Disclosure: I own shares of Anglo American, BHP Billiton and BP.
My purchase of Fenner plc (LON:FENR) back in January 2015 was woefully mistimed. I was far, far too early to catch the bottom of the mining downturn.
I should probably have cut my losses and sold when this became clear to me, but instead, I did what I usually do in such circumstances — nothing.
As it turns out, this was a successful strategy.
I sold my shares in Fenner this week for a total return of 27% (including dividends, after costs).
That’s not outstanding in 22 months, but it’s far from a disaster.
If I’m honest, I’m not sure whether this year’s move back into profit is the result of good investing process or just dumb luck. (This is a topic that’s worth considering — Ben Hobson published an interesting article on this subject on Stockopedia recently).
But in this post, I’m going to focus on the three reasons why I’ve sold.
1. Uninspiring outlook
Fenner’s recent 2016 results were pretty solid. But the outlook statement was very measured, in my view. (All bold is my emphasis)
Coal: Operational gearing means that rocketing coal prices have provided an instant profit boost for miners. But Fenner is only expecting to see a gradual pickup in conveyor belt sales. It isn’t directly exposed to the upside from rising commodity prices. Here’s what the group said about the coal market:
This is a more positive situation which we believe will eventually lead to increased demand.
Oil & Gas: Fenner’s other big profit driver is the US onshore oil and gas market. The North American rig count has been rising slowly in recent months and yesterday’s OPEC production cut deal suggests this trend could continue. But Fenner believes a return to historical levels of profit may take some time:
The structural changes that have taken place in the industry will, we believe, act as a short-term constraint to growth but, in the longer term, will enable us to accelerate our market share gains and, over the next few years, return the business to the levels of profitability we enjoyed before the decline of the last 18 months.
Medical business: Promising, but several years will be needed to deliver meaningful growth:
Our medical businesses have created a technology platform incorporating some important patents which will provide significant new opportunities for growth, albeit the incubation period for such products is likely to be several years.
None of this is bad news. But Fenner’s valuation now looks reasonably demanding and there’s competition for cash in my portfolio. This outlook doesn’t seem a compelling reason to hold.
2. Would I buy now?
A good test of whether to hold onto an investment is to ask whether you’d buy it now. In Fenner’s case, the answer is no.
The shares trade on 23 times 2016/17 forecast earnings, falling to a P/E of 20 for 2017/18. Forecast eps growth of 13% next year doesn’t seem that exciting at this valuation. Dividend cuts mean that the yield on offer is less than 1.5%.
Fenner’s balance sheet also remains under some pressure, thanks to net debt of £150m. At the end of August, this resulted in a net debt to EBITDA ratio of 2.4x, up from 1.7x a year earlier. Although it’s still below the group’s covenanted limit of 3.5x, this is quite high, given current low profit margins.
Fenner’s net debt also looks high using my favoured measure of net debt to net profit. Even if we take a generous view and compare the group’s debt to 2017/18 forecast profits of £25m, Fenner’s borrowings still amount to six times its post-tax profits. I normally look for a maxmium of 4-5 times.
These factors would be likely to put me off buying at current levels.
3. Historically cheap, or not?
Another measure I favour is the classic value investing ratio, the PE10. That’s the ratio of the current share price to ten-year average earnings per share.
Following Fenner’s latest results, I recalculated its PE10. I calculated two versions — one using reported earnings per share (eps), and the other using the group’s adjusted figures. Here are the results, based on a share price of 254p:
- Reported eps PE10: 21.5
- Adjusted eps PE10: 12.3
As you can see, Fenner looks quite affordable based on historic adjusted earnings, but much less so using the group’s reported eps.
I’m often unsure whether to use reported or adjusted earnings when calculating a PE10. In an ideal world, there wouldn’t be much difference between them. In reality, there often is, as companies seek to massage out genuine exceptional costs — and sometimes to simply disguise indifferent results.
Interestingly, Fenner’s reported and adjusted figures used to be pretty close. It’s only in the last few years that they’ve really diverged. To some extent this is understandable, but I’m still wary about relying totally on such a rose-tinted view of the firm’s profits.
Although the Adjusted PE10 is still pretty low, I’m no longer convinced Fenner is truly cheap by historical standards.
I’m aware that I may have sold Fenner too soon. Earnings upgrade momentum is improving and future earnings could be better than expected.
On the other hand, I’m already heavily exposed to commodity prices through my holdings in BP, Anglo American and BHP Billiton. I wanted to free up some cash in the portfolio in order to be able to focus on new opportunities, as they arise.
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.