Does the results herald a new era for Photo-Me?

Photo booth operator, Photo-Me saw revenue grew to £214m the biggest increase in over a decade. However, investors remain unimpressed, despite record net cash profits, as shares have stagnated for 18 months.

To understand shareholders’ scepticisms, we got to ignore this year results and review the period from 2003 to 2016. The years that saw sales for another two years, before its long and steady decline.

After that, we explore how this year results and how it will shape Photo-Me business strategies in the future.  

Before 2017, Photo-Me is operating as a Mature Business

Before today’s results and interim results, Photo-Me was a mature business. And there were several clues to the reason why.

Clue 1: No Revenue Growth; – If you compare 2003’s sales of £187m to 2016’s sales of £184m. Then, Photo-Me is maintaining their operations.

 

Clue 2: Fall in Capital Spending; – Capital expenditure varies year after year, but if you total 13 years of capital expenses and depreciation charges, you have these numbers: –

Capital Expenditure: £330m;

Depreciation: £373m.

This suggests it is maintaining their assets. Also, you could make the case it is at a slow pace decline.

To reconfirmed this assumption, look at Photo-Me non-current assets, there was a gradual decline from £97m to £87m in value suggesting no growth in the business.

 

Clue 3: Management focusing on cutting internal costs; – The graph below could suggest Photo-Me could be emulating WH Smiths, a business with falling sales, but rising profits. See below:

Photo Me revenue and profits

You see dipping revenue and rising profits meaning that management is focusing on cutting internal costs.

 

After today’s results, are we ready to suggest that Photo-Me is now a growth company? Or, is it because they reached a stage where without revenue growth their won’t be any growth in profits?

 

Give Photo-Me Some Props

(N.B.: Period covered is from 2003 to 2017, unless stated.)

Despite being a “semi” mature business, Photo-Me has made good progress. Here are some of these achievements: –

 

Photo-Me is paying dividends through increased earnings.

Here is the chart:

Photo Me EPS and DPS

 

 

Earnings per share have previously peaked in 2005 of 6.2 pence. Back then the share price average £1.10.

Now, the company trades on 9.3 pence with this year share price at £1.64. With regard to dividends, Photo-Me shareholders saw record payout on dividend per share of 8.7 pence, compared with the previous peak of 1.8 pence.

 

Photo-Me has managed to reduce its debt levels.

The change in Photo-Me total borrowings saw it fell from £44m to £10.7m.

On a net debt/cash level, it saw the biggest improvement when it turned from having the £33.4m net debt turn to £39m net cash, this was down from £62m net cash because of capital expenses and that huge dividends payment.

Like one of those hardcore analysts, I like to include receivables, payables and pension deficits for an accurate measure of net debt.  

That would see Photo-Me report an improvement from £33.9m in net debt to £41m in net cash. A slight impressive.

Having a net cash position is supportive of Photo-Me share price because it eliminates the needs of the company to raise financing (if required) to meet immediate liquidity needs.

 

However, the same hardcore analysts would ask: “Is there a reason Photo-Me is registering a net cash position?

The reason it is registering a net cash position comes down to several attributes.

Tighter Cash Cycle

One of them is tightening their cash cycle. A quicker cash cycle means the company credit policies are tightening, holding fewer inventories or delaying payments to suppliers.  

The Answer: –

When you see tightening cash cycle it means the company have more working capital and doesn’t need to borrow money to keep operations running smoothly.

The graph below depicts how the company working capital improves from £1m to £37m (down from £53m last year). The cash cycle was close to zero last year, but until we get the breakdown of payables and receivables, we can’t determine for this year.

 

Photo-Me Cash Cycle and Working Capital

Sometimes, management may want to hide payables by recording it as “other liabilities”, but it doesn’t appear to be the case as total liabilities fell from £93m to £67.7m.

Lower Capital Expenses

You can see lower capex leads to positive free cash flow in this chart.

Photo-Me FREE CASH FLOW and CAPEX

 

To make the chart meaningful, we need some data to back up this thesis. From 2005 to 2008, accumulated free cash flow amounts to a negative £21.6m. At the same time, average capex was £36m.

While this was going on, total borrowings rose from £30.7m to £76.4m.

 

Then the financial crisis forces Photo-Me to streamline their operations to keep their business competitive.

From 2009 onwards, it recorded positive free cash flow of £199m, that’s because average capex during this period was £20m, which led to total debt falling £76m to £10.7m.

 

With that extra money, where did it go? Well, some went to building the company cash reserves as cash balance grew from £19m to £47.5m. The rest went to paying higher dividends.

So, from 2005 to 2008, dividends payout average £7.1m per year. But from 2009 to 2017, dividends payout average £12.7m per year, despite not paying a dividend in 2009 and 2010.

 

Okay, we understand why debts got reduced as the business enjoy a growing cash balance, along with paying out higher dividends.

But, is all this sustainable?

Are we missing a piece in this jigsaw?

To answer these questions, you got to delve into the company’s assets.

 

Is Photo-Me Profiting at the Expenses of Assets?

We know over a 13-year period from 2003 to 2016, the total depreciation was higher than total capital expenses. However, we still need to ask: “Has Photo-Me under depreciate their assets, despite the company maturing?”

 

The answer is Yes and No.

The “YES” part comes from this chart: –

 Photo-Me depreciation rate

(P.S. Until the annual report comes out we won’t know the depreciation rate for 2017.)

A lower depreciation rate helps to boost earnings as Photo-Me report lower depreciation expenses. During 2008 and 2009, when it reported a net loss of £19m and £15m, respectively. The company’s depreciation charges were £39m and £36m in that period.

In 2015 and 2016, the photo booth operator reported £16m in each of these years, this is a fall of 57%. This is despite non-current assets falling by 36% from 2008.

That means Photo-Me could have under depreciate their assets by a total of £17m in the past two years alone!

You could say Photo-Me has overreported earnings by £8.5m for each of the last two years.

Another litmus test is to compare net cash profits with the net profit. From 2013 to 2016 (when depreciation rate was approximately 7%), net profit rose from £17m to £29m, a rise of 70.6%, whereas net cash profit rose from £38.9m to £40.4m, a rise of 3.9%!

 

Looking at it, you could say “so what?”, net cash profits were already high! So, no harm was done.   

 

Now, to the “NO” part.

When a company lower depreciation of assets, the net book value of these assets tends to be higher in proportion to the original costs of these assets. However, the opposite is true.

 Photo-Me cumulative depreciation ratio

(P.S. Until the annual report comes out we won’t know the depreciation rate for 2017.)

 

Photo-Me net book value is worth 25% of original costs, while in the period they were reporting higher depreciation charges, the net book value was 30% to 38% of original costs. It sounds bizarre, but on the other hand, does this mean the photo booth operator needs to invest more on capital expenditure because assets are getting older?

Funnily enough, the company is ramping up their expansion after so many years of stagnation.

 

Has this year results means a change in Photo-Me strategies?

In 2017, Photo-Me has reported sales of £214.6m (the consensus was £222.4m) with two analysts forecasting sales to jump to £241m by 2018. These sales increases were accompanied by a rise of capital expenses of £36.7m in 2017, a similar capex is expected next year because of its laundry expansion plans (now accounting for 10% of total sales). 

Looking back at Photo-Me previous years’ results, we know a rise in capex would lead to extra borrowings or a drawdown from existing funds.

 

Photo-Me Forecast

Currently, Photo-Me has a market capitalisation of £658m and a share price of £1.63 per share.

Earnings for 2017 came in at 9.3 pence, up from 9.2 pence consensus. By next year that is forecast to rise to 9.82 pence per share, according to two analysts giving it a forward adjusted P/E of 17.2 times.

The company earnings growth in 2018 is 9%, with a PEG of 1.8 times.

 

 

I won’t do a share price forecast until the annual report comes out.

 

Thoughts on Photo-Me

With the share price, close to record highs (though down quite a bit today), here are my thoughts: –

  1. Photo-Me decision to expand was the right one because revenue has gone down for years. Now it has a laundry unit that is growing fast.
  2. The decision to increase dividends payout was wrong because Photo-Me is expanding and should be deploying cash towards that objective. That £32m payout was equivalent to 5% market cap. and contributed to a £25m in cash outflow. But, expect that was a one-off event!!
  3. The laundry unit is looking to balance their photo booth unit as sales grow by 80% to £21m. They want to operate 6,000 units by 2020. Currently, it has 3,251 units.
  4. With higher future capital expense, expect Photo-Me to start borrowing more money or reduce dividends to realise these objectives.
  5. Other tell-tale signs of increasing borrowings are the fall in working capital from £53m to £37m, a five-year low.
  6. Expect higher depreciation charges in the future, similar to £30m-£35m. It is currently at £22.4m.

 

OVERALL

I would take the “Wait and See Approach” because valuation is at 18 times earnings. The expansion is at an initial stage, so we need to understand how it will affect the balance sheet in the medium-term. Another big reason is to expect a dividend cut in the future because it isn’t affordable unless they take on more debt.

 

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Thanks for Reading!!

 

Disclosure

The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.

Finally, the writer does not own the company’s stock, unless stated otherwise.

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