Category Archives: Investment

Articles on investment topics, published on this website and on clients’ sites.

Royal Mail sorting parcels

Results review: Royal Mail plc delivers progress but value is uncertain

Royal Mail sorting parcels

Source: Royal Mail

Roland owns shares of Royal Mail.

FY17 results: 18 May 2017

My review of Royal Mail’s 2016/17 full-year results.

Royal Mail is a holding in another of my portfolios. This has historically focused on income, but I’m now shifting it towards my value strategy.

I’m trialling a new format for this article, based on my personal notes on the stock. My hope is that posting like this will enable me to post more often around other work commitments. But let me know if it’s too hard to follow.


The narrative seems reasonably positive. Ongoing shift to focus on parcels and manage the decline of the letters business. Growing contribution from international GLS business.

However, it’s also worth remembering that Royal Mail already has a 50% share of the UK parcels market. The group is aiming to keep this share steady, growing in line with the parcel market (about 3% p.a., according to Royal Mail figures). Significant market share growth could be unlikely, as competition from Amazon and other parcel operators appears to be intense.

This is a key risk, in my view — retaining this dominant market share is probably essential to ensure the profitability of Royal Mail’s universal delivery network. Any reduction in market share could be seriously bad news.

Total capex has fallen from £694m in FY16 to £529m in FY17. Guidance for FY18 is c.£450m, with sub-£500m expected for the foreseeable future.

Earnings analysis

Reported eps rose by 14% to 27.3p, so the stock looks fully priced on a P/E of c.15 @ 435p

Adjusted eps is more encouraging at 43.8p, giving a P/E of about 10. Are the adjusting items reasonable (in my opinion)?

Operating adjustments:

  • Transformation costs £137m (FY16: £191m) – Good to see this number falling. But I’d still include these costs in my calculation of operating profit, as in my view they’re necessary for both the present operation and the future survival of the business.
  • Employee free shares £105m (FY16: £158m) – I’d normally argue these were part of remuneration and should not be adjusted out, but in this case the free shares appear to have been gifted by HM Government into trust for distribution to employees (see 2016 Annual Report Note 15). So for the time being, it seems fair to ignore the income statement cost of these, as the actual cost to RMG appears to be zero.
  • The other adjusting items to operating profit are small and perfectly fair, in my view.

My estimate of ‘clean’ FY17 operating profit = £324m (FY16: £296m)

This gives an operating margin of 3.3% (FY16: 3.2%) and an earnings yield (EBIT/EV) of 7.3%. The operating margin is low but the earnings yield is quite attractive. Thus these figures suggest to me that the current valuation of the group is quite attractive, relative to its profitability.

Non-operating adjustments:

  • Net pension interest: £120m (FY16: £113m) – Royal Mail’s pension scheme is currently running a surplus, hence this line item. But it’s an accounting item only — it’s non-cash and isn’t a business-related gain. So in my view it should be excluded from earnings per share.

My estimate of ‘clean’ FY17 pre-tax profit = £320m (FY16: £283m)

The average tax rate over the last two years is 17.7%. Using this rate gives:

My estimate of ‘clean’ FY17 after-tax profit = £263.5m (FY16: £232.9m)

My estimate of ‘clean’ FY17 earnings = 26.3p per share (FY16: 23.3p)

This gives a trailing P/E of 16.3, which isn’t obviously cheap for a low-growth business. Does the cash flow situation paint a more favourable picture?

Cash flow analysis

The beauty of the cash flow statement is that you don’t need to worry about non-cash items distorting the results. The only adjustments I might make here are based on my view on whether a cash item is truly exceptional or not.

The figures from last year’s cash flow statement seem to confirm my view on profits. Free cash flow is the metric I’m most interested in here, given that this is a dividend stock with low growth expectations.

I’ve calculated free cash flow to equity on this basis:

Free cash flow to equity = Net cash inflow from operating activities – net cash outflow from investing activities – finance costs paid – payment of obligations under finance lease contracts

My calculations indicate free cash flow to equity = £153m (excluding acquisitions = £275m)

Note re. acquisitions: I usually exclude acquisitions from free cash flow calculations, but in this case I haven’t. Royal Mail has made similar sized (fairly small) acquisitions in each of the last two years as part of its growth plans for GLS. This seems likely to continue, so I want to see if the dividend is affordable alongside these costs.

The cost of the dividend last year was £222m, exceeding my estimate of the free cash flow available for shareholder returns. That’s one possible reason why Royal Mail’s net debt rose from £224m to £338m last year — the group’s cash flow wasn’t enough to support its transformation costs, acquisitions and dividend.

I’m not concerned about Royal Mail’s use of debt or its level of gearing, yet. But it’s something to watch.


I’ve done a quick calculation of return on capital employed for Royal Mail. The results are quite interesting:

  • FY17 ROCE (including pension surplus): 5.1%
  • FY17 ROCE (excluding pension surplus): 13.1%

These figures suggest that Royal Mail’s underlying business does generate a reasonably attractive return on capital employed.


A key attraction, the full-year dividend has been increased by 4% to 23p per share, giving a trailing yield of 5.3% at a share price of 430p.

The yield is attractive, but dividend cover is poor based on my eps estimate of 26.3p per share and on the group’s reported eps of 27.3p per share. Dividend growth may be limited over the next few years.


Royal Mail has 50% of the UK parcel business. With such a dominant market position, I don’t think it’s reasonable to expect anything more than low single-digit growth in parcel revenues. The group is hoping that its international GLS business (of which Parcelforce is the UK arm) will provide some growth to offset the decline in the letters business.

If you’re wondering about the discount to book value which shows up on some data services, I’d be aware that that this is only due to the pension surplus, which was listed as a £3.8bn non-current asset for FY17. Even if this persists (we’re told it won’t), I don’t see this as an attraction for equity investors. Stripping out the pension surplus gives a book value of about £1.2bn, putting Royal Mail on a pension-adjusted price/book ratio of about 3.7.

In my view, Royal Mail’s current valuation is probably attractive for income investors. This was the original reason for my purchase of the stock.

I’m moving away from income to focus more heavily on value. And I’m less certain whether Royal Mail is cheap enough to qualify as a value buy. Although the earnings yield and ROCE are fairly attractive, the parcels business is fiercely competitive. I’m not sure how much room the group will have to increase profits or margins, especially as it will have to maintain capacity in its declining letters business.

Overall, I’d rate the stock as a hold. I’m going to mull it over, but may soon sell some or all of my holding.

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.

Offshore oil or gas platform

Portfolio update: BP, Hargreaves Services & Gattaca

Disclosure: Roland owns shares of Gattaca, BHP Billiton and Hargreaves Services.

Today I’m going to provide an update on recent changes and news affecting three of the stocks in my portfolio, BP plc (LON:BP), Hargreaves Services plc (LON:HSP) and new arrival Gattaca plc (LON:GATC).

BP: sold

After watching BP’s share price regain some of the ground it lost at the start of the year, I decided to sell. There were two main reasons for this.

The first is that my portfolio retains oil exposure through a holding in BHP Billiton. Although BHP isn’t a pure play on oil and gas like BP, it does have a more attractive financial profile than BP. In particular, BHP Billiton boasts three attributes I like and which BP lacks:

  • Strong free cash flow
  • A dividend that’s comfortably covered by both earnings and free cash flow
  • Falling net debt and lower gearing than BP

The second reason I sold BP is that I wanted to free up money for new and — I believe — better opportunities elsewhere.

I suspect BP remains attractive as a long-term energy pick, but I don’t find the current valuation compelling. So after just over a year, I’ve sold my holding in BP for a respectable gain:

  • Total return (after costs, including dividends): 50.6%
  • Annualised total return: 42.6%

Hargreaves Services

I’ve been waiting patiently for Hargreaves’ management team — who I rate highly — to report progress on their plans to monetise the company’s land bank. On 29 March the firm released a RNS which sent the shares up by 20% in one day (my bold):

Hargreaves Services plc (AIM: HSP), a diversified group delivering key projects and services to the infrastructure, energy and property sectors, is pleased to announce that it has today received planning approval in principle for 1,600 new homes at Blindwells, on part of a 392 acre site near Tranent in East Lothian, which is situated less than 15 miles from Edinburgh city centre. The approval, which includes affordable housing and mixed use development, represents the first phase of a wider master plan for more than 3,200 homes to be developed over the next 12-15 years.

The Blindwells site was an open cast coal mine until 2000. Hargreaves will need to spend £5m to put in some infrastructure but the assuming the housing market remains stable, this looks to me like a big win for the group.

According to Hargreaves’ RNS, “the grant of planning is expected to generate a meaningful uplift to the market value of the Blindwells site” relative to its book value, which was £129.2m as of 30 November 2016.

An independent valuation of the group’s property portfolio is underway and will be published with the group’s results in August.

Hargreaves’ stock has risen by 24% so far this year. The tangible value of the firm’s assets is starting to be reflected in the group’s share price. However, I believe there is likely to be more upside to come. Obviously this isn’t without risk: the housing market or a dislocation in financial markets could threaten the group’s plans.

To reflect the risks but remain exposed to potential upside, I trimmed my holding in the wake of this news. Notwithstanding this, Hargreaves Services remains one of the largest holdings in my portfolio.


With masterful timing I added Gattaca to my portfolio on 6 April, seven days before the small-cap recruitment group issued a profit warning.

Full-year profits is now expected to be 10-15% below previous expectations. This isn’t disastrous — I estimate it puts shares on a forecast P/E of about 8.5.

The explanation for the expected profit miss sounds reasonable to me and should be a one off. Several factors were mentioned:

  • Slower hiring during H1 following the Brexit vote.
  • Unexpected one-time costs relating to setting up “new international entities” to support a European contract win, plus more general spending on infrastructure upgrades.

However, the group’s sound more confident about the medium term, saying:

Given the opportunities we see, the Group has continued to strategically invest in sales headcount, up 24 since 31 July 2016 and we expect to see a return on these investments during the second half and beyond. We are particularly confident that the headcount investments which we have made in our overseas businesses will lead to accelerated growth next year.

This does worry me

In my view, what’s more worrying than the profit warning itself is that it reflects poorly on management credibility. Last week’s warning came just over two months after a far more bullish trading update in February, when the Board had this to say about the FY outlook (my bold):

Having made these investments over the last 12 months, the phasing of planned client projects in the second half of the year and, encouragingly, the improving performance of our IT Division, the Board has confidence that profit for the full year will be in line with its previous expectations.

Did the board really have no visibility of the issues raised in last week’s profit warning in February?

Is the dividend safe?

There was no mention of the dividend in last week’s profit warning. But a second concern must surely be that Gattaca will be forced to cut its dividend. The stock currently offers a forecast yield of 8.5%.

A yield that high is usually a warning that a cut may be required. Although the forecast payout of 23.3p should still be covered by earnings, which I estimate at about 33p per share, the problems mentioned above may have had a disproportionate effect on short-term free cash flow.

While Gattaca’s last-reported net debt of £25m is very manageable, I wouldn’t want the firm to borrow more simply to maintain the dividend. A modest cut to the payout might be more prudent.

However, that’s all in the future for now. I haven’t made any changes to my Gattaca holding following the profit warning, and continue to hold.

Assuming there are no more profit warnings in the pipeline, the firm’s next update should be interim results on 20 April. I’ll comment here if anything material changes in my view of the firm after the figures are published.

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.

Glass skyscraper building

ShareSoc Leeds growth company seminar 3 Nov 2016 review (NIPT, EVG & PCA)

Glass skyscraper buildingDisclosure: I have no financial interest in any company mentioned.

ShareSoc’s northern expansion is continuing (!), and the society held another of its growth stock seminars in Leeds last week.

The companies presenting were Premaitha Health (LON:NIPT), Evgen Pharma (LON:EVG) and Palace Capital (LON:PCA).

As previously, the event was very well organised, with food and drink provided. The seminar was held in the Cosmopolitan Hotel in central Leeds, which is just five minutes’ walk from both Leeds station and a multi-story car park. It’s a very easy location to get to.

Further events are planned in Leeds and Manchester, as well as the usual locations ‘down South’. Full details are available here.

Here’s a quick summary of my notes and thoughts from the event.

DISCLAIMER: Please note that these comments are based on my impressions from the seminar. They are not advice or buying recommendations. I haven’t looked closely at these companies’ finances but would certainly do so before considering investing. Please do your own research if you’re considering buying (or selling) these stocks.

Premaitha Health

The story: AIM-listed Premaitha Health is focused on developing non-invasive pre-natal DNA tests (NIPT) for pregnant women. The firm’s main product is the IONA test, which was launched in February 2015. This test estimates the risk of a fetus being affected with Down’s syndrome, Edwards’ syndrome or Patau’s syndrome.

The IONA test is designed to provide more accurate results than the current ‘combined test’, while avoiding the risk and discomfort associated with more reliable but invasive tests such as amniocentesis.

Premaitha claims a reasonable share of the NHS market, and says that it is growing abroad. The firm says that the market for NIPT is growing fast globally, and believes IONA has some significant advantages over competitors.

Revenue rose to £2.5m last year, during the firm’s first year of commercial sales. Revenue is expected to be about £6.5m this year, but Premaitha expects to continue running at a loss as it expands its marketing operations and laboratory installations globally.

Possible problems? Unfortunately, a cancelled train meant that I arrived halfway through Premaitha’s presentation. As I sat down, Premaitha’s management was on the receiving end of some pointed questioning from the audience. There were two topics.

The first was the details of a £9m funding deal with Thermo Fisher, whose DNA sequencing platform is used by Premaitha. I’m not quite sure what the perceived concern was, but at least one audience member wanted to know more about the detail of this deal than management was prepared to divulge. I assume the investor’s ultimate concern was potential dilution.

The second concern was the ongoing patent infringement action against Premaitha by DNA sequencing platform Illumina (a rival to Thermo Fisher). Premaitha’s firm view is that the allegations are unfounded. However, defending them is likely to be costly. Premaitha provisioned an additional £5.8m against litigation in its results last year.

My view: Premaitha appears to have a good product and to be showing signs of successful commercial growth. But as a layman, I’ve no real way of knowing how likely it is that IONA will become a major commercial success. There’s also the overhanging risk of the legal action.

Evgen Pharma

The story: Evgen Pharma floated on AIM at the end of 2015. It’s essentially a ‘one-molecule company’, but its product, SFX-01, already has three or four potentially major applications. Two of these — for treating subarachnoid haemorrhage (a very dangerous type of stroke) and metastatic breast cancer — will enter Phase II trials later this year.

The gist of the story is that the molecule behind SFX-01, sulforaphane, is naturally derived from brassicas, most notably broccoli. The clever bit is that it’s only released by another molecule once the digestive process starts. You can’t extract it directly.

It’s science like this which lies behind Daily Mail stories about superfoods, but don’t think you can cure cancer by eating a lot of brocolli. According to CEO Dr Stephen Franklin, you’d have to eat 2.6kg per day of broccoli per day to get one dose of SFX-01. Most people, he advised seriously, are sick after about 300g.

What makes Evgen slightly different to some other small drug development companies is that the therapeutic properties of sulforaphane have been known about for many years. According to Evgen, more than 2,000 peer-reviewed articles have been published on sulforaphane since 1992. All have been positive. The problem has been finding a way of packaging the molecule stably for clinical use. Sulforaphane on its own must be stored at -20C!

Evgen has managed to find a way of packaging sulforaphane in a clinically stable format, known as SFX-01. If either of its Phase II trials are successful, then the shares could be worth multiples of the current price. These trials are expected to complete by H1 2018 and Evgen is now fully funded until the end of 2018. This means investors should have a clear picture of what to expect.

My view: One of Dr Franklin’s key goals was to convince us that Evgen is lower risk than many other small pharma stocks. His case is that the large volume of peer-reviewed literature backing the science behind sulforaphane reduces the risk of the drug trials failing.

As a layman, I was impressed with Dr Franklin’s presentation and clarity of his investment proposition. However, as with Premaitha, I can see no way for a non-expert investor to quantify the likelihood of success or failure, so I’d class this as a high-risk, high-return investment.

Palace Capital

The story:  Palace Capital was founded in 2010 by Neil Sinclair, a very experienced property man. He reversed into an AIM-listed shell company and then started making acquisitions in the regions, at a time when the view in London was that the rest of the UK was still in recession.

Mr Sinclair’s view is that there is still a supply shortage of decent commercial space outside London, especially in tier 2 cities like Milton Keynes. There has apparently been a lack of new development since the financial crisis. Management believe that rental rates are still rising strongly in these areas.

Palace Capital’s modus operandi is to use Sinclair’s experience and network of contacts to acquire distressed, partially-let and off-market properties, where the sellers are keen to sell and Palace is able to get a good price.

Once a property is acquired, Palace will actively manage and — if necessary — redevelop or re-purpose a property in order to increase rental rates and add capital value. There’s a strong focus on capital growth, rather than just rental yield. This could be one reason why Palace isn’t a REIT — I didn’t manage to ask the directors about this.

Evidence so far suggests that Palace is executing well on this strategy. Net asset value has risen to £106.8m, based on  £63.5m of equity raised to date. Rental income rose from £7.5m to £11.8m last year. Net gearing is acceptable — if not especially low — at 40%.

Palace has started paying a progressive dividend, which is expected to rise to 18p per share this year. At current prices, this gives a forecast yield of 5.1%.

My view: Palace shares currently trade at a 14% discount to their last-reported book value of 414p per share. This discount, plus a 5% dividend yield, should be an attractive package.

My concern is that while Palace’s business model clearly works well in a bull market, it might be more vulnerable than some of its peers in the event of a downturn.

The group’s focus on buying distressed and partially-let properties means that both the weighted average unexpired lease term (WAULT) and weighted average debt maturity seem relatively low to me.

Palace’s WAULT at the end of March was 6.3 years, up from 4.5 years in 2015. To be fair, this does seem to be improving, as the group finds new tenants and renews existing leases. However, occupancy fell from 90% to 89% last year. Alongside this, the group’s average debt maturity is just 5.1 years.

By way of comparison, Town Centre Securitiesan obvious peer — has a weighted average debt maturity of 10 years, and occupancy of 98%.

If interest rates remain low and the commercial property market remains healthy, then Palace should be able to sign new, longer leases with its tenants. This should secure a higher and more robust level of rental income, and enable the firm to refinance with long-term loans.

However, if the market slows before that process is complete, then I think there’s a risk that Palace could be more heavily exposed than some of its peers to a slowdown. This could have a significant impact on the value of the firm’s equity.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Glass skyscraper building

ShareSoc Leeds growth company seminar 19 July 2016 review (TOWN, FISH, INS & IHC)

Glass skyscraper buildingDisclosure: I have no financial interest in any company mentioned.

As a North Yorkshire resident, I can’t generally justify travelling to London for investor events. So I was happy to receive an invite to the inaugural ShareSoc Growth company seminar in Leeds on Tuesday 19 July.

The Leeds seminar was apparently ShareSoc’s first Yorkshire event and featured presentations from four small-cap companies:

  • Town Centre Securities (TOWN)
  • Fishing Republic (FISH)
  • Instem (INS)
  • Inspiration Healthcare (IHC)

The evening followed a pleasant format, with a break half-way through and a buffet at the end, giving everyone a chance to speak to each other and to the execs from the presenting companies. Drinks and refreshments were available throughout and the organisation was excellent.

The location was a central Leeds hotel, just five minutes from the station and from a nearby multi-storey car park.

A similar event is planned in Altrincham in on 27 September and again in Leeds later this year, so if you’re interested in attending (it’s free), keep an eye on the Events page on the ShareSoc website.

Here’s a quick round-up of my notes from the event.

DISCLAIMER: Please note that these comments are based on my impressions from the seminar. They are not advice or buying recommendations. I haven’t looked closely at these companies’ finances but would certainly do so before considering investing. Please do your own research if you’re considering buying (or selling) these stocks.

Town Centre Securities

A small cap (£151m) REIT focusing owning and developing provincial retail property. Headquartered in Leeds, where 55% of its portfolio is located. Other major sites are in Manchester, Glasgow, Edinburgh and increasingly some of the outlying London towns, e.g. places like Watford.

Family owned, with the Ziff family controls a total of 61% of the shares, according to executive chairman Edward Ziff, who is the founder’s son. Listed since 1960 and has never cut its dividend — although the payout also hasn’t increased since 2011.

On the face of it, this looks a well-run company which has adapted to the decline of the small town high street by withdrawing from smaller towns and focusing on larger properties in key cities. The group is currently in the middle of its second successful foray into the parking business, although Ziff warned they might sell at an opportune moment, as they’ve done before.

One potential concern here is that gearing is high by REIT standards, with a loan-to-value ratio of almost 50%. This compares to c.35% for larger REITS such as British Land and SEGRO (disclosure: I own shares in SEGRO).

Ziff was unapologetic about this and says the group’s stable lease income has historically enabled the  firm to maintain high gearing without problems. He made the fair point that Town Centre Securities didn’t have to raise cash following the financial crisis, unlike a number of its peers.

A set of financial data for each company was provided by Stockopedia, which highlighted an interesting quirk. Stockopedia show’s the firm’s earnings per share falling dramatically in 2016. But this isn’t the case.

According to FD Duncan Syers, this is the result of accounting rules requiring the group to state earnings per share including a property valuation surplus. True earnings last year were 12.1p, inline with forecasts for the current year.

My view: Town Centre Securities currently trades at a 20% discount to NAV and offers a yield of about 3.7%. Earnings and dividend growth seems likely to remain slow, something Ziff blamed on the low interest rate environment. The shares look reasonably valued at the moment, but I might be tempted if they fell further.

Fishing Republic

Fishing Republic is a retail roll out that’s targeting the creation of a nationwide chain of large format (4,000 sq. ft+) fishing tackle shops.

The group floated on AIM in June 2015, and has opened or acquired four new stores since then, taking its total to 10. When questioned about expansion plans, CEO and founder Stephen Gross said that the group was comfortable with the rate of expansion it had managed since the IPO, from which I’d infer that four large stores a year is achievable, perhaps more.

Questioned about the size of the target market for acquisitions, Gross said that there were 2,300 tackle shops in the UK, of which about 100 are large enough to meet Fishing Republic’s requirement for a large format store.

Questions regarding the rate of stock turnover and working capital were raised in the context of Paul Scott’s comments on Stockopedia. FD Russell Holmes said that stock turn varies widely — some stock turns over very quickly, e.g. bait and consumables, while some is much slower. Overall he’d expect established stores to have a stock turnover rate of 3-6 months.

My view: I can see that a strong brand plus a large choice of stock in-store will help Fishing Republic build up a loyal client base. This will help to generate big ticket sales and gain market share. But it does seem to require the group to tie up a lot of money in stock. The company invested almost £1m in working capital last year, versus forecast sales for this year of £6.5m. Cash generation could be a concern here.

If historic operating margins of 10%+ can be maintained, along with decent like-for-like growth on top of acquisitions, then this model could work. The group recently raised £3.75m in a placing from a group of investors including former Tesco boss Sir Terry Leahy (disclosure: I own shares of Tesco). This year’s interim results should provide a more accurate view of progress.


Instem provides software and related services which helps life sciences and pharmaceutical companies manage and compile the data they need to test, develop and gain approval for new products. The company has an impressive roster of clients, including most of the big pharmaceuticals.

As you might imagine, developing and testing new drugs involves a lot of data. Because patent protection starts from a relatively early point in the development process, there’s money to be made from speeding up this timeline. Doing so extends the time during which the drugs can be sold with patent protection — i.e. at much higher prices. The impact of the ‘patent cliff’ seen over the last few years has brought this into sharp focus, both for investors and for the industry.

Instem’s goal is to make itself an indispensable service provider whose software helps speed up drug development. A 98% customer retention rate suggests that Instem’s products are quite sticky. Once years’ of test data are populated into a system, shifting to an alternative isn’t attractive.

Looking at the financials, Instem’s revenues have risen by 63% since 2010, but profits haven’t followed suit. The company says this has been due to investment in a more comprehensive global sales and support network.

My view: CEO Phil Reason says the firm’s expansion is now largely complete and that results should start to follow. Current broker forecasts are for earnings of 10.4p per share this year, putting the stock on a P/E of 22.

I can see that helping manage big data for pharmaceutical firms could be a big business. But I’d want to do more research to understand the size of the potential market and the position of Instem’s competitors.

I’d also take a closer look at the firm’s accounts — Instem is quite an old business and a quick look shows a £3.9m pension deficit that required a £427,000 cash payment last year. These are material figures versus a forecast 2016 net profit of £1.7m.

Inspiration Healthcare

Inspiration Healthcare arrived on AIM last year by reversing into medical equipment firm Inditherm. Thus all the historic financials available on Stockopedia and elsewhere for Inspiration Healthcare are misleading — they refer to Inditherm, not Inspiration.

Inspiration specialises in selling medical equipment for neonatal intensive care and operating theatre applications. It started as a distributor, but is moving progressively into selling its own equipment, which offers greater growth and profit potential.

The company was founded in 2003 by CEO Neil Campbell and sales director Toby Foster, who were at the presentation. They came across as expert and enthusiastic and clearly have a successful long-term partnership. There’s certainly a key person dependency here — if either were to leave the company, shareholders would be right to be worried, in my view.

The firm does a lot of business with the NHS — Campbell estimated that some of its core neonatal intensive care equipment has a penetration rate of 70-80% in UK hospitals.

Overseas growth — selling its own product range — is an opportunity that could deliver long-term gains. However, this may come at a measured pace, due to the time which can be required for regulatory approvals.

The UK’s leadership in medical training appears to be a key advantage in terms of overseas growth. Doctors from all over the world are trained here. They then do rotations in NHS hospitals, where they gain exposure to Inspiration’s equipment. On returning home they then act as advocates for its adoption in their own countries.

Inspiration stock is very tightly held by Campbell, Foster and the two other founding investors. Free float is just 20% and the spread is pretty painful. Campbell says they are aware of this problem and are working on a way to release stock into the market without (in their view) selling too cheap or spooking the market with an apparent founder exit.

My view: According to Campbell, the company has always been cash generative and remains so. Forecasts for this year and next put the stock on a P/E of about 17, which seems reasonable for a company with a track record of steady growth. As with Instem, I’d want to do more research to understand the competitive landscape and growth potential.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.


Stanley Gibbons’ latest update reveals boardroom purge and aggressive accounting

StampsDisclosure: I have no financial interest in any company mentioned.

Today’s update from troubled stamp deal Stanley Gibbons (see here for my previous coverage) has triggered a further slide in the firm’s shares.

As is traditional, the update started with the good news. Targeted annualised operating cost savings of £5 million have now been secured, and further savings may be possible.

I’m also pleased to see that the company is likely to abandon its  misguided attempt to build its own eBay-like online marketplace and focus simply on selling its own stock:

the Company is undertaking a full review of its E-Commerce strategy which will refocus resources upon selling its own proprietary assets of high class collectibles and world renowned publications.

More good news — in my view — is that chief executive Mike Hall and his CFO Donal Duff are to leave the business. Mike Hall was the architect of Stanley Gibbons’ debt fuelled and ultimately unsuccessful empire-building push. It turns out that Hall and Duff were also the brains behind some quite aggressive accounting.

In an exceptionally long and hard to read paragraph at the end of today’s update, the firm provides an initial update on its new auditors’ findings.

It seems that changes will be required to Stanley Gibbons’ accounting policy for its philatelic business. As a result, “historic reported revenue and profit will be materially reduced”. There will also be a reduction in net asset value.

Aggressive accounting threatens book value

One of the things that consistently puzzled me about Stanley Gibbons’ accounts was why the value of the group’s inventories rose so quickly:

  • 31 Dec 2012: £20.7m
  • 31 Dec 2013: £30.6m
  • 31 Dec 2014: £42.1m
  • 31 Dec 2015: £53.8m

The group’s regular assurances that inventories were held on the balance sheet at cost led me to assume that the firm was simply buying everything possible into a rising market. Stock was also added from acquisitions.

This explanation would have been bad enough. I was already expecting big impairments in the firm’s next set of accounts. However, today’s update makes it clear that the true explanation may be even worse.

The group’s investment plans have drawn a lot of money into the rare stamp business over the last few years. One of their attractions (and I use the term loosely) was a guaranteed buyback facility. Customers wanting instant cash at the end of their plan could sell the stamps back to Stanley Gibbons, usually at pre-defined discount their current catalogue price.

These stamps were then returned to Stanley Gibbons’ inventories — but how was the cost booked? Today’s update seems to imply that they returned to the inventory at their repurchase cost, not the cost at which they were originally purchased into the business (my emphasis):

The necessary accounting adjustments will also increase the carrying value of creditors at 31 March 2016 and require the carrying value of a related element of stock to be reduced from the price at which it was repurchased back to original cost.

Presumably Stanley Gibbons justified booking stamps at their repurchase cost on the basis that they had been repurchased from a third party. There are two problems with this logic, in my opinion:

  1. The stamp is effectively being valued based on a discounted retail catalogue price. Subsequently describing the inventory as being held at cost seems disingenuous to me.
  2. This valuation isn’t based on a market transaction, it’s based on the company’s own catalogue prices. Most stamp experts I’ve spoken in the past agree that these prices are at the upper end of what’s commercially achievable. Now that the market appears to be cooling, there’s a real risk that the book value of some stock will be above its current market value.

This historic accounting policy may help to explain why Stanley Gibbons’ operating margins and cash flow collapsed in 2014 and 2015. I imagine that company was spending a lot of cash on repurchasing stock at potentially inflated prices.

This news may also shed some light on why the company’s previous auditors resigned in Februray. The outgoing auditors considered “the risks and uncertainties associated with the audit to exceed the level that they are willing to accept.” I suspect what they really meant was that having previously signed off on Stanley Gibbons’ aggressive accounting, they were not the right people to unravel and correct it.

Is Stanley Gibbons still a sell?

I think we can be fairly confident that Stanley Gibbons’ last reported inventory value of £54.9m is going to materially impaired in the firm’s next set of accounts. But that’s already reflected in the price, to some extent.

What’s less clear is whether market conditions have continued to deteriorate. Today’s update didn’t contain any information on that front, but the firm’s last trading update (in February) wasn’t encouraging:

The Group has continued to experience lower revenues throughout the business, with sales of rare collectibles to high net worth clients being at a lower level than expected and trading being particularly difficult in the interiors division.

Today’s update makes it clear that the company is having a boardroom clear out. The CEO, CFO, former chairman and another NED are all leaving the business. New chairman Harry Wilson has become the executive chairman and will take a more active role in managing the turnaround, alongside the new Group Managing Director and CFO, Andrew Cook.

I believe that Stanley Gibbons’ stock, expertise and reputation in the philatelic sector remain valuable. I’m impressed by the speed, confidence and expertise with which Harry Wilson (who is a stamp collector) appears to be taking control of the business.

My view is that at some point soon, Stanley Gibbons could become an attractive turnaround investment.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

A falling knife.

Stanley Gibbons Group: coverage archive + updated outlook

A falling knife.Disclosure: I have no financial interest in any company mentioned.

One of the biggest investing disasters of the last year — among real businesses, not obvious joke stocks — has been stamp and collectibles dealer Stanley Gibbons Group (SGI.L).

The bad news came to a head on Monday when the firm announced a £13m placing and open offer at just 10p per share — a 50% discount to last Friday’s closing price.

Without wanting to blow my own trumpet, I’ve been consistently flagging up the risks with this stock since September 2014. The shares have fallen by 94% since then. I thought it might be worth gathering together a record of my coverage of the stock in order to show how the problems unfolded:

My record isn’t always this good. But the signs were there. Rising debt, poor cash flow, excessive spending on acquisitions and an accumulation of potentially overvalued stock.

I think it’s this last point that has persuaded investors to sit tight when they should have bailed out. Stanley Gibbons net tangible asset value has been a cornerstone of the value investing case for the stock.

The problem is that these tangible assets are stamps, autographs, rare coins and old furniture. In other words, objects with zero intrinsic value whose market value is highly subjective.

Stanley Gibbons is known in the trade for its high catalogue prices, which many other dealers consider excessive. I suspect the firm may have started to believe its own marketing. Rare stamps won’t climb in value for ever, just like stocks don’t. The rare stamp market crashed back in the 70s/80s. I suspect prices are falling again, as the China-led boom cools.

I’m not suggesting the firm’s inventories aren’t worth anything. Clearly they are, and the fact that they are booked at cost should provide some downside protection. But the firm recently commented that it is targeting:

a return to more disciplined buying and selling strategies which should help to improve the stock profile, restore the stock turnover to more normalised levels and thereby reduce the holding costs

To me this suggests that buying and selling have become undisciplined and that the firm may be burdened with stock it’s struggling to shift.

What next?

I’m pretty sure some value will emerge from the wreckage of Stanley Gibbons. If I did hold the shares, I’d probably take part in the open offer.

As I don’t own any, I intend to wait until the placing and open offer have completed and until Stanley Gibbons has published its next set of accounts. I’ll then take a fresh look at whether this could be a good turnaround buy.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

A falling knife.

Worldview takes control of Petroceltic debt: what next?

A falling knife.Disclosure: I own shares of Lonmin.

In Las Vegas, they say don’t bet against the house, because the house always wins.

On the AIM Casino, it’s the lenders against whom you shouldn’t bet. They always win.

Over the last year or so, we’ve seen this with African Minerals, Petropavlovsk, Afren and Lonmin.

It now looks very likely that oil and gas firm Petroceltic will be the next firm to join this club. Earlier today, the firm’s lenders sold 69.44% of Petroceltic’s debt to Sunny Hill Limited at “a significant discount to face value”.

Sunny Hill is a company that’s owned by Petroceltic’s largest shareholder, hedge fund Worldview Economic Recovery Fund. Worldview recently made a very generous 3p per share offer to Petroceltic shareholders, but this was slapped down.

Inexplicably, the shares continued to trade at 10p on the morning after this offer was made. As I warned at the time, this provided a golden and probably final opportunity for shareholders to retrieve some value from their shares.

That door has now closed — permanently, I suspect. The shares are currently suspended as a result of Sunny Hill’s petition to an Irish court to appoint an examiner to the firm. This is similar to adminstration (UK) or Chapter 11 protection (USA).

Today’s announcement from Sunny Hill suggests that Worldview will now arrange a debt for equity swap for the remaining 30.66% of Petroceltic’s debt it does not already own.

Remember, a firm’s lenders have a right to be made whole (if possible) before equity investors are entitled to anything at all.

Petroceltic’s banks have already taken a substantial loss on this debt — it was sold to Sunny Hill at a “significant discount”. In my view, there is no way that the banks will let existing shareholders walk away with any value unless they are willing to stump up significant fresh cash.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

A share tip circled in a newspaper share listing

Forget AO World’s mission to “redefine retailing” — it’s not the next Amazon and is grossly overvalued

Disclosure: I have no financial interest in any company mentioned in this article.

John Roberts, chief executive of online electrical retailer AO World declared today that the company is continuing to deliver on “our mission to redefine retailing”.

As far as I can tell, this simply involves undercutting the competition and making no profit. Mr Robert’s claim that by investing in marketing and undercutting the competition he will improve repeat business is nonsense, in my view.

Customers don’t show loyalty to a box shifter like AO, they just buy their next washing machine or fridge from wherever’s cheapest. If AO is always cheapest, it’s mostly because it appears to have abandoned all intent of making a reasonable profit.

Let’s look at some of the key numbers from today’s interim results:

  • Group revenue was up 21.7% to £264.3m
  • Group operating loss of £8.9m (versus £0.9m profit for HY2014)
  • Net funds down to £29.6m (HY2014: £43.9m)
  • Loss per share of 1.58p (HY2014: earnings per share of 0.12p)

The losses are of course blamed on expansion, specifically the investment in German growth and startup in new European territories, such as the Netherlands. So can we assume that AO’s UK operations are churning out free cash flow to fund this largesse? Sadly not:

AO World 2014H1 results summary (courtesy of

AO World 2014H1 results summary (courtesy of

Note that AO’s adjusted EBITDA margin — the most generous and flexible measure of profitability that exists — tumbled from 3.4% last year to just 2.0% during the first half of this year. As a result, AO’s adjusted operating profit for UK operations fell by 44.7% to just £3.1m on £248.6m of sales.

Interestingly, share-based payment charges only fell by 3.5%, from £1.3m to £1.2m. It’s good to know that 39% of the adjusted operating profits from AO’s only profitable division are being used to enrich senior management with stock options.

In a sense, though, my problem isn’t with AO’s thin profit margins. This is a tough business. For comparison, Darty reported a group operating margin of 1.7% last year, making £14.2m of post-tax profit from £3,512m of sales.

The problem is that AO is sub-scale and massively overvalued. Darty is valued on a forecast P/E of around 19, falling to 15 in 2017.

AO, which has sales of just 14% those of Darty, is valued on a 2017 P/E of 103 and continually pushes back the date at which it expects to make a profit. Consensus forecasts for 2016 earnings per share have fallen from 4.2p 12 months ago to -0.29p today.

Darty is valued on a price-to-sales ratio of 0.22. That’s reasonable for a firm with such low margins.

Why then, is AO valued on a P/S of 1.44? AO’s market cap of £686m is actually bigger than Darty’s £520m market cap…

Still a sell

I would add that I’ve been a customer of AO World over the last year. When we replaced our kitchen we bought a number of our appliances from the firm, benefiting from some kind of discount code and cashback offer which made them much cheaper than anywhere else.

The service was good, although we did get a telephone call a few days later giving us a the hard sell on an extended warranty agreement. Needless to say I said no, as despite the headline appeal of a promised lifetime new-for-old replacement policy, the policy on offer was far too expensive to make sense.

I suspect this is where what little profit the firm makes comes from.

The shares are grossly overvalued and remain a sell, in my opinion.

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.


Stanley Gibbons Group: dreadful results, uncertain outlook

StampsDisclosure: I have no financial interest in the companies mentioned in this article.

Having been bearish on Stanley Gibbons for more than a year now, I thought I should comment on the firm’s latest interim results.

What a dreadful set of figures they were too.

Here are a few highlights:

  • Net debt up nearly 50% in six months, from £11.5m to £17.0m
  • Gross margin down from 57% in FY2014/15 to 48% during H1
  • Stamp sales down 40% to £9.1m
  • Trading profit margin on stamp sales down from 28% last year to just 4%
  • Interim dividend cancelled, final under review

The firm has now admitted that its relentless and costly focus on acquisitions has caused management to take its eye off the ball at the group’s core stamp division. Chairman Martin Bralsford has pledged to reverse this decline.

I agree that the acquisitions have been overly-ambitious and highlighted the risks of Stanley Gibbons multi-year acquisition spree here.

However, I’m not sure whether the firm’s decision to blame acquisition distractions is just a smokescreen for a slump in underlying demand for rare stamps. Is the China-led boom in rare stamp collecting running out of steam?

In fairness, the company says that this year’s auction calendar is weighted towards the second half of the year, so sales could/should improve.

As various commentators have pointed out, the shares now trade close to their net tangible asset value of 90p. In theory, this should provide good downside protection. Stanley Gibbons should be able to generate some postitive cash flow to reduce debt by selling off some of its stock.

I do have a few concerns about the practicality of this approach, though:

  • High value sales to the firm’s top 10 high net worth clients fell by 58% during the first half, compared to the same period last year. It seems likely that this is linked to the downturn in emerging markets, principally China. By the firm’s own admission, Trading performance in philatelic dealing is largely influenced by high value sales made to key high net worth clients.“.
  • Debt has ballooned dramatically and is now 4.7 times 2014/15 operating profits. Net cash outflow during the first half was £5.5m. Net cash outflow from operations and capex was £17.6m last year. How long will the banks continue to fund this state of affairs before they demand some cash generation?
  • Stanley Gibbons has £55m of inventory at cost on its balance sheet, but if the firm needs to use this to generate cash quickly and the market is soft, then big markdowns on normal retail prices may be required. This will effectively erode the firm’s NTAV, as it won’t be able to replace the stock on a like-for-like basis.

We’ll know more when we get a trading update for the second half of the year, during which the firm’s auction calendar looks busier.

In my view, this is a finely-balanced situation with little visibility for shareholders. Things could go horribly wrong, to the extent that a rights issue or placing may be required.

Alternatively, Gibbons could stop blowing cash on acquisitions and generate some cash instead, by delivering bumper H2 trading with strong sales of rare stamps and coins. Coins and medals are sold through Gibbons’ Baldwins business and appear decently profitable at the moment.

As far as I can see, good and bad outcomes seem equally likely, at best. That is why I still wouldn’t want to be long here.

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.


Stanley Gibbons: 4 reasons why things could get worse

StampsDisclosure: I have no financial interest in the companies mentioned in this article.

I’ve been quite bearish on Stanley Gibbons over the last year.

In my view the firm has been exhibiting the characteristics of business riding an unsustainable bubble.

In this article I’ll explain why events so far seem to have vindicated my view and take issue with the more bullish stance taken by others, notably Tom Winnifrith and until quite recently, Investors Chronicle.

What I said

Back in September 2014, I took a look at the firm’s investment schemes and promotional offers, which I found unappealing and even slightly worrying.

I also explained why Stanley Gibbon’s role as a price setter (through its widely-used catalogues) means that it might be able to create price inflation to serve its own purposes, as long as it can find a ready supply of punters investment buyers and discerning collectors.

More recently, I took a dim view of the firm’s costly acquisitions and online investments in an article for Stockopedia.

What’s happened

Events so far suggest my view may have been correct to be cautious.

The firm’s shares have fallen by 65% so far this year, from 285p to just 96p. The latest trading update  — a profit warning, just 13 days after the previous trading update — has flagged up several of the problems I warned about previously.

1. New money drying up?

The number of high value sales appears to have fallen below expectations. The rare stamp market has been fuelled by new Chinese money over the last few years, but this supply of fresh capital may be slowing along with the Chinese economy.

Stanley Gibbons says that while it did manage to complete some high value sales during the first half, “sales achieved for the first six months were only at a similar level to the same period last year, despite the inclusion of sales from the Mallett acquisition completed in October 2014.”

High-end antique dealer Mallett is another firm that’s likely to have lumpy irregular sales, a costly inventory of illiquid stock and a dependence on new (overseas) money. So far, this £8.6m, debt-funded acquisition doesn’t seem to be paying for itself.

2 The illiquidity problem

For sellers seeking to achieve a top market price, like Stanley Gibbons, rare stamps are highly illiquid. The have no intrinsic value, generate no income, and have no meaningful utility.

In this week’s update, the firm says that “the weakness being experienced in our Asian operations and the continued illiquidity in high value stock items[my emphasis] are the main reasons it will miss full-year profit forecasts.

In my view this acknowledgement of the illiquidity of their stock is significant. The cost value of the group’s inventories rose by £11.6m to £53.8m last year. This is the asset backing to which Tom Winnifrith has referred frequently (most recently here, at about 9m30).

Much as I generally respect Tom’s views and analysis, in this case I must disagree. The value of these assets is highly subjective and subject to writedown if the market dips, in my opinion.

As Stanley Gibbons is currently demonstrating, it’s very hard to sell high-value rare stamps if the market dries up, unless you are willing to slash prices.

3. Margins under pressure

Stanley Gibbons shares are already trading at their net tangible asset value, but in my view this provides uncertain downside protection. Prices may have to be cut to get stock moving, and profit margins are already falling. In this week’s profit warning, Gibbons warned investors that:

“Gross margins and profits are expected to be substantially below those of the same period last year, which benefited from high margin sales of material sold from exceptional purchases of major collections.”

My reading of this is that Stanley Gibbons is having to pay closer to market rates for its stock than it has done previously. Thus the margin left for price cuts is much lower than it was. This is a classic feature of the top of a cycle.

I’ve worked a little in the antique and collectibles sector, albeit at a lower level than Stanley Gibbons. I’ve seen how the market value of an item can collapse, for no apparent reason. It’s just down to fashion, sentiment and availability of disposable income.

There is far less rhyme and reason to the valuation of such alternative investments than there is to shares, in my view.

4. Is the balance sheet safe?

At the end of March, Stanley Gibbons had no cash, net debt of £11.7m and a £5.8m pension deficit (all much worse than at the same time in 2014). On this basis, I’m not sure I can agree with Tom Winnifrith’s view that the firm has a “very solid balance sheet”.

In my view there could be further trouble ahead. At best I’d say it’s 50:50 as to whether trading will improve over the next 6-12 months.

I wouldn’t be long here.

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.