I spotted the value in these shares when they were only about 25p c.2008-9, and did make a profit on them, but sold far too early. They've now risen to five times that, being 124p currently. This demonstrates the power of a retail roll-out as an investment - i.e. once a retailing format is proven to work (i.e. be decently profitable) in a small number of locations, then at that point it is a fantastic investment, because all management then need to do is to roll out the format to many more locations, which obviously makes profitability grow by a huge amount as it grows into a chain.
All this is a lot of hard work (I've taken part in a retail roll out myself as the FD, when my former employer grew the business from 16 shops to almost 150 over 8 years), but after a while just becomes a well trodden path for all the staff involved, and really just follows a standard formula - i.e. secure premises on the right financial terms, engage the fit-out team to actually build the shop, recruit staff, train them, put in place all the necessary goods & services, supply it with stock, advertise the opening, and open the doors to start trading. This is then done over & over again, and you get better & better at it, learning from each new shop that is opened.
That's exactly what Prezzo are doing, and it was obvious this was going to be a successful retail roll-out, because the early shops made a decent profit in a variety of locations. A store visit confirmed to me in 2008 that it was a good format, as luckily there was one next door to where I was living at the time in Hertford Street in Mayfair. Mind you, the credit crunch soon put paid to my delusions of grandeur, and the Mayfair flat had to go, as did my Prezzo shares unfortunately. Patience really has paid off here for those who were able to hang on to their shares. I see shrewdies Hargreave Hale hold 5% - it's always worth taking note when they are on the >3% list, as they really do know what they're doing in small caps.
However, the opportunity has passed now, and at 124p the market cap for Prezzo is £287m. They produced £8.2m in profit before tax for the six months, and it looks as if there is an H2 trading bias, so the full year looks as if it's heading for the £18-20m range, judging by last year's outcome and extrapolating out the H1 uplift to the full year. So that means probably just over 6p for the full year, which means they are trading on a PER of about 20. That's a full price in my opinion, even allowing for the fact that Prezzo has an ungeared Balance Sheet with some freeholds on it.
So, nice company, a missed opportunity for me, even though I saw the opportunity at 25p I was too short-termist in my thinking, and didn't just hold for the long-term. However, that's water under the bridge, and the price is now too high for me. There's not a great deal of upside in the next year or two from the current price, and the dividend yield of just 0.3% is not enough to persuade me to buy and hold from this point.
As you can see from the Stockopedia "traffic lights" valuation graphics above right, there's not a lot green (which indicates value), although the ROCE section is strong, showing the power of the roll-out (i.e. opening new shops is a good use of capital, generating a strong return).
I also have nagging doubts that their format is getting a little dated now, but the operating margin of over 10% says otherwise. At some point though, I think they will need to spend quite a bit of money to refresh their shops, and I note that onerous lease provisions crop up in every set of accounts recently, so they could be sitting on some problem leases. None of those are major problems though, in the context of a nicely profitable business - and a reminder that good businesses do well, even in a depressed economy.
Mar City (LON:MAR 11.5p) is a new one to me - it's a small housebuilder that has reported good profits growth this morning in its interim results to 30 Jun 2013. This comment from them is interesting:
Activity in the house building sector has increased dramatically in the last 12 months. In particular, the Government's Help to Buy scheme is having a strong positive effect on demand for the type of housing that Mar City provides. We remain confident that our expertise in constructing desirable and sustainable new homes will provide many opportunities in the coming years.
It seems to me that the Government are simply reflating a housing bubble using artificially cheap money, which can only end in disaster once interest rates normalise - millions of households have grown used to paying very little on their mortgages, which now feels normal. Inevitably interest rates will have to rise, or there will be a run on sterling (eventually, once other economies have recovered & raised interest rates). That will then cripple many households, who will be unable to meet the much higher mortgage payments, leading to forced sellers flooding the property market with supply, and remember with only 3% of houses changing hands each year, pricing is set from marginal supply & demand.
Furthermore, once house prices start to fall, a second wave of sellers will come from the many amateur Buy To Let landlords, who mistakenly think that renting out properties is a one-way bet in terms of capital appreciation, and rents received dwarfing the mortgage payments. Replace that with falling prices, and increased mortgage payments, and many will probably put their properties on the market, causing a glut of supply & further falling prices.
So the conditions are currently being set for a precipitous decline in house prices in the future. It's all just an accident waiting to happen, certainly in the South anyway. Although as readers have pointed out, this is not an issue generally in the North, where property is still quite affordable.
For these reasons, I've generally steered clear of housebuilders, with the exception of Inland Homes (LON:INL), which was one of my best performing shares of last/this year, but that one was so well asset backed, that it stacked up even before Help To Buy came along.
When I do invest in housebuilders, I don't use a PER basis for valuing them, because it gives false valuations. The point is that profits are generally not consistent. They are highly cyclical, in that when a cheap land bank from depressed times meets buoyant demand, then profits are high. Gradually profits fall as more expensive land feeds through to lower profits. Then they make huge losses when prices fall, and the land & WIP has to be written down in value. Then the whole cycle starts again.
So when the current bubble does eventually burst, which will probably be in 2015 or 2016, when interest rates rise, then we could see a big correction in the shares of housebuilders. That's why I think this sector is fraught with hidden risk, and needs a wide berth.
My preferred method of valuing housebuilders is the build-out value - i.e. taking an asset based approach, of looking at the current Balance Sheet net tangible asset value, working out what profit will be made on the existing land bank, discounting that back to present value, and adding it on to NTAV. Then take off a bit to give me my upside on the shares, and compare that to the current share price. If it looks favourable, then I'd buy, and if it doesn't, then I won't.
So applying this approach to Mar City (LON:MAR) makes their valuation look way too high. It only has £3.2m in net tangible assets at 30 Jun 2013. Yet the market cap is about £28m after today's 11% rise to 11.5p per share. Surely this is a mispricing then? Also they have no land bank, which is odd. I think they might get their land from another company, or other arrangements, but it seems to me that it's just a bog standard builder, with nothing much on the Balance Sheet. So putting it on a multiple of short-term profits that are unlikely to be sustained, seems mistaken to me. Maybe I've missed something here? Anyway, it doesn't interest me. The profits are not likely to be sustainable at this level (run rate of c.£2m p.a.), as other builders will just undercut them and/or bid up the price of land.
Regulars here will know that Staffline (LON:STAF 540p) was a favourite share of mine this time last year, at 226p, when I spotted the value opportunity and bought some shares after meeting management and reporting on it here.
At the time my closing sentence was:
"I've no idea what the share price will do in the short term, however I believe that with a 12 month+ view, this share has excellent upside potential, mainly because of the growth anticipated from the welfare to work programme. That's not in the price, hence why I think it's good value."
That was bang on the money, as it's been an outstanding performer since, having risen 139% since then to 540p! As usual, I sold too early, but that was more because of churning my portfolio too rapidly, chasing after gains on other things, when it would have been better to just buy & hold. And in fairness to myself, the things I bought with the proceeds have done very well too, so it's only ever really a mistake if you sell something too early and reinvest the money into something else that performs badly.
Let's have a look at their chart:
Anyway, the figures today from Staffline are interims to 30 Jun 2013. They look good. Revenues are up 14% to £187.2m, underlying profit before tax is up 32% to £4.9m. Remember that the apparently very low profit margin is because turnover is really an inflated figure, as it includes the wages for the contract workers. So really gross profit is probably a more sensible figure to consider as turnover, which in this case is £19.2m for the six months (up 26% against H1 last year).
Diluted (adjusted) EPS drops out at 17.1p for H1, and the outlook statement says that H2 has started well, and they are confident of meeting full year market expectations. Stockopedia shows the broker consensus as 41.2p for the full year, calendar 2013, which means at today's 530p price, the shares are on a current year PER of 12.9, which is hardly expensive for a growth company.
Wind that forward to next year, and the current broker view of 44.3p is probably too conservative, given the track record of gradual increases in estimates throughout the year - so I wouldn't be surprised to see STAF hit nearer 50p next year, in a recovering economy. That might command a PER of say 14-15, so I can see perhaps 200p upside on the current share price to around 750p if things continue to go well in the next year.
All in all, it continues to strike me as an ambitious, well managed company. What they are doing on the Govt's Welfare to Work Scheme is very interesting, and a key point of difference. Although it involves up-front costs, it has the potential to be highly lucrative for Staffline in the longer term, and they seem to be doing well with it.
I'm not going to buy back in at this price, although I'll certainly be looking carefully at it again on any general market sell-off, the next time we have one. As you can see, Stockopedia's traffic light graphics (on the right) show a generally medium valuation here.
Almost forgot to mention the dividend - they have increased the interim divi by almost 23% to 3.8p, so the full year payout looks set to be about 10p. That would give a useful, but strongly growing dividend yield of 1.9%. Not exciting in itself, but for long-term shareholders, it's a nice income stream that should grow considerably faster than inflation, on top of the main gain which is likely to come from capital appreciation of the shares, IF things continue to go well. As always with any share, there are no guarantees, and things can go wrong unexpectedly.
The main risk with STAF is probably that the Govt scraps the existing Welfare to Work scheme, but there's no sign of that, and the company points out that all 3 political parties support it. Increases in Minimum Wage might have some impact too at some point, as my main reservation with companies like Staffline is that they are arguably having a negative social impact, by putting employees into generally Minimum Wage jobs, which are effectively a taxpayer subsidy for large companies. Since the only way those employees can survive on such low wages, is through extensive taxpayer support via Tax Credits, and Housing Benefit.
Also staff have little to no job security, and are stripped of employment rights. The zero hours contract issue really needs sorting out too, as it just isn't fair. So at some point I think there will need to be a major change in Govt policy towards low paid agency workers, which could pull the rug out from companies like Staffline. No sign of that happening any time soon though, but it's a potential risk further out.
So with a General Election in 2015, I'd be carefully looking a the likelihood of a Labour Govt coming back, as they would almost certainly do something about low paid workers with little to no rights. Even the Tories are realising that having a significant part of the workforce languishing on Min Wage is not conducive to a sustained economic recovery. The deal in 2010 should have been that in reducing the Corp Tax rate, they raised Min Wage at the same time for larger companies, but the Govt missed a trick there.
Next, I've had a quick look at Sqs Software Quality Systems AG (LON:SQS 386p) but am really strugging with this one, as I don't really understand the business. or what factors might drive the sector. They describe themselves as, "the world's largest supplier of independent software testing and quality management services".
That sounds great, and I would have guessed they have some pricing power. However, it seems not, as their margins are rather thin, as interims to 30 Jun 2013 published today show - turnover up 4.9% to E107.8m, and adjusted operating profit of only E4.5m, so that's a profit margin of only 4.2%. Generally speaking I prefer to invest in companies with at least a 5% operating profit margin, and preferably a 10%+ margin.
Higher margins mean pricing power, which generally means you're supplying something that customers value, and hence you get paid more quickly, have more repeat business, and generally better sustainability to the business. As Buffett put it, good margins mean the business has an "economic moat", i.e. some sort of (set of) competitive advantages which protect that business & its profits.
That said, SQS are increasing their margins (from a low base), and their outlook statement today is positive - saying that current trading is strong, and that they are "confident of meeting full year market expectations". Stockopedia shows those as E0.30 for 2013, and E0.39 for 2014, which brings the PER down to 11.7 based on the 2014 estimate. Not amazingly cheap, but might be worth a deeper look possibly, if you understand their business model?
The forecast dividend yield is 2.1% this year, and 2.5% in 2014, so good growth potentially in the pipeline there. Net debt reduced usefully to E10.3m, which looks OK to me. Overall then, it doesn't really jump out at me as being a particular bargain, but if you think they have good growth potential, and are able to out-perform against forecasts, then it might be worth a look?
OK, that's it for today. See you back here tomorrow from 8 a.m. as usual!
(of the companies mentioned today, Paul has a token shareholding in INL, and no other long or short positions)