Small Cap Value Report (13 Mar 2014) - MDM, FRP

13th Mar '14 by Paul Scott

24 comments 19530 reads

Good morning!

MDM Engineering (LON:MDM)

A takeover bid at 170p per share cash has been announced for this resources sector engineering group, based in Africa, but Listed on AIM. This share has cropped up on my Value screens a few times, and it has a notably strong Balance Sheet, as well as seeming to be weathering the downturn in capex in the sector pretty well.

It's questionable whether shareholders will be celebrating though, I'd be feeling a bit short-changed if I held these shares. The 170p offer is only a 15% premium to last night's closing price, which looks like an opportunistic low-ball bid to me.

We are likely to see a lot more takeovers this year I reckon, as that's another sign of a bull market which has not really been much in evidence so far. We've got an IPO boom, and takeover booms usually go hand in hand with that.

IPO Frenzy

I may have to stop using this heading, as it seems to me that some of the froth is coming off the boiling IPO market perhaps? After the fiasco with Royal Mail, with people getting tiny entitlements, the same thing has happened with Pets At Home (PETS). It was massively over-subscribed, so people were scaled back to tiny allocations. I looked at the figures for PETS and thought it looked over-priced, even at the bottom end of the proposed pricing range. Organic growth was pedestrian, and it was being left with too much debt.

I have golden rule with IPOs. If the vendor is Private Equity, don't touch it with a bargepole - they will probably have squeezed out every penny, and will be selling it at a high valuation, with too much debt, which is exactly what KKR has done with this one. The PER seemed to be over 20, which given the high levels of debt, even after teh fresh cash raised, is too high.

The market was unimpressed, and instead of going to a premium, PETS ended its first day at a 3% discount to the 245p IPO price. That's not good. To maintain investor appetite, IPOs must be priced at a level where they go to an immediate premium, otherwise people will stop applying for the shares!

Poundland fared better,…

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RichardK

13th Mar '14

I hold MDM and am very disappointed with the 170p take over price. It is below the 12 month high of 175p and in my view significantly undervalues a good business. Can only hope that another bidder steps in a sit is current trading at 160/165,

I did an analysis of PETS and came to the same conclusions as you. Not an attractive buy.

Richard

bsharman

Hi Richard. Why did the board accept such a low ball offer? Value of the business is over £2 per share IMO. Do you know if we will receive the dividend payment due for July - there was nothing mentioned in the statement?!

SevenPillars

In terms of big company value hunting, retailers like Morrisons, Sainsbury and Tesco could be the bargains of the market right now, but is anyone prepared to sit through the agony of a relentlessly falling share price as market sentiment appears to hate them right now?

The Poundland IPO was well ramped and I do wonder how the market justifies the valuation it will give to companies like this and Ocado, yet talk down the major retailers, I suspect because of their "mature" status. This reminds me of the tech bubble days when "old economy" stocks went out of fashion, for new, sexy, tech stocks, valued at £billions in some cases with no earnings let alone profits.

Where I live there are 4 Poundland stores, each of which I occasionally visit. What I've noticed is that while there are plenty of bargains to be had, mainly because I suspect they use their buying power to buy a lot of end of line or closing down stock, they are also very expensive for many products compared to an equivalent product at say Tesco or ASDA. The main supermarkets sell thousands of products for less than a pound, which is difficult for a pound shop to do as their key selling point is the attraction of buying something for a pound, although they do sometimes have 2, 3 or 4 for a pound type offers. I suspect they hope that consumers will not notice that the product might retail for less than a pound at one of the big supermarkets

The BBC recently ran a series on the Pound Shop wars, and what came out from it was that the margins the like of PoundWorld operate on to get a profit seem to be horrendously small. Poundland are US backed so maybe their margins are better. They are well aware that the likes of Tesco and ASDA could take them on and increasingly are taking them on.

Despite its overvaluation I can see Poundland shares having the potential to go much higher if only because for the next few years the company has plans to double its number of stores. The market also seems to like these promises of sexy growth, while being bored of the £billions of profit that the likes of boring old Tesco or Sainsbury are making.

Then there is price inflation. Surely eventually in an inflationary money system pound shops will find it impossible to maintain their business model?

kenobi

I'm a bit skeptical about ipo's like so many other offers that as a private investor I get calls for. I recall being called for funding for half a dozen different films most recently a couple of years ago for henry VII but set in modern times. It was a dead cert, distribution rights had been sold, and a big return in the bag, with payments coming in for the next 20 years. If it's such a great deal, why aren't the studios financing it themselves ? they never call me when they need funding for a bond film do they ?

likewise what a surprise, the institutions tell poundland what level they'll buy at and it goes up from there. pets are us, they just sell to the suckers ! Why would anyone buy a pet retailer anyway ? what competitive advantage has this shop got ? If it's coming from private equity, they will have loaded it with debt, and be selling at a premium. The best ipos are the ones you can't get into or are from the government, like royal mail or direct line. will be interesting to see how they flog off lloyds, but I guess it will be like privatisations in the 80's where there are staged payments and a discount to the current share price.

K

Paul, any chance you could highlight some ipo's that are potentially interesting coming up which might be open to investors ?

cheers K

Leggett

The recent Koovs.com IPO looks potentially interesting (admission document here; corporate site here). Koovs is aiming to be the ASOS for India. It has an impressive array of heavy-hitters on its board, including the ex-chair of ASOS and the former FD of French Connection. Dame Gail Rebuck, ex-CEO of Random House is also among the non-execs.

I own all three large supermarkets - at around the price they are today (except Morrisons, which is 7% down) I agree that they could be the market bargains right now and i'm prepared to sit in for the medium to long term and wait for a recovery and earn the 5-6% dividend each year.

Hi Bsharman. It could be that MDM is not performing well as we thought, or has other skeletons that we are not aware of, or the board and management have done cushy employment or pay off deals for themselves. I have no idea about the July dividend, nor anything beyond what was in the statement. as a small shareholder the only practical course is to sell in the market, but the price is to low. We could complain to the board through the Chairman, but will almost certainly be ignored.

Richard

yes I'm in a similar postition though only with 2, they are only small positions though I bought a few more tesco today under 300, using exactly the same reasoning, however, what if what we are seeing is a change in the market ? what if the big 4 are increasingly having to compete with lidl and aldi ? what if food retailing is going to take a turn for the lower margin, and the divis and share prices of today are unsustainable ?

I'm not sure that's the case, I think people prefer to shop at the big 4 than lidl or aldi, but the price difference is big enough to entice people away. So the question is, what price difference are people willing to pay for more choice and a nicer shopping experience ? I don't believe there's a quality issue with most of the stuff in these stores, usually the quality is very good. It's not as nice to shop there, but I do find myself refusing to buy apple juice, canned tomatos eggs etc at our local morrisons and stocking up when we go to lidl, if the price difference were smaller I probably wouldn't bother, what difference would it make to morrisons bottom line to reduce these items though ?

K

At the moment, the way in which Aldi and Lidl are positioned, I don't believe that you can do a 'full' shop in either. Yes they have good offers for certain foods - such as the German cheeses and meats and a few years back I was able to buy a bottle of Prosecco for a fiver in Lidl, which my Italian friends raved about! There is a definite structural change in the market - and that market is incredibly competitive and the margins already quite slim. Tesco's are making their stores 'destination' shops - hence why they bought Giraffe. Waitrose is fantastic but expensive. Morrisons is likely to be taken private - there was talk a few weeks ago of private equity looking at ways to raise finance. Tesco is an international business and Sainsbury's could also be taken over.

I suppose there could be a question mark over whether the dividend will hold for Morrison? They've reduced their profit expectations going forward and intend to sell off some property it would seem to maintain the dividend until the turnaround comes. If it doesn't, they could get squeezed.

It could be a bargain, but I don't like the downtrend they have been in for some time. History suggests they could get cheaper. Morrison is now close to 200p down 12%+ on the day. Most of the figures seemed to have been expected, but I'm wondering if the market is now spooked at the move to a loss? Even if technically it's a one off, they've also downgraded future profit expectations as they re-structure to apparently take on Aldi and Lidl. It's likely to be a long haul back and I do wonder if the Morrison family will look to take it back into private ownership to get away from the market madness? If they announced a private equity deal next week I doubt it would be at 200p a share and you would then see a mad rush in market sentiment towards its real value.

As an aside, they also shot themselves in the foot slightly today by announcing a dividend of 9.20p and convenience store annualised sales at £400million. They've now changed this to 9.16p and £350million.

Statement.

The following amendments have been made to the 'Final Results' announcement released on 13th March 2014 at 07:00 under RNS No 2092C.

Put the dividend number to two decimal places in the Financial Summary and the Chairman's section to align with the financial statements (changed from 9.2p to 9.16p)

Clarified footnote 4 to be underlying profit before tax (previously underlying earnings)

Under section 'Accelerating our presence in new channels' subheading 'Convenience' the annualised sales from convenience figure now reads as around £350m (previously £400m)

Basic errors on a day when they needed to show some professionalism and be spot on. Makes them look like a bunch of amateurs.

I forgot to mention that Morrisons has property valued at £9 billion and an enterprise value of £8 billion. Perhaps they should unlock some of this value?

superrupededupe

So you can buy Tesco which is well-entrenched as the largest supermarket in the UK, is 2 years into a turnaround and makes approx. £2.5 b of profit per annum for approx. £25bn...
...or your can buy Ocado which has a website and a couple of distribution agreements and makes approx. £0 of profit per annum for approx. £3bn

Off-topic of small-caps but my opinion is that this is a highly irrational market we are seeing here.

toddwenning

Free cash flow cover of the grocers' dividends has been paltry or non-existent in recent years and real estate monetisation (sale and leasebacks, etc.) has bridged the gap while the companies have gone on spending binges. There's a limit to real estate monetisation, of course, and eventually the firms will need to generate authentic free cash flow from their operations to support current payouts.

marben100

Good point, Todd - will need to keep at close eye on that at J Sainsbury (LON:SBRY) . Must admit, they do seem to be investing a lot in new space with a fairly poor ROCE (around the 10% mark).

NS23

Gostevie.... totally off topic, but i clicked your link and ended up spending a fair bit of the afternoon skimming your story. Fascinating stuff and very commendable that you have the outcome of your DFD. I never really find anything of value at TMF but that forum looks fantastic for people in need.
Best wishes for your future and i hope you continue making knowledgable contributions here.

Nigel

I think these retailers probably need to be careful with how much they unlock and then what they do with the money. Morrison's did announce that they were going to unlock around a £billion over the next three years, reports suggest that this will go some way to maintain the dividend while profits come in lower during a re-structure. However, once they've sold an asset it is gone. Morrison's share price is depressed right now with a market cap value of around £4.8billion, so if they want to keep interest in any takeover or private equity buyout, I don't think they should go around selling off their assets when profits are falling and a major re-structuring is happening. They may have property valued at £9billion, but it might be better to keep it as bait for any predator.

doug2500

Hi Paul,

Firstly I really enjoy your commentary, thank you for doing it.

On fairpoint, although I agree with everything you've written, I feel it's only fair to point out that they believe they can maintain or grow revenues due to regulation that will drive industry consolidation, which will work in their favour being one of the bigger players.

They also think that the (inevitable) rise of interest rates will cause difficulties for some people, so there is potential for growth in revenues, although I grant you it's potential, not guaranteed.

It's enough for me to hold, for now anyway. It's a good yield, and not likely to get in trouble anytime soon, but I would sell on bad news.

Doug

floatUpstream

I've held MDM since July and am reasonably happy with this development. Undervalued but who knows where revenues are going, with the drop off in commodities (super cycle la la la).

davids_h

14th Mar '14

Re: Fairpoint

When a company says things such as this:

Opportunities to provide additional products and services are being pursued, including legal services, to ensure continuing momentum.

How can you have any comfort that they have a long-term business proposition?

1. IVA income is being squeezed. They don't make clear why, other than vague market conditions. I'm assuming this is simply due to more competition, perhaps from the free providers (who increasingly offer a very professional service). They may pick up more business when interest rates rise and mortgage holders act to protect their housing assets by containing unsustainable non-priority creditors, but I suspect the FCA will look closely at fee structures and levels if that happens.

2. Their DMP busines is growing via acquisition, not organic growth. This doesn't offer a great deal of future revenue visibility or certainty. I would also question why anyone would (or should) continue paying £350pa (£5.5mn/15k plans) to service the debts they can ill-afford to pay, when they can do it for nothing. At the lower end of the market Debt Relief Orders (DROs) have all but wiped out DMPs as the default money advice option.

3. They refer to growth in their 'claims management' business. I'm assuming that relates to PPI reclaims, as they appear to be cross-selling from their IVA clients. But is the PPI reclaim market a long term growth area? Surely it must be a steadily diminishing market. And if not PPIs, then what else is going to be re-claimed?

Even if I didn't object to what they actually do, I can't see the investment appeal other than perhaps the 5% yield. That payment looks currently well covered, assuming they don't have to use that free cash to bolster their revenue stream with lots of acquisitions.

Rgds

David

Small Cap Value Report (13 Mar 2014) - MDM, FRP

MDM Engineering (LON:MDM)

IPO Frenzy

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Paul Scott

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