Reflections on Haynes Publishing Group (LON:HYNS)

Haynes Publishing (LON:HYNS) is familiar to most people as the publisher of detailed DIY car repair manuals. Haynes produces these DIY manuals for a range of vehicles, mainly motorbikes and cars. In this sector, Haynes is the market leader but it is also involved in publishing books on a wide range of subjects (frequently licensing the Haynes brand) and has recently acquired some digital capabilities. The company is typically recognized as a British brand (as this recent BBC video suggests) but the majority of  revenue now comes from US sales and all manufacturing/production now for the DIY manuals takes place in the US although other operations like licensing are still based in the UK. HYNS also has some significant sales operations in Australia.

First, I will look at the quantitative factors. With HYNS, this is quite straightforward as the statements are extremely consistent with a clear record going back to 1990.  Since then, it has lost money in only one year and it has made consistently good returns for shareholders. Looking purely at these returns we would think valuing the company at book would be somewhat rational. HYNS would therefore be worth just under £40m which is about 100% more than the current price. However, money doesn’t usually fall from the sky and I will suggest some reasons for this undervaluation in the final section.

Looking at the determinants of return on operations we see that 2008 was an important year for the company. Growth in margins stopped whilst the pace of decline in net asset turns increased. Interestingly, revenue growth was 8% in 2008 which suggests that part of the fall comes from how HYNS is investing its cash. It is obviously slightly more difficult to tell where the cash is going as there are a lot of moving parts but we will give it a go.

My suggestion is that the decrease in 2008 alone was something of an anomaly due to acquisitions. However, more generally, the company’s cash cycle has slowed down since 2008 and capex since 2008 has averaged just over £3m which appears heavy (although the record we have is limited). In 2008, the company took 350 days to convert inventory into cash but in the last fiscal year this had increased to 470 days and although this was partly offset by improvement in converting payables (in the past two years receivables produced around £1.5m in cash), the cash cycle has increased by about 100 days since 2008. The capex costs are pretty self-explanatory and are split evenly between “development” and PPE. So the company is investing heavily in its business and it doesn’t look like this is paying off as RNOA falls. However, the returns for this investment will probably be further in the future and so qualitative judgement will play a greater role.

The dividend is another attractive factor in investing in HYNS so we should ask how sustainable this is. Operating cash flows have been consistently more than pre-tax earnings which is usually a good sign. In addition, the heavier capex has been partly paid for by liquidation of receivables however, we shouldn’t count on this being a factor going forward. So with operating cash flows around £8.5m, capex around £3.5m and a dividend around £2.75 we see that the company is fairly generous in returning cash to shareholders (considering operating performance). The company did use an overdraft to pay for the 2008 acquisition but has paid this off quickly. So everything here is looking good if the capex is worthwhile.

The qualitative factors are more difficult here in that HYNS is a small company operating in something of niche. We can see from the 5yr CAGRs above that revenue and profit growth has been slowing. In fact, the top line has hardly grown since 1999 and the bottom line has been stagnant since about 2002. Looking at this another way, 10yr Revenue CAGR has been about 0.02% but 10yr Asset CAGR has been 2.64%. In other words, investment in the business hasn’t really gone anywhere and the improvement in profit has been achieved largely through falling sales and distribution costs. Improvement in margins is a one-time thing and so we can’t really rely on this to drive operations although with the relocation of manufacturing to the US (more specifically, Tennesse where everything will, most likely, be cheaper) we would expect some continuation of this trend. Some encouraging changes are the sale of the loss-making UK print business and the centralization of manufacturing in the US. Also, the Australian business could be a source of future growth. The acquisition in 2008 was obviously a big deal as well. The company acquired Vivid which is described as the leading European supplier of technical information to the motor trade. Obviously, this is tangentially related to what HYNS is already doing but means interacting with professionals instead of “enthusiasts”. Also Vivid’s products are digital which means HYNS can exploit possible software/information synergies (i.e it could offer some kind of retail product). The acquisition appears to make sense on some level.

So the company is clearly making changes despite apparent stagnation. Whilst I wouldn’t say the company was completely isolated from the competitive problems in the broader publishing industry it appears to be trying to grow within its niche internationally. This is probably a smart move as the rest of the industry is having trouble. As a private investor, it is difficult to see how effective this strategy is going to be but the company is willing to cut off parts that aren’t working and move into new areas which is a good sign that management are thinking about shareholders. As already mentioned, much of these investments haven’t paid off yet but I can see how they will. I would also emphasize that the management emphasizes this change in direction with the CEO, Eric Oakley, being appointed from the North American Division and a new Group Chairman, the founder’s son, in 2010.

Now we deal with the elephant in the room explaining the 0.43x book multiple, the pension deficit of £14m. In the last fiscal year, this widened from £10m to £14m with a reduction in the discount rate. Recent legislative changes may lower the deficit but the problem, as far as I can tell, appears to arise from the very heavy equity allocation of the policy. I don’t really know too much about the accounting but the clear implication of this is that HYNS may end up being a simple leveraged beta bet. In other words, if the market goes up, the deficit will close and HYNS will be worth more.

This idea is obviously problematic as this isn’t really a very sophisticated way to make money and it would be just as well to buy a levered index fund. However, I think that HYNS’s growth opportunities make sense and I think it has enough assets and can generate enough cash to pay off this deficit. The management is making good choices/investments and the upside here is significant if everything works out. Our main concern though is the downside and therefore the pension deficit. There are really no clear catalysts for the resolution of this problem and the subsequent revaluation of the company so we can’t allocate a signficant amount to the company. This is particularly unfortunate as the company appears to be well run and the outlook for operations is quite healthy. Shareholders have been let down with poor financial managment and, possibly, a bit of bad luck with the markets.

As usual with a small family company, the liquidity is pretty poor and the shares are dual-class with the family still holding a significant share. In addition, Hunter Hall, an Australian fund manager, holds around 30% of the company however, compared to companies with a similar structure the current liquidity is quite decent.

Disclosure: No position in HYNS but may acquire one over the next week or so.