Can Johnson Service Group maintain high earnings to keep high valuation?

Can Johnson Service Group maintain high earnings to keep high valuation?
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If you were the lucky few who bought Johnson Services near the bottom ten years ago, your gains would have registered more than 2,000%.

And today’s trading statement sounded positive with management forecasting results to be slightly ahead of expectations. Also, they acquired StarCounty Textile Services Limited for £3.9m.

The statement is to reassure investors and shareholders alike. With shareholders hoping to see the share price take another leap higher!


But at Walbrock, it’s all about the long-term outlook.


Cylindrical and Earnings

Back to the magnificent share price gains. These kinds of gain are likely to occur in cylindrical companies or growth businesses and less so with mature businesses with stable cash flow.


I classify Johnson Service as a cylindrical business. The problem with cylindrical is we can’t predict “peak” earnings and “stability” of earnings, compared with mature businesses.


The simple reasons for this unpredictability are:

-Acquisitions could buy the company earnings, but at what costs?

-The UK economy can grow for a longer period than expected.

And many more.


But Johnson Service Group valuation is near all-time highs, we can assess the company’s earnings and growth cycles.


Let’s take a look at the company.


Introducing Johnson Service Group


Founded in 1780, it is a laundry service firm. It owned the following brands:

-Johnsons Apparelmaster;

-Afonwen; – bought for £52.6m in 2016.

-London Line Group; – bought for £69m in 2015.


-Stalbridge Linen;

-Bourne Textile Services; – bought for £22m in 2014.



Is there share price upside by looking at future profit forecast?


Last year, it made record net profit of £20.6m. Given the cylindrical nature of Johnson Service Group, the trend in earnings are very important.


And brokers are forecasting net profit in:

2017: £24.6m, a 20% increase;

2018: £25m, a 1.6% increase;

2019: £26.3m, a 5.2% increase.


Johnson service group capital spending


With a market capitalisation of £520m, their current earnings give a multiple of 25 times PER.

So, using projected Brokers’ earnings forecast, then consider the following forward-PE:

2017:  21.1 times;

2018: 20.8 times;

2019: 19.8 times.


RULE: Slower earnings growth tends to have a lower PER multiple attach, which means a lower valuation. It is more likely to occur when the business is prone to being cylindrical.


Watch out for rising borrowing 

Another factor that would hamper share price from rising is the rise in borrowing without an equivalent rise in “Earnings before Interest and Tax.”

Why is that important?

Businesses borrow money to grow, and with growth comes higher profits.


With an enterprise value at £637m, consisting of market capitalisation of £520m, net borrowing of £99m (up from £28m in two years) and a pension deficit of £18m.

Using the EV/EBIT ratio, the current multiple is above 20 times. But looking ahead, brokers have pencilled in the following EBIT:


2017: £42.2m;

2018: £42.5m;

2019: £44m.


This leads to the following forward-EV/EBIT multiple:

2017: 15.1;

2018: 15;

2019: 14.5.


On a historical valuation, the average EV/EBIT multiple for Johnson Service is 8.22 times between 1998 and 2016.

But like PER multiple, the 2017’s EV/EBIT is down to 15 times from over 20 times in 2016. So, the current enterprise value is justified, but for how long?


About that Brokers’ forecast

Brokers’ forecast changes all the time when results get reported. You can see the changes by visiting financial websites with brokers’ forecast.

In the website, you can find Johnson Service’s share price forecast (by clicking on the link).

It shows how broker, Investec has upgraded Johnson Service’s share price as its fundamentals improved.


Has Johnson Service Group been here before?

If you have read the introduction section, you have noticed the acquisition value attached to the brands JSG owns.

This serves a purpose.

Here is that purpose:

 Johnson service group capital spending


The chart shows two patterns, the acquisitions and capex before the financial crisis and after.


The Acquisitions

So, between 2000 and 2007, the company acquired £237m worth of acquisitions and sold off £50m of assets giving net acquisitions of £187m.

And between 2008 and 2016, it made £160m in acquisitions and sold £101.2m in assets, giving net acquisitions of £59m.


The capex

Between 2000 and 2007, capex totals £282m, while selling off £91m of assets, giving net capex of £189m.

Between 2008 and 2016, capex totals £221.7m, while selling off £15m of assets, giving net capex of £206.7m.


Putting it together

Net capital investing since 2000 totals £664.4m and the depreciation of assets total £514.6m, leaving net growth capex of £150m (est.).


The extra capex only produce an incremental sales increase of £36.3m, so for every £1 of capital invested it produces 24 pence in sales.

On the basis of return on asset, the £8.4m increase of net profit and £150m in growth capex gives a return on asset of 5.6%.


Other Things of note

Here is a round-up of the other important stuff about Johnson Service Group:

1). It has goodwill of £115m, which turns equity of £147m to net tangible equity of £32m.

So, in a liquidation event, it has too little assets to meet their liabilities. And with a market cap. of £520m, shareholders will get wiped out.


2). Despite record-breaking cash flow of £72.6m in 2016, their capex spending of £50m didn’t include £58m on acquisitions bringing the total to £108m.

When there is a deficit of £35m in cash outflow, the company either reduce their cash balance or requires external financing. As I mentioned earlier, net borrowings did saw an increase of £70m in two years.




Final Assessment of Johnson Service Group


Since I don’t know what “slightly ahead of expectations” entails, therefore If brokers forecast is true, there are signs of overvaluation in the Johnson Service Group.

With future earnings growing less than 5% in 2018 and 2019, any rational investors won’t be placing a multiple of 20 times or more for the business.

The obvious conclusion is to “de-rate” Johnson Service to 13 to 15 times PER.

P.S. Normally, businesses with zero growth sees PER of 7 to 8.

And using forecast earnings, this means the market capitalisation could fall between these ranges:

2018: £325m to £375m;

2019: £342m to £395m;


That gives the future share price range on Johnson Service Group, as follows:

2018: 91p – £1.05;

2019: 96p – £1.11.

The current share price of £1.41 looks vulnerable.


Unless Johnson Service decides to continue acquiring businesses for profit growth, then expect their share price to decline steadily in the future.

And any disruption to trading operations would severely put the share price under pressure!

My advice would be to hold the shares for those long-term shareholders are to hold the shares for a month and then take some money off the table.


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Thank you for your patience!




The above analysis is based on my opinion and nobody else. It does not constitute professional investment advice. Data is correct on at the time of availability.  I don’t hold the company’s shares unless stated.