SIF Portfolio: I add Zulu pick Cambria Automobiles, plus an upgrade for Somero

My view of markets at the moment is that until evidence to the contrary appears, we need to treat UK plc as a going concern in reasonably good health. Ultimately, I expect the outcome of Brexit to be neither as good nor as bad as some pundits are suggesting. Thus the economic reaction may also be fairly middling.

I’d argue that the market reaction to the referendum has only exaggerated trends that were already visible. Weak trading on the high street, a more cautious view on housebuilders and a recovery in commodity stocks were all apparent before we voted to leave.

One company that was doing well before the referendum and appears to remain in good health today is Cambria Automobiles. The referendum result hit car dealers’ share prices hard. But there’s no reason yet to believe trading has been affected, so this could be a buying opportunity.

Last week’s trading update from Cambria reported strong trading through to the end of June. Results for the year ending 31 August are expected to be in line with expectations. As the Stockopedia graphic below shows, these have risen steadily over the last year:

You could make a case for saying that car dealers are nearing the top of a cyclical market. I’ve questioned this myself. But I believe the post-referendum fall in Cambria’s shares has left them cheap enough to offset this risk, on just 9 times trailing earnings.

I’m also less concerned about cyclical risks than I am with housebuilders. Unlike houses, new cars are more affordable than ever. High levels of new car registrations should be creating a multi-year pipeline of high-margin servicing and warranty work for big dealers.

This is especially true for the many cars bought on personal contract plans, where monthly payments are calculated based on an expected final value. I stand to be corrected, but I’d expect that failure to maintain a main dealer history might result in a reduction in the contractual final value of a car.

I’m also encouraged to see that recent decline has caused Cambria to qualify for the Jim Slater Zulu Principle screen. This popular screen has generated an annualised return of 18.3% since its inception.

Cambria’s StockRank of 92 has also pushed it close to the top of my SIF screen, so I’ve decided to add this stock to the SIF portfolio.

Value where it matters

Regular readers may have noticed that I’m very partial to free cash flow. Indeed, if a stock’s price to free cash flow ratio is attractive, I’m not usually too bothered about the P/E. That’s certainly the case here.

Cambria boasts a trailing P/FCF ratio of 3.8. To be fair, this does seem to be an exceptional result. However, the group’s normalised free cash flow per share has risen by an average of 12.4% since 2010. This is only slightly behind Cambria’s normalised earnings per share growth of 14.7%.

The shares look good value on most metrics, as the ValueRank breakdown below shows:

As with Total Produce last week, Cambria demonstrates that companies with low profit margins can still deliver a high earnings yield (EBIT/EV), if the valuation is right. Cambria’s earnings yield of 15% is a big attraction, in my view.

I’ve no concerns about Cambria’s value, other than the medium-term risk of a cyclical downturn.

Understated quality?

Cambria’s growth plan is to buy and turnaround underperforming dealers. The group’s management appears to be fairly adept and has generated a long-term average return on capital of 14.1%, while keeping net debt close to zero.

Cambria’s Piotroski F-Score of 6/9 seems relatively average. But as is often the case, the firm’s ‘fails’ are only marginal. For example, Cambria’s gross margin has fallen from 12.0% to 11.8% over the last year. That’s not a concern, but knocks one point off the stock’s F-Score.

The F-Score is heavily weighted in the QualityRank calculation. In my view, Cambria’s QualityRank of 70 may slightly understate the quality of this business.

Growth & Momentum

I don’t usually look at GrowthRank, as it isn’t one of the holy trinity of Quality, Value & Momentum which make up the StockRank. But since I’m classing Cambria as a growth pick, it seems to make sense to take a closer look at the stock’s growth credentials.

In this case the signs are positive. Cambria has a GrowthRank of 92, thanks to strong historic and forecast earnings growth:

Moving over to momentum, the recent share price slide has made the picture more uncertain:

(You can access these breakdowns from the stock sector pages -- just click on the rank numbers.)

I believe the metrics that really matter in this situation are the earnings estimates. With Cambria trading on a 2016 forecast P/E of just 7.6, I’d expect any further earnings upgrades to lift the shares.

Indeed, the firm’s house broker has recently upgraded its forecasts for both this year and next year. I’m encouraged by this. While broker forecasts are certainly not infallible, not all growth stocks have such a confident outlook.

The chart for Cambria also looks encouraging in my opinion. If we zoom out to a two-year view, the recent slide appears no more than a blip in a steady upwards trend. The moving averages remain well separated and are trending higher. You could argue that the shares look oversold:

I’ll be adding Cambria to the SIF portfolio this week, but please remember that this isn’t a stock tip. It’s just my opinion. If you’re investing, then please DYOR.

I’d be very interested to hear your views on this stock and on the outlook for car dealers in general in the comments below.

Somero upgrades profit guidance

I won’t go into Somero’s latest update in detail, as Paul Scott covered it in his report on Tuesday. But in case you missed it, SIF portfolio stock Somero Enterprises said on Tuesday that full-year profits would be slightly ahead of expectations after a strong close to the first half.

Most of Somero’s profits come from North America, where Somero says activity was “particularly strong”. However, what’s perhaps more encouraging is that the group said that China, the Middle East and Europe also contributed to overall growth. Somero’s growth potential, in China in particular, is a key attraction of the stock for me.

The update appears to leave Somero trading on around 9.6 times earnings, or less if you strip out the firm’s net cash balance. The shares have risen by 10% since I added them to the portfolio and remain attractive, in my view.