In a previous post I had a quick look at Dart Group PLC. An initial glance at the company suggested that a very defensive balance sheet that generated reasonable returns lay behind a very low valuation.
To be honest, I had forgotten to go back and do some in-depth research of the annual reports. There were three principal reasons as to my neglect:
(ii) The company generates much of its returns from its airline division. In the airline industry companies with returns such as Ryanair have been the exception rather than the rule. It has been a dreadful sector for investors.
(iii) I was wary of the momentum. The stock has not participated at all in the risk on/value rally of the past three to four months. It just drifts downwards in a reasonably well-behaved downtrend.
A recent post at Kelpie-Capital has put the stock back on my radar screen once again.
Who are Dart Group plc?
Dart Group PLC is an aviation services and distribution company. The Company is specialized in the operation of leisure aviation services throughout Europe, and the distribution of fresh produce and temperature-controlled and ambient products to supermarkets and wholesale markets throughout the United Kingdom. The Company operates in two segments: Aviation and Distribution. The Aviation division consists of its leisure airline, tour operation and associated commercial activities, trading under the Jet2.com and Jet2holidays brands. The Distribution business, Fowler Welch, is a logistics provider serving the United Kingdom retailers, importers and manufacturers. During the fiscal year ended March 31, 2011 (fiscal 2011), the Company operated over 800 passenger charter flights. Its subsidiaries include Fowler Welch-Coolchain Limited, Jet2.com Limited and Jet2holidays Limited.
Market Capitalisation: £85m
Share Price: 62p
Freefloat: c. 27%
Dart Group is interesting in that the equity has de-rated pretty significantly despite profitability and returns remaining in line with the long run average. It would seem as if this is a stock that has simply been forgotten by the market.
I was initially wary of the industries that the company operates in. Both airlines and distribution are extremely competitive with very low barriers to entry. Return on assets has remained reasonably stable over time, while the return on equity of almost 12% is decent given that the balance sheet has been de-leveraged and now runs with a net cash position.
The spike in returns in 2009, I fear was an aberration. In that year the item called ‘other direct operating costs’ fell to £28m from £46m in the prior year. The company reported this at the time as strong cost management. Results since then would suggest that it was a one-off gain rather than a structural improvement in the cost base of the company.
|Dart Group plc||2008||2009||2010||2011|
|EBITDA Margin – Distribution||5.2%||4.8%||6.9%||3.2%|
|EBITDA Margin – Aviation||12.1%||20.0%||14.2%||14.9%|
|EBIT Margin – Group||3.1%||9.2%||5.2%||5.0%|
The company maintains a decent return on equity and has grown its book value repeatedly.
|Dart Group PLC||2007||2008||2009||2010||2011||10yr Avg|
When I began to disaggregate the moving parts of the company, it struck me that much of the fall in returns has been down to a declining asset turnover ratio. Initially I assumed that this was down to the business becoming increasingly asset intensive. However it is not so simple.
|Dart Group PLC||2007||2008||2009||2010||2011||10yr Avg|
The real driver of lower returns has been the build up of cash on the balance sheet. At the recent interim results for the half-year ended September 2011, Dart Group plc reported a balance sheet that contained the following data:
Total Assets £423.1 m
Total Equity £263.8m
Net Cash £85.4.
I am a big fan of a prudent balance sheet, but it do shareholders really benefit from the hoarding of cash on the balance sheet? I readily concede that much of this cash build up is actually deferred revenue – in this respect this cash is not readily available for distribution to shareholders. It exists to pay future costs and generate future profitability.
This begs the question that if more of the revenue is being generated by forward booking of holidays by customers, then maybe there are consequences in terms of returns for that revenue visibility?
This business has evolved from being a low-priced airline carrier (Jet2.com) focusing on flying out of destinations in the North of England and Scotland to also having a direct package holiday sales business(http://www.jet2holidays.com/). As was pointed out in the post on Kelpie Capital, the company has benefited superior yield. management compared to much of the industry.
Our revenue and IT teams work closely together to deliver additional customer focused services including choice of seating, meals, onboard entertainment and car hire. Together, these yielded £25.39 in additional retail revenue per passenger during the last financial year (2010: £21.12).
Source: 2011 Annual Report
The company carried 98,000 customers on package holidays in the 2011 fiscal year. The goal is to double that this year. Dart Group is the owner of 30 airplanes and leases 8 others. During the 2011 year, the company carried 3.6 million passengers, with 5% of these being package holiday customers also. The company comes across as opportunistic and entrepreneurial. Eight of the planes are what are terms Quick Change planes. The interior of these planes can be re-configured quickly in order to fulfill first class mail delivery for the Royal Mail.
While I know very little about aviation, I am wondering, that while this is earning two revenue streams from the same asset, does this go some way to explaining why average depreciation is about half of capex in the cashflow statement. Much of the capex is related to airline maintenance.
Source: 2011 Annual Report
I would rather not be a cheerleader for a company and I must remind myself that both the airline and holiday industries are incredibly competitive with a litany of failed companies and sore shareholders. The interim report mentions that aviation division margins have declined due to cost growth exceeding revenue growth (particularly in relation to Jet Fuel prices).
It should be noted that the company has reported a contingent liability of $2.5m, as a result of being involved in litigation against two US companies (Sutra Inc and Noavk Niketc).
Fowler-Welch, the distribution business owned by Dart, is a leading UK ambient and chilled produce distribution company.
Source: 2011 Annual Report
This is a standard distribution business. The company explains that the profit decline during the year was principally due to the opening of a new distribution hub (Manchester) and the closure of the Felixstowe site. This has not reversed in the interim results (for half-year ended September 2011). Profit margins have continued to slide on the back of a weak container market.
Given that this business transports produce from manufacturers to retailers, it should not be surprising that conditions are weak given what we know about the state of UK retail. The company claims that the new Manchester hub opened last year is now operating at a break even rate.
Cashflow & Working Capital
I have chosen to analyse the cashflow statement using the % of sales methodology over a ten year time period. The recent strong cashflow generation would appear to be related to a combination of a large working capital inflow as well as a reduced level of capital expenditure. The spike in working capital is due in part I think to a relatively new strategy of pre-selling direct holidays to the client base. I am not banking on such a large working capital inflow every year.
|Cashflow as % of Sales||2007||2008||2009||2010||2011||10yr Avg|
|Group Operating Profit||5.3%||3.1%||9.2%||5.2%||5.0%||4.6%|
|Depreciation & Amortization||6.1%||7.1%||7.0%||7.6%||6.9%||7.0%|
|Share Based Payment||0.0%||0.0%||0.0%||0.1%||0.1%||0.0%|
|Chg in Work Cap||6.3%||1.5%||-1.0%||4.2%||10.3%||4.5%|
|Net Operating Cashflow||17.1%||8.8%||13.4%||16.8%||21.0%||15.1%|
The interim results paint a picture where profit margins are under pressure from cost increases as opposed to revenue declines. My worry would be that one has cost pressures in tandem with revenue declines. It does not appear that we are there (just yet).
|Graham & Dodd PE||7.8|
Implied Book Value
This, I believe is a reasonably conservative assessment of value given that I use a 10% discount rate with a zero growth perpetuity assumption.
The use of a DCF in valuation is a controversial one, in that the analyst can get any result you want (within reason) by simply playing around with the assumptions.
I am going to use the 10 year average figures.
|Revenue (12mth trailing)||648.2|
|FCF as % 0f Sales||1.50%|
|Cost of Equity||8%||10%||12%||14%||21%|
In plain english, using the assumptions that I have used, the current valuation is implying a 21% cost of equity. I think that this is excessive, unless the cashflow profile of the company in the future begins to deteriorate markedly.
The stock has been a dog for most of the past five years. As I mentioned in the opening, it is worrying that the stock did not really participate in the market rally of the past few months (especially as this rally has been particularly favourable for beaten up value stocks).
In terms of main indicators, Dart trades below its short and intermediate moving averages. The weekly MACD and RSI indicators are beginning to register some slight positive divergences.
The reality remains that Dart Group remains in a well-behaved downtrend of lower highs and lower lows. There is significant resistance about 10pence below the present price level. The line of least resistance is toward that level.
There is a lot to like about Dart Group as a value investor. The business is operated by an owner manager that has managed to sustain reasonably decent results through the past decade in what are highly competitive industries. There are few enough business that generate double-digit returns on equity on a strong balance sheet that trade at a significant discount to book value. This would appear to be one.
I believe that the valuation is highly supportive and unjustifiably low. In terms of momentum, the technical picture is pretty anemic to say the least and I have no idea what the catalyst for a re-rating will be. Perhaps valuation will be sufficient.
Investing is really about the numbers. Regardless of the attractiveness or otherwise of the business, a company has an ability to earn a decent return or it doesn’t. If it does, then over time the market will recognise this. I am beginning to think that Dart certainly fits that bill.
On the grounds that I find it extraordinarily challenging to find cash generative businesses that have double-digit RoE’s trading below book value with an undergeared balance sheet, there is enough here for me to invest in Dart Group plc. I will take a small position in the stock and evaluate before increasing that position to say 4-5% of my own fund.