Stock Pitch - Macfarlane (LON:MACF)

6th Jan '22 by Jack Brumby

45 comments 4497 reads

Sometimes the best investments are boring, overlooked companies with a strong track record of operational execution. This is the kind of situation we might have at Macfarlane, a Glasgow-based packaging company that has more than 70 years of experience in its chosen sector.

Demand is resilient and growing. Profits have increased every year over the past decade, with impressive progress on operating margins thanks to increasing scale.

And Macfarlane recently announced its best ever first half performance. Meanwhile the shares continue to trade on a modest valuation of just 12.6x forecast earnings. Unsurprisingly, the group qualifies for Stockopedia’s Neglected Firms screen (as well as three others).

In return for buying the stock, shareholders gain exposure to a proven strategy of steady revenue growth, sensible bolt-on acquisitions, and resulting margin enhancement opportunities. That in turn suggests scope for the market to rerate Macfarlane should the perception of this quietly expanding enterprise change.

Broker forecasts factor in very modest progress going forward. Is this view overly prudent given the group’s track record, or, with management warning over cost pressures, are there good reasons to anticipate lower levels of earnings growth in the medium term?

Macfarlane was pitched to the Stockopedia Investment Club on the 7th December 2021 at 135p.

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About the Stock

Macfarlane (LON:MACF) is a packaging distributor and manufacturer listed in the Containers & Packaging industry group of the Basic Materials sector. It’s an Adventurous Super Stock, with a Quality Rank of 81, a Value Rank of 63, and a Momentum Rank of 85 combining for an overall StockRank of 92.

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Its shares currently trade at 136.50p on the LSE Main Market, giving a market cap of £215m. Liquidity is decent for a small cap, with a 37bps spread and an exchange market size of 3,000.

About the Opportunity

Macfarlane can be characterised as a quality GARP (growth-at-a-reasonable price) stock, with above-average growth prospects and a below market-average valuation. The forecast PER of 12.6x belies an impressive track record of year-on-year revenue growth and operating margin expansion.

Revenue is measured along the left vertical axis of the chart below, operating margin on the right.

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Macfarlane has achieved this by aligning itself with growth markets such as ecommerce, focusing on value-added…

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ExpectingValue

7th Jan '22

To a man with a hammer, everything looks like a nail

Doug2b

MJP - I had a look back at the sahre issuing over the past 7 financial years, based on 8 years of data. c39% over this time period, c5.6% pa on average. MACF clearly feel that this is a level of share issuing that they can get away with. If anaysts and investment journalists are not flagging this up it continues on. Clearly the info is out there, but this is the largest single investment community blind spot. You will find that the share issuing/shareholder dilution is never mentioed in the annual and half year FD financial summaries, they will nevefr refer to it all, just to the legal requirement within the documentation.

To a lemming, every cliff looks like a water slide!

Coracleman

Many thanks EC, I'm learning a lot from the discussion in the thread and will pay closer attention to the company's own accounts in future.

I know that this is tough for you all, you have been blindly stumbling around taking the advice that is given, no questions asked and when things turn out not to be as you dsperately wanted them to be, it is tough for you, I get that. Points:

1. 10 months without issuign shares, what an achievement for MACF, how could I have doubted them. Actually they have gone for a few years now without signifciant share issuing, but old habits die hard, watch this space.

2. If MACF can desist from issuing shares for another 2 years, then the tangible surplus will move towards the 4% to 5% area, barely even a fair price, but that will take a couple of years, they will no doubt be itching to find a reason to issue more shares by now.

3. Every business has its so called reasons to justify share issuing, so they are paying down a pension deficit, does that make them a strong investment?

4/5. Nothing wrong with acqusitions and intangibles, intangibles are obviously how you account for aquisitions made above the tangible asset value, which will always be the case in this sector. But tangible assets must ultimately create tangible wealth, ideally in the form of cash. That is not happening anything like sufficiently yet and anyway, the growth in goodwill at MACF is not a big deduction within the tangible surplus calculation. Financing acqusition via a mix of debt and share issuing is usual, the debt financing is not a big factor in this.

In summary. If MACF can abstain from share issuing for a couple more years then yes the tangible surplus will improve, but only to slightly below fair price based on the evidence so far. I think that MACF may well struggle to avoid share issuing, it is an option that they have turned to much too readily in the past.

So your best hope is that MACF avoids trouble over the next 2 years and if they do, which could be a big ask, the current share price would only place the business as moderately over priced at that point. That remains a very poor investment thesis, surely as an investor, you are looking to back the horse when it has already passed the winning post, then all that you are waiting for is the short term irrational market to come around to your point of view, which if you are right, it usually does in time. There is no such basis for investing in MACF at the present time.

FederalReverse

I like to use free cashflow (per share, to account for dilution) to value a business like this. I would love to know where Doug thinks all the free cashflow has gone in those four years, and what this is likely to be (and where it will go) in 2022 and 2023. According to you this has no relevance to the company valuation?

You're pretty much implying some form of accounting fraud here, given they report all this free cashflow and you're claiming by your (crude) tangible equity change valuation that no value has been added to the company. EC's response pretty much covers the various destinations of the cashflow during this time, which you have failed to account for. Your valuation approach is plainly absurd.

Effortless Cool

I've made over £300k from investing In Macfarlane since 2015, based on my own analysis and projections, so I do struggle with this assessment:

.... you have been blindly stumbling around taking the advice that is given, no questions asked and when things turn out not to be as you dsperately wanted them to be, it is tough for you, I get that ....

As to your responses, they show a lack of understanding not only of Macfarlane (LON:MACF) but also of basic investment principles. I can only conclude that you are all piss and wind.

simoan

Condescension will get you nowhere. There's no need to talk down to people. Perhaps people don't get it because your approach is nonsense. There are many ways to make money from stockmarket investing of which yours may just be one. Lots of us have made superior returns but don't feel the need to push our own agenda and make out others are idiots.

BnB

“surely as an investor, you are looking to back the horse when it has already passed the winning post, then all that you are waiting for is the short term irrational market to come around to your point of view, which if you are right, it usually does in time. There is no such basis for investing in MACF at the present time”

No doubt true if there were only one basis for valuing a business and its prospects. But the investment case here rests on a number of alternative opportunities, not least that management has a good track record of acquiring growth on terms that are accretive to the share price, or alternatively that the TAM of the business is expanding attractively driven by ESG and e-commerce.

Your strategy is no doubt remunerative for you, but, despite likely never meeting your criteria, long term holders of Macfarlane have greatly benefited from its performance.

I think we’re all intrigued by your thoughts and admiring of your stated returns, but in your statement you are making false assumptions about others’ motivations for buying a share. Someone described your bets as cigar butts recently and that sparked a reaction from you. Aren’t you committing the same offence in inveighing against Macfarlane and its management?

It doesn’t meet your criteria. Fine. But it does meet those of other investors and there is proof in the past performance pudding. Let’s all respect and learn from each other’s differences.

MiserableJacktPotato

2: Here is one of your main problems. You're basing your numbers for two years time on the 2018 figures when the company has been going through a significant turnaround. You've taken the 2018 number (the average of your rolling four years) and projected it four years into the future predicting nothing will have changed in their returns to shareholders. In two years your four year average will reflect the accounts at the end of 2020. To get an accurate forecast you should take last year's figures and use them for your basis. You can then calculate with and without 5% dilution.

So what you're saying is, because management had to turn around the company in the past and save it from its massive debt pile (which has almost gone), it has no hope for the future, even though the management have actually saved it. Madness.

Rusty2

"It should be said, in the interests of fairness, the Bogdan on Daily Telegraph that uses this method and puts a lot of efforts into comments on Questor explaining it, has had exceptional returns over several years verified by the DT."

Most gains seemed to have been made after the 2008/9 financial crash, when he bought housebuilders. In the last 5 years, by his own statement, he has not beaten Fundsmith.

Epsilon

Even a blind squirrel finds an acorn once in a while.

Yes. I do believe he is right in that "value will out", I just don't necessarily fully agree with how to determine a value play :)

All good and a very interesting discussion.

Caper4

I cannot recall, at least in recent history, when the members of the Club voted unanimously to invest in a particular stock . Obviously this does not mean it will prove to be a winner, but as a long term holder of the stock, it sure gives me comfort

Re Fundsmith, my stocks are UK facing which as a broad sector has faced a lot of head winds over the past 5 years. I am behind Fundsmith and SMT and the like over the past 6 years, but over a 12+ year period or the slightly shorter period since Fundsmith's inception, I am well ahead of them both. Perhaps 30% ahead of SMT since 2009, but more than 100% ahead of Funsmith since inception.

My current holdings generate a net tangible suplus averaging around 10% of their MCap's SMT, Fundsmith and the like have a net TS of between 1% and 2% on average for their current holdings. 6 years is not a long time in stock market cycles, never in the history of the stock markets has such over valuation as currently shown by the hot stock funds remained. Conversely, never has such extreme under vlaution as shown by my holdings currently been ignored by the market for long. Soon the likes of SMT and Fundsmith will be very distant in my rear view mirror over the short and the long term.

12 years to April 2020 - unleveraged SIPP fund, 17x, i.e. 1,600% - please don't ask me to explain why 17x gains is the same as 1,600%, 2x gains is 100% etc - without any additional inputs into the fund.

Housebuilders in part, my really big winners are from various sectors - 2009/10 Senior and Petrofac, 2010 - to 2013 Barratt, 2012 to 2013 Dart Group and Kentz, 2014 Inland, 2016 to 2017 Ithaca Energy and many smaller gains from various sectors. Ithaca was a PFC contolled project in effect, back when PFC were very dependable. I also stepped away from the market, largely, in late Feb 2020 and bought back in late March 2020, which worked out well.

Current holdings in order of size are: LGEN, BWY, Fort, ScS, Boot, CAML, Plus500 and a small short position in Tesla.

on_27

8th Jan '22

Please can you explain why 17x gains is the same as 1,600%?

2x = 100% gain, 3x is 200% gain and so on.

So now you can foretell the future as well! I have found the longer I have invested in shares, and the older I have got, the more humble I have become. Dare I suggest, perhaps you could use a little more humility? Anyone who has only ever invested through the greatest bull market ever, will no doubt get a good dose of humility at some point. If you're honest, you have no idea what your future performance will be, or that of the funds with which you compare your performance. Unfortunately, I don't take well to such blatant dishonesty.

IMHO concentrating on absolute returns is a complete nonsense. Only investors who are completely ignorant of risk do that. The only thing that matters is risk-adjusted return to any sane investor. You claim great performance but with a very concentrated portfolio that is by its nature very high risk. I hope you can understand that on that basis, your performance doesn't make you a better investor than someone with lower returns who has consciously taken on far less risk. I'd say that is the case for both of the funds you try to compare your performance against. There is no doubt some skill is required in achieving such great returns but you also must have the humility to acknowledge there is also a great deal of luck involved.

For instance, I'm sure someone will be along soon to tell us they bought $5,000 USD worth of Tesla shares 10 years ago, stuck them in a drawer and forgot about them until last week. They are now a dollar millionaire. Does that make them a better investor with a better investment process than you?

PS. I will not be commenting further on this thread and hope it will soon revert to discussion of Jack's excellent article and the investment case for Macfarlane (LON:MACF)

DaviStoVest

I can only concur. I have no interest whatsoever in the self-satisfied, smug and poorly argued case presented here through the intrusion of one poster.

JamesS

Thanks to both of you for a good mannered discussion on the subject. Always good to hear both sides of the argument and informative for newer investors like myself.

Stock Pitch - Macfarlane (LON:MACF)

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Jack Brumby

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