Jackup rig

Lamprell makes a quick exit from the portfolio

Jackup rig

I recently bought back into Lamprell, citing the group’s net asset value and high cash balance as reasons to buy after December’s slump to around 60p.

I was targeting “another bounce to the region of 90-100p, at which point I would most likely sell again”.

I almost made it. The shares were close to 90p earlier in January, giving me the opportunity for a quick 40% profit. Unfortunately I hesitated and most of these gains were lost last week, when the company put a figure of $80m+ on the losses expected from its East Anglia offshore windfarm project.

This was only ever meant to be a trade, not a long term position. So I exited the following morning at 72.2p, locking in a 13% profit in just over a month.

I’ve recently been trying to focus my portfolio on fewer, larger positions with higher conviction levels — stocks I’d be happy to own if the market shut down for a while. Lamprell didn’t fit that description, so along with several others, it has now exited stage left.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Sainsbury's CEO, Mike Coupe

Why I’ve changed my view on Sainsbury and sold my shares

Sainsbury's CEO, Mike Coupe

Mike Coupe, Sainsbury’s chief executive (image: J Sainsbury)

My position in J Sainsbury (LON:SBRY) had  not been working out as well as I’d hoped. So after a year, I decided to revisit my reasons for buying to see if they still stacked up. I often find this can be a worthwhile exercise.

Discount to peers

The main thrust of my investment case was that Sainsbury’s stock was trading at an unwarranted discount to its two main listed rivals, Tesco and Morrison.

Despite a fairly solid performance last year, Sainsbury’s price/sales ratio of 0.23 puts it at a significant discount to listed rivals Tesco (P/S = 0.27). and Morrison (P/S = 0.35).

I also noted that based on 2016/17 figures, Sainsbury’s earnings yield (EBIT/EV) was much higher:

• Sainsbury: 9%
• Morrison: 6.7%
• Tesco: 3.4%

So my argument was that this discount should gradually close and that Sainsbury might increase in value. A particular attraction was the group’s earnings yield of 9%, which is reasonably high.

What actually happened?

Revisiting these metrics showed me that the gap has closed, but not in the way that I’d hoped. While Sainsbury’s share price has gone nowhere much, weak earnings performance means that its valuation relative to earnings has increased:

Here’s how the earnings yields (EBIT/EV) compare now on a TTM basis, ahead of each firm’s FY18 results:

  • Tesco: 6.4%
  • Morrisons: 7.5%
  • Sainsbury: 7.4%

Sainsbury still trades at a price/sales discount relative to the others, but it’s not as large as it was. It seems clear to me that in terms of profitability, all three supermarkets are more closely matched than they were.

Is it worth holding?

In terms of profitability, none of these three supermarkets seems especially expensive. However, it’s worth understanding why Sainsbury’s earnings yield has fallen from 10.3% at the time of my original purchase to 7.4% today.

Unfortunately it’s because the group’s profitability has fallen, rather than because the shares have risen.  The group’s full-year operating margin fell from 3% in FY16 to 2.4% in FY17. And the TTM operating margin for 17/18 is 1.7%.

The reason for this, from what I can tell, is that Argos is diluting the group’s margins (as some commentators suggested at the time of the Home Retail acquisition).

It was apparent before the acquisition that Argos had a lower operating margin than the supermarket business, but I had hoped that higher sales density achieved by moving Argos branches into under-utilised supermarkets would offset this. As yet it’s not clear whether this will be the case.

Obviously the integration of the two businesses will need a year or two to bed in and deliver synergies. But how great will these be?

According to 1H18 results, Sainsbury’s board is targeting £142m of EBIT synergies by the end of 2018/19. But to achieve this, the group will incur £130m of integration costs and £140m of integration capex — that’s a total of £270m of cash expenditure.

Broadly speaking, I don’t expect the benefits of this integration spending to appear fully until 2019/20. And even then the reality may still be that Argos is simply a lower margin business.

I might have been tempted to give the board the benefit of the doubt here, but Sainsbury’s management has opted to report all retail sales as one segment (as of 1H18 results). So there will be no segmental breakdown of profit from Argos and Groceries.

This means that it will be very hard to see how the different parts of the business are affecting the group’s overall profit margins. On balance, my view is that the current valuation is probably about right. I’m no longer convinced by the case for a re-rating, so I decided to sell.

Including dividends, I scraped a 2% profit after one year. Not great, but certainly not a disaster.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Growth image

Why I’ve sold Kingfisher & Pets At Home

Growth image

As part of my decision to focus more closely on value stocks, I reappraised my positions in the various retailers I owned. Along with Next, two other casualties of this cull were Kingfisher (LON:KGF) and Pets at Home Group (LON:PETS), both of which I’ve sold for modest single-digit percentage profits.

My reasoning isn’t necessarily that they aren’t attractively stocks. Rather I concluded that both were fairly priced for what they are. There was no inherent value that I could see. Instead, the upside potential on offer is dependent on management executing growth strategies or operational improvements over multiple years.

Here’s a quick summary for each.

Kingfisher

I’ve previously admired this group’s cash generation, strong balance sheet and healthy margins. And these qualities remain. But earnings growth has been woeful over the last decade and the value in these shares isn’t obvious to me, as these metrics (my calculations) show:

  • PE10: 16.6
  • 10-year average eps growth: c.0%
  • 5-year average ROCE: 10%
  • Forecast P/E & yield: 13.3 and 3.3%

It seems to me that from a financial perspective, Kingfisher has been treading water (profitably) for some time. When one division does well, others tend to lag. At the moment, strong performance from Screwfix and okay performance from B&Q is being offset by weaker performance from the group’s French stores.

CEO Veronique Laury’s ONE Kingfisher transformation strategy aimed to provide £500m of sustainable extra profit by the end of FY20/21. Ms Laury may be successful, but without this I can see little reason to think that earnings are going to surge ahead. And I’ve no way of knowing whether this programme will be successful. Although you could argue that Ms Laury is simply aiming to collect money that’s currently being left on the table, reorganising a group of companies as large and complex as this is never trivial and rarely problem free.

Pets at Home Group

I’ve admired Pets at Home Group’s multi-channel strategy. The group aims to build a loyal customer base by selling pet-related products online and instore, while upselling higher-margin vet services that are located on the same site. So you can click and collect a month’s worth of dog food and get Fido de-wormed at the same time.

The problem is that most pet goods are highly commoditised. And they’re often available cheap on Amazon and elsewhere. So Pets at Home has had to cut prices on these goods to maintain market share.

As such, future profit growth is now more heavily dependent on a growing contribution from services. As with the Kingfisher story, this could well work. But it doesn’t seem like a value play to me — in my view it’s more of a growth situation.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Next store

Why I’ve sold Next

Next store

Image credit: Next plc

I don’t normally have a problem with volatile stocks or deep drawdowns on value investments. But during the time I held Next (LON:NXT) shares, I was unable to find my usual level of conviction. I’ve documented some reasons for this here and here.

I suppose I wasn’t entirely convinced that Next really was a value stock. By this I mean that I wasn’t sure if there was any unrealised value in the group, or whether it was simply fairly priced for a business whose profits are currently declining or at best stagnating.

After the firm’s strong Christmas trading statement and the stock’s subsequent journey back to the £50 levels, I decided to sell, locking in overall profit of 26%, equivalent to an annualised total return of 32%.

This sales may prove to have been short-sighted. We will see. I wouldn’t rule out buying back in again if the stock appeared cheaper. But I’m trying to tighten the strategic focus of my portfolio on genuine value and special situations.

I’m not sure if Next is either at the moment. Here are a few metrics to illustrate why I came to this conclusion:

  • PE10 = 15.6 – Next’s earnings grew powerfully in the years up to FY16. They’ve fallen since then. For this PE10 to be cheap you’d have to take a view on Next as a growth business, not a mature business. I don’t see this.
  • Forecast P/E of c.12.5 & prospective yield of 3.3%. The board’s decision to switch back from special dividends to buybacks probably makes sense. But this valuation seems entirely fair to me. With earnings expected to fall this year, it’s hard to see why the stock should be worth much more.
  • Uncertainty and a new lack of disclosure over the future profitability of the Directory Credit business. Although the Directory Credit loan book is an attractive asset per se, recent comments have suggested the profitability and growth rate of this lucrative element of Next’s business could be changing.

I freely admit I may have been too cautious and too pessimistic with Next. I wouldn’t be entirely surprised to see the shares trading much higher by the middle of this year. But I’ve made my decisions as part of a wider clear out of retailers in my portfolio.

One problem may be that non-food retail is not a sector I feel I understand very well — while the accounting is simple enough, the dynamics and growth drivers of this business aren’t entirely clear to me at the moment.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Jackup rig

New stock: Why I’ve bought Lamprell plc (again)

Jackup rig

Disclosure: Roland owns shares of Lamprell and Petrofac.

Having sold my shares of Lamprell (LON:LAM) back in July for 103p, I bought back into the stock on 30 November for 62p — a fall of around 40% in five months.

My purchase came after the shares tanked following news that the group’s foray into renewables had met with some hitches. By its own admission, the company is learning on the job and “the learning curve has proven to be steeper than anticipated”.

I’m fairly relaxed about this operational setback. In my opinion (and experience), the reality of engineering businesses is that when a company takes on a sizeable project in a new area of work, setbacks are very likely. In my view, Lamprell generally has a reputation for good quality engineering and for delivering projects on time (and usually) on budget.

Why I’ve bought

I don’t normally dip in and out of shares, but it struck me that as before, Lamprell’s share price had fallen so far that the business was almost being thrown in for free. The strength of the balance sheet is worth noting — net cash was $305m (c. £231m) at the end of H1, versus a market cap today of £237m.

Although net cash is expected to fall somewhat in H2, these figures suggest that the firm’s current enterprise value could be as little as £10-20m. I believe Lamprell’s business is worth much more than this.

I’m also attracted by cyclical factors, as anecdotal evidence seems to suggest that the oil market recovery is now starting to trickle down to services companies (although CEO Christopher McDonald has warned that he doesn’t expect any improvement in FY2018).

Value credentials

Here are some key metrics from September’s interim results to illustrate the fundamental value I believe exists here:

  • Net cash: $305.9m
  • Net current asset value (current assets – current liabilities): $389m
  • Net current asset value (current assets – total liabilities): $327m
  • Net tangible asset value: $527m or c.116p per share

And here’s how these figures compare to the current market cap:

  • Market cap today (17 Dec 2017): £238m (c.$315m)
  • Share price today (17 Dec 2017): 69p

Allowing for some reduction in net cash during H2, it seems likely to me that Lamprell is currently trading somewhere close to its net current asset value. That seems too cheap to me for a company with such a strong balance sheet and a strong franchise in the jack-up rig-building sector.

I paid 62p for my shares on 30 November. I’m hoping for another bounce to the region of 90-100p, at which point I would most likely sell again, as my core holding in this sector is Petrofac.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.