Continuing with the manufacturing theme here, today I'm looking at an company ostensibly similar to Castings. Chamberlin (LON:CMH) is also in the business of castings and related machined products - credit has to go to them for making it easy to find relevant and interesting information about their business. I like it when companies cater to ignorant laymen like me, for instance by breaking down their revenue into end-markets; 30% passenger and commerical cars, 31% in construction, safety/security and hydraulics, and the rest in smaller markets like mining, power generation, oil & gas and so on. It gives me a quick and easy feel for the business, which appears to be more diversified than Castings with a wider spread of products and less stock in a few major customers.
While what they do is a little similar to Castings in a broad sense, how they do it evidently isn't, as we quickly get to the cusp of the differences between the two companies: Castings and, it should be noted, Tricorn (another manufacturing company) interested me because of their stability of returns. The recession was noticable from their reports and their performance, but they continued to turn out operating profits. Outside of the recession, both of those companies earned good returns. Chamberlin's strength is less evident. Over the '07-'11 period in its totality the company lost money, and returns even before that were hardly spectacular - they were throwing off something like 8 and a half percent on their operating assets, with leases capitalised.
In a hoo-rah for market efficiency, you might say that's why Chamberlin is significantly cheaper than Castings. This is true. A question surrounding the relative valuations of the two, then, hinges on whether you think Castings's returns will get worse, or Chamberlin's will get better. It's notable that Chamberlin's share price has come down from ~190p in October 2012 - about double the current price. At the risk of succumbing to a generous helping of hindsight bias (everything's obvious when it's already happened!), I think that price substantially overvalues the company as it stands.
Here's the problem - we're presented with a company which has, over the last 10 years, made £9.7m in operating profits. My adjusted, after-tax operating profit figure sits at £7.7m for that time period. Given the amount of assets employed in the company - operating assets have hovered around £15m over that time period - this is a poor return. Last year's performance, the first 'good' one in the last 6 years, simply pushes returns back into reasonable territory - about 10%. On top of that, there surely must be some sort of penalty for volatility - the fact that Chamberlin's profits are so difficult to decipher. Management, as one might expect, talk about most of the variation over the last few years as being down to economic conditions. That might well be true, but it's not what investors want to hear - it simply suggests a business with no real competitive advantage, one which is buffeted by market forces.
I'm simply not sure the promising first impressions are borne out by the figures. They say they operate in markets with high barriers to entry, protected by 'process know-how' - a sign that they should have some sort of intangible capital inside the business built up from years of operations, but we don't see any sign of that in the profits they've been making. Given the end-markets they're involved in, they're probably right in saying that macroeconomic conditions have been a big dampener on trade - but, given their history, I'm not really too comfortable with any sort of mean reversion narrative. Even getting back to an optimistic 10% that they (sometimes) earned pre-crisis wouldn't make the company particularly undervalued.
Realistically, the most interesting thing I've taken away from reading Chamberlin's reports for the last few years is how much I can be swayed by presentation. Consider even the investor relations pages; Castings first, and then Chamberlin. Bear in mind the latter is a company with a market cap of ~£8m, and the former is well over £100m. Open up a few annual reports if you want a better demonstration. Castings's presentation of information is no-frills and to the point. They list what they are required to by the regulatory bodies and very little else. Chamberlin's is far more engaging - there's more discussion of the business, more explanation, and the usual little anecdotes. I hope I maintain neutrality and an even head, but I wonder if there's a valuation difference for small-cap companies based on how free they are with the information they disclose and how far they go out of their way to help investors find information they want.
One final note - their pension deficit, of £3m, is extremely large relative to the size of the company. As I've mentioned a few times, this figure is volatile - and if we assume that times are unusual enough so as to exaggerate the level of deficit (by inflating the liability and by assets being undervalued - not given assumptions, I'd add) we have an non-operational factor that enormously impacts on the valuation.