Category Archives: Investment

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

Ocado delivery van

How long before Ocado Group PLC investors get a reality check?

Ocado delivery van

An Ocado delivery van (source: Wikimedia / Waggers)

It’s only taken 15 years for Ocado Group PLC (LON:OCDO) to turn a profit, but the online grocer managed this feat last year, according to the firm’s full-year results, which were published this morning.

Although Ocado did manage to move into the black, it was hardly a banner performance.

Net profit of £7.2m was substantially below consensus forecasts for £12m. and the firm still reported negative cash flow, due to high capex and rising operational costs.

Does this mean that Ocado is now a buy? Hardly, in my view. The online grocer’s shares still seem overvalued on any measure you care to name, and the growth in its cost base last year is pretty shocking.

There are other risks, too: if you’d like to know more, I explained all of these issues in a new article for the Motley Fool this morning, which you can read here.

In the meantime, I remain short of Ocado and am comfortable holding that position in anticipation of a likely reality check later this year.

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

An open-cast coal mine

Is Fenner plc Now A Clear Buy?

An open-cast coal mineThe downturns in coal, iron ore and oil have not done many favours for Fenner plc (LON:FENR), which specialises in reinforced polymer technology, and makes products such as the large, heavy duty conveyor belts used in coal mines.

Fenner also makes a range of other polymer products, including hoses, belts, rollers, seals and medical device components. I’ve watched the firm’s share price fall by more than 50% over the last year and have become interested, because as far as I can see, all of Fenner’s products are consumables.

This is significant because while growth might be slowing among some of Fenner’s key customers, they aren’t shutting up shop: the kind of components made by Fenner need regular replacement in order for expensive plant to remain operational.

What’s more, as Fenner is keen to point out, its products are relatively low value, when compared to the kinds of operational and capital expenditure faced by large industrial and commodity firms. This should give Fenner two key advantages, in my view:

  • Customers will remain loyal as long as Fenner products maintain their market-leading qualities
  • Customers will not be especially price sensitive (within reason)

What about the numbers?

I’ve explained above why I believe Fenner could be an attractive business in which to own shares — the question now is whether the price is right.

Valuation

Let’s take a look at Fenner’s valuation:

  • PE10: 10
  • 2014 P/E: 9
  • 2015/16 forecast P/E: 10
  • 2015/16 forecast yield: 5.85%
  • Price/book ratio: 1.2

I’m a big fan of the PE10 (current price/10-year average earnings per share) as a tool for identifying stocks that are cheap based on historic average earnings, but that may currently be experiencing short-term problems.

In Fenner’s case, all three P/E measures are broadly equal, highlight the firm’s current out-of-favour status — but also its stability, in my view.

Quality and profitability

I’m satisfied that Fenner looks fairly cheap — the question now is whether it is cheap for a reason. The most likely reasons for this are a lack of growth prospects, and/or poor profit margins.

Growth is likely to be cyclical and also dependent on the firm continuing to innovate and offer products its customers need. That seems a reasonable assumption to me, given the firm’s 153-year track record, so what about profitability?

  • 5-year average operating margin: 10.0%
  • 2014 operating margin: 6.1%
  • 5-year average return on capital employed (ROCE): 12.7%
  • 2014 ROCE: 7.7%

It’s clear that Fenner’s profitability varies through the economic cycle. Fenner’s operating margin rose from a low of 3.4% in 2009 to a peak of 13% in 2012. In today’s market, I can live with the current 6.1% margin, given the potential for improvement as the effects of Fenner’s planned cost cutting take effect and/or the firm’s markets become more buoyant.

There’s also the question of debt. Fenner’s closing net debt last year was £117.3m, slightly lower than in 2013. That equates to net gearing of about 35%.

Interest payments were £14m last year, giving interest cover of 4.9 times net cash from operating activities, or more conventionally, 3.2 times operating profit. Both measures seem comfortable enough to me, especially as Fenner expects its cost-cutting  measures to reduce cash overheads by an annualised £9m over the next two years.

Fenner’s dividend may come under pressure, but earnings cover should be around 1.6 times this year, and a reduction in capex should mean that last year’s free cash flow cover can be maintained, protecting shareholders from a cut.

What’s the outlook?

I think Fenner’s performance over the next year or two is likely to be pretty subdued, but as I explained earlier, I don’t expect a wholesale collapse in sales or profits, due to the consumable and essential nature of the firm’s profits, and their wide and diverse installed base.

I’ve recently added some shares in Fenner to my portfolio, as over the next 3-5 years, I expect Fenner to deliver gradual earnings growth and benefit from a re-rating towards a P/E of around 12-13. Combined, these give me a tentative target price of between 250p and 300p.

In the meantime, I’m happy to collect Fenner’s 5.8% dividend yield and await further developments.

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

Clothes rail in shop

£28 might be a fair price for ASOS plc shares, but there’s no point paying this much

Clothes rail in shopInvestors tend to associate Ben Graham with value investing, but the master investor had an opinion on growth stocks too.

Usefully for us, Mr Graham developed a very effective simplified alternative to discounted cash flow valuations.

The Graham Formula, as it became known, provides an estimate of the intrinsic value of a growth stock over a 7-10 year period.

Here’s the formula. Note that it can easily be rearranged to calculate the growth rate, g, using the current share price:

Intrinsic value of stock = EPS * (8.5 + 2g) * 4.4 / Y

(EPS = last reported adjusted earnings per share, g = long-term forecast earnings growth rate, Y = yield on 20-year AAA-rated corporate bonds — see here)

How is this relevant to ASOS?

With this in mind, I was interested to come across an old article by Stockopedia founder Ed Croft which used the Graham Formula to value ASOS plc (LON:ASC), back in February 2012. At the time, the online clothing retailer’s shares were trading at around £18, which seemed expensive enough and implied a 7-10 year annualised eps growth rate of 27%. ASOS shares did of course quadruple in value from this point to last year’s £70 high, before crashing back down to trade at their current price of around £28.

Given the strong performance of ASOS stock, you might think that ASOS has been outperforming its implied 27% annual eps growth rate since 2012. Yet it hasn’t. After Ed’s article was published in February 2012, ASOS went on to report a 67% fall in earnings per share for 2012, before recovering somewhat in 2013 and 2014.

Over the three years from 2011 to 2014, ASOS delivered annualised earnings per share growth of just 5% per year! Of course, three years is much less than the 7-10 year timescale specified by Ben Graham, but a 27% annualised growth rate still seems a bit ambitious.

Whare are growth expectations today?

Given this, what does today’s ASOS share price imply about future growth, using the Ben Graham Formula?

I’ve crunched the numbers, and the current ASOS share price of 2,850p implies an annualised growth rate of 19% per year for the next 7-10 years. Is that reasonable? It’s certainly not impossible, if ASOS achieves its goal of becoming the Amazon of online fashion retail, but it’s a demanding goal.

ASOS’s recent results suggest that selling online is not more profitable than selling on the high street — ASOS’s operating margin of around 5% looks pretty dismal alongside the 20% margin generated by Next — and I think it’s fast becoming obvious that there is no secret sauce that makes online retailers better businesses than those who trade on the high street as well.

More to the point, today’s valuation of ASOS leaves no room for disappointment, and little room for ASOS to exceed expectations. Given that growth stocks typically only outperform the market when they exceed expectations (or when a bull market gets out of control), I don’t see any reason to buy ASOS at today’s price.

Mind you, that’s what Ed said back in 2012 — since when ASOS shares have gained another 60% or so… It just goes to show that while statistics and modelling can be a useful guide to market-wide returns, almost anything can happen to individual stocks — although personally, I am still pretty sure ASOS is overvalued.

Disclaimer: This article is provided for information only and is not intended as investment advice. The author has no interest in any company mentioned. Do your own research or seek qualified professional advice before making any investment decisions.

A share tip circled in a newspaper share listing

AO World PLC Flashes Sell As Early Backer Cuts Stake (updated 12/01/15)

A share tip circled in a newspaper share listingI have to admit that Norman Stoller isn’t a name that was familiar to me until today, when I saw that he had sold £10m worth of shares in online appliance retailer AO World PLC (LON:AO), back in December.

A quick Google made things clear: millionaire businessman Mr Stoller was one of three men who helped fund AO when it was originally founded, more than a decade ago.

Of course, after such a long time, it’s only natural that Mr Stoller might want to lock in some gains, but I’ve had AO on my list of shorting candidates for some time and have previously highlighted its crazy valuation.

Founder selling, in my view, is the final piece of the jigsaw needed to justify a short sale.

Let’s take a quick look at AO World’s financials:

  • 2014/15 forecast P/E: 216
  • 2015/16 forecast P/E: 69
  • Operating margin (TTM): 2.5% (adjusted) / 0.4% (reported)

Hardly a value buy — even if earnings per share double again in 2016/17, AO would still be trading on a P/E of around 35 at today’s 260p share price. Given that so much growth is already baked into AO’s share price, even the tiniest slip-up could result in a major fall, as we saw when Boohoo.com shares fell by 40% earlier this week, after Boohoo reported sales growth of 25%.

What concerns me most, however, is AO’s wafer-thin operating margin. This company clearly makes almost no profit on the goods it sells, and I don’t see any potential for this to improve — it doesn’t really have any way of differentiating itself from its competitors, except by competing on price.

There’s little doubt this is a viable business with reasonable scale, but the valuation makes no sense to me.

AO is due to publish a third-quarter interim statement on 22 January, so we shouldn’t have too long to wait to find out how the company fared in the Black Friday sales — and whether there will be any changes to full-year guidance.

Update 12 January 2015: AO has brought forward its planned update to big up its Christmas sales figures. Website sales rose by 38% during the final quarter of last year, while total revenue rose by 25%.

Interestingly, these are exactly the same as the equivalent figures in the firm’s interims, which cover the previous two quarters. AO has confirmed that it expects full-year results to be in-line with current expectations, which are:

  • Revenue: £500.7m
  • Post-tax profit: £5.5m
  • Earnings per share: 1.2p
  • (Taken from latest Stockopedia consensus figures 12 Jan ’15)

However, there’s no mention of profitability in today’s update, and in my view the valuation risks I highlighted in my original article above remain valid.

It’s worth noting that today’s gains have only pushed AO’s share price back to the level it was at before Mr Stoller’s £10m share sale was disclosed.

I remain short.

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.

A share tip circled in a newspaper share listing

A balanced view on Quindell PLC

Is it possible to take a balanced, non-partisan view on Quindell PLC (LON:QPP)?

I think I managed this difficult feat quite well, in a new article for the Motley Fool this morning, which takes a closer look at news that a significant institutional shareholder has increased its stake in the insurance outsourcing firm.

Decide for yourself here.

Disclaimer: This article is provided for information only and is not intended as investment advice. The author has no interest in any company mentioned. Do your own research or seek qualified professional advice before making any investment decisions.

 

Parcel wrapped in brown paper with fragile label

Is City Link asset buyer DX (Group) PLC an attractive investment?

Parcel wrapped in brown paper with fragile labelNews that AIM-listed DX (Group) PLC (LON:DX) has purchased some of City Link’s assets prompted me to take a closer look at this firm, whose liveried delivery lorries I’ve started to notice more and more in my local area.

DX isn’t a straight parcel service: the company specialises in providing high-value, time-sensitive mail and parcel delivery, as well as two-man services (presumably as a result of the firm’s acquisition of the business formerly known as Nightfreight in 2012).

The theme running through DX’s service proposition is added value: chief executive and industry veteran Petar Cvetkovic is determined not to engage in the kind of margin-slashing race to the bottom that led to City Link’s demise, and has given rise to the kind of working conditions and pay rates which Hermes drivers, for example, are subjected to.

What about the financials?

I’ve taken a look at DX’s current and forecast financials in a new article for the Motley Fool, so I won’t repeat myself here, except to emphasise my comments about DX’s balance sheet, which seems rather weak.

At the end of the firm’s last financial year, DX had negative tangible assets and a current ratio substantially less than one, which implies that it couldn’t satisfy all of its current commitments in a liquidation situation.

On the other hand, operating cash flow was impressive last year, suggesting the balance sheet weakness could be manageable.

To find out my conclusion on DX Group, read my Motley Fool article, here.

Disclaimer: This article is provided for information only and is not intended as investment advice. The author has no interest in any company mentioned. Do your own research or seek qualified professional advice before making any investment decisions.

Tesco Tiverton store

Every Lidl won’t help: Why Tesco PLC and its peers will recover

Tesco Tiverton store

“Tiverton, Tesco – geograph.org.uk – 85534” by Martin Bodman – From geograph.org.uk. Licensed under Creative Commons Attribution-Share Alike 2.0 via Wikimedia Commons – http://commons.wikimedia.org/wiki/File:Tiverton,_Tesco_-_geograph.org.uk_-_85534.jpg#mediaviewer/File:Tiverton,_Tesco_-_geograph.org.uk_-_85534.jpg

The apparent decline of the big supermarkets — Wm Morrison Supermarkets PLC (LON:MRW), Tesco PLC (LON:TSCO) and J Sainsbury plc (LON:SBRY) has resulted in the predictable surge of City analysts and journalists foretelling the demise of these big names.

Who will want to shop at the big stores, they argue, when you can save money at Lidl and Aldi?

The unprecendented level of television advertising this Christmas has also helped fan the flames.

Targeted directly at middle-class customers who used to think that Lidl was a dirty word, they promise cheap lobster, fine wines and a raft of other popular foods that are clearly aimed at the mid-upper end of the market.

Yet this is only half the picture. There are lots of reasons to believe that the rapid growth of Aldi and Lidl must slow soon.

Quite apart from the fact that trees don’t grow to the sky, there are other, more practical reasons why I am confident the big supermarket players will get their act together in 2015, and will put a stop to the meteoric sales growth reported by the discounters.

In a recent article for the Motley Fool, entitled 3 New Reasons To Buy Tesco PLC, J Sainsbury plc And WM Morrison Supermarkets PLC, I explain why I’m bullish on the big three supermarkets.

I won’t reveal those three reasons here, but i will leave you with a fourth reason: my wife visited Lidl to do some Christmas shopping this morning.

On her return, she reported that staff from local hotels and B&Bs were touring the aisles ahead of her, treating the place as if it was a cash and carry: picking up multiple crates of fruit and veg, almost the entire shelf stock of toilet paper, and so on.

Presumably this is because our local Lidl is currently cheaper than the local cash and carry — but the point is that anyone who has spent the last 10 years shopping at Tesco, Sainsbury, Morrisons or Waitrose, and has the money to do so today, will soon get sick of this sort of thing, as it meant that there were gaps in the shelves that clearly couldn’t be refilled until the next delivery arrived, much later in the day.

To read the Motley Fool article I mentioned above, which explains why I’m backing the big supermarkets, click here.

Disclaimer: This article is provided for information only and is not intended as investment advice. The author owns shares in Tesco and Wm Morrison Supermarkets. Do your own research or seek qualified professional advice before making any investment decisions.

Tesco Tiverton store

Tesco PLC: New profit warning suggests troubles run deep

Tesco Tiverton store

“Tiverton, Tesco – geograph.org.uk – 85534” by Martin Bodman – From geograph.org.uk. Licensed under Creative Commons Attribution-Share Alike 2.0 via Wikimedia Commons – http://commons.wikimedia.org/wiki/File:Tiverton,_Tesco_-_geograph.org.uk_-_85534.jpg#mediaviewer/File:Tiverton,_Tesco_-_geograph.org.uk_-_85534.jpg

Tesco PLC (LON:TSCO) shares tumbled more than 10% this morning, after the firm unleashed a major profit warning.

Tesco has cut full-year trading profit guidance for this year to a maximum of £1.4bn, around 30% below recent market expectations of £1.8bn – £2.2bn.

That’s a staggering 60% less than last year’s trading profit. Ouch.

Today’s update also suggested that considerable effort was being spent on restructuring the firm’s commercial relationships with suppliers, to avoid any risk of the profit overstatement seen earlier this year being repeated.

By implication, things were much worse — and more deep-rooted — than investors may have originally thought.

We won’t find out any more about Dave Lewis’ plans for turning around the Tesco business until January 8, but in a new article for the Motley Fool this morning, I’ve taken a closer look at today’s Tesco update — and considered what it might mean for shareholders, including a look at the dividend. outlook.

You can read the full article here.

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

Fifty pound note

Cloudbuy PLC chairman abandons EFH deal and admits voting rights are lost

Fifty pound noteThis morning saw another round of fallout in the Equity First Holdings (EFH) scandal, with Cloudbuy PLC (LON:CBUY) chairman Ronald Duncan deciding to abandon the planned second part of his “sale and repurchase” deal with the firm:

Ronald Duncan, Chairman, has notified the Company that he has agreed with Equities First Holdings LLC (“EFH”) that he will not proceed with the transfer of the second tranche of 2,250,000 ordinary shares of 1p each in the Company (“Further Transfer”) to EFH which was expected to take place by 11 December 2014.

Unsurprisingly, Cloudbuy shares have risen on news of Mr Duncan’s change of heart, and were up 5% shortly after the markets opened.

However, what’s more interesting is that Mr Duncan puts a different spin on the voting rights implications of the EFH deal than did his AIM counterpart, IGas chief executive Andrew Austin, yesterday.

Bizarrely, Mr Austin claimed that he remained interested in the voting rights of the 7.5m shares he had transferred to EFH, despite not owning them. Cloudbuy’s Mr Duncan, however, has taken a more logical approach and admitted that “the voting rights for the Transferred Shares are with EFH”.

However, Mr Duncan didn’t go so far as to admit that he no longer has any interest in the shares at all, claiming, as did Mr Austin, that he remains interested in the first tranche of 2,250,000 shares he transferred to EFH because of the repurchase obligation in his agreement with the firm.

As I explained yesterday, assuming all of these corporate leaders have signed similar agreements with EFH to those employed by Quindell’s Rob Terry and Laurence Moorse, the credibility of this repurchase obligation seems questionable: the only security for the deal is the shares which have already been transferred. What’s more, it seems the EFH agreements can be dissolved, without further recourse, by merely refusing to pay a margin call.

Of course, Mr Austin and Mr Duncan may have more robust repurchase obligations than those assigned to Mr Terry and Mr Moorse. We can’t be completely sure.

Disclosure: This article is provided for information only and is not intended as investment advice. The author has no interest in Cloudbuy or IGas Energy and a short position in Quindell. Do your own research or seek qualified professional advice before making any trading decisions.

A share tip circled in a newspaper share listing

How bright is the outlook for J Sainsbury plc?

A share tip circled in a newspaper share listingUnder the leadership of Justin King, J Sainsbury plc (LON:SBRY) built an enviable reputation for outperforming its peers, thanks to 36 consecutive quarters of like-for-like sales growth.

That era is now officially over, but I’m not sure the firm’s management really believe it.

Despite last week’s interims being dominated by a strategy shift involving a hefty dividend cut, a £600m+ property impairment and the admission that 1-in-4 of its stores are a little too large, Mike Coupe and his colleagues seem to believe that they won’t face the same level of competitive pressure as Tesco and Morrisons.

Chief executive Mike Coupe’s position seems to be that by continuing to aim upmarket, Sainsbury can get away with more targeted price cuts than its peers — i.e. it will remain slightly more expensive, as it is currently, in my view as a regular shopper at Sainsbury, Tesco.

I’ve other concerns too — but to find out more and decide for yourself, have a read of my latest Motley Fool article, in which I take a closer look at the issues above, and at some of Sainsbury’s latest financials.

You can read the full article here.

Disclosure: This article is provided for information only and is not intended as investment advice. The author owns shares in Tesco and Wm. Morrison Supermarkets. Do your own research or seek qualified professional advice before making any trading decisions.