Category Archives: Portfolio

Jackup rig

Why I’ve sold Lamprell plc

Jackup rig

Disclosure: Roland owns shares of Petrofac.

I’ve sold my entire holding of Lamprell for a net profit of 21.6%, and an annualised net profit of 14.6%.

In essence, my decision was made because the company appears to be moving from a deep value investment to a future growth story. There were two specific factors behind my decisions to sell.

Uncertain outlook

The oil market recovery is taking longer than expected. While Lamprell continues to generate cash as its receivables unwind, the outlook for revenue is poor for the next two years. Consensus forecasts show revenue of $407m (2017) and $459m (2018). No profit is expected during this time.

Thus the firm’s valuation is becoming heavily dependent on its cash pile and future growth. This leads me to point two.

Growth plans may erode value

News of the Saudi Aramco-backed Maritime Yard project joint venture in Saudi Arabia is potentially exciting for Lamprell in the long term. It appears to put the firm into a group of well-respected companies with preferential access to future work from Saudi Aramco, and potentially from other Middle Eastern groups. But it will require an investment of up to $140m by Lamprell and isn’t expected to be operational until 2019.

There’s some prospect of Lamprell taking JV work in its Dubai yards in the meantime, but given the state of the oil market I’m not sure how immediate or material this is.

In the meantime, Lamprell’s financial commitments to the Maritime Yard JV and the fixed costs of its existing facilities seem likely to eat up the group’s net cash of $275m (31 Dec 2016). Although this stock may well still be an attractive buy for long-term growth, that’s not what I signed up for. So I’ve sold.

Balancing the portfolio

The other reason I sold is that my relatively large position in Petrofac means I’ve ample exposure to the oil market and the Middle East, without Lamprell.

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.

Scales of justice

Why I’ve sold Murgitroyd Group plc

 

Disclosure: Roland does not own shares of Murgitroyd Group.

Murgitroyd Group plc (LON:MUR) was a recent addition to my value portfolio. It appears to be a cash generative and conservatively-run business, but a comment on Twitter from @maynardpaton has made me look again at this firm’s accounts and reconsider my view on the firm’s appeal:

For at least the last eight years, MUR has credited increasingly large and very material credits to operating profit as a result of exchange rate gains. These appear to relate to EUR and USD versus GBP.

You can find details of these credits in the footnotes to the firm’s annual reports. To gain a picture of what might be happening, I’ve collated the exchange rate gains versus operating profits since 2009. Something interesting appears to have happened to the firm’s margins:

Year 2009 2010 2011 2012 2013 2014 2015 2016
Revenue (£’000) 28904 29429 33218 35699 35969 38353 39819 42231
Operating profit (£’000) 3494 4008 4184 4538 4679 4133 4182 4294
Op. margin including FX benefit 12.1% 13.6% 12.6% 12.7% 13.0% 10.8% 10.5% 10.2%
Foreign exchange credit (£’000) 348 418 555 734 1237 1355 1656 2394
Operating profit ex. FX (£’000) 3146 3590 3629 3804 3442 2778 2526 1900
Op. margin excluding FX benefit 10.9% 12.2% 10.9% 10.7% 9.6% 7.2% 6.3% 4.5%

Source: Annual reports 2010, 2012, 2014 & 2016

It’s hard to understand* quite why the FX credits have increased so rapidly, but the underlying trend seems fairly alarming to me.

These figures seem to show that excluding favourable exchange rate movments, operating margin has fallen from 10.9% to 4.5% over the last eight years.

Is the mix of business changing?

I wonder if this decline relates to the rapid growth of the group’s US revenues and the stagnation of the UK business during this period?

  • 2009: UK revenue: £18.3m / US revenue: £3.9m
  • 2016: UK revenue: £16.7m / US revenue £18.8,

In 2009, US revenues represented 13.5% of the total. This figure has increased steadily and US revenue now accounts for 44.5% of all revenue, more than the UK (39.5%).

Oddly, the company doesn’t provide a segmental breakdown of operating profit, citing IFRS 8 and saying:

The Group does not manage its business by reference to separate geographical locations. Consequently, an analysis of net assets and operating profit by location is not monitored and is therefore not provided.

Really? Personally, I’m a bit surprised that a listed company with £40m+ of revenue doesn’t know how much profit it’s making it its two largest operating geographies.

I often feel sceptical about companies which refuse to breakdown profitability by segment. There’s sometimes a good reason why they don’t want to shout about this information.

Having missed this potential risk in my original review of the company, I’m not ashamed to change my mind and admit I may have been wrong. Although these FX gains may continue to support profits for years to come, they may not. I’m no longer sure that Murgitroyd is worth the risk, and have now sold my position.

*A somewhat opaque description of the group’s currency management policy is given:

Foreign currencies

Transactions in foreign currencies are recorded using the rate of exchange ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated using the rate of exchange ruling at the balance sheet date and the gains or losses on translation are included in the income statement. The assets and liabilities of overseas operations are translated at the rate of exchange ruling at the balance sheet date. The revenues and expenses of foreign operations are translated at an average rate for the period. Exchange differences arising from this translation of foreign operations are taken directly to reserves.

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

Sainsbury's CEO, Mike Coupe

Does J Sainsbury plc deserve such a big discount?

Sainsbury's CEO, Mike Coupe

Disclosure: Roland owns shares of J Sainsbury plc.

I’ve been reviewing the stocks in my portfolio recently, with a view to culling low conviction positions and focusing more heavily on stocks where I feel there’s significant value on offer.

As part of this, I reviewed my holding of the UK’s number two supermarket, J Sainsbury plc (LON:SBRY). The firm’s recent FY results seemed broadly as expected to me and didn’t highlight any serious concerns.

The group’s main value ratios still look attractive to me:

  • Trailing price/earnings = 14.5
  • Price/book ratio = 0.9
  • Trailing dividend yield = 3.65%
  • PE10 = 11.1
  • Price/sales ratio = 0.23

Why the big discount?

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

One possible explanation for this is different debt levels. But if we swap price for enterprise value, the result is the same. In fact, Sainsbury’s discount is even greater:

  • Sainsbury EV/sales = 0.27
  • Tesco EV/sales = 0.36
  • Morrison EV/sales = 0.43

The conventional explanation for this should be that Tesco and Morrison are significantly more profitable. Are they? Let’s compare each firm’s 2016/17 return on capital employed (ROCE):

  • Tesco = 2.6%
  • Sainsbury = 5.8%
  • Morrison = 7.3%

So Morrison is currently more profitable than Sainsbury, while Tesco is less so. Leaving Tesco’s valuation aside, this might go some way to explain why Sainsbury’s has a lower price to sales ratio than Morrison.

However, I would argue that the scale of Sainsbury’s price/sales discount is too large for this to be the only explanation.

A different angle

One of my favourite valuation measures is earnings yield, calculated as EBIT or operating profit divided by enterprise value. This provides a profitability-weighted measure of valuation. Here’s how the three supermarkets compare in terms of earnings yield:

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

On this measure, Sainsbury is significantly cheaper than both of its rivals. The only logical explanation for this seems to be that the market is expecting Sainsbury’s profits to stagnate or fall, while those of Morrison and Tesco are expected to rise.

I’m not sure I share this view. I’d have thought that competition in this sector is tough enough to make such diverging performance unlikely unless managers at one company display rank incompetence . The only big risk that springs to mind is that Sainsbury’s expansion into non-food via its Argos business will be a disaster that distracts management from the core food business.

Sceptics may yet be proved right, but the signs so far are that the Home Retail acquisition is working to improve sales intensity in Sainsbury’s stores, and thus improve their profitability.

What if the discount closed?

If Sainsbury traded on the same price/sales ratio as Morrison, then that would imply a market cap of £9.2bn. That’s about 50% higher than the current figure of £6.1bn. In this best-case scenario, the shares could be worth about 420p.

On the other hand, Morrison’s price/sales ratio might fall, closing the discount in a different way. Sainsbury’s share price could languish at current levels.

A third option is that that two stocks will meet in the middle.

I’ve no idea what combination of shifts will take place, but I believe the valuation discount between Sainsbury and Morrison is likely to narrow at some point. In the meantime, I’m continuing to hold.

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 and gas platform

Is Petrofac Limited now too cheap to ignore?

Offshore oil and gas platform

Disclosure: Roland owns shares of Petrofac.

I was attracted to (but not invested in) Petrofac Limited (LON:PFC) before the news of the Serious Fraud Office investigation broke and the share price collapsed.

Prior to the SFO news, I think it’s fair to say that outlook and valuation for Petrofac were reasonably attractive for value investors. The stock was trading on a forecast P/E of about 9, with a prospective yield of 6.3%.

Fast forward two weeks, and the shares now trade on a forecast P/E of 4.5, with a prospective yield of 12.8%. Notably, the stock trades on a multiple of about 4.4 times trailing free cash flow.

Measured against Petrofac’s profits over the last ten years, the current share price of 395p gives a PE10 of 6.1. That’s potentially very cheap, if the firm can continue to operate as it has done in recent years.

I note that various newspaper articles have suggested a potential fine of $800m in the event that Petrofac is convicted of alleged corruption offences. For more on this, see – The Times (paywall), The Telegraph and Financial Times (paywall).

I’m not going to attempt to expand on this, but I have bought Petrofac shares as they’ve fallen, with an average buy price of 513p.

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.

Game Digital

New stock: I’m unable to ignore value credentials at Game Digital plc (updated 07/07/2017)

Game Digital

Source: Game Digital

Disclosure: Roland owns shares of Game Digital and Next.

Update 07/07/2017: In my view, Game’s recent profit warning didn’t change the story much as I’ve set it out below. The prospects for next year still seem likely to improve and the firm’s amazingly short lease portfolio should give it an unusual level of flexibility and (hopefully) some protection for shareholders.

I don’t see this as a long-term buy, but I do believe it’s a special situation with the potential for some attractive upside.

Furthermore, with the shares trading at roughly half my purchase price, averaging down seemed more likely to improve my eventual result than to worsen it.

So I added more Game Digital shares to my portfolio at 23p.

—-

Today I’m reviewing my latest stock purchase, video game retailer and event organiser, Game Digital plc (LSE:GMD).

The abbreviated form of the post is once again an almost-direct transcription of my personal notes, in order to (hopefully) increase my posting rate to this blog.

The story

The physical retail of games may be subject to long-term decline in favour of online distribution, but the group’s business appears to remain viable at present. Game Digital is also taking steps to build its brand and convert its stores into destinations, by organising local gaming events and by becoming become a gaming conference event organiser.

In my view, there’s no immediate sign of demise. This retailer also has an unusually strong balance sheet with very limited liabilities. The valuation doesn’t seem to reflect this; hence my recent decision to add Game Digital to my value portfolio.

Value credentials

Game Digital appears to be priced for failure, or at least imminent decline. No value at all is being assigned to the group’s net cash, even though it remains profitable and is generating positive cash flow.

Here is a summary of the reasons why I’ve invested.

Net cash of £69m versus market cap of £73.5m: this implies that the market believes either that the current business is almost worthless, or that Game Digital’s net cash will be consumed by the business without generating any improvement in profit. I’m not sure either of these views is reasonable. Net cash has bounced around at these levels for the last few years. The business is profitable and doesn’t appear to be burning cash uncontrollably.

Net current asset value (current assets – total liabilities) = 37.8p per share versus a current share price of 43.5p per share — that looks cheap to me

Forecast dividend yield of 4.6%, comfortably backed by cash.

Forecast P/E of c.12 looks reasonable based on expected growth and doesn’t take into account net cash.

Market sentiment is poor, the stock is down by 55% over the last year, but broker forecasts have been fairly stable since January.

Asset light model: average UK lease 1.2 years, average lease in Spain is one year. Game Digital says that it has 240 “lease events” due in the next two years. The company appears to be capitalising on falling high street rents to drive hard bargain with landlords.

According to the recent interim results, 22 leases were renegotiated on improved terms during the first half of this year, realising over £0.5 million of annual rent savings. The firm says this represents a rent reduction of approximately 44% across these properties.

Game Digital’s unusual lease profile suggests to me that its store portfolio could be rapidly re-shaped or reduced if necessary, without excessive cash losses on unproductive stores.

In my view, falling high street rents and greater flexibility from landlords is likely to be a recurring theme among successful retailers over the next few years. It’s certainly something that’s helping Next, another of my value portfolio stocks.

Major shareholders: One final point is that the list of major shareholders contains some encouraging names (in my opinion):

  • Chief executive Martyn Gibbs has a 1.2% stake
  • Woodford Funds has 19%
  • Schroders has 5%

My feeling, having looked at the numbers, is that Game Digital is unreasonably cheap at the moment. Although this business isn’t without risk, the narrative in the recent interims seemed encouraging to me. The firm expects to benefit from the launch of the Nintendo Switch in H2 and Microsoft’s Project Scorpio in H1 of the 2017/18 year. Overall, the firm’s recent commentary suggests to me that Game Digital has the potential to adapt and evolve to remain relevant and profitable.

Time will tell. For now, I hold.

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.