On Thursday 26th October, I will be covering Debenhams, Connect group and OPG Power Venture (was supposed to give a trading announcement).
Before that, here is a brief summary from other UK stocks:
1). CareTech Holdings (AIM: CTH), the provider of elderly care has said business has remained strong as bed numbers rose 248 this year. The acquisition of Selborne Care Limited has contributed to a third of new beds. Meanwhile, it stated net debt fell to £147m from £157m.
2). Inchcape (LSE: INCH), a car dealer said business is robust around the world except for the UK, where revenue manages to grow by 1.8%.
Share price: £0.46 (unchanged)
Debenhams has been suffering from their experience with being owned by private equity firms. And is now resurrecting from their heavy debt burdens.
Onto the results:
Today, Debenhams reported a 2.1% LFL growth with digital growing by 12.7%. Its beauty and food division grew by 5% and 8%, which was impressive. Their less desirable clothing line declined by 0.5%, a drag on results.
Reported profit before tax is down to £59m vs. £101.7m caused by £36m in exceptional costs. However, the Underlying profit before tax fell by £20m to £95.2m vs. £114.1m.
Surprisingly, their pension deficit is in a surplus of £80m, despite low interest rates. Add in further improvements of their net debt position to £257m from £273m, as well as lower net finance costs by 1.6% to £12.3m.
Net cash flow from operations fell to £173m from £214m, due to lower operating profits. It continues to invest in IT to grow digital sales.
Meanwhile, dividend remains unchanged.
Although Debenhams have been increasing sales, the rate of increase has slowed dramatically. The effect is starling when we assess the change in gross profit.
Growth in gross profit is largely negative and this is due to falling turnover growth.
Today’s result saw the company report 2% turnover growth, but gross profit fell by 4%, which caused underlying profits to fall.
The result is falling pre-tax profit.
Here’s something positive:
Debenhams was a victim of private equity firms, which load the firm up with debt (before PE took it over, it has debts of £100m) while they reap the profits. So, when it got re-floated back in 2005/06, Debenhams net borrowing ballooned to £1.8bn. It manages to reduce their debt levels to £279m (thanks in large part to raising £1bn from investors). It is also trying to maintain a dividend payment of £40m per annum.
Five brokers including Investec, Cantor, Peel, Canaccord and Numis have all projected falling EPS from 7.8 pence in 2016 to 5-6 pence by 2018/19. Normalised EPS fell to 6.4 pence in 2017. So, the projection is on track!
Also, they projected pre-tax profits to fall in the range of £80m-£100m from £125m.
Are the shares showing CRAZY undervaluation?
When PER is at 5 times and EV/EBIT is at 4.8 times, it’s hard not to see value at Debenhams. Especially when it continues to generate a decent level of profits and consistently reduces their debts. But the market seems to think the current department store set-up is old, however, Debenhams is playing catch up.
Brokers forecast of lower profits will mean PER and EV/EBIT will rise above current levels unless the share price tracks lower.
The fall in earnings is priced in. But with continuing uncertainty and a growing risk of their dividend getting cut. I see them as reasons to remain cautious. Debenhams has been around a long time and with the right strategy it could recover and deliver value for shareholders.
Right now, the share price is fairly value, at best.
Share Price: £1.01 (up 11%)
Another company struggling with change is newspaper distributor Connect Group.
Today’s results are somewhat of a mixed bag. Revenue has declined slightly to £1.6bn, down by £50m, due to the disposal of their education and care segment.
Profit before tax was down by £1m to £34.2m.
One positive takeaway is the increase in dividend per share to 9.8 pence, even though basic EPS is down to 11 pence. Taking the dividend yield over 10%, if you assume the share price of 94 pence.
The effects of this disposal spill over to their balance sheet as non-current assets fell from £227m to £158m. Along with a fall in inventories and trade receivables, total assets have decreased by £80m to £340m.
Also, there was a similar drop in total liabilities by £90m to £315m which leaves equity doubling to £25.1m.
The biggest improvement came from net debt falling to £82.1m, which took net debt/EBITDA ratio to 1.2 times vs. 1.7 times.
Net cash flow from operations declined slightly to £51.2m, which isn’t a big deal as Connect saw cash inflows from their investing activities of £39.5m. Net financing saw a larger cash outflow due to debt repayments.
The sale of their Education & Care for £64.4m gives it much needed net cash proceeds of £58.2m. Also, they made £19.0m in profit from this transaction.
In 2018, they plan to sell off their book division. This division distributes 20m books to bookstores, high street retailers, supermarkets, online retailers, public libraries and educational establishments, as well as selling direct to consumers.
How much will their book division sell for?
When they sold their Education and Care for £64.4m, that division had £64m in revenue and £7.8m in adjusted profits. At the time when sales were declining.
Connect Group’s book division is a lot bigger with revenue of £196m, but it has adjusted operating profit of £2.5m. However, this division is seeing growth in wholesale and wordery, but libraries have seen a big decline.
We could see a similar disposal proceed as their Education and Care unit. But if a buyer were to identify significant cost savings, then don’t be surprised if they sold it for £70m-£80m.
When they bought Tuffnells Parcel Express in 2014 for £113.4m. The deal was half finance via Rights issue and half debt. It touted a great synergy. But times are tough when the subsidiary is facing a challenging year with adjusted operating profit of £12.0m was down by 19.9% (FY16: £15.0m).
Since their demerger with WH Smiths, Connect Group saw revenue grew from £1bn to £1.9bn. Gross profit has managed to grow and able to maintain an 11% margin.
The problem lies in their administrative expenses which rose from £98m to £208m. That has restricted profit growth leading to stagnation with profits ranging between £30m and £45m.
Contrasting fortunes with WH Smith
Connect Group and WH Smith went in different paths in terms of fortune. Connect Group is currently on a PER of 5 times, while WH Smith has re-rated from PER of 10 to 20.
See the share price chart for both companies:
You can see that WH Smith his outperformed Connect Group by 900%.
Although the level of dividends paid from Connect Group saw a better than 50% increase this pales to WH Smith, which increase their dividends by 400% or more.
What are the key indicators driving Connect Group’s share price?
The share price of Connect Group has fallen from £2.40 to £0.94. So, what are the main drivers of this decline?
1). Its business model; – They operate in the distribution of physical things that are turning digital. And the market is of the view that it will go under in the near future.
2). Generous dividends; – Connect Group is compensating for the share price decline by paying out a 10% dividend yield. However, dividend coverage is barely above one, so expect dividends to get the chop in the future.
Despite the rise in dividend and future disposal of assets, I think Connect Group is in a slow and steady decline. It is fighting against the tide as things become increasing digitalises. The distribution of newspaper will soon become a thing of the past. I also get the feeling that it will hit a pivotal point when the older generation of physical newspaper readers get smaller and smaller.
Where’s the share price heading?
Funnily enough, I can easily see the shares rising by 20%-30% easily because the dividends will be maintained and further disposals are on the cards.
But, all this is a short-term solution.
Their main newspaper business will continue to be in terminal decline. Unless management is willing to change the nature of their business then the long-term future looks uncertain.
Share Price Forecast
Expect a 20%-30% share price gain in the next 6-12 months. I won’t be surprised if it pops by 50%. However, I am negative in their long-term prospects and wouldn’t recommend it as the business is riding against the tide!
OPG Power Venture
Share price: £0.287 (up 1.8%)
The company was supposed to give a trading statement. I guess this isn’t happening.
This Indian-based electricity generation company is in the right sector when it comes to the energy needs of ordinary Indian. Because India is Asia fastest growing economy and will show the greatest potential in the demand for energy.
Energy consumption growth potential confirmed:
India is one of the lowest energy consumption countries per capita. Since 2014-15 it saw each person consumed 1,010 Kilowatt-hour, compared to China’s 4,000 and developed nations averaging around 15,000.
As noted earlier, turnover has increased rapidly from £7.3m in 2009 to £205m by 2017. On top of that, it makes a decent amount of profits where pre-tax profit rose from £6m to £17.5m. Also, net cash from operations is generally positive, albeit the inconsistency. The market value placed on the shares is less than £100m!
Why is the market low balling OPG Power Venture?
First, the rise in net borrowing to fund its energy capacity appears unsustainable. That has risen from net cash of £11m to net debt of £310.6m, this growth is faster than sales.
Secondly, OPG debtors and creditors are still high.
The debtors to turnover column appear fine, but it isn’t. That’s because it’s a new business with volatility in their ratios. For example, in 2010, OPG has receivables of £34m vs. turnover of £11m. But since it grew turnover naturally becomes greater than debtors.
However, in the last five years, debtors to turnover saw no improvement as credit customers took close to 150 days to pay off OPG Power. This presents cash flow challenges
Another problem is OPG Power Venture suppliers want to get pay earlier (60 days earlier than OPG’s clients). And this causes a mismatch between debtors and creditors which have contributed to extra borrowings.
Third, the net interest costs have skyrocketed to £37.2m from £15m. That is an equivalent to 17% of turnover and has caused pre-tax profit to fall from £28.6m to £17.5m. The adverse effect is mitigated when it received a tax credit of £5.6m.
Fourth, it is an Indian company. The memory of cheap Chinese companies with buckets loads of cash on their balance sheet has tricked and robbed investors. So, anything that is foreign-related, especially from Asia gets frown upon.
Something Positive (unless its misleading):
Here is an illustration of how much OPG Venture have grown their energy capacity:
This has given the company some good profit margin and earnings yield:
As you can see earnings yield has shot up due to the collapse in their share price from £1 to 28 pence. Furthermore, it manages to maintain EBIT margin.
A Change in Direction?
Something strange is happening to OPG Power. They are slowly reducing their capital expenditure. Is this a new direction?
Here’s a chart showing this:
First, the company begins to pay their first dividend to shareholders, a sign that business is drastically slowing their expansion. Also, high-interest costs in financing mean it is time for them to repay their loans.
Market Valuation Uniqueness
The market is valuing this business close to four times PER and less than two times net cash flow. If you use their enterprise value, it is more realistic and values it at 15-20 times EV/EBIT.
The share price is low because of their high debts along with debtors and creditors mismatch. I view this share speculatively, but uniquely. What I mean is if OPG Power Venture manage to reduce debt by £30m to £40m each year. Then I can see the share price appreciate by 20% each year. The enterprise value remains the same for each year.
The above case scenario is if OPG maintains their business size for three to four years.
This would be a good recovery play, however, given the pessimistic view on Asian companies, I feel the bad rep. outweighs any opportunity.
Therefore, I won’t be recommending this share a buy, until some in-depth research is done on the company.
Sorry for the late post. Hope you find it simple to read and informative.
Please remember to subscribe and share this post.
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.