Why Ben Graham Would Probably Have Liked Molins

Saturday, Feb 11 2012 by
5
Why Ben Graham Would Probably Have Liked Molins

Next on my whistle-stop tour of the bargain bucket bin is Molins.  It’s an international business designing and making machinery for high-volume consumer goods like food and tobacco. It also supplies related services as well.

As with most of these low debt, low P/B companies it’s a small-cap with a market value of just over £20m.

It has borrowings of about £6m and cash of about £12m.

Sales are over £80m which is almost four times the market cap.

There’s also a reasonable history of dividend payments and the yield is currently almost 5%, which is a bit of a bonus. 

But, I’m a system-addict so I can’t get ahead of myself with excitement. Let’s fill in those simple numbers first:

The numbers, step-by-step:

  • Price to book = 0.43
  • price to tangible book = 0.6
  • Price to Sales = 0.25
  • Net cash = £6m

So it's a classic low debt manufacturing business selling at a large discount to tangible assets, something that Graham and Schloss spent much of their time investing in.

Are they about to go bust?

Not that I can see. The latest news and annual report just seem to confirm that the company is bumping their way through the economic landscape, just as they have since 1912.

A toe in the water

I’m not much of a stock picker. One of the things that differentiates me from most value investors is that I have little faith in the benefits of extremely deep analysis.  I prefer to stick to a small number of key factors and ignore the rest.

Other than in rare cases, I think it’s almost impossible to beat the market by working harder and analysing deeper than everyone else. There are just too many smart people working long hours across the globe for me and my little 3lb brain to have any chance of success by being BETTER or SMARTER than everyone else.

However, I think it is possible to beat the market if you are DIFFERENT from everyone else (or at least from the vast majority of market participants).

In my case that primarily means buying out of favour stocks (the central theme of value investing) and holding them longer than most other investors, a process known as time-arbitrage.

For these small-cap stocks I have a fixed holding period of 5 years because that seems to be the time horizon over which the most outperformance can be had for the smallest amount of effort.

And on that note Molins has joined the 21st century net-net portfolio with a 1.7% weighting (1/60th). You can see the existing holdings below and how some of them have already jumped up in value.

The difficult part is to fight the urge to do something, to be clever and make a quick 25% in a month. Short-term trading is so alluring and that’s why so many stock pickers do it because the gains can look fantastic. However, in the longer-term it almost never works out and many short-term investors find themselves on the road to day-trading hell.


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This article is for information and discussion purposes only and nothing in it should be construed as a recommendation to invest or otherwise. The value of an investment may fall and an investor may lose all their money. Any investments referred to in this article may not be suitable for all investors.  Investors should always seek advice from a qualified investment adviser.


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Molins PLC is engaged in the supply of machinery, instrumentation and services for the production and packaging of consumer products. The Company operates in three divisions: Scientific Services, Packaging Machinery and Tobacco Machinery. Scientific Services includes operations of Arista Laboratories, an independent tobacco and smoke constituent laboratory, and Cerulean, which develops, assemblies, sells and maintains process and control instruments for tobacco industry. The Packaging Machinery division includes operations of ITCM, an engineering supplier, developing technology and packaging machinery; Langen Packaging Group, a designer and manufacturer of cartooning machinery, end-of-line and robotic solutions, as well as a provider of turnkey projects involving design and integration of packaging systems. The Tobacco Machinery division designs, manufactures and services secondary tobacco processing machinery, particularly mid-speed cigarette makers, packing and handling equipment. more »

Share Price (AIM)
138p
Change
0.5  0.4%
P/E (fwd)
6.2
Yield (fwd)
4.3
Mkt Cap (£m)
27.7



  Is Molins fundamentally strong or weak? Find out More »


10 Comments on this Article show/hide all

shipoffrogs 18th Feb '12 1 of 10
2

Isn't Molins a large pension scheme with a small manufacturing business attached to it?

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UK Value Investor 18th Feb '12 2 of 10
2

In reply to shipoffrogs, post #1

That's a pretty good description. I haven't seen anybody come up with a sensible way of factoring in pension size into company valuations though so for now I don't really pay any attention to them.

Perhaps if somebody has a link to a study on correlations between pension size and stock prices or earnings growth or failure rates they could post it here?

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shipoffrogs 19th Feb '12 3 of 10
2

I haven't looked at Molins in detail, but the basic facts seem to be that it last undertook an actuarial valuation in 2009 (suggesting one is due this year). Then it reported Scheme assets of £276m and a surplus of £12m - so pension liabilities of £264m.

Now those are big figures compared to the company's net assets of £47m and a market cap of £20m (according to your article).

My guess would be that the next valuation would show a bigger rise in Scheme liabilities than in Scheme assets, as actuaries will be discounting at a lower rate and longevity of members is generally rising.

Molins looks as cheap as chips on operational metrics - but the pension scheme is the elephant in the room - I think any analysis of the company should take it into account.

For valuation purposes - find some companies that have done a recent valuation and compare the % decline against their valuations done in 2009 - take the approximate decline and apply it to Molins and adjust the net assets accordingly. Then factor in a deficit recovery payment program against its earnings and see what's left.

Studies on correlations - I don't know of any - but try and find a quoted company that has still kept open a final salary scheme - that should tell you what directors think of their impact on earnings, liabilities and risks that are out of their control.

Apologies for being so negative - but I did look at this company a couple of years ago and thought then that the pension scheme was just too big.

I'm no Ben Graham expert - but I'd have thought he'd walk away from this.

Good luck.

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MadDutch 20th Feb '12 4 of 10
1

In Molins favour, Sharescope gives good fundamentals;

P/E; 4.6.
Yield; 4.35%
Dividend cover; 5.0 times.

This is after the share price has doubled since August 2010.

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shipoffrogs 20th Feb '12 5 of 10
4

Operationally, it looks a very good company selling at a cheap price, as suggested by the metrics that you're quoting. Let's face it a 4% yield covered 5x and a p/e ratio of less than 5 in a company not in imminent danger is a no-brainer; but no brainers are thin on the ground.

All I'm saying is that there is an off balance sheet liability of some magnitude and probable future demands that will divert cash flow away from shareholders.

I'm just making the point that net-net may be a flawed approach with a company like this.

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emptyend 21st Feb '12 6 of 10
2

All I'm saying is that there is an off balance sheet liability of some magnitude and probable future demands that will divert cash flow away from shareholders.

I'm just making the point that net-net may be a flawed approach with a company like this.

FWIW I am in complete agreement with that point.

And I would add that the returns are likely to be largely influenced by the general stock market (because markets going up will reduce the risk of cash calls from the pension fund etc).

One certainly shouldn't ignore the pension fund - and I personally wouldn't touch the shares without seeing a detailed report on the disposition of assets and liabilities in the pension fund.

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UK Value Investor 23rd Feb '12 7 of 10
2

"This is after the share price has doubled since August 2010"

This highlights my point really.  I think if you were going to take a big position in Molins then yes of course the pension fund is very important as it may have a big impact on the future of the company.  However, the correlation between the pension fund and the share price is about zero.

I have put Molins into a model portfolio with a 1.6% weighting, so to be quite frank I don't really care if it goes bust.  However, if it did go bust it would teach me something (perhaps, depending on the reason) and if it doesn't go bust I think (and history shows) there is a better than even chance that the share price will be up considerably from where it is today over my expected holding period of 5 years.

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MadDutch 23rd Feb '12 8 of 10
1

shipoffrogs,

Thank you for your wise words, and I have to agree with your caution.

I have dated personal knowledge of Molins; I had a factory on the Winall trading Estate in Winchester in the 1970s; they were my next door neighbours and I sold my factory lease plus my fork lift to them. I liked them and was impressed with the competence of the management. Their product had a very good reputation and the firm has obviously stood the test of time.

I am interested in British engineers as I think they will do well in the post Euro world. I will check their current product range and if it looks good, will buy a small parcel, £1500 to £2000 worth in the next few months.

MD.

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shipoffrogs 23rd Feb '12 9 of 10
2

UKVI you said - the correlation between the pension fund and the share price is about zero.

I think we're all agreed that operationally the company looks very good, and the share price is as cheap as chips, particularly in relation to any operational ratios you want to measure it by. I would suggest that it's so cheap simply because of the size of the pension fund. And the correlation is therefore very high indeed.

A pension deficit is just just another form of debt, and debt can correlate to share price. Whilst it's latest accounts show it to be in surplus that's based on a 2009 valuation, a 2012 valuation would I suspect show a deficit given the fall in discount rates and rising mortality rates, with maybe some set off by rising asset values - but the former is likely to outstrip the latter.

Where I have some sympathy with your approach is in restricting the bet to less than 2% of your portfolio. Now I consider this to be a high risk investment, and if I placed 10 bets like this I would expect substantial losses on most of them and very high gains on a few, which hopefully outstrip the losses. But they'll only outstrip the losses if you run the gains and avoid the temptation to bank a 50 or 100% profit (something that requires considerable discipline). If you think it's high risk (and you make a reference to being philosophical about losing the lot here) - what's your exit strategy?

Thanks Mad Dutch - you and Molins have been round for some time! I wonder though whether in a post Euro world sterling would soar and damage UK exporters.

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UK Value Investor 5th Mar '12 10 of 10
2

In reply to shipoffrogs, post #9

shipoffrogs, yes in terms of the magnitude of the share price in relation to things like book value or sales or earnings etc, the pension probably does correlate. Big pension = lower share price.

What I really meant was the change in the share price over time. So if the pension is big we may have a low share price, but that share price may double in a year if there is some random good news about the company which has nothing to do with the pension. That was the lack of correlation I was getting at, but yes you're right, the share price is very probably low because of the pension risks.

You're point about avoiding the temptation to sell the few big winners after a 50% gain is very important. I think it's one of the big mistakes that Ben Graham made (although to be fair he couldn't have known it was a mistake and he pretty much invested this sort of investing if I remember correctly). His approach was to sell after 2 years or a 50% gain, whichever came first, but more recent research suggests that net-nets may outperform for up to 4 or 5 years and perhaps longer (as a group, on average), and that a small number of stocks may go up by several hundred percent and that's where much of the outperformance comes from.

So the point about not cutting off the big winners too early is critical I think to making the most of this approach.

My exit strategy is to sell after a fixed period of time to remove any chance of trying to be 'clever' and sell when the time 'looks right'. I aim to hold each stock for 3 years (originally 5 but for practical reasons I've cut that back a bit) which should be long enough for most of the big winners to do their thing, while allowing a diverse portfolio of 30-40 stocks to be held (originally 60 but cut back for practical reasons!) without too much work, i.e. one trade a month once the portfolio is full.  So even if something goes up by 500% I won't sell, although that in theory, in reality I may sell so that the position size doesn't dominate the portfolio.  Perhaps a 10% maximum position size limit.  If each holding starts at 2.5% or so then that's a 300% gain before I'd consider it too big.

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My name is John Kingham and I'm the editor of UKValueInvestor.com, a website and newsletter for defensive value investors. Defensive value investing combines defensive investing (buying large, successful companies with long track records of profitable dividend growth) and value investing (buying those companies at low valuations and with high yields). The site includes a unique stock screen and a model portfolio which is managed using a systematic investment process.  The goal is to produce a high income and growth portfolio with below average risk, which is easy to manage in just a few hours each month.   more »



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