Screening for Value: P/TBV Ideas

In my last article, I started to look at the results from my discount to Tangible Book Value screen. I used the following Stockopedia feature to scroll through the StockReports of the screen results quickly:

Using this, I could exclude a number of companies I didn't consider worthy of further investigation. Modern investors have a lot of information at their fingertips and a limited amount of time. The ability to conduct a rapid initial assessment of a company and home in on the most promising prospects is vital to successful investing in the information age. The StockReports provide this edge.

The two main reasons for exclusion were a lack of asset quality or excessive cash burn. Many of these excluded companies were in the resources sector. Although I am not averse to investing in this sector, assets that are not currently generating strong cash flows require more specialist sector knowledge than I possess. Concerns around excessive liabilities or poor earnings quality are still valid here, but when looking at net tangible assets, these tend to be less of an issue.

This left 15 companies that I believed warranted a more detailed look. This week I will look into the first seven

Airea (LON:AIEA)

Airea make floor coverings, mainly carpet tiles, for the commercial and leisure sectors. In 2018 they closed their loss-making residential carpets division. A much larger carpet maker, James Halstead (LON:JHD) , looked at making an offer for the company in 2018, but ultimately, nothing came from it. Since then, the company has been profitable on lower revenue:

Unfortunately, no forecasts are available in the market, so we are reliant on the outlook statement in the interim results to judge if the 8.9x TTM P/E is indicative of the future. Here they say:

"Our order book and sales of new products continue to grow as we strengthen our portfolio of products.

Recovery of our UK market has been pleasing with recovery in export sales expected to continue, however it must be noted that the Ukrainian conflict has adversely impacted some of our key export markets.

We have experienced unprecedented pressure on costs over the last 18 months and we have taken numerous actions to mitigate the impact on profitability. Those cost pressures and managing them will continue to be challenging over the remainder of this year and into the future."

The use of the word "unprecedented" doesn't sound great here. Neither does the company not paying an interim dividend to conserve cash. This shouldn't be a problem for a company with £5.45m of cash on the balance sheet, although net cash is just £2.6m after various loans are taken into account.

The assets are of relatively high quality. The net cash and £4m of investment property are unencumbered. The last Annual Report shows that around two-thirds of the rest of the assets are also property. The rest include relatively new machinery since the company has been investing in improving productivity. The £4.82m of net working capital has a significant inventory component. On 31 January, this was over 80% finished goods, so the cautious investor may want to discount this somewhat. Nevertheless, the overall quality of the assets makes the current price to tangible book value look highly attractive:

There is a large pension fund that did require ongoing contributions. However, these are no longer needed, suggesting that the Pension Trustee is now comfortable with how the scheme will look at the next triennial valuation.

There are a couple of downsides. This is a highly illiquid stock, and trades don't seem to be executed much inside the current quoted spread of 26-30p. Investors here have to be in for the long haul and willing to look through the short-term inflation concerns since they will need to overcome the 12%+ spread to be in profit. And there are question marks over the sale of all of the previous CEO's shares to the Employee Benefit Trust at 45p per share, pretty much the all-time high. I am assured by those who follow that company closely that this was all above board. However, this isn't a great look.

Sadly, that CEO died this year after a short period of medical leave, so the company is currently searching for a new leader. I can't help feeling that the company would be better off seeking to be part of a larger group. Perhaps the appointment of a new CEO will push them into new hands. I think it will take this type of corporate action to unlock the value here, and I would be reluctant to buy without some indication that the new CEO will do whatever it takes to do that. Otherwise, it may remain an unloved and illiquid plodder.

N Brown (LON:BWNG)

N Brown Group is an online retailer focusing on unusual sizing in clothes, plus homewares. At first, the £261m of debt versus a market cap of £117m would appear to indicate a business in extreme distress. However, one key point here is that this business predominantly sells clothes on finance. So that debt is funding a large credit book. These credit books can be valuable in their own right – they can be securitised or be attractive to bidders. For example, in 2016, Home Retail, which owned Argos and Homebase, received a takeover offer from Sainsbury's at a favourable premium. The market had missed that Home Retail had a large credit book that represented a saleable asset, and hence the stock was mispriced.

In N Brown's case, this loan book reflects the company's origins in retailing through catalogues. Short-term receivables stood at £533m on 26 February, of which £508.5m is the net customer loan receivables, with debt secured against these of £302.5. If this credit book is accurately priced, then the net amount more than covers the current market cap. Discretionary retail and consumer credit are not great places to be when going into a consumer recession, so I can understand the market's reticence here. However, they were too cautious in their provisioning during COVID-19. In the last year, bad debt provision actually decreased, which they put down to the prevalence of government support:

"The FY21 level was inclusive of £15.4m (2.5ppts) to cover future Covid-19 default risks. Of this, £1.6m was utilised and £13.7m was not required and released in the year. The FY22 provision ratio includes a £5.8m (1.0ppts) provision for the new macro risk of inflationary pressures. The FY22 ratio of 11.9% therefore remains above the pre Covid-19 level reported in FY20 (10.9%)."

Here are the details:

This suggests that it would require an additional 15% provision to eliminate the difference between the current market cap and net loan receivables. I suspect that would require an unprecedented consumer recession. However, another concern is ongoing litigation with Allianz over historical PPI. This year is the first that they have fully provisioned for this:

The Group is involved in a legal dispute with Allianz. More details of the Allianz claim and the JDW counterclaims and defence are set out in note 6. The eventual financial outcome of the dispute is highly uncertain for both parties. We believe that it remains in the best interest for the parties to settle the dispute and an accounting provision of £28m has been made to cover settlement, or award at trial, plus future legal costs.

If this is a reasonable estimate of the eventual cost to the company, this is good news since this amount will be easily met through existing facilities. However, they do say:

Given the nature of the issues in dispute, the Court will have considerable discretion in reaching its conclusions relating to, amongst other things, which sums should be brought into account and what proportions of the liabilities each party should have to bear. Accordingly, the range of potential outcomes, in either direction, could be many times materiality and involves a significant level of estimation.

A market dislike of uncertainty may well be one of the reasons for the low valuation here.

Finally, on assets, there is an accounting pension surplus that the company is unlikely ever to be able to access, so it makes sense to ignore this in the net asset calculation.

In the Q1 Trading Statement released in June, the outlook was in-line with expectations:

"Sales volumes since the start of the financial year have been softer, reflecting various well-documented pressures on consumer confidence, which are showing no signs of abating in the short term. As these pressures persist, we expect the trading environment to remain challenging and will, therefore, continue to take actions to mitigate the effects wherever possible.

Despite this uncertain backdrop, our FY23 Adjusted EBITDA expectations remain in line with previous guidance, as we balance cost control and our variable cost base with investments in our technology, our people and in our strategic brands."

Broker Shore Capital estimates 2023 EBITDA to be £86.5m, down on the 2022 figure and in line with 2021. EPS is expected to be 5.8p, which may yet prove optimistic. However, there is no sign of significant losses, which would erode the discount to the net loan book. As such, and despite some considerable uncertainty, this looks too cheap.

Camellia (LON:CAM)

Camellia is a strange beast. It traces its origin back to 1959, when Walter Duncan set up a tea business in Calcutta in partnership with Playfair of Glasgow. Over the years, the company expanded its agricultural operations into other regions; and added banking, insurance and engineering subsidiaries. This made it incredibly complex to analyse, although they have sold off the banking side, which helps.

Their last trading statement, issued to coincide with their AGM at the end of June, was a profit warning:

As always, our financial results remain largely dependent on Agriculture where the majority of harvesting, and hence sales, takes place in the second half of the year. It is therefore too early to give a firm indication of the likely results for 2022 however despite an expected net positive profit impact from the factors set out above in respect of our Agriculture, Engineering and Food Service businesses, if the trading conditions experienced by BF&M in Q1 2022 continue through the remainder of the year it will lead to an overall adjusted profit before tax* for the Group which is significantly lower than market expectations.

Weak trading has meant that this has traded below net assets for almost all its recent history. Still, a P/TBV of 0.45 means that the returns to shareholders would be good if the assets could be made productive again. However, the company is effectively controlled by a family trust, meaning there was little incentive to shake things up to avoid a takeover on the cheap. However, the board now seems ready to take action that they weren't before. They announced a strategic review for the insurance business and are trying to sell off "Heritage Assets, " presumably artworks or similar, hanging on the wall at HQ. The rest of the assets are plants, land and equipment across the globe.

Because of these streamlining efforts, the company is likely to become more concentrated on agricultural performance in the future. This means that profits will be even more dependent on the vagaries of the weather and global pricing. I don't see how an individual investor could accurately predict the profit or the value of the agricultural assets to a buyer. As such, there is little attraction to being a minority holder here.

Conygar Investment Co (LON:CIC)

Conygar is a property investment company. Interim results to 31 March give the NAV per share at 212.5p, which means this is trading at a 36% discount to net assets. This compares favourably to listed peers. In addition, they have been selling several properties at a premium to their September 2021 valuation, suggesting that the actual discount may be even greater. However, despite these profitable sales, they still raised money via a placing recently at a significant discount to NAV. This means that the NAV has been declining:

"NAV per share decreased by 5.16p per share to 212.25p as a result of 8.58p per share dilution from issuing shares at a discount, partly offset by a 3.42p per share increase from the £1.93 million profit realised in the period."

The proceeds are said to be for progressing the mixed-use Island Quarter site in Nottingham. This gives the impression that they may have bitten off more than they can chew here. Given that so much of the future NAV of the business seems to be in the success of one or two major developments, and I am not a property expert, I will leave this one to those more knowledgeable than me.

Helical (LON:HLCL)

Helical is another property company. This is a much larger company with a market cap of £472m and pays a dividend. It has recently converted to a REIT, meaning it doesn't pay tax on its property earnings as long as 90% of these are paid out to shareholders. Results to 31 March show Net Asset Value up 13.0% to £687.0m (31 March 2021: £608.2m). Subsequent sales appear to be at a premium to NAV, which suggests that this may be conservative.

Helical generally focus on central London. So this could be a good play on the return to cities and offices post-COVID. This will be attractive to firm believers in that narrative. The only caution I have is that the forecast property distribution yield of 3% doesn't line up with the net rental yields on individual properties quoted by the company, particularly when considering the discount to NAV. This may be due to significant unrented development property or that brokers haven't caught up with the change to REIT status yet. It bears further research and potentially contacting the company about it for those considering investing. Being a mid-cap, the brokers are Peel Hunt, JP Morgan and Berenberg, so, sadly, these notes aren't available to the individual investor to confirm this that way.

Hunting (LON:HTG)

Hunting mainly provides oil field services but recently has been looking to utilise its engineering knowledge to expand into non-oil & gas areas. With the current oil price, you'd expect Hunting's business to be booming. Indeed, the last time the oil price was around $100/bbl, the Hunting share price was above £8 compared to just over £2 today.

One of the reasons is that their last trading update disappointed the market. Although the company said, "H1 2022 trading has been in line with management expectations", analysts took this update as a profit warning. RBC said, "Hunting expects the Q3 and Q4 EBITDA run-rate to increase about 20% from the second quarter, which implies a full-year EBITDA of about $44 million". However, this was below the consensus of $60.8 million for core profit.

So, what is going on? I explained the effect in one of my previous articles:

However, more recently, the focus on ESG has meant that banks are unwilling to fund large shale oil drilling programs. Production growth has to come from reinvested profits rather than funded through debt. Although this hasn't removed the cyclical nature of the oil markets, it does mean that the response to current oil price rises is slower than in the recent past. This effect is visible in the global rig count, which is far lower than it has been for the same oil price previously. I expect this will normalise eventually. However, in the meantime, it will generate extra profits for those oil companies with producing assets.

Hunting's revenue and profits are driven by drilling activity, not oil prices. This activity has been slow to respond to the higher oil price.

Regarding assets, the current market cap is almost entirely covered by cash plus net working capital. This is attractive since these are the most liquid of assets. Of course, this attraction may wane if there is a chance that they don't get paid or the inventories are not worth their book value. However, their customers will generate plenty of cash to pay them at current oil prices. In terms of inventories, they took write-downs in 2020, which helps re-assure that they are accounting for this accurately. In an inflationary environment, we may see the opposite as the value of inventories increases.

Ultimately, an investment here depends on the belief that the oil market cycle is not dead but operating more slowly than previously. If this proves to be the case, these assets will become very productive, and returns will accrue to shareholders again.

IG Design (LON:IGR)

IG Design Group provides craft and gifting products to major retailers. They were an investor darling, with their share price approaching £8 before COVID-19. They managed to navigate 2020 reasonably well. However, their recent performance has been woeful:

This appears to be another example of a company pursuing revenue growth at all costs. The issues they faced started long before the Ukraine war caused global dislocation. In their January profit warning, they laid blame on supply chain issues:

"…the Group experienced further supply chain delays and headwinds which resulted in a significant volume of seasonal orders being processed and shipped in a shorter time window than previously envisaged, thereby incurring fulfilment related cost premiums. During the same period craft sales in the US fell below the higher prior year Covid-19 levels, a trend that is now forecast to continue into the final quarter of the financial year."

Although they report net cash at the year-end, similar to many companies, this is a carefully chosen date. In their post-close trading update, they flagged that they required a banking covenant waiver in order to build stock for their seasonal peak period. This caused their share price to fall to less than 50p. Thankfully, this waiver was given, although it came with additional restrictions on dividends and a hefty arrangement fee; they flag that we can't expect any dividends from them for at least the next two years.

Despite rising to 135p, the shares remain at 0.66x Tangible Book Value which could represent good value. However, most of those assets are inventories, which will be an even higher proportion of current assets going into the seasonal peak period. It is unclear whether these inventories can be sold profitably or are worth book value. A small change in inventory values could easily wipe out this discount.

On top of this, the share price has risen strongly on no news. This suggests that having repriced all their options at lower levels, the management may be touring the city, putting a positive spin on things. Or that traders are touting the shares as a buy. In the PI World investor presentation, it seemed that management had no contrition for running the company so close to insolvency. If you only watched the presentation and didn't read the results, you would come away with the impression that it was another great year full of awards and success. Such promotional activity may attract some. However, the value investor tends to be put off by such speculative excess and run the other way.

That covers the first seven shares I wanted to look at in more detail. In next week's article, I will look at the remaining eight ideas generated by the Price to Tangible Book Value Screen.