SIF Portfolio: Why I'm Investing My Own Cash, Plus RM, Costain & Taptica

12th Apr '17 by Roland Head

3 comments 7617 reads

As I mentioned last week, I’m in the process of shifting part of my own portfolio into the SIF portfolio stocks. In the interests of transparency, I thought I should explain what I’m doing in more detail this week.

I won’t be buying all of the stocks already in the portfolio, although I have bought some. But what I will do, in general, is to buy each new stock which joins the SIF Portfolio. I started this process last week by investing in McBride.

I’ve decided to do this for two reasons. I’ve been writing the Stock in Focus column weekly for nearly two years. During that time I’ve learned a lot about how the StockRanks system works and been impressed by the results achieved to date.

I’ve also been encouraged by the progress of my rules-based SIF portfolio in its first year, so I’ve decided to put some skin in the game by investing some of my own cash into this portfolio.

What I’m not doing is providing buy or sell recommendations. I do not guarantee to invest in any of the stocks I write about, and I’m free to sell those I do own at any time, without notice. The SIF portfolio fantasy fund will not be a direct match to my personal holdings and shouldn’t be treated as such.

I’m sorry to labour the point, but it’s all too easy for opinions to be taken as advice. That’s not what I do here.

What about a new stock?

The good news is that the Stock in Focus screen has identified several new stocks recently. Most of them must be ruled out as they duplicate existing holdings, but they are still worth a brief look:

Costain: This engineering and construction business overlaps too heavily with recent addition Morgan Sindall. But Costain was the company I wrote about in my first ever Stock in Focus column, in May 2015.

It’s turned out to be a great case study of a good, improving stock with high QVM scores:

	May 2015	April 2017
StockRank	99	99
Share price	c.325p	c.460p (+40%)
Forecast P/E	15	13.2
Forecast…

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Lennart

13th Apr '17

Stockopedia thinks there is a high risk of earnings manipulation going on. Such shares are best avoided. RM may well be a value trap. The numbers do not impress me.

jonno

Hi Roland
An interesting review of RM and one to consider as a potential investment. The increase in recurring revenue streams at RM Education resulting from the transition to higher margin software services is attractive, as is the acquisition of the Connect education business. However the acquisition is subject to CMA approval, which is presumably anticipated, but not a given.

Also I note the anticipated adverse £2m fx impact on the results to Nov 2017, which I assume is included in current forecasts.

Best wishes

Jonno

Roland Head

Hi Lennart,

Thanks for your comment. I agree with you in general, but in this case I think RM's restructuring and change of business focus may make things seem worse than they are.

There are currently three fails in the M-Score earnings manipulation results. I've included my comments under each one. I've not included an explanation of how each metric is calculated, as the calculations are explained in detail if you click on the M-Score link.

* Is the quality of assets stable?

There are several moving parts here. But playing with the numbers suggests to me that the single factor which caused this test to fail is the £8.3m reduction in RM's cash balance last year. This money corresponds to the one-off extra £8m pension deficit payment made last year. Reversing this payment and leaving all other variables as reported for 2016 achieves a pass score on this test.

So I guess the lesson here is that a big pension deficit can threaten the quality of a firm's earnings. That makes sense, as deficit reduction payments can drain the cash out of a business, preventing it from generating free cash flow from its profits.

* Are SG&A expenses under control?

I mentioned RM's lower operating margin in the article. This was the result of a rise in operating expenses last year. The three main items were all exceptional items:

- A £2.4m release of lease dilapidation provisions in 2015
- A £1.6m restructuring charge and £525k of acquisition costs on 2016

I'm fairly comfortable with adjusting these items out, as they appear to be genuine one-offs. On this adjusted basis, operating expenses actually fell last year. So I'm quite comfortable with the situation here.

* Are accurals low as a proportion of total assets?

I can't be sure about this. Accrued income did rise last year, while trade receivables fell quite significantly. This doesn't sound very attractive, but there are a couple of comments in the results which suggest it might be a side effect of the group's changing business activities:

"Cash generated from operations is expected to continue to be less than operating profit in the year ahead, reflecting the reversal of a favourable working capital position related to long-term contracts."

RM also says that one of the key risks to the business is:

"significantly increased working capital requirements within the RM Education and RM Results long-term contract portfolios and requirements in evolving RM Education business models"

The changing profile of the business is likely to bring with it some changes in working capital requirements and payment profiles. I'm not in a position to assess them in detail, but it's definitely a risk to watch, as this could place demands on the group's net cash pile.

Overall, I'm going to record an open verdict here. I'm not concerned about the increase in operating expenses, but the other two factors need to be monitored. In my view the key risk is the pension deficit, as it could prevent the group's net cash from being fully available to fund growth.

Cheers,

Roland

SIF Portfolio: Why I'm investing my own cash, plus RM, Costain & Taptica

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Roland Head

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