Monday, April 18, 2011

PIC.L - Pace - crazy price

Perennial investor disappointer Pace saw its share price fall a further 1.48% today, although the Footsie itself was down a little over 2%. PIC qualifies as a "Magic Formula" company.

According to Google Finance:
Pace plc, formerly Pace Micro Technology plc, is a United Kingdom-based developer of digital television technologies for the pay television industry. The Company's principal activities are the development, design and distribution of digital receivers and receiver decoders for the reception of digital television and the reception/transmission of interactive services, telephony and high-speed data.

Analysts expect mid-double digit EPS growth over the next two years. In a report on 8 March for y/e 31 Dec, directors reported adjusted EPS up 24%, improved return on sales, revenues up by 17%, and the completion of three strategically import acquisitions. The board expects similar levels of revenue growth in 2011, and improved returns on sales. "Overall, the Board is confident that Pace has created an excellent platform for growth as its customers continue to lead the global evolution of managed digital services into and around the home."

Sounds pretty good, right? So why is PIC trading on a PER of only 6? Well, the company delivered two bombshells that caused the share price to plummet after it issued its report. The first thing the market didn't like was a one-off exceptional cost of £19m from "transaction related expenses, acquisition integration costs and restructuring to implement post-acquisition operating structure". Consensus seems to be that the board landed that one as a bit of a surprise. The second one, which isn't in the report, but was mentioned during the presentation, was that a customer decided to forgo plans to upgrade, in favour of switching to Pace's next-generation technology in 2012. It appears that this will not affect analyst forecasts.

PIC is a growth company, but it does operate in a competitive business. So, whilst growth is expected, there is clearly some risk with this company. At a PER of 6, it appears that the market is way over-pricing the risk involved. News flow through this and the last year has actually been quite positive, with new deals in India in the offing, which could be huge, new deals in Brazil, and a favourable court ruling on the tax status of its set-top boxes. All the favourable points have been completely overshadowed by the events I have mentioned above.

Potential investors will have to take a view on this one: weighing up the quite positive growth prospects against the risks. Maybe Pace will be out-competed, but that doesn't seem to be the main problem here. If you believe that the company has been unfairly hammered by negative sentiment, then now is a golden opportunity to load up. Not a company to bet the farm on, but the upside seems very favourable compared to the risks and the share price.

Saturday, April 16, 2011

AQP.L - Aquarius Platinum

In the earlier part of the 2000's I took a punt on LMI.L (Lonmin), which mines platinum. It did exceptionally well for me, although it was definitely vastly more luck than skill. Since then I've pretty much fallen asleep at the wheel on platinum miners, although I still remember it as one of my great successes.

Fast forward to today. I noticed that directors of AQP.L (Aquarius Platinum) forked out £654k on shares. The share price is down 56% over 5 years, compared with a flat Footsie over the same period. Shares peaked at about 1691 in 2007Q3. They now stand at 344p - a loss of nearly 80% from the peak. This seriously piqued my interest: shares severly underperforming the market over a 5-year period, coupled with director purchases could be indicative of a huge undervaluation. I decided to dig a little deeper.

According to equity clock[]: "Demand for platinum in 2011 is expected to increase significantly thanks mainly to continuing recovery in auto production and sales."

Look at the net profit margins for AQP over the last 5 years:

YEAR 06 07 08  09 10
NPM% 38 26 39 -47  6

We see that 2009 was a disasterous year for AQP, with only weak margins in 2010. LMI painted a similarly bleak picture. Median NPM over the last decade was 21%. This increased my enthusiam, as I figured that I could be getting a big bargain due to the depressed margins. Factor in my previous arguments, and the shares look enticing.

However, my enthusiam waned when I considered the following arguments. Recent interims put net profit at £58m against revenues of £208m, giving it an NPM of 28% - slightly above median of 21%. Assuming that the next half is like the first half, AQP will have a net profit of £116m. At a price of 344.5p, the market cap of the company is £1.6bn. That gives it a PE of about 14. Suddenly, a huge undervaluation looks like only a fair valuation at best.

There are other factors to worry about, too. According to Platinum Today [], platinum was around 500 UPTO (USD Per Troy Oz), rose to a peak in 2008Q2 to 2060, and then dived to 844 in 2008Q4. In March 2011, platinum is at 1770. The average from Jul 1992 to Apr 2011 is 770.

In summary, platinum is rather high at the moment, and the shares look only fair even when you use that high valuation.

In conclusion, it seems that AQP has a lot of downside risk and is not undervalued, despite a long-term decline in the share price and director purchases. It would appear to be better to stand aside from this one, and wait for a much more opportune moment. Perhaps other, wiser, men would care to share their insights as to why my thinking is right, or wrong.

Thursday, April 14, 2011

GAW.L - Games Workshop - undervalued

GAW - Games Workshop - 440p/£136m

Games Workshop Group PLC and its subsidiaries design and manufacture miniature figures and games and distribute these through its own network of hobby centers, independent retailers and direct through the Internet and mail order.

GAW is yielding 5.7%, and has net cash of £11.5m. It has a z-score of 8.11, giving it a  "bullet-proof" balance sheet. Projected PBT for y/e May 2011 is £12m (a decrease from £16m in 2010), £15m for 2012, and £16m for 2013. Let's say that the long-term PBT is £15m. GAW has neglible interest, implying an EBIT of £15m also. According to Digital Look, it has an EV of £120m (which sounds about right to me). That gives it an EBIT/EV of 12.5% (= 15/120). This a very good unleveraged earnings yield. It earns high returns on capital (28%, according to Digital Look).

Three directors have just bought shares to the tune of £55k combined. A trading statement on 8 Apr 2011 is brief; PBT is likely to be ahead of market expectations, and cash generation remains healthy.

The directors seem frank and folksy, and it is like reading Buffett. In the y/e May 2010 accounts they admitted:
As we have stated in previous years, we believe that the key risks which face Games Workshop are not external but internal. We are not significantly affected by economic factors, as recent results show. Performance shortfalls in the past have been down to the quality of management and decision making.

GAW has a niche business. It is possible for the niche to grow, but I would not anticipate rapid growth. Think of it as a 5.7% inflation-linked bond, maybe with a little growth potential. My view is that it deserves a higher price on account of the current dividend yield.  I had recently seen a detractor of the company rate it as a "strong sell", citing that "the company has never had a sale in twenty years". I take the opposite view on this little factoid: a company that hasn't needed a sale in the last twenty years must be in a pretty good business.

In conclusion: GAW is a company with a high dividend yield, excellent returns on capital, with a high unleveraged earnings yield. Directors have recently bought in, bolstering confidence in the likely sustainability of profits. It currently trades at a price to free cash flow of 7.4, although 2010 was an exceptionally profitable year.

Monday, April 11, 2011

BLT.L - BHP BILLITON - a Magic Formula Company

Magic Formula Investing Filter explained

In his book, "The Little Book That Beats The market", Joel Greenblatt laid out an investment formula for selecting a portfolio of shares that should beat the market over the long term. His formula contains a few grey areas. Sharelock Holmes has a screen for Greenblatt; although it is unlikely to be an exact replication of the formula. It is proably "good enough", though. As part of my filter, I select companies with a market capitalisation of at least £300m. Investment Trusts are excluded, not least because the database doesn't hold their details. They are unlikely to be suitable candidates in any event. As at March 2011, this yields a universe approaching 400 companies, which is a goodly selection to choose from. I then focus on the top 40 stocks within that universe. The purpose of the MFI (Magic Formula Investing) filter is to find stocks that are "good and cheap". "Good" is measured by ROC (Return On Capital), calculated as EBIT (Earnings Before Interest and Taxes) to "tangible capital employed". "Cheap" is measured by EY (Earnings Yield), being EBIT/EV (Enterprise Value). Greenblatt uses a slightly modified version of EV. He also excludes financials from his screen, although I include them for simplicity's sake.

Elevator Pitch

BLT.L - BHP Billiton - Mining - 2587p/£56bn
BLT is a blue chip mining company with good prospects and a solid balance sheet. It qualifies as an MFI company, having high returns on captital available at an attractive price. It deserves a place in a diversified portfolio, despite some uncertainty about the direction of commodities.


I could describe this company as a commodity play, but I wont. I have heard so many bullish and bearish arguments about commodities that it is impossible for me to decide who to believe. My feeling is this: mining is an important sector, so unless you have a strong bearish conviction about the sector, BLT deserves a place in a balanced diversified portfolio. If commodities tank, then BLT will likely tank, too. That's the risk you take. In a different post, I remained sanguine about the outlook.

There are other interesting miners/oil/gas companies in the MFI that are also likely to be worthy of attention, although I haven't looked at them myself: CNE, DGO, KENZ, RIO. I was mainly attracted to BLT when I was searching for MFI stocks around christmas time. I noticed a hefty director purchase of £1m, and share buybacks, so it was a stock that particularly piqued my interest. (Link)

The balance sheet of BLT is excellent from all angles. It is on a z-score of 3.5 - a very comfortable score. It has a gearing of 0%; and net cash of £125m, compared with net profit at the latest interim stage of £6.6m (for 6 months).

BLT has enjoyed consistently good ROEs throughout the last decade, and analysts predict robust growth in future earnings. It trades on a rolling PER of 11.4, and a PBV of 1.6. That is a shade higher than that recommended by Ben Graham for enterprising investors, but I am not going to quibble. Although it marginally fails to meet that test, it does pass his test that PE * PBV < 22.5. No doubt they'll be chuckles at the quaintness of my respect for Graham's work.

BLT is yielding 2.3%, which is a little under the median for the Footsie, which stands at 2.7%. I don't consider that a factor worth much attention though, unless you are an income investor.

For those that are keen on oil companies (it seems that the boys on Stockopedia talk about nothing else!), I notice that 14% of their FY09 revenues were in petroleum, with the underlying EBIT of 22%. It's interesting to see a disproportionate amount of their profits comes from a relatively small part of their turnover.

Good company. Good price.

Saturday, April 9, 2011

Book review: There's Always Something To Do - The Peter Cundill Investment Approach

Title: There's Always Something To Do - The Peter Cundill Investment Approach
Author: Christopher Risso-Gill
Publisher: McGill-Queen's University Press

Peter Cundill established the Cundill Fund in 1974, later renamed the Mackenzie Cundill Value 'A' Fund. Tragically, he died in March 2011, and this book recounts his investment career and philosophy. The author has known Peter for thirty years, and had access to Peter's investment notebooks, snippets of which are reproduced in this book.

Since inception in 1974 to the period ended 30 September 2010, the Cundill Fund returned a 13.5% CAAR, compared with an 11.2% CAAR for the MSCI World Index, adjusted to Canadian dollars. An investment of $10,000 at the inception of the fund would now be worth $927,522, compared with the index of $437,428. It appears that much of the truly superior returns were achieved over the last 10 years.

The book reveals that Peter was a value investor in the Graham tradition, and was particularly fond of "net-nets". His search for them took him all over the globe, an activity that he seemed to enjoy greatly. He formed a personal relationship with legendary investor John Templeton, and was praised by Warren Buffett as the kind of man he would be looking for as his next chief investment officer. He has been described at the "Indiana Jones of Fund Managers".

This book will appeal to investors wanting to learn more about the history of Peter and his fund, as it is not so much of a "how-to" book on investing. He does reveal some of his personal investment philosophy, though, and shares his thoughts about what makes a great money manager. Chief amongst them is "patience, patience, and more patience". He warns that "None of the great investments come easily. There is almost always a major blip for whatever reason and we have learnt to expect it and not to panic".

Friday, April 8, 2011

Magic Formula Retailers

Oh dear, retailers haven't been fairing so well lately, have they? CPR.L (Carpetright) recently issued a profit warning, as reported on Stockopedia. DXNS.L (Dixons) recent trading statement also reported deteriorating conditions. The stock market pros have been shuffling their holdings in Dixons throughout last week. Nearly all of them are lightening up their holdings on Dixons, according to the RNS filings, with only Skagen reporting an increase in their stake. It should be noted that in this article I am only concentrating on "general" retailers, and specifically excluding food and drug retailers, for whom I have a much different perception.

Overdone share price drops, or more yet to come? More on that later, but first some statistics. Here are a complete list of retailers that pass on my Magic Formula screen, together with some stats:

DEB  1.1  -517     97 3.1 DEBENHAMS
SMWH 5.2    56     69 4.8 WH SMITH
NXT  6.0  -530    400 3.9 NEXT
JD.  5.4    60     43 2.3 JD. SPORTS FASHION
DXNS 2.7  -220     60 0.0 DIXONS
HOME 3.5   364    209 7.2 HOME RETAIL

EPIC - company code
Z - z-score - above 3 is acceptable, below 3 is much more marginal
CASH - net cash in £m. Negatives imply net debt
PROFIT - profit £m for latest financial year
YLD - dividend yield %
NAME - name of the company

Note that the cash and profit figures for JD., DXNS and HOME are the latest available year-end figures, which are over 6 months old. Be warned. Figures are taken from Sharelock Holmes. The first take-away from the table is that some companies are sitting on cash, and some are saddled with debt. Applying a strict z-score filter of at least 3 would lead us to rule out DEB and DXNS immediately. A measure of debt on a cash to profit basis doesn't make them look too bad for them at first flush, though. Still, if you're going to choose a magic formula stock, then why not favour the ones with a lot of money to spend?

So. Retailers. Are they a buy?

With the likes of Dixons trading on PERs of 7, and retailers having taken a beating, is it time to now back up the truck?

THE BULL CASE: In his article Dixons in the dock, Kevin Murphy, of Schroders, argued that there was a window of opportunity for value investors. He notes that at 12p, DXNS trades very near its 2008 all-time low. Its bonds yield 12%, compared to early 2009, when they yielded 20%. He further comments that at a yield of 12%, the bondholders obviously do not consider the company risk-free, but that there is reason to suppose that it is putting its house in order.

THE BEAR CASE: Simply put, things are getting visibly worse: VAT hikes, government cutbacks, rising input costs, employment insecurity and low wage inflation don't bode well. About the only good news is that the Bank of England are unlikely to put up interest rates any time soon - although one could posit a bear case even for the current state of interest rates. Now, you could argue that with so much bad news reflected in share prices, the companies are a steal. I would urge caution on that front, as I fear that potential investors may be walking into a classic value trap. IF profits take further significant beatings (and I have no sagely insight as to what will really happen, other than that things aren't looking too good at the moment), then
those low multiples will probably offer no downside protection to the investor. In the dire words of Peter Lynch: buying cyclicals on low PEs is a proven way to lose money. The lesson of HMV.L looms large in my mind. Now there's one sick puppy that kept sliding, sliding, sliding, and then sliding some more. Just make sure that if you buy, you're not buying into another HMV.

I actually hold JD.

I haven't really thought much about all the retailing stocks in the magic formula list, but I would rule out DEB and DXNS, given that there are better alternatives. When I went into DEB last, it seemed to have more shop staff than customers. The JD. shop I went in was small, and whilst not bustling with trade, at least the (paying!) customer to staff ratio was greater than 1. I'm not sure about HOME. My dad doesn't like them, I know that. I think NXT and SMWH might be reasonable buys, with a preference given to SMWH on account of its cash position. Besides, everyone still needs stationery, right?

So, why do I hold JD.? Well, it is a magic formula stock, and trades at a PER of 7.8. That doesn't stop it from being a value trap, of course. The yield isn't great, but I'm not going to overfuss on that. In January of this year, the company reported increased like-for-like sales during the christmas period, and maintained its gross profit margins. That's in stark constrast to some other retailers, who really felt some pain over christmas. It appears that the snow that affected the weak retailers somehow didn't present much of an obstacle for JD.. Peculiar that, isn't it? JD. did note, however, that it expects tough trading conditions this year. JD. will make a preliminary 2010  earnings statement on the 13 Apr, so I think we'll get to see if I was woefully wrong, or not. Some encouraging news is that JD. has a strong balance sheet, likes to operate in niche areas, and has been buying up some of the competition that has fallen by the wayside. Even if we see declining like-for-likes, we could well see increased revenues and profits. "Yes, but the like-for-likes are declining", I hear you object. My counter-argument would be yes, fair enough, the company is facing tough conditions, but it is buying up the weaklings on the cheap. If and when conditions do improve (and it's by no means certain that like-for-like will drop), I think JD. will have shown itself to have made some shrewd purchases. I am also encouraged to see that JD. has withdrawn from the bidding of JJB Sport. It gives me some confidence that the directors are being selective in their purchases, and are not just buying any thing at any price. Admittedly, there are risks of share price deterioration.

My Magic Formula Screen
In his book, "The Little Book That Beats The market", Joel Greenblatt laid out an investment formula for selecting a portfolio of shares that should beat the market over the long term. His formula contains a few grey areas. Sharelock Holmes has a screen for Greenblatt; although it is unlikely to be an exact replication of the formula. It is proably "good enough", though. As part of my filter, I select companies with a market capitalisation of at least £300m. Investment Trusts are excluded, not least because the database doesn't hold their details. They are unlikely to be suitable candidates in any evernt. As at March 2011, this yields a universe approaching 400 companies, which is a goodly selection to choose from. I then focus on the top 40 stocks within that universe.

Wednesday, April 6, 2011

Director buys - March 2011

In his book "The Little Book of Value Investing", Christopher Browne says: "Stocks bought by insiders outperform the market by at least two-one". With this fact in mind, I have been keeping tallies of director buys during last month, and trying to find the most promising candidate. I look through Director buys daily, and keep a note of interesting buys. It is a first stage screen, in which most companies are rejected. Once a shortlist is compiled, I then pair off companies, selecting what I think is the most promising buy. Companies making it through that round are then paired off again, and the process repeated until a winner emerges.

The candidates
The companies that passed the selection stage are: £AQP, £BARC, £CEY, £CNA, £CPP, £CW., £DPLM, £FCAM, £HWDN, £ICP, £III, £JPR, £LGO, £LLOY, £NXT, £POL, £PSN, £RRS, £RTN, £SPO, £VTC. They do not necessarily represent strong ideas; merely ones that, at first glance, have some kind of merit.

Of these companies, £DPLM, £HWDN and £NXT crop up on my "Magic Formula" screen, so readers may want to pay these companies another look.

Financials are a prominent sector on director buys this month. Based on historic PBV, £BARC and £LLOY look particularly cheap, with the possibility of doubling (and quite possibly even more) if business returns to usual levels. £BARC, for example, is trading at a PBV of 0.69, whilst its median over the last decade was about 1.74. It is also trading at a ROE of 9%, when the median was 19%. If you believe that the current clouds hanging over it will lift, and returns will revert to their historic values, then the banks look cheap.

The winner - ICP.L
My top pick for March 2011 is £ICP, 331p/£1.3bn. It is on a yield of 5.1%, and a rolling PER of 10.6. Low double-digit growth is expected in 2012. £ICP is engaged in the provision of mezzanine and equity finance to companies throughout Europe, Asia Pacific and North America, and the management of third-party funds in mezzanine, debt, high yield bonds and related assets. Director T. Attwood bought nearly £1m of shares last month. Other directors also bought shares in September and December 2010. The company's latest interim management statement in late January was upbeat:
Overall we are pleased with the performance over the last three months.  Our investment portfolio continues to perform well and we have made progress in growing our fund management business.
 Historically, ICP.L traded at a PBV of 1.86. It currently trades at a PBV of 1.1.

The runner-up - NXT.L
Second place goes to Next (forgive the pun), the apparel retailers, at 2030p/£3.6bn. It is on a yield of 3.9%, and a rolling PER of 9.6. It has a z-score of 5.9 and a net debt of £530m compared to a net profit for the latest financial year of £401m. Those debt figures look good until you see that its gearing is 228%. Estimated growth for the next two years is in the low single-digits, although those estimates may be too optimistic in light of the recent statement in the latest year-end results:
Looking ahead we are facing a tough trading environment.  Increases in VAT, cotton prices and labour rates in many of the countries in which we source means the price of our products are rising at a time when our customers are experiencing increased demands on their income.  However, we believe NEXT can continue to thrive by keeping to our strategy of investing in the Brand, improving the products, and developing new avenues of growth. 
As noted previously, Next is a "Magic Formula" company, but people will have to decide for themselves whether a PER of 9.6 represents an attractive valuation or a cyclical trap. The company has engaged in  strong buy-back activity lately, and four directors have bought shares at the end of March to the tune of £918k, combined. Next has won praise in this article on Stockopedia by QFinance for its honest, no-nonsense approach to communicating with shareholders.

Saturday, April 2, 2011

DPLM.L - Diploma - Qualifies as a Magic Formula company

£DPLM (website) operates in the following areas:
  • life sciences - supplying a range of consumables, instrumentation and related services to the health care and environmental industries
  • seals - supplying hydraulic seals, gaskets, cylinders, components and kits used in heavy machinery
  • controls - supplying specialised wiring, connectors, fasteners and control devices
 At a price of 328p (£372m market cap), it trades at a PER of 15.2, a yield of 3.0%, and a PBV of 2.7. It has a very solid balance sheet, with a z-score of 6.4, non-current liabilities at only half last year's net profit, and a gearing of -22% (negative gearing). Analysts estimate an EPS growth of 24% for 2011, and further growth of 10% for 2012. Median ROE for the last decade was 15%, which co-incides with the current ROE for the latest reported full figures. All good signs, in my opinion.

In a recent trading statement, the directors noted a strong increase in revenues and profitability in the first quarter of trading, which has continued into a second quarter, and expect that the adjusted profit before tax for the year ending September 2011 will be materially ahead of the market consensus of £36m.

Directors have been making purchases to the tune of £69k in March, and £90k in February.

£DPLM is also appearing high on my Magic Formula screen. I use Sharelock Holmes to produce a "Greenblatt Ranking" (which is Sharelock's calculation of the Magic Formula score) for companies with a market cap of over £300m. Investment Trusts are excluded. This returns a list just short of 400 companies. A company in the top 40 is worthy of further investigation, in my opinion. £DPLM meets such a test, possessing a high return on capital, and an "earnings yield" (actually more like EBIT/EV) of 10%. It is difficult to know, for sure, how closely the Sharelock Holmes results would match the actual rankings if they were produced by Greenblatt, but judging by the glossary on the Sharelock websites, it would seem that the results are likely to be "close enough". £DPLM thus qualifies as a "cheap and good" company.

For those that like a little bit of momentum behind the share price, £DPLM has a relative 6-month strength of 7% (i.e. it outperformed the market by 7% over 6 months), and a relative strength of 56% over a 12-month period.

On the downside, Interactive Investor blogger Richard Beddard recently estimated a fair value for £DPLM of 200p using a residual income model with 5-year projections. The web page contains a detailed explanation of the methodology used, and was praised by Steven Baines, a professional investment analyst. Richard produced a revised valuation of 480p yesterday (no, it wasn't an April Fool's joke), but the model was based on 10-year projections instead of 5. The RIM he used calculates quite conservative carrying values, so extending the forecasting horizon has the effect of upping the intrinsic value.

Conclusion: £DPLM is a magic formula company with a solid balance sheet, good returns on capital, and is available at a reasonable price. You even get a divvie out of it. The outlook for the company is good, and recent director purchases bolster this bullishness.

Disclosure: I own shares in £DPLM (I never take short positions).