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

Tuesday, Jul 02 2019 by
26
SIF Folio Lookers update  a closer look at Capital Drilling

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…

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Lookers plc operates as a motor retail and aftersales company in the United Kingdom. The Company operates through two business segments: motor distribution and parts distribution. The motor division consists of over 150 franchised dealerships representing over 30 marques from approximately 100 locations. Aftersales represents the servicing, repair and sale of franchised parts to customers' vehicles. Its parts division operates in the independent aftermarket sector of the United Kingdom's motor retail market, where it operates through three operating companies: FPS, Apec Braking and BTN Turbo. FPS is a warehouse distributor of automotive parts. Apec Braking is a provider of dry braking (pads and discs). BTN Turbo is a distributor of turbochargers and supplier of related value added services. Its operations are also carried out across Ireland. It sells approximately 180,000 new and used cars and vans per year. In addition, it has an independent parts distribution business. more »

LSE Price
52.8p
Change
-0.4%
Mkt Cap (£m)
206.3
P/E (fwd)
6.6
Yield (fwd)
7.5

Capital Drilling Limited is a drilling services contractor. The Company is engaged in offering a range of drilling services and solutions to mining and exploration companies, starting from the exploration phase of the mining cycle through to production. The Company operates through two segments: Africa, which provides drilling services, and Rest of world, which provides drilling services and related logistic, equipment rental and Information Technology (IT) support services. The Company also provides survey and information technology services for mining and mining exploration companies. For exploration, drilling services are focused on diamond core, air core, reverse circulation and deep hole diamond; for mine development, its drilling services are focused on paste holes, geotechnical, dewatering and reverse circulation, and for blast and production, its services are focused on grade control, blast hole, underground, rotary and pre-splits. more »

LSE Price
62.5p
Change
-2.3%
Mkt Cap (£m)
87.2
P/E (fwd)
10.4
Yield (fwd)
3.1



  Is LON:LOOK fundamentally strong or weak? Find out More »


6 Comments on this Article show/hide all

heregoes18 2nd Jul 1 of 6

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'.

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crazycoops 2nd Jul 2 of 6
1

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.

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dangersimpson 8th Jul 3 of 6
2

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.

Book: Excellent Investing: How to Build a Winning Portfolio
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Roland Head 8th Jul 4 of 6
1

In reply to post #490556

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

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finebone 18th Jul 5 of 6

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

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finebone 18th Jul 6 of 6

And a further 8% fall so far today?

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 Are LON:LOOK's fundamentals sound as an investment? Find out More »



About Roland Head

Roland Head

I'm a private investor, analyst and writer on stock markets, with a particular fondness for free cash flow, dividends and value. My main interests are UK and US stocks. I also have an interest in (profitable) commodity stocks.  I have passed the CFA Level 1 exam and hold the CFA UK Investment Management Certificate (IMC). One of my investment interests is developing rules-based strategies such as my Stock in Focus portfolio. This reflects a significant part of my personal portfolio and is the subject of my weekly column here at Stockopedia. In earlier life, I worked as an engineer in telecoms and IT. The rules-based and quantitative approach required for this kind of work undoubtedly influenced my investing style.  I also learned a lot from seeing the tech bubble deflate in 2000-1, when I was working for a very large and now defunct Canadian telecoms firm.  more »

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