Category Archives: Investment

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

CCTV security camera

Will IndigoVision stay true to form and rebound?

CCTV security cameraDisclosure: I have no financial interest in any of the companies mentioned but intend to buy shares in IndigoVision within a few days of the publication date of this article.

Small cap IP video security specialist IndigoVision has a history of inconsistent performance, which appears to be due to the lumpy nature of its orders.

This is a fairly common problem with small caps, but means that the firm appears to veer between profit growth and profit warnings with some regularity.

While frustrating for long-term shareholders, this does appear to present an opportunity for value investors. Indigovision has a strong balance sheet and has historically generated attractive returns on capital.

Buying when the shares are cheap and waiting for earnings to recover could be a sound strategy.

Is now the time?

I mention this now because IndigoVision’s last update to the market was a profit warning. The shares have fallen by 35% so far in 2015 and by 52% over the last year. IndigoVision stock currently trades at a post-2011 low of 230p.

This leaves the shares trading on an attractive historic valuation, given last year’s strong results*. Here’s the usual extract from my investment spreadsheet, which I populate when reviewing a company with a view to adding to or selling from my value portfolio:

TTM P/E TTM P/FCF TTM yield PE10 P/B P/TB P/S Current Ratio Dividend cover FCF dividend cover Cash interest cover Net gearing
8.40 10.40 3.30% 15.2 0.9 0.91 0.35 2.4 3.5 1.8 1109 -10.20%

*IndigoVision reported results over 17 months in 2014, in order to move its accounting year-end to 31 December from 31 July previously. To get 12-month figures, I’ve crudely normalised last year’s earnings and free cash flow by multiplying the reported figures by 12/17.

In keeping with my increasingly quantitative approach to investing, I am placing a lot of emphasis on the historical numbers. After all, nothing fundamental has changed in the business, so there is no real reason to think that this level of earnings cannot be regained.

Historic growth and forecast earnings?

I don’t completely ignore the outlook for a stock or its past performance. Here’s how things stand at present (30/06/15) for IndigoVision:

Fwd P/E Fwd yield 5-yr average ROCE 10yr eps growth 10-yr divi growth
12.1 2.75% 13.80% 0.40% 6.20%

You can see that while long-term return on capital employed (ROCE) and dividend growth are strong, earnings per share growth is not. However, due to my (hopefully) well-timed entry at a low point in IndigoVision’s cycle, this may not be an issue.

What about the story?

I’m not a purely quantitative investor.

My investment spreadsheet also contains a section of note, where I provide note down the context and my moderately subjective interpretation of the figures above, plus my investment decision.

I ensure that I have a general idea of what a company does and any obvious problems or opportunities it faces. In IndigoVision’s case, I like that its revenues are widely distributed across a global customer base in many industries.

I also see the merit in its video over IP (Internet Protocol) approach, which (for non-techies) means that everything is digital and can be integrated with the firm’s powerful analytics and management software. InidigoVision’s products can operate over any standard data or mobile broadband network, making connecting up remote locations a doddle, I’d imagine.

However, I try not to predict the future in too much detail. This is a pastime for growth investors, in my view.

I prefer the traditional value investing approach of buying a proven good business at a low price, and then waiting for something good to happen.

It’s with this in mind that I plan to buy shares in Indigovision in the next day or two. When I do, I’ll add details of my holding to my value portfolio.

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.


3 reasons why it may be too late to invest in housebuilders

HousebuildersDisclosure: I have no financial interest in any of the companies mentioned.

The big housebuilders have proved to be a spectacular investment. Barratt Developments, for example, has risen by 500% in five years.

Even if you were late to the party and only invested one year ago, you would still be up by almost 75% at the time of writing.

Of course, housebuilders are cyclical businesses.

Bulls tell me that they remain reasonably priced, but I’m not convinced. I believe housebuilders are starting to look expensive.

Indeed, while housebuilders’ profits may continue to rise for a little longer yet, I reckon the warning signs of an advanced bull market are starting to appear.

1. Gazumping

If you live in the south east, you’re probably familiar with the reality of home buyers gazumping each other. It’s when a seller reneges on a previously agreed deal to accept a higher offer from another potential buyer.

What you might not realise is that this is starting to happen among developers and builders, too.

Last week, small cap housebuilder and developer Inland Homes announced a £19m land sale to “a major housebuilder”. The sale was for 205 residential plots, with planning permission, at the firm’s Drayton Garden Village project.

The interesting this about the sale was that in March, Inland reported being “very advanced in our negotiations with a substantial institutional investor in the Private Rented Sector” for the sale of the same plots.

According to Inland, these discussions were suspended as a result of “the significant offer received from the major housebuilder.” That sounds like large-scale gazumping, to me. The housebuilder was willing to outbid another major buyer to secure the land.

2. Affordability is plummeting

Affordability is now nearly as bad as it was at the peak of the last boom, in 2007/8.

The grim reality of this situation was brought home to me in a recent blog post on John Kingham’s excellent UK Value Investor website.

Like me, John very much relies on quantitative methods to determine whether an investment is cheap or expensive, rather than sentiment or subjective views on the future. John points out that according to the Halifax house price index, house prices are currently 5.1 times higher than the average earnings of home buyers.

That’s considerably above the long-term average (since 1983) of 4.1, and closing in on the 2007 all-time high of 5.8 times earnings. As John points out:

Since 1983, the UK housing market’s price to earnings ratio has been lower than it is today more than 87% of the time. The only time the ratio has been higher was during the absolute peak of the pre-financial crisis property boom.

The reality is that house prices have been supported by low interest rates and the outrageous and reckless use of taxpayers’ money (via Help to Buy, for example). Liquidity in the market has also fallen, as the ‘haves’ — existing homeowners — opt to stay put rather than sell for lower prices.

The final ingredient required to support prices has been the booming private rental market, which provided housing for the rapidly rising number of people who cannot afford to buy. This too has been supported by taxpayers’ money, in the form of housing benefit.

These trends won’t continue forever. At some point, house prices will weaken or stagnate. Otherwise, the housing market will shrink to include only an affluent minority of the population…

3. Land prices rising?

My third point is that people with decent land to sell are reporting strong growth in profits from land sales to major housebuilders.

Back in March, listed developer Henry Boot reported a 26% rise in operating profits from land development. That means buying land and developing it to the point of planning consent, before selling it onto major housebuilders.

Results like this suggest to me that housebuilders are buying more land and paying more for it.

A classic top?

In the UK at least, housebuilding is and will probably always be heavily cyclical. On the upward leg of the cycle, house prices rise, demand grows and housebuilders increase the number of houses they build. Share prices and dividends (a.k.a. cash returns) rise rapidly, as we’ve seen recently.

At some point, demand is satiated and/or prices start to become unaffordable, which dampens demand. Housebuilders are then left with more houses to sell than they really need. They are forced to cut prices to sell completed stock and — naturally — slow or pause their pipeline of new developments. Share prices and dividends fall rapidly, as we saw after 2008.

At the bottom of the cycle, housebuilders can be found trading for less than the book value of their land and completed houses. That’s the time to buy, in my view.

Current valuations of more than two times book value hold no appeal for me, however high their accompanying dividend yields might be. P/E valuations are largely meaningless, as housebuilders earnings are not sustainable or stable over a 5-10 year cycle.

I’m certain we are getting close to the top of the market, but that doesn’t mean we’re there.

It could be three months or three years. In fact, that range of time would be my best guess.

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.

Shoe shop

Is Shoe Zone PLC a supermarket alternative?

Shoe shopDisclosure: I own shares in Shoe Zone.

After disappointing investors with an early profit warning in April, less than a year after its listing, Shoe Zone PLC (LON:SHOE) appears to be back on track.

At sub-200p, the shares look more attractive than they did before April’s slide, too.

At least that’s the conclusion I came to after reading the firm’s recent interim results. Shoe Zone appears to be cheap, profitable and cash generative. Its balance sheet looks strong and the shares have an attractively high dividend yield.

These are attributes we used to associate with supermarkets, but no longer do.

Low prices, high margins

There’s no doubt that Shoe Zone’s shoes are cheap. This makes the firm’s gross margin of 60.5% all the more impressive. This suggests a firm grasp on manufacturing costs and an efficient supply chain.

Unlike some retailers, such as AO World, Shoe Zone’s profits are not eviscerated by administration and distribution costs. The firm’s trailing operating margin of 5.9% is pretty pleasing too — remember, this is a ‘pile them high, sell them cheap’ retailer.

Shoe Zone’s strong balance sheet helps ensure that this operating profitability is converted to post-tax profits and dividends. According to the firm’s latest accounts, net cash is £5.9m and debt is zero, although there is an employee benefit liability (pension, I assume) of £6.5m.

A current ratio of 2 is also impressive for a retailer, many of which maintain lower current ratios as they receive payment in cash for goods sold before they have to pay their suppliers. Negative working capital (current assets minus current liabilities) is quite common with big retailers such as supermarkets.

All of this leads to a forecast dividend of 9.45p per share for the current year. This gives a prospective yield of 5.0% and should be covered almost twice by earnings.

Stores vs. online

Shoe Zone’s store portfolio is constantly being refined to improve performance and Shoe Zone seems to have a firm grip on costs.

The company says that rents fell by an average of 28% after renewal over the last six months. Store fit-out costs seem likely to be low (take a look at a Shoe Zone store next time you pass one) and a shift towards larger format stores is helping to control wage costs.

As supermarkets and corner shop owners know all too well, larger store formats require fewer employees per unit of space/merchandise than small stores.

Things are going well online, too. Internet sales rose by 30% during the first half, through a combination of eBay, Amazon and own website sales. Customer returns are just 10.5% of sales, which is well below the average for online fashion retail.


Shoe Zone shares trade on a trailing P/E of 12.1 and a 2015 forecast P/E of 10.4. That doesn’t look expensive, given that the latest consensus forecasts suggest earnings per share should rise by around 12% in 2015 and 2016.

Shoe Zone’s modest valuation, cash-backed high yield and healthy profit margins are the key to its appeal, for me. Given current growth forecasts, I can see the potential for a double-digit total return over the next year or two.

As a result, I recently added some Shoe Zone stock to my value portfolio.

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

Should I add RPS Group Plc to my value portfolio?

Offshore oil or gas platformDisclosure: I have no financial interest in companies mentioned in this article.

I recently considered adding consultancy group RPS Group Plc (LON:RPS) to my value portfolio. This firm specialises in energy and infrastruture consultancy, with a particular emphasis on oil and gas.

I was attracted by RPS’s seemingly modest valuation of 10 times 2015 and 2016 profits, and its 4.2% yield. The firm’s strong presence in the Middle East, where cutbacks from the oil price collapse seem less severe than among the big oil majors, was also attractive.

However, when I delved deeper in the numbers, I was not convinced that RPS is a genuine value opportunity.

1. Focus on acquisitions

RPS’s stated strategy is to expand by acquiring smaller companies operating in the same, or complementary, sectors. The firm committed £58m to six acquisitions in 2014. That’s 11.5% of its reported fee income of £505m.

This strategy has generated rising revenue, but not rising profits, which have stagnated since at least 2009. Constant acquisitions have also left the firm with a backlog of deferred consideration, which stood at £26.7m at the end of 2014.

Deferred consideration is payment that will be paid for previous acquisitions, if they meet performance targets. RPS has £17.2m of deferred consideration potentially due for payment in 2015. That’s quite material for a firm which reported operating profits of £50.4m in 2014.

RPS reported a cash balance of £17m at the end of last year, suggesting that additional debt may need to be drawn down to meet these deferred consideration payments.

RPS’s acquisition-led growth strategy might be acceptable if it generated high returns, but I’m not sure that it does.

2. Costly acquisitions?

RPS has a five-year average return on capital employed (ROCE) of 10%, which doesn’t seem exceptional for a knowledge-based business. In contrast, the firm’s larger peer, WS Atkins, has a five-year average ROCE of 24.6%.

One possible reason for this could be that RPS is paying slightly too much for its acquisitions. This might result in large chunks of intangible assets bulking up its balance sheet, but generating sub-par returns.

RPS’s earning per share growth appears to support this theory. The firm’s 10-year average earnings per share growth is just 5.5% per year, using reported earnings. These include amortisation of acquired intangibles — in other words, the write down of goodwill paid for acquisitions.

Although RPS likes to emphasise its adjusted profit figure, which excludes these amortisation costs, these represent actual cash paid out for acquisitions. According to the 2014 income statement, Amortisation of acquired intangibles and transaction related costs”  was close to £20m in both 2013 and 2014.

That’s a big chunk of the firm’s profits each year. RPS’s operating profit was £51.4m in 2009, since when it has remained below this level, in part due to the costs described above.

Shareholders may want to ask if these constant acquisitions really adding enough earning power to the business to justify their cost.

3. Financial strength?


FInancially, RPS appears quite strong at first glance, with net gearing of just 19%. However, net debt doubled from £32m to £73m last year. Looking at the balance sheet, RPS’s current ratio of 1.5 is also decidedly average. I’d prefer to see this closer to 2.

Free cash flow isn’t amazing either. Excluding last year’s acquisitions, the firm’s dividend was barely covered by free cash flow, which of course was heavily negative when acquisitions were included. I’ve already mentioned the pressure on cash flow created by a constant stream of deferred consideration.

RPS may be a good company, but it doesn’t seem a particularly compelling investment at the moment, in my view.

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.

A share tip circled in a newspaper share listing

Did I sell Tullett Prebon Plc too soon?

A share tip circled in a newspaper share listingDisclosure: I have no financial interest in companies mentioned in this article.

In June 2014, I bought shares in interdealer broker Tullett Prebon Plc (LON:TLPR).

At the time, the firm’s stock was languishing well below 300p — I paid 282p for my shares. This put the stock on a forecast P/E of around 8, from memory, with a prospective yield of about 6%.

These seemed attractive value credentials, and a closer look at the firm did not reveal any major problems, other than somewhat languid performance. This appeared to be caused by two factors:

  • A lack of market volatility (which stimulates trading)
  • A technological shift away from voice broking and towards electronic trading in many of the firm’s markets

I was also encouraged by the acquisition of oil broker PVM, which was announced shortly before I made my purchase. All in all, it seemed like a good company suffering from poor sentiment, which was made worse by the impending departure of its charismatic CEO, Terry Smith.

That’s the buy, what about the sell?

Tullett shares now change hands for around 400p, having risen strongly over the last six months.

Earlier this week I decided to sell my holding, for a net gain of 42% in one year. The question is whether I sold too soon.

Tullett is still exhibiting strong momentum, and you could argue that it may have further to run. However, I’m a value investor, and my purchase was based on the firm’s shares being unwarrantedly cheap. That’s no longer the case.

While its current P/E of about 12 is hardly overpriced, the yield has dropped to 4.2%. Tullett no longer looks all that much cheaper than peer ICAP, when that firm’s superior operating margin (9.3% vs 6.8% for Tullett) and stronger forecast growth are taken into account.

It’s entirely possible that I sold my Tullett shares too soon — it’s a classic problem for value investors, who tend to buy too soon and sell too soon.

However, I’m happy to lock in a 42% gain in one year and perhaps leave something on the table for the next person. Tullett is only expected to deliver earnings per share growth of about 5% this year and in 2016, which doesn’t seem likely to prompt a further re-rating of the shares, in my view.

Taking a wider view, it seems inevitable to me that all but the most specialist voice broking services will gradually be replaced by electronic trading. There is a useful slide in the 2014 analysts’ presentation which illustrates how Tullett sees the market changing in this direction.

Although Tullett’s yield remains attractive, I’m running this portfolio to try and maximise total returns, with a bias towards capital gains. So I sold.

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.

Aircraft wing with jet engine

3 reasons why I’ve bought Flybe Group PLC

Aircraft wing with jet engineDisclosure: I own shares in Flybe Group.

Results update 10/06/15: Flybe published its final results for 2014 today. There was little to add to the April trading update, really: the recovery plan appears to be proceeding to plan. 

Flybe confirmed an underlying proft of £16m, putting the group on an underlying P/E of less than 8. Operating cash flow was strong, at £30m, and net cash remained flat, in part because of a net £22m release of restricted cash. Average revenue per seat and load factor both rose, which was encouraging.

Net asset value fell from £194m to £140m, erasing the shares’ discount to book value, but £22.5m of this was due to the reduction in restricted cash, which is largely good news. Of the remainder, there were moderate increases in deferred income, provisions and derivative liabilities, although not enough to cause me any serious concern.

In an article for the Motley Fool last week, I touched on the attractions of niche regional airline Flybe Group PLC (LON:FLYB) as a value investment.

It’s a stock I’d been considering buying for some time, but as often happens, the experience of writing about it helped me clarify my thoughts and provoke a decision.

Here’s how and why I decided to add some shares in this small-cap airline to my SIPP portfolio.

1. An attractive business with a problem

With a market cap of just £123m, Flybe is a relatively small, simple business. This makes the investment case easier to assess in this case, I believe.

The situation is that Flybe’s underlying operations are profitable, but it’s lumbered with a number of surplus Bombardier E195 jet aircraft it can’t use, which are costing it £26m per year in finance costs. Flybe started out with 14 of these aircraft and has now got the number down to seven.

Removing this huge pressure on the business would reveal a much more attractive picture, in my opinion, and be likely to prompt a re-rating of the share price.

The firm’s year-end trading update appears to supports this conclusion:

Results for the full year to March 31st 2015 are anticipated to be in line with market expectations, with Flybe on track to achieve around break-even at pre-tax profit level, before the £26m cost of the E195 jets and any impact of USD loan revaluation, but after the Finland JV write down of £10m and EU261 flight delay provision of £6m.

Stripping out all exceptional costs, this implies underlying pre-tax profits of £10m or even £16m, depending on how you view the EU261 provision. (This relates to the court ruling that airlines must pay compensation for delays even in “extraordinary circumstances” like strike action, when they previously refused to pay).

If we assume a middle ground of £13m, then Flybe is trading on around 9.5 times underlying net profits.

That fits quite closely with the 2016 consensus forecast for the firm, which suggests net profits of £19.1m. This assumes that the firm’s turnaround continues to deliver in the current year and implies a 2015/16 forecast P/E of just 6.4 (see Stockopedia/Reuters for forecasts)

An additional attraction is that Flybe currently trades at a 25% discount to its last reported tangible book value of 75p per share. However, it’s worth noting that the likely reason for this is that this discount will be eaten away by continued cash burn due to the cost of the surplus aircraft.

2. Cash, cash and cash

Of course, having a profitable underlying business is worth very little if you don’t have enough cash to sort out your problems.

Luckily, Flybe is well funded. The airline had net cash of £49.7m at the time of its last interim results, and total cash of £149m.

Importantly, this means Flybe should have the time it needs to dispose of its surplus aircraft without having to take on extra debt to meet the finance costs.

Flybe’s generous cash balance is the result of a fundraising in March 2014, which raised £155m at 110p per share.

Shareholders who bought in this placing and open offer are now sitting on a 50% loss, but I suspect all of those who are going to sell have already sold, so I don’t expect the shares to fall much further unless new problems appear.

We should find out more soon, as last year Flybe published its final result on 11 June (it has a 31 March year end).

3. Supportive macro picture

I don’t base my investment decisions on macro themes, but I think it’s naive to completely ignore the state of the real economy, a view shared by Neil Woodford.

Happily, times appear to be quite good for airlines at the moment.

Fuel costs are low and look likely to stay low for a while, allowing airlines to hedge in future years at attractive prices. The UK economy is showing some signs of growth, as are some key European economies.

I wouldn’t say we’re enjoying a genuine boom, but things could be worse.

While Flybe’s recovery has lagged behind that of larger peers like Ryanair and IAG, I believe the airline should still be able to capitalise on this benign trading environment.

Additionally, I believe Flybe enjoys some additional benefits, principally that some of its services are niche in nature and face less competition than the mainstream routes operated by budget airlines like easyJet and Ryanair, for example.

It all adds up to a value buy, in my view, hence my decision to add Flybe to my personal portfolio.

Let me know what you think in the comments below or @rolandhead on Twitter.

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.

Takeaway pizza

Will Just Eat’s latest acquisition be a dodgy takeaway for shareholders?

Takeaway pizzaI’ve been bearish on Just Eat PLC (LON:JE) for some time now, but today’s acquisition suggests the firm’s management really have lost touch with reality, in my view.

The UK-based firm is planning to pay £445m for Menulog, a similar firm operating in the Australian and New Zealand markets. That’s a stunning 33 times last year’s Menulog revenues of £13.5m, and and even more bizaare 371 times Menulog’s 2014/15 EBITDA of £1.2m.

This deal will be financed through a proposed issue of new shares — and while Just Eat claims it will be eps accretive in the first year of ownership, I reckon shareholders need to consider how many years this acquisition will take to pay for itself.

Let’s look at the numbers

Given that Menulog has been building its takeaway business since 2008, it’s not clear to me what stage it’s reached in the growth cycle. However, if we generously assume it can extend the 96% year-on-year growth seen over the last quarter for the next four years, we see Menulog’s turnover rising to around £82m by 2019.

This would imply an EBITDA profit of around £7.3m, based on Menulog’s 2014 EBITDA margin of 8.9%.

In turn, this suggests that Just Eat may have paid around 60 times Menulog’s expected earnings in 2019!

Maybe I’m wrong

In fairness, it’s possible that Menulog’s sales will rise faster than this. Just Eat says that online penetration of the £1.6bn AUS/NZ takeaway delivery market is currently just 22%. I’d expect this to rise to between 40% and 60%, giving a potential market of, say, £800m.

Of this, a fat slice — perhaps 50% — will be taken by big brand firms, such as Dominos, which will never come onto the Just Eat/Menulog platform. That leaves a target market for Menulog of around £400m.

Menulog is unlikely to get this all to itself, given the lucrative nature of the business, but let’s be generous and say it might be able to build up to revenues of £200m, giving EBITDA profit of around £20m. However, even in this favourable case, Just Eat is planning to pay 22 times future EBITDA profits — which are likely to be at least five years away.

In my view, the £445m purchase price for Menulog just does not stack up, however you look at it.

To add insult to shareholders’ likely financial injury, this deal will be funded with new shares. It was no surprise to me to see Just Eat shares fall heavily after the news had sunk in on Friday. I suspect there could be further to fall.

The last word

For what it’s worth, I think Just Eat is a good business, but seriously overvalued. This premium valuation, combined with the current mania for consolidation in the online takeaway delivery market, seems to have led Just Eat’s management to massively overpay for Menulog.

I doubt this acquisition will pay for itself in the next decade, if ever.

I remain short of Just Eat.

Disclosure: This article is provided for information only and is not intended as investment advice. The author has a short position in Just Eat. Do your own research or seek qualified professional advice before making any trading decisions.

Takeaway pizza

3 reasons why Just Eat may have just peaked

Takeaway pizzaJohn Maynard Keynes famously said that “the market can remain irrational longer than you can stay solvent“.

It’s this risk — more than anything else — that makes shorting overvalued growth stocks such a hazardous occupation.

For this reason, I prefer to find additional reasons to enter into such short transactions, over and above excessive valuations.

My favourite measure is founder or director sales: this worked a treat with Ocado Group, and is also looking very promising with AO World, one of whose founder backers sold out late last year, and whose chairman Richard Rose sold 88% of his holding last week, as soon as the post-IPO lock-up allowed him to.

AO World and Ocado also suffer from another problem — they don’t really make any money. That’s not an issue for Just Eat (LON:JE), which is making plenty of cash — a fact that may explain why the placing of a 7.7% stake by four of the firm’s pre-flotation shareholders in December didn’t have a lasting impact on Just Eat’s share price.

However, despite this, I feel that Just Eat may be nearing peak valuation — or at least approaching a correction of some kind.

Yesterday’s blockbuster full-year results appeared to confirm my view: reading them before the market opened, I expected big gains when trading started, akin to those seen with ASOS last week (another overvalued stock with falling profit margins).

However, despite genuinely impressive results, Just Eat stock barely flickered higher yesterday, and has opened down by 5% today: have we just seen the top?

I think we may have done, for three reasons:

1. Consolidation and competition in the industry are becoming a real concern and could herald pressure on margins: Just Eat finance director Mike Wroe said yesterday that some of the recent merger and acquisition activity in the sector had been “pricier than we were willing to get involved with, so in that sense it has got more competitive”.

There’s also increasing competition pressure from peers such as Hungry House, and big brand takeaways, such as Domino, which runs a superb online service.

2. Yesterday, Just Eat announced a big beat on 2014 earnings, which were 4.2p per share, versus consensus forecasts for 3.1p per share. Orders rose by 52% last year, and sales were up 62%.Just Eat also issued a bullish forecast for 25% revenue growth in 2015, slightly ahead of consensus forecasts.

Yet the shares didn’t budge, and are down around 5% today. To me, this is a classic sign of a growth stock with a toppy valuation: investors are jaded and are no longer getting the ‘hit’ they need, despite strong results.

Just Eat shares now trade on 82 times 2014 earnings, and 63 times 2015 forecast earnings. To justify this high-octane valuation, post-tax earnings are expected to double in 2015, based on a 25% increase in revenue. That might be achievable if spending on acquisitions stops, but then where will the outsize growth rates come from?

3. Just Eat’s 12% operating margin appears to have been partly supported by an increase in commission charge for UK restaurants from 11% to 12%, which came into effect on January 1 2014. 

The firm says this accounted for the majority of the 10% increase in UK average revenue per order (ARPO) seen in 2014. To put this in context, ARPO rose by just 2.4% in 2013, when driven only by takeaway price inflation.

I’d suggest that without the increased commission charge, ARPO growth might have been lower in 2014 than 2013, given the widespread food price deflation being seen in the UK. To compound this, wage growth is also low, at the bottom end of the labour market, where most Just Eat customers presuambly operate.

I’m guessing that to compensate for this, Just Eat demanded a bigger slice of the cake (kebab?).

I’m not sure how sustainable this is: 12% seems a pretty hefty commission in a sector that’s quite price sensitive and must surely have fairly low margins (who’s seen a set of accounts for a takeaway/restaurant?).

Short Just Eat?

I’m not sure that Just Eat is a short just yet, although I am thinking about it. What I’m certain of, however, is that I wouldn’t want to be long of the stock at today’s price of 347p.

Update 24/03/2015: According to three RNS announcements today, three major shareholders have reduced their stake in Just Eat by a total of 4.8% since the firm’s results were published last week. The share price rose following the news, perhaps because a big overhang had been cleared? It seems bearish to me, however, that a number of major backers are choosing now to lock in some of their gains.

Disclosure: This article is provided for information only and is not intended as investment advice. The author has short positions in Ocado Group and AO World. Do your own research or seek qualified professional advice before making any trading decisions.

Scales of justice

Is Lancashire Holdings really cheap?

Scales of justiceFull disclosure: early in January 2015, I purchased shares in Lancashire Holdings Limited (LON:LRE).

At the time they were trading at around 550p and seemed very cheap. Two months plus a 20% gain later, I’m not so sure. To be honest, I’m not sure my reasons for the purchase — into a value portfolio — stack up all that well.

Obviously I’m not complaining — a 20% return in two months is not to be sneezed at — but I am thinking about selling.

I try to continuously evaluate my investments with an open mind, as I believe that from fixed viewpoints cometh many losses… In this article, I’ve tried to explain the thought processes that led me to buy, and now consider selling, Lancashire Holdings.

1. Cheap valuation?

Lancashire’s shares nose-dived at the end of November, after two founder non-executive directors left the board, just a few months after the firm’s founder, Richard Brindle, also left the firm.

Such departures are often a sign of bad news, but so far there hasn’t really been any, making the short spell the shares spent between 500p and 550p look like a good buying opportunity for income seekers.

That’s when I bought in, tempted by a 2014 forecast P/E of less than 8 and a near-10% dividend yield.

I was also reassured by the firm’s low valuation relative to its history of strong earnings: although specialist insurers like Lancashire inevitably have good and bad years, the firm’s 10-year average earnings of 73p per share gave a PE10 of 7.6 at my 552p purchase price, and of 9.1 at the current price of around 665p.

Lancashire’s other metrics also seemed impressive. Since 2009, the firm’s combined ratio has ranged between 45% and 70%, which seems outstandingly low compared to mainstream insurers, which generally seem to operate with a combined ratio above 90%. Return on equity was good, averaging 18.8% between 2009 and 2014.

Finally, shareholder returns were clearly a priority, so I was happy to buy in to what looked like a cheap and very profitable firm, even though it wasn’t trading below book value. (I’ve previously used book value successfully for insurers, buying into Aviva and Friends Life Group when they traded below book value — both subsequently enjoyed a strong re-rating).

2. Maybe it’s always this cheap?

So far, so good. But as Lancashire’s share price rapidly re-rated over the last two months, I started to wonder where this would lead — how would I judge when the shares were fully valued?

As the portfolio containing the shares is value only, not income, then holding for the dividends, regardless of valuation, wasn’t an option.

Here’s how Lancashire’s current 2015 forecast P/E compares to some of its peers:

  • Lancashire: 2015 P/E 10.7
  • Amlin: 2015 P/E 12.1
  • Hiscox: 2015 P/E 14.5
  • Catlin: 2015 P/E 12.3

On this basis, Lancashire still looks a little cheaper than average, although not by a huge margin.

However, another consideration is the historical norm: some companies always trade on low multiples, for various reasons.

A look back at the figures suggests Lancashire could be such a company. For this list, I’ve calculated an approximate trailing P/E for the shares using the share price in March after the listed year’s results would have been published (e.g. share price in March 2014 following publication of 2013 results):

  • 2010 P/E: 5.0
  • 2011 P/E: 9.7
  • 2012 P/E: 10.7
  • 2013 P/E: 9.5
  • 2014 P/E: 8.6

It’s very approximate, but this list suggests to me that today’s forecast P/E of 10.7 is about right. Lancashire has not tended to trade much above this, relative to actual earnings.

3. I don’t understand it

My last point above brings me onto the final reason I am considering selling my shares in Lancashire Holdings: it may be a great business (I believe it is), but I don’t really understand it very well.

Conditions are said to be soft in the specialist and reinsurance sectors at the moment, due to an influx of new capital seeking higher returns. Lancashire is showing discipline and maintaining solid profit margins, but it’s also benefited from a period of low claims. I don’t really understand how things will pan out, over the next year or two.

Ultimately, I don’t think Lancashire currently fits my criteria for a value investment: a company that is trading at a low valuation relative to its likely earning potential or book value, offering the opportunity for a re-rating.

Given this, I am probably going to sell mine over the next few day, although I believe Lancashire shares could make an excellent long-term income stock.

Disclosure: This article is provided for information only and is not intended as investment advice. At the time of publication, the author owned shares in Lancashire Holdings Limited and Aviva. Do your own research or seek qualified professional advice before making any trading decisions.

A falling knife.

AO World slumps as reality strikes: is there worse to come?

Should you catch a falling knife?Back in January, I highlighted AO World PLC (LON:AO) as a plausible short, based on the combination of a significant founder share sale, a ludricous post-IPO valuation, and borderline profitability.

At the time, I disclosed my short position, which remains in place.

The shares went on to rise above 300p, putting my short into the red for a while, but as with Ocado Group previously, I had faith in my judgement and have now been vindicated.

AO World shares fell by almost 50% when markets opened this morning, and are down by around 30% as I write.

In a new article for the Motley Fool, I explain why I believe the shares are still significantly overvalued, despite today’s decline. Leaving aside the fact that profit warnings often come in threes — a stock market truism that is, surprisingly often, true — the valuation still looks crazy, while AO’s outlook and profitability are uncertain, at best.

You can read the full article here.

Disclaimer: This article is provided for information only and is not intended as investment advice. The author has a short position in AO World. Do your own research or seek qualified professional advice before making any investment decisions.