Monday, November 21, 2011

Diary: aly, dplm, fccn, grg, jd., mrw, pic, rtn, rwd

I see that the market's taking a tumble today. Down 2.02% as I speak.

DPLM - Diploma - Support Services - 302.5p/£342m

Gratifyingly, DPLM is actually up 2.94% on latest prelim announcement of final results for y/e 30-Sep-2011. All-round excellent news of revenues up 26%, profit for the year up 20%, adjusted earnings per share up 48%. The only negative is FCF down 16%. Revenues up from strong demand and acquisitions, margins up due to cost reductions.

Net cash is down to £12.2m (2010 £30.1m), but there was an acquisition of £28.2m, so I'm happy with that. Full dividend up 33%. Excellent. Good performance across all divisions.

A new phrase that I like from DPLM is "GDP plus":
Diploma's businesses are focused on essential products and services that are generally funded by the customers' operating rather than capital budgets, providing recurring income and stable revenue growth. This resilience gives us confidence in delivering the "GDP plus" levels of underlying organic revenue growth which we aim to achieve over the business cycle.  In addition, by supplying essential solutions, not just products, we are able to sustain attractive margins by delivering real value to our customers and suppliers.  Finally we encourage an entrepreneurial culture which ensures that our businesses are agile and respond quickly in changing economic and market conditions.
Maybe I'll use that to replace the phrase I sometimes use as "steady compounder". 

I have held these shares since the end of Jan 2011, during which time the shares have risen 3%, against a Footsie decline of 13.3%. The company has a ROE of 19%, against a decade median of 15%. As I reported yesterday, the company has been growing its dividends by about 16% pa over the last decade. Yet it trades at a PER of 10.8, and offers a dividend yield of 4.0%. In the directors outlook, they describe the business as resilient, a good geographic spread of activities, a strong balance sheet, and expect further "GDP plus" performance.

Very good buying opportunity, especially at these levels.

I think DPLM, along with BATS, is starting to drive home, very slowly (I seem to be a slow learner), that if you buy decent companies with good balance sheets and reasonable growth prospects at sensible prices, then you'll probably do well. I'm not saying you can't go wrong, but at a PER of 10.8, that looks a pretty sweet deal for DPLM. The problem with "value" shares like the banks, insurance companies, iffy retailers and suchlike, is that they're "all over the place", swaggering around like drunken sailors on shore leave. Those falling knives are very difficult to catch. It's not so much that I "mind" volatility, it's just that it seems to be too easy to be wrong about them. Look at Bruce Berkowitz's Fairholme fund. It's down 31% YTD, compared with +2% for the DJIA. He might ultimately be right on the financials, I think he's a very smart guy, but he has created an enormous headwind for himself.performance-wise.

6 months ago

Time for me to take a trip down memory lane, to see what I was writing about in May.


I had a look at RWD, which is down 18% over 6 months, compared with Footsie down 12%. That's possibly not especially meaningful, because it is only int the last 2 months that the share has underperformed. So it could just be market noise. I see that on 15-Nov-2011 Numis has downgraded RWD from add to hold. The share price has underperformed the market by 3.6% since that date. That could be a contrarian indicator as much as anything.

It's now on a PER of 9.5, which is by no means stretched. The fly in the ointment is that EPS is expected to decline by 41% in 2012. It has low gearing and a PBV of 1.1, which is very low. ROE of 16% looks respectable, and it's trading on a PFCF of 6.6, which seems almost irresistable. Berkowitz has said that he is looking for a free cash flow yield of at least 10%, and can't kill the company. RWD would appear to meet both of these criteria. It's a bit disappointing to see net debt increase to £28.2m since I last looked at them. It should be said that their balance sheet is still very robust, though.

I said that the prior reduction in operating profits by 30% looked scary, but it should be remembered that y/e Apr 2010 was particularly strong for them. I calculated an EBIT/EV of 13%, which offered an attractive return. Revising for the interims, I get EBIT 30.1m (= 13.7+37.4-21.0), and EV 209.4m (= 187.9+21.5), giving UEY (i.e. EBIT/EV) of 14%. So about the same.

Towards the end of my post on RWD, I said:
 Expectations reflect a lot of negativity surrounding consumer spending and commodity prices. If sentiment improves, then the share price will, hopefully, reflect a shift.
So far, we're still waiting.


I also took a look at DPLM, an "old-fashioned British combine dating back to 1931 that's seen more restructurings than Joan River's face". The directors report was confident in their outlook, Interactive investor said "the stock still looks good value and shows long-term potential", and Richard Beddard said " looks like a superior business that will continue to earn high returns". He said other good things, but a bear point for him was that although its products are specialised, most companies succumb to competitive pressure sooner or later. "The odds are against Diploma". He didn't like its price at 2.5X BV and 27X 10-year average earnings.

Greenblatt talked about the issue of competitive pressure some time ago. When someone asked if he was worried about reversion to the mean, he replied that he thought there was a distinction between reversion to the mean, and towards the mean. So, I think the point is that long term we're all dead, but that doesn't necessarily mean we'll be dead tomorrow.

I noted one investor write about the company:
I watch some shares go up and down like West Ham but not this one. Just lie back and smell the Roses.
How right he was!

My ultimate verdict on DPLM was:
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.
Indeed, the shares haven't dazzled me with their performance (although they are beating the market by 20% YTD, so I guess I must be fussy ;) ),  but I believe that DPLM is now at a very attractive valuation. The whole thing about a dozen such companies looks completely on-the-money, in retrospect. Well, I had to get something right, didn't I?


Ah yes, good ol' retailers. Haven't they had a rocky ride lately?! I took a look at FCCN (French Connection) and JD. (JD Sports). Rental lease obligations are generally off-balance sheet, tending to make retailers look better than they are. I gave a whole spiel about trying to adjust for them.

In my original post, I noted that there was heavy negative sentiment surrounding retailers. During the 6 month period, JD lost slightly less than the market (-8.7%, compared with FTSE -11.7%). FCCN is down 32.1%, an unmitigated disaster.

I said that I expected the company to be bigger in 5 years time than it is now, although short term outlook is for a decline in EPS for 2011. Despite all the doom and gloom, and for all the ostensible wobbliness that you associate with retailers, JD. has been an exceptionally steady company. I had the feeling that the market was not quite "getting" what JD. was about, so I continue to have some confidence in the future of JD..

Contrast that with FCCN. It had had a cracking share price performance at the time - up 20% YTD, but has since come down to earth in a big way. I wrote recently that it was approaching net-net territory, but that didn't necessarily make it touchable. Its operating margins are wafer thin, and it occasionally has to dip into its surpluses, thereby diminishing its NCAV. I view FCCN as a risky turnaround, with a healthy but diminishing supply of fat to live off. If it can pull off a reversal of fortunes, this will probably become a spectacular share. The problem is: will it? FCCN's latest trading statement didn't make for pleasant reading, hence the slump in share price.

Another company that I mentioned was ALY (Laura Ashley). It showed record profit in y/e 29 Jan 201, but did note a decline in performance since the report. In the 6 month period, ALY has had a similar performance to JD..


I took a look at 3 defensive companies: GRG (Greggs), MRW (Morrisons) and RTN (Restaurant Group). It's a bit debatable whether one could call RTN a defensive. I think "quality compounder" what be a better description. It clearly wont have the resilience of Morrisons the supermarket.

Over the 6 months period, all three shares have held up better than the Footise, a fact that should surprise no-one. FTSE is down 11.6%, RTN -2.8%, MRW + 0.4%, GRG -6.6%. I recently highlighted RTN as a company that has been growing its dividends by nearly 11% for the last decade.


Ah, PIC. I took a look at this, and noted:
 Pace is infamous for being a "serial disappointer", and this year it has seen it perform a veritable tour de force on that score.
And my, its catalogue of woes just keeps getting bigger.  Since then, we've had floodings in Thialand, which have created supply problems of the hard disks used by PIC.

PIC is down 52% in 6 months, vastly underperforming the Footsie by a massive margin. It currently trades at a PER of 2.39, a PBV of 0.58, and has a yield of 4.8% (despite having a dividend cover of 8.6). Analysts expect dividends to increase throughout 2011 and 2012, although I wouldn't count on it. Seeings as PIC isn't really what you call a "dividend share", the company would probably be better off conserving cash and paying off debt.

Like I say, I have been wrong at every stage on this share.

Stripping out exceptionals, I calculate an EBITDA of £88.4m (DB02/25), and net debt of £181m. This gives an Net debt/EBITDA of 2.0, so we're still looking safe enough at the moment in terms of debt.

Despite all the crud that's happened to this company, I still reckon it's a buy, albeit risky (did I mention that  I have been wrong at every stage on this share). My "variant perception" is that everything that has happened to this company has been the result of temporary setbacks, rather than a deterioration of trading per se. Mind you, any breakup of the Euro, bank failures, rising of sea levels, or hell being full causing the dead the roam as zombies, wont help.

What did we learn?

I'm always wary of this question, because I think that's there a big risk of learning the wrong lesson, or just being wise after the event. The general lesson seems to be is one of a "continuance of trends", I think. DPLM was a good company, and still looks a good company. RWD is "solid enough", but not great, as it is still in a bind with its pricing power. FCCN has been a flakey company for years, and so has been up and down. JD. seems to have a little extra which makes it much more resilient.

Against declining stock market, the defensive and quality companies have shown a better performance. I think there are two things at play here. The first is that quality coupled with good, if unspectacular, growth, has one out over the ropier candidates. It has paid to go with the trend, rather than against it. Secondly, the results could simply be an artifact of market conditions - high beta is a two-edged sword. Market volatility (as measured by the VIX) is high, suggesting that a move to some of the cruddier end of the market may prove more profitable. And yet, and yet, I have skepticism. We may yet come to see the economic picture deteriorate, in which case the solid companies will probably continue to do well.

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