SIF Folio: Lookers Update + A Closer Look At Capital Drilling

2nd Jul '19 by Roland Head

6 comments 3840 reads

The ink was barely dry on last week’s article when another SIF folio stock was hit by a massive sell off. The culprit this time was FTSE-listed car dealership group Lookers, which shocked the market with news of an FCA investigation.

I’m going to cover this news and then take a look at mining services group Capital Drilling. Is this a suitable stock to replace last week’s departure, Sylvania Platinum?

Dealer profits could suffer

LOOK shares fell by about 25% last Tuesday, as Paul reported here. The subject of the investigation is the firm’s regulated activities between 1 January 2016 and 13 June 2019.

I think the main risk this flags up is that dealers’ profits may have become too dependent on big commissions from finance and insurance products. One estimate I’ve seen suggests that around a third of the profit on each car may have come from financial products.

In its 2018 annual report, Lookers flagged up a contingent liability in this area, warning that it had identified “certain matters requiring review” in its regulated activities. However, at the time, the company said it wasn’t yet practicable to estimate the potential size of any financial liabilities that might arise.

I don’t have any insight into this situation. My rules allow me discretion to sell in situations like this. But when I’ve done so in the past, I would often have done better to sit tight. Stocks hit by regulatory news sometimes recover strongly when more information becomes available.

Lookers only joined the SIF fund in March, but the fund’s position is now down by 50%. It’s not a great start, but the stock is still scheduled to spend at least six more months in the portfolio. Until we have more concrete information -- or a formal profit warning -- I’m inclined to sit tight and await further developments. I won’t be selling Lookers for now.

Mining opportunities?

I have had some good investment results with mining stocks over the years and maintain an ongoing interest in this sector. However, I do have some ground rules.

Mining companies must have a profitable business model, a proven track record and a sound balance sheet. As a general rule, I also prefer dividend-paying companies. I believe this provides useful evidence of cash generation and boardroom…

Unlock with Email

Unlock with Google

Already have an account?
Login here

heregoes18

2nd Jul '19

I'm still a relative novice in this stocks and shared lark, but I've been watching Capital Drilling for a few months and spookily took a small position only yesterday so your article is very timely/welcome. I also like the cyclical play, there was also a nice update and interview on proactiveinvestors a few days ago which finally prompted me to 'press the button'.

Brilliant Leader

Fantastic write-up on Capital Drilling (LON:CAPD) Roland. It’s in my watchlist but not sufficiently compelling for me to take the plunge. Nonetheless, it was a great presentation of the investment thesis, thanks.

Mark Simpson

8th Jul '19

Capital Drilling (LON:CAPD) was my Stockopedia StockSlam pick at November's Mello London and I rate it highly. A couple of additional thoughts:

You are right to highlight the cyclical nature of the business, which shows up in their profit figures, however, it is also worth looking at their operational cash flow, which has remained positive during the last downturn. Effectively, when the market is weak they just turn off some of the capex and the business still generates cash, then in an upswing they invest again.

They have been building a small portfolio of investments in junior miners that they drill for. Usually via placings but the net effect is that they have been providing drilling services for shares. Not everyone likes this given its increased risk profile, but if you trust that their on-the-ground management knows the good prospects better than the average mining investor then you are also getting some option-like exposure to a sector that may be entering the cyclical upswing.

Where I would like them to improve is being more aggressive with their cash holdings. Cash is piling up on the balance sheet and they have limited opportunities at this stage to deploy the capital into the business, only Blast Hole rigs are really at capacity in their fleet. I'd really like them to use their buyback authority or pay a special dividend. They could have taken a good chunk of the Burton stake into treasury if they had wanted to and would have been earnings enhancing given their lowly rating.

Roland Head

Hi dangersimpson,

Thanks for your comments and additional insight on Capital Drilling (LON:CAPD).

Re. the rising net cash balance, I agree that investing in new capacity doesn't appear to make sense, given reported fleet utilisation. I'd be happy to see a small shareholder return, but I would prefer to see this company maintain a fortress-like balance sheet.

Given the firm's customer concentration and its exposure to political, operational and commodity price risks, this isn't a business I'd want to own if it became substantially indebted. The experience of Gulf Marine Services (LON:GMS) over the last five years, although not directly comparable, is educational, in my view.

Regards,

Roland

finebone

18th Jul '19

Any idea why CAPD share price fell 10% yesterday on a fairly neutral trading update?

And a further 8% fall so far today?

SIF Folio: Lookers update + a closer look at Capital Drilling

Dealer profits could suffer

Mining opportunities?

Unlock the rest of this article with a 14 day trial

About the Author

Roland Head

6 comments

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

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