real estate) owned (Retail Properties). Asset monetization strategy defined: important future source of capital to the company’s investments through sale & lease back transactions.
- 3,2x Net Debt to EBITDA.

Sonae Sierra:
- 50% owned joint venture with Grosvenor. Owns and develops shopping centers (49 shopping centres with openmarket value of approx. 6.4 billion euros).
- International diversification: the Portuguese business component represents 45% of its business.
- Strong presence in Brazil (20%), Spain (14%), Germany (13%) and Italy (6%).
- IPO of Sonae Sierra Brazil in 1H2011, raising €200M for future developments in the region.
- GROWING, despite the dramatic crisis, both in Sales and Income.
- Conservative Loan-to-Value: 43%.
- Occupancy rate: 96,8%.
- Returns close to 20% in the last several years.
- Sonae SGPS's earnings where very penalized after the downturn in 2008 mainly because of its participation in SonaeSierra and the devaluation of its properties since then. NAV has come down to €1.188M from €1.713M. These losses appear to be stabilizing.
- Current Market Value of Sonae SGPS participation: 1.187,63M (NAV at 30-09-2011) x 50% = €593,82M.

Sonae.com:
- Third telecom operator in Portugal, with a 21,1% market share.
- Stable/growing standalone mobile business.
- France Telecom has a 20% stake which they want to divest.
- Long dated talks of possible merger with Portugal’s biggest cable operator – Zon Multimedia. Sonae.com’s management have for some time pointed this solution has the best one for the creation a bigger, more profitable operator. Zon Multimedia has recently removed statutory limits making this possibility more credible.
- 1,5x Net Debt to EBITDA.
- Current Market Value of Sonae SGPS participation: €464,03M x 53,16% = €246,68M.

Current market values per share of Sonae SGPS core partnerships (Sonae Sierra and Sonae.com), and excluding its main core businesses, is about 0,436 cents or almost current share price for the total company of 0,46.

Debt and dividends:
- Total net debt amounted to €2.958M, translating a cumulative reduction of €479M over the last two years. Total debt is expected do drop significantly during the next 6 years. Retail Units Net Debt to EBITDA stands at 3,2x.
- Significant portion of debt tied to retail properties: €1.000M.
- Growth efforts by leveraging on cash flow generated by market leader stable operations in Portugal.
- Dividend per share 0,0331 or 7.2%. Payout ratio of 39%.

VALUATION (Sum of Parts)

- Average Estimated Cycle Net Income for Retail operations (food and specialised) and retail properties: €95,43M
- Sonae.com Estimated 2011 Net Income: €59,47M
- Current NAV Sonae Sierra: €1.187,63M
- Shares Out: 2.000M
- Current stock price: 0,45€

Value (Sum of Parts): Between 0,9€ and 1,34€.

EURO RISK - The risk of Portugal leaving the EU

It is in the interest of the euro zone and of the leading countries (Germany and France), that these solvency issues by several country members are resolved soon and their economies recover. That would allow the leading countries to strengthen their growth and protect their financial sector as its institutions were the ones that lent money to Greece, Ireland, Portugal and Spain.

Portugal has already a restructuring program designed to reduced budget deficits and total debt as well as to make the economy more flexible and increase productivity, concentrating on export activities.

The program was designed by the EU, ECB and IMF to bailout the country after it could not finance itself. Portugal will have a couple of years with slow GDP, but structural changes being made will reduce the government involvement in the economy and reduce unproductive businesses activities like building and construction. Odds are the country will eventually emerge stronger.

Portugal did not have a recent housing bubble like UK or Ireland. It also doesn’t have has much public debt as Greece, Italy or Belgium. Hence, the Portuguese problem rests on competitive issues that are being address.

We think the risks of Portugal leaving the euro are low. Ultimately if it did happen, the margin of safety of the ideas presented is so huge that it would protect the investment even in that worst case scenario.