Small Cap Value Report (27 May 2014) - RNO, PUB, ZZZ, ACSO

27th May '14 by Paul Scott

14 comments 18727 reads

Good morning! I trust everyone had an enjoyable long weekend, and are not suffering too much from adrenalin withdrawal symptoms with the market being closed for the extra day!

Renold (LON:RNO)

This is the industrial chains manufacturer which I always reject because of its weak Balance Sheet, which has too much debt, and a horrible pension fund deficit.

The company issues results for the year ended 31 Mar 2014 this morning. These show a good turnaround underway at the underlying operating profit level, which has risen 54% to £11.1m (but this strips out £11.8m of exceptional items, and £0.6m of admin costs for the pension fund).

Adjusted EPS rises from 1.4p to 3.2p, so a big increase, so at 55p per share that values these shares on a PER of 17.2. The 3.2p figure looks to be about 10% ahead of broker consensus, so it's a decent result. However, the valuation looks very rich to me. I could accept a PER of 17.2 if the company had net cash, and a rock solid Balance Sheet, but it's the opposite - there's a lot of debt (£24.8m), and a very big pension deficit (£64.9m before tax). Those are highly material to a company with a market cap of £123m, and together mean that these shares are looking significantly over-priced in my opinion. I certainly wouldn't pay anything approaching this valuation, given that there is no dividend, and in all likelihood the business will be directing perhaps about half of its profits over the next five years to reducing debt & plugging the pension fund deficit (£2.5m p.a. + RPI + admin costs).

I feel that investors generally are being far too sanguine about pension deficits at the moment. You can't just ignore them, they are cash outflows from the business, and hence the valuation must be adjusted downwards accordingly. I would only be interested in this this company at under half the current share price. The PER should be in single digits to reflect the debt & pension deficit, in my opinion.

Although it depends what the future earnings progression is like. It seems a mature business to me, so strong growth in turnover looks unlikely, therefore it's a question of what level of operating profit margin can they reach? Broker consensus is for further growth in EPS…

Unlock with Email

Unlock with Google

Already have an account?
Login here

Ramridge

27th May '14

Hi Paul. Re Renold. I agree with your analysis and would add that the adjusted EPS looks good only because it excludes the pension adjustments. Not convinced that they are a one off. Also revenues are down and the outlook for increasing sales can only be marginal in this mature market. I sold my holding this morning.
Regards, Ram

Start of the football world cup is just round the corner. Any views on the likely shares to come out winners by the end of the year? My nap is Domino Pizzas.

bsharman

I like the look of William Hill. Bookmakers tend to do well during a world cup year.

johnrosier

Hi Paul, Just looking at the plain numbers I can see where you are coming from with Renold. I do however feel that there is a good recovery going on at Renold under the new chief executive. Pension Fund deficits should not be ignored but at least we know the extent of the problem and the annual cost. The problem could get worse and it could get better- my money is on it getting better as I expect the last valuation will have been performed when bond yields were at rock bottom. There were costs last year with closing the Bredbury plant and other cost cutting measures which hit the balance sheet but underlying cash flow seems to be on an improving trend, something that makes the £2.5m annual pension cost less of a (relative) burden. I do believe that companies can grow out of these problems, admittedly given a fair wind.

This is a recovery story and investing in it requires some belief that it can eventually achieve its target of double digit operating margins which would push earnings towards 10p per share. It is a recovery story and I do share some of your reservations and appreciate the risks, hence it is the smallest holding in the JIC Portfolio at 1.9%.

LancashireLad

My concern on Renold is their ability to continue to drive forward on the international stage - given that most opportunities for this company lie outside the UK. There is highly competent competition from German, South Korean and US players and I wonder about Renold's longer-term competitive edge. Add the pension issues to the pot and it makes me wonder if my cash can be deployed more prudently elsewhere.

Re. Renold. They took a £7.7m foreign exchange currency hit, net of hedging. Not insignificant. The strength of the pound is a major factor for companies deriving a significant proportion of their revenues outside the UK.

DarwenLad

Completely agree with scepticism about RNO. It has a globally recognised brand name but it is operating in a mature low margin industry, and it is not the market leader. The new management team has talked up the recovery story, and backed up their confidence with sizeable share purchases - all very admirable.

But the group's balance sheet remains in a terrible shape. Leaving aside the huge pension deficit, the company's net worth fell from £31m to £18.1m in the latest year whilst its net debt rose from £22.8m to £24.8m.

If ever there was a company that needed a rights issue to repair its balance sheet it is RNO. Have always been surprised by the long-term loyalty of some of RNO's biggest institutional; shareholders, particularly M&G, which have stuck with this company as it struggled to survive.

Perhaps they will stump up for another rights issue (the last one was at 20p in 2009). But, like Paul, I would not be tempted to reinvest in this company until its shares drop below 30p.

intuitive6191

In fairness to Punch they have tried to dispose of Pubs - its just that they have a huge number which is difficult for the market to absorb.

I recall that in 2011 they tried to sell 2300 pubs to landlords on the basis that these pubs had no future for either the tenant or Punch under existing arrangements. I would guess that this was about 30 - 40% of the pubs they owned at the time.

The real problem is that the pub market is weak and the tenanted business model is flawed. Far too much financial baggage for Punch. Very interesting to see what happens when interest rates rise.

cig

"Very interesting to see what happens when interest rates rise."

Isn't almost all of their debt fixed interest? Is there anything to refinance at maturity? If their debt is essentially a repayment mortgage on the pubs they should be debt free by 2035 when the last issues mature and they shouldn't have an exposure to rates between now and then.

I think Renold is well placed internationally; It has 14 manufacturing sites around the world and 20 sales offices. In the year ending March 2014 North America accounted for 38% of sales, Europe ex UK, 28%, Australasia 12%, UK 9%, China 4%, India 3% and other 6%.

Only 558 of its 2739 employees are UK based.

It gives management a good platform to successfully implement the second stage of its three stage turn around; Phase II focuses on organic growth and market share gains by leveraging its market and brand leading positions and superior products.

I think there is a risk people are being too sceptical; yes its risky but recovery situations usually are and I think in this case new management have demonstrated sufficient progress so far.

Paul Scott

Hi John,

I think Renold (LON:RNO) have done well with their turnaround.
My only issue is the price - it's far too expensive, given the weak Bal Sheet.

I wouldn't pay more than a PER of about 6, given the extent of debt & pension deficit. That's the right sort of price in my view. Maybe push it up to 8 if more earnings recovery is coming. But a PER of 17 for a mature company with such weak finances, is pretty crazy in my book!

Regards, Paul.

iiimurray

28th May '14

Paul
General question - are you still recording shares in your value/GARP listing for further research? Last entry I have on spreadsheet was Creston in December.

Regards

Peter

Hi Peter,

Oh, I'd forgotten about that! LOL!

There's not much value around now, and I think people just used to treat it like a tipping service, which wasn't good, and then I forgot about it. So it's in limbo really!

Regards, Paul.

11th Jun '14

You could well be right. The Punch debt is very complicated but I would guess that there is some sensitivity to interest rates. I am intrigued that after much bun fighting a debt for equity swap is being agreed just as there is a real possibility of an interest rate rise.

Interest rates could also affect indebted Landlords and consumers so I doubt that a rise could be good news for Punch.

Ive looked at Punch as one of those companies that might be a turn around situation but have always pulled back from investing due to it's weak financial position and it's shrinking market.

2035 must seem to be a long way into the future for Punch. Will it last that long?

Small Cap Value Report (27 May 2014) - RNO, PUB, ZZZ, ACSO

Renold (LON:RNO)

Unlock the rest of this article with a 14 day trial

About the Author

Paul Scott

14 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...