SIF Portfolio: Why Coats Group Could Beat The Market In 2017

22nd Mar '17 by Roland Head

3 comments 5803 reads

For Stockopedia junkies like me, one of the interesting aspects of corporate results season is seeing how each company’s results affect its StockRank. The effects of a fresh set of figures can be dramatic.

By ignoring whether a stock is cyclical or defensive, the StockRank system often highlights value in areas where market sentiment and broker forecasts suggest that stocks might be fully valued. Housebuilders are one example, mining stocks and big retailers are two other which currently score highly for value.

I recently added FTSE 250 miner South32 and housebuilder Redrow to the SIF Portfolio after these firms’ interim results boosted their StockRank metrics. These same figures also caused them to qualify for the Stock in Focus screen.

However, although my screen results are sorted by StockRank, stocks qualify for the screen based on my own set of fundamental criteria. StockRanks are not used for stock selection and companies which qualify may not have rising StockRanks.

One example is today’s stock, thread manufacturing company Coats Group. This 250-year old group has recently qualified for my screen.

Coats reported full-year sales of $1.5bn last year. It’s the global market leader in industrial thread for the clothing and footwear industry. Customers include Adidas, Burberry and Next. The group is also a big player in the US craft market and makes various other types of industrial yarn.

When Graham Neary reviewed the firm’s 2016 results on 24 February, Coats had a StockRank of 97. Now that last year’s accounts have been added to the Stockopedia database, Coat’s StockRank has fallen 20 places to 77. That’s still a decent score, but isn’t outstanding.

However, I am attracted to Coats’ market-leading business, which would add useful retail exposure to the SIF portfolio. Sentiment towards the company has also improved markedly since December, when Coats agreed a deal with the UK Pensions Regulator to resolve its pension deficit. This has enabled Coats to restart dividend payments. I believe it should also drive strong growth in free cash flow from 2018.

Although Coats’ share price has doubled over the last six months, I think there’s a good chance of further gains. I believe this stock is definitely worth considering for the SIF portfolio.

Value: serious potential

Coats’ ValueRank of 55 isn’t obviously attractive. But in my view, a closer look…

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Benson212

22nd Mar '17

Hi Roland,

Thanks for writing the article - an enjoyable read!
Coats (LON:COA) qualified for a few of my screens with its 90+ StockRank, However, after some further digging I thought the shares could be a value trap.

The concern for me was the overall trend in cash, working capital and net debt.

Cash has consistently fallen since 2014
Working capital has steadily fallen and dropped off a cliff in 2016
The company has taken on vast amounts of debt in recent years which has significantly reduced the net debt position.
Pension deficit has ballooned which is strangling cash flows
Current ratio has nearly halved.

The company has destroyed its balance sheet and now has negative tangible assets.

I'm not an expert on balance sheets so I may well have missed something, but it would be interesting to hear people's views on this. Personally, I think there is trouble down the line for this company.

Roland Head

Hi BH1991,

Thanks for your comment, you make some good points about Coats (LON:COA) but I'm not sure I agree with your interpretation of some of the metrics you list.

Net cash Net cash fell by $162m last year. Looking at the figures, there were three main reasons for this:

- $74m foreign exchange losses
- $36m spend on acquisitions
- $99m UK pension scheme payments

Foreign exchange losses were made worse because the company had to repatriate cash in USD, AUD and NZD to GBP in H2 to support the pension deficit. This is an unfortunate situation but is presumably a one off. I don't usually lose much sleep over FX losses unless they suggest inept management, which I don't think is the case here.

Debt: I'm also not sure it's fair to characterise Coats' debt as "vast". Excluding the pension deficit, gross debt fell slightly from $409.3m to $398.3m last year. That doesn't seem a big concern to me given the $476.5m cash balance.

Current ratio: The fall in the current ratio was mainly due to $315m of pension deficit liabilities being classified as a current liability, up from c.$40m last year I'd imagine this will be reversed by the pension settlement this year, so the current ratio should improve again during 2017.

Working capital: The unusual classification of a large chunk of pension deficit as a current liability is also the reason why working capital dropped sharply in 2016. If we strip out the current pension deficit in both 2015 and 2016, working capital fell from $724.8m to $593.3m last year.

My view: Looking at these issues together, I'd say that the biggest issue on which investors need to take a view is the pension deficit.

If you believe that this year's one-off pension contribution and then rising interest rates/bond yields will cure the deficit, then the outlook seems positive to me. If you think that the deficit will cause further problems, then the outlook is more uncertain.

Obviously all of this is only my opinion -- it's certainly possible to build a more bearish picture, so all investors should DYOR.

Regards,

Roland

24th Mar '17

Hi Roland,

Thanks for replying.

I will certainly take your comments re Coats (LON:COA) on board and its always interesting to gain insight from someone who can analyse a balance sheet in more detail (unlike me, but I'm learning!). Personally, I will stick to the stock ranks until I become more familiar with balance sheets, then I will adopt a blended approach.

Best of luck with the SIF Portfolio, look forward to your next article.

SIF Portfolio: Why Coats Group could beat the market in 2017

Value: serious potential

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Roland Head

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