Tuesday, May 17, 2011

There's profits to be milked at Robert Wiseman Dairies


RWD.L (Robert Wiseman Dairies) processes and distributes milk and associated products (like cream). It supplies store-brand milk to supermarkets as well as milk under its own label in its distinctive packaging. It delivers over 30% of the fresh milk consumed in Britain, every day. The company was established in 1947, starting out from a milk run at the family farm in East Kilbride.

Annual Results

Today (17 May). RWD reported results for the 52 weeks ending 2 April 2011. The market clearly didn't like the results, as the shares plunged over 3% today on their announcement, although I don't think there were too much in there that I didn't expect. The good news is that turnover increased by 3.5%, but the bad news is that operating profits decreased by 30%. The company is being squeezed from both ends: by their customers (the supermarkets), and their suppliers (the farmers, and other input costs).

On the demand side, milk is often a loss-leader for supermarkets, who use its price to lure in shoppers. There has been intense competition amongst supermarkets in the last year, so it is natural that RWD is caught in the crossfiire. On the input side, prices of feed has increased, and farmers are of course looking to pass this cost on to RWD. RWD has also said that the price of petrol is hurts them, as this increases the costs of producing containers for the milk.

Here are some highlights for the year:
  • Net debt reduced by £16.2, to £4.9m. The company has always had a strong balance sheet, and interest cover is at a very high 36X.
  • Bridgewater facility has been completed, and has a capacity to 500 million litres per annum. RWD can now distribute over 2 billion litres of milk per annum. The company believes that the facility is critical to the volume growth and improved efficiencies in recent years
  • Expansion of Market Drayton milk reload depot expected to be completed in 2011
  • Closure of some smaller depots as part of cost savings
  • increasing input costs necessitated a renegotiation of contracts with the supermarkets. The bugbear with this is that oil-related costs have continued to rise even after the contracts were revised.
  • RWD is the lowest cost operator in the sector, and continues to target cost reductions, for example by investing in transport planning softwar
  • dividend is maintained
A look at valuation

Whilst a reduction in operating profits by 30% sounds scary, it should be remembered that y/e Apr 2010 was a particularly strong year for RWD. PBT (Profits Before Tax) has averaged £35m over the last five years, which coincides with the PBT that was achieved in the year just ended. Analysts have penciled in PTB forecasts for next year of £27m, and for the year after of £29m. Financing costs look to be about £1m pa, so let's say that RWD has an EBIT "power" of £30m. Hopefully, this will prove to be a conservative figure, given that the average over the last five years is higher.

At a share price of 324.1p, RWD has a market cap of £229.4m and net debt of £4.9m, giving it an EV of £234m. This gives RWD an EBIT/EV of 13% (30/234), which is quite a good rate of return.

RWD's ROC (Return On Capitial) comes out at 15% according to my reckoning (but you should always be suspicious of my calculations). I am calculating ROC in the manner suggested by Greenblatt, being EBIT over capital. Here capital is £195m, being net working capital (£-41m) + tangible fixed assets (£236m). Net working captial should be net of "excess cash", but cash is low in relation to turnover, so I figure that net working capital is simply equivalent to net current assets. 30/195 gives 15%.

A company on an earnings yield of 13% and a ROC of 15% looks relatively attractive to me.

RWD has managed to increase its EPS at a rate of about 10% pa over the last decade. If you include analyst estimates in the calculation, then that rate drops to about 6%. A lot depends on how accurately you think  analyst estimates will work out. ROE over the last decade has averaged 17%, which is quite good. ROCE has averaged about 22%, as reported by SharelockHolmes. SharelockHolmes bases their ROCE only on tangible assets; although RWD's intangibles are only paltry amounts anyway.

So, it looks possible to get a 15% annual compounded return out of RWD, sorta; which of course wont give you a track record to rival Buffett, but on the other hand, is a higher return than you would expect from the market in an average year. Expectations reflect a lot of negativity surrounding consumer spending and commodity prices. If sentiment improves, then the share price will, hopefully, reflect a shift.

DPLM.L - Diploma - Good interims

Business activities

DPLM.L (Diploma) has three divisions:
  • life sciences: making measuring kits and other items for the healthcare and environmental industries
  • seals: gaskets, cylinders and industrial machinery
  • controls: specialist wires, connectors and fasteners
It is headquartered in London, but most of its operations are in North America and continental Europe.

Interactive Investor produced a video on on DPLM recently, in which it cheekily referred to its trading activities as "a random business" collection, and an "old-fashioned British combine dating back to 1931 that's seen more restructurings than Joan River's face". Don't let that put you off, though, as they wind up by saying that the stock still looks good value and shows long-term potential.

Recent update

DPLM (Diploma) has issued a nice half-yearly report today. Note that a trading statement was made back in March, so the market knew what to expect in this report. Comparing 6 m/e 31 March 2011 to 6 m/e 31 March 2010, revenues are up 31%, operating profits are up 51%, and operating margins are up, too. Interim dividends are up 25%. Improvements were noted in all three divisions. Shareholders can be very pleased with that result. Net debt is £1m, compared with a net cash position at the finals stage of £30m. The group spent £27m acquiring businesses and £11m in dividends during the period. The balance sheet remains strong.

The directors report a confident outlook, and expect that the strong performance in H1 will continue in H2, although comparitives are becoming tougher.

What the bulletin boards are saying

Richard Beddard shared his thoughts on 9 May:
  • looks like a superior business that will continue to earn high returns
  • it has performed well in a recession because most sales have come from consumables
  • its products are specialised, so it isn't easy for customers to switch
  • while some companies remain competitive for decades; most succumb to competitive pressure sooner. The odds are against Diploma
Ultimately, he doesn't like the price at 2.5X BV and 27X 10-year average earnings, based on a share price of about 274p at around that time. The shares currently stand at 360p, giving it a market cap of £411m.

Discussion on DPLM is rather thin, but one bullish investor noted the following at the end of December 2010:
 As a long term Diploma Investor I have learned to just sit back and watch, make the odd irelevant comment and generaly [sic] smile. Its just one of those strong shares that everyone has in their potfolios and we all wish we had more.Fundamentals are V good, reputation in the industry is A1 and management is solid. I watch some shares go up and down like West Ham but not this one. Just lie back and smell the Roses.

Director transactions

It is difficult to divine much meaning in the directors dealings. In January, 3 directors cashed out their options to the tune of £195k at 276p. In February and March, 3 directors made purchases totalling £182k at prices in the range 276p-299p.

The numbers

As already noted, the balance sheet for DPLM is still strong, so no worries there. Interest cover is nearly 17, and the company also does well on z-score and gearing measures. DPLM has spent £70m in acquisitions over the last 5 years, during which EPS rose from 10.48p in 2005 to 18.90p in 2010, for a compound annual return of 12.5%. Looking over the period of a decade using a least-squares exponential fit, the rate of growth in EPS was 15% pa, with a "coefficient of determination" of 95% - suggesting that its EPS has been growing in a predictable way, rather than being subject to a lot of wild variation. Operating profits have grown at a rate of about 16.5% pa with similar regularity. ROE has been about 15%, made more impressive by the fact that it was achieved with a strong balance sheet rather than a highly-indebted one.

Dividend cover is 2.3, and current yield is 2.8% (based on a share price of  360p).

During the decade, DPLM only had two years when earnings contracted: 2002 and 2009. 2002 was preceded by a very strong growth in 2001 of 68%, and 2009 was followed by a strong growth of 28% in 2010. So it appears to be a good stable business not easily buffetted by economic upsets.

Turning to valuation metrics, it has an EV/EBITDA of 11.5, just slightly over the market average of 10.7. PER tells a similar story, at 15.8 compared with the market of 13.9. Figures were taken from SharelockHolmes, and incorporate the recent results. Benchmark statistics were computed by me (so you've been warned!) using median figures of companies with market caps over £200m, excluding investment trusts.

The verdict

I concur with Interactive Investor's conclusion that it shows "long-term potential". The company has demonstrated a solid performance over the last decade, with acceptable returns on equity, balance sheet position, and rates of increases in EPS. Prospects look good, and if the company continues to do as well as it has done in the last decade, investors should be well-rewarded. Valuations look in line with the market, and don't appear to be stretched. Given current valuation levels, the market seems to have recognised the merits of the company, so I wouldn't expect a short-term pop out of it. However, I would expect a portfolio of say a dozen such companies of similar quality at similar valuations to give investors a satisfactory performance.

Saturday, May 14, 2011

Retailers and rent - and JD Sports

One thorny issue that comes up with retailers is off-balance sheet finance due to rental obligations under leases, which tends to skew the figures. Richard Beddard of Interactive Investor is cautious on this matter; and with companies like Woolworths and HMV, he has a right to be. Richard recently wrote about JD Sports Fashion, a company in which I own shares.

The question is how to size up a retailer when there is a big rental component. If anyone has some good ideas, then please let me know. One way I thought of approaching the matter is to recompute a return on capital adjusted for rent.

Let me examine JD.L (JD Sports Fashion) to obtain its ROCE (Return on Capital Employed), and RAROCE (Rent-adjusted ROCE); the latter being a fictitious number devised by me. I will look at y/e Jan 2010 accounts to make my computations. Although y/e Jan 2011 has passed, I don't have access to a full set of accounts to make my adjustments.

I define ROCE as:
where CE is Capital Employed.
CE = TA - CL
where TA is Total Assets, and CL = Current Liabilities
We could have many debates here about whether CE should include only tangible assets, and whether an average capital should be used. I prefer to include intangible assets in with my ROCE. I shall use y/e Jan 2009 balance sheet to to calculate ROCE, rather than average 2009 and 2010.

According to my calculations, EBIT for 2009 (i.e. for y/e 30/1/2010) was £61.4m, and CE at the beginning was £129.2m (= TA 220.6m - CL 91.4). This gives a ROCE of 47.5% (=61.4/129.2) - a suspiciously high figure.

Let me now adjust for rental obligations under leases. According tot he accounts, JD. had obligations under plant and equipment too, but they do not appear material, so I am ignoring them. According to note 3 of the accounts, rent for the period was £75.8m. According to note 28, total commitments under leases at the beginning of 2009 (actually 20/1/2009) was £537.4m, of which £68.5, was due within a year. This means that leases due outside of 1 year amounted to £468.9m (= 537.4-68.5).

This means that our revised earnings are £137.2 (= 61.4 + 75.8), and our revised capital employed is £598.1 (= 129.2 + 468.9), implying a RAROCE of 22.9% (= 137.2/598.1).

So we have revised our return on capital from 47.5% down to 22.9% (rent-adjusted); which is still a high return. At the current price of 893.8p, JD. does seem quite underpriced, having a PER of 7.8. The market is attaching a lot of doom and gloom to the high street at the moment, and its fear is not necessarily groundless. I should point out, though, that the share price plummeted in 2008 to a low point of about 200p, and traded at a low PER (less than 6). During that period, though, adjusted EPS grew by nearly 30%. So investor fears were completely unfounded.

A statement by management last month expressed "extreme" caution in outlook, noting that VAT increases will have an adverse rebasing effect, as well as "adverse fiscal changes in addition to the multiple current economic pressures". In their christmas trading statement, the board also expressed concerns about increased raw material prices.

It should be noted, however, that JD. has net cash of £86m. Also, JD. seems to have a knack of surprising on the upside, which is the kind of knack that I like to see! This is why I continue to hold, and I am not anxiously edging towards the exist. I think one point that is overlooked about JD. is that it is good at acquisitions. If conditions worsen, then it will likely be able to pick up struggling competitors at bargain prices. Having a good cash position is a definite help here. Also, as noted on 14 April, JD. has a agreed £75m funding with the banks to refinance existing debts and "provide additional growth funding". A statement by one of the bankers involved in the deal seems particularly bullish:
By continuing to provide the finance to support their ongoing strategic plans, I'm confident JD will take full advantage of the growth opportunities in the markets they operate in.

I see JD. as being a bigger company five years down the line than they are now.

Investors interested in retailers might also want to check out ALY.L (Laura Ashley) at 20.5p/£149m, which showed record profit to y/e 29 January 2011, but they did warn that "Since the beginning of February, we have seen a decline in our performance which we attribute to a general weakening in the consumer economy."

A retailer that has been getting much more interest lately is FCCN.L (French Connection), at 102.7p. It is on a PER of 13.8, but it has a net cash position of £34m against a market cap of £98m. Share performance has been strong, having risen nearly 20% in year-to-date. In a statement of preliminary results, the company announced significant growth in profit, although it also noted: "The current economic environment is clearly difficult and it appears likely that it will remain so in the coming year."

Wednesday, May 11, 2011

Defensives - recent roundup

Mr. Market has been kind to my defensive portfolio over at Stockopedia lately, putting it into one of the top 3 performers for the month. This is remarkable for the fact that the companies I have selected are quite stodgy. It seems highly unlikely that I will be able to repeat this performance in the future; so I must guard against the temptation to puff myself up like a proud preening popinjay. Neil Woodford's recently-expressed opinion that careful selection of defensive stocks could be a "career-making opportunity" is beginning to look remarkably prophetic. All hail to the Woodford!

Anyway, enough of my self-contratulating silliness. Some companies that I have taken an interest in for my defensive portfolio have recently released statements, so I thought that now would be time to give a quick rundown of the results, together with my opinions.

GRG - Greggs 524p/£529m

Greggs is a bakers, owning a chain of 1500 shops through which to sell its bread, sausage rolls, cakes, etc..

In an IMS today, Greggs reported:
  • total sales growth in first 18 weeks up 4.8%
  • like-for-like up 0.8%
  • strong Easter performance
  • new shop expansion of track
  • financials remain strong
The numbers: PER 13.8, yield 3.5%, returns on equities over the last decade about 20%, z-score 6.6, EV/EBITDA 6.6

My view: good quality company, happy to have it in the portfolio.

MRW - Morrisons - £7.9b/301p

Morrisons is a supermarket. No points for getting that one right. The price dipped 1.8% today. On 8 May, it reported:
  • attracted record numbers of customers into its stores over the Easter holiday
  • encouraging start to the new financial year with sales growth continuing ahead of market
  • expects challenging economic conditions for customers
  • prices of oil and increasing commodity prices had compounded pressure on consumers' disposable incomes
  • Total sales, exc. VAT and fuel were up 4.2% (7.3% including fuel).
  • Like-for-like grew by 2.5% (5.8% including fuel)
  • plans to buy back £1b over the next two years
 In his blog, Terry Smith commented on the issue of share buybacks:
 Capital allocation decisions are amongst the most important decisions which management of companies make on behalf of shareholders. Yet share buybacks are not sufficiently understood by company investors and commentators, and maybe even by company management. One of the most important facts that is continually overlooked is that share buybacks only create value if the shares repurchased are trading below intrinsic value and there is no better use for the cash which would generate a higher return.
Commenters on his blog made reference to MRW:
The Wm Morrison buyback is a classic example of when NOT to buyback shares - and certainly not on borrowed money by a Company supposedly expanding and needing all the Funds and borrowing facilities it can lay it's hands on - what happens tomorrow when an unexpected opportunity arises?

MRW has a PER of 12.8,  yield of 3.3%, z-score of 3.7, PTBV of 1.5, EV/EBITDA if 7.3. Analysts forecast mid-double-digit growth in 2011 and 2012.

My view: MRW is on an attractive valuation, with good growth prospects. Returns on equity are in low single digits, but that's to be expected with supermarkets. I am sanguine about "challenging economic conditions" and the whole buyback program. I am very happy having this company in the portfolio.

RTN - Restaurant Group - £605m/303p

RTN operates 367 restaurants. Its main brands are Frankie & Benny's, Chiquito and Garfunkel's. It runs pub restaurants and concessions within airports.

In a recent AGM statement, the company reported:

  • Trading for the first 18 weeks has been satisfactory with total sales 5.5% ahead of the previous year and like for like sales 0.5% ahead.  Margins are broadly in line with management's expectations.
  • the Leisure division has traded well 
  • we have opened two new Frankie & Benny's restaurants and one new Chiquito. These are trading ahead of our expectations.
  • Our Concessions division has continued to trade well 
  • In total we expect to open between 22 and 27 new restaurants this year
  • The Group's balance sheet remains strong
  • Outlook: Trading conditions during 2011 look set to continue to be similarly challenging to those we experienced during 2010, with consumer sentiment remaining cautious and household inflation and disposable income still under pressure
RTN has a PER of 14.7, a yield of 3.0%, and a z-score of 4.4. EV/EBITDA is 7.6.

Return on Capital has been impressive during the last decade. The share price is down nearly 8% today, prompting me to take a nibble for the portfolio. At a PER of 14.7, it doesn't offer amazing value, but with a great balance sheet, low double-digit growth expected, I am tempted to take a small bite. Good quality company.

PIC.L - Pace - I got it wrong

Having been so bullish on PIC.L (Pace), I have now reversed my opinion. I originally bought on growth expectations at reasonable price. Although revenues look set to continue expansion, there appears to be problems on the cost side. Pace has hit a number of speed bumps this year, and it is clear that the rosy picture I had envisaged originally is fading fast. Pace is infamous for being a "serial disappointer", and this year it has seen it perform a veritable tour de force on that score.

Even as recently as 18 April, a time when PIC was at 153p (now at 97p) I commented that on a PER of 6 and double-digit growth expected, it was clearly undervalued. I did note some risks. I seems tht those risks are now increasing. Let's recap the position as I understood it at the time. The good:
  • y/e Dec 2010 reported revenues up 17%, EPS up 24%
  • Similar levels of revenue growth expected in 2011, and improved return on sales on top of that
  • "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."
The bad, which caused the share price drop in March:
  • exceptional charge of £19m for acquisition integration costs
  • delay in a customer upgrade plans to 2012
 In a trading update yesterday, Pace reported the following:
  • increased costs due to inventory building
  • Japanese Tsunami exacerbating supply chain issues
  • Pace Europe profitability below expectations
  • closure of Pace Networks as a standalone business unit due to insufficient demand
  • Operating profit expectations for 2011 reduced to £97m-£110m
  • Pace Americas performing ahead of plans. Well, at least that's some good news.
  • Pace Europe has continued to win business, for example with Tata Sky in India and Net Servicos in Brazil
  • the first half underperformance will not be made up in the second half
Some views on the boards, including FT Alphaville:
  • consensus downgrades to 2011E forecast of c. 25% in EPS expected
  • switching KPI (Key Performance Indicators) is a worrying sign of moving the goalposts. As Warren Buffet would have it: painting the target around wherever the arrow landed
  • the market is complex, and it's difficult to know who the winner will be
  • Since the acquisition PIC has lost the cash and lost the positive net tangible assets - leaving it with a nice PER and a small dividend. If the PER is now threatened I'm not seeing much attraction. 
  • there is suspicion over the reference to "operating profits" rather than pre-tax profits, suggesting that there could be some nasty exceptionals coming up
  •  Massive dent to board confidence today, Mr. Tighe needs to think wisely, lessons not learnt still after all these years.
Perhaps the most damming indictment comes from Altrium Securities, as reported in the Guardian:
The [IMS] statement offers a list of reasons that contributed to the lowered margin expansion, none of which seems to be credible in our view [emphasis added]. This statement also stands in stark contrast to the first quarter performance of its two closest peers – Motorola Mobility and Technicolor. In the first quarter, Motorola's set-top box revenues were up 11% and Technicolor reported flat revenue growth (unit growth of 21% year on year). Both these vendors remained bullish about the prospects of the market and did not highlight any pressure on margins. In addition, the closure of Pace Networks is a surprise particularly as this was a "key area" of opportunity in 2009.

The numbers: PIC has rebounded 5.3% this morning, compared to a drop of about 40% the day before. Based on a closing price of 92.9p, I have the following numbers on a rolling basis: PER 3.9, 83% gearing, PBV 1.2, PFCF 63. z score 1.9, EV/EBITDA 3.3, interest cover 51, net debt £201m, negative tangible value £-181m. I will refrain from posting broker estimates, as they seem a gonner now.

My position: I am a disgruntled holder of Pace shares. Now that my view on Pace has significantly deteriorated, my original reason for buying has largely evaporated. That being the case, it is not a "buy" under my original premise.  On a PER of 3.9, and an EV/EBITDA of 3.3, I don't think it's a sell either. With an interest cover of 51, and a net debt of £201m compared with net profits for 2010 of £50m, I am not too concerned with the debt position at this point in time. Risk is building up in this company for sure, and growth is evaporating. Given the low PER and EV/EBITDA rating, I think that a doubling of the share price is possible. Pace is of a much poorer quality than I originally imagined, and I do not now view it as a good growth share. I continue to hold.