Small Cap Value Report (1 Aug) - TNI, PMP, UTW, CAP, CMS

1st Aug '13 by Paul Scott

20 comments 22027 reads

Good morning. Trinity Mirror (LON:TNI 115p) interim results (six months to 30 Jun 2013) have been issued this morning. As regulars will know, many of us did tremendously well on the re-rating which began exactly a year ago, as I spotted the astonishing value in the shares at 25p. They were great value when I bought at 25p last summer, but I don't see them as good value any more, at 115p.

Even though the PER is very cheap, at about 4 times, you can only value a business on a PER basis if profits are sustainable. In the short term (or even medium term) profits are sustainable, as today's interims demonstrate. However, the continued decline in turnover (down 8.5%) to £332m for the six months, puts a fairly finite life on the print businesses. There will come a time when they just can't strip out any more costs to maintain profitability. Hence it should be priced on a low PER.

EPS actually rose 5.5% to 15.4p, so they are heading for about 30p for the full year probably, which is a bit ahead of broker consensus of 28.1p.

Good progress has been made on debt repayment, with net debt down to £120.3m, with £36.7m having been repaid in the six months, which is very impressive. As I mentioned last year, Trinity Mirror's debt repayments are scheduled to coincide almost perfectly with its cash generation. So the net debt was never going to be a problem, the market just got that wrong last year in regarding it as a major problem, when it never was. Also the debt is covered by freehold property assets, which have a book value of considerably more than the net debt now, although the group was very coy about what the free market value of those properties actually is, when they were asked directly at the AGM a couple of years ago, which I attended.

The pension deficit has remained stubbornly high, which is disappointing. As mentioned yesterday, rising bond yields should now be shrinking pension deficits, but in this case it has fallen only marginally, to £297.7m (equal to £229.2m net of deferred tax).

Remember that pension deficit recovery payments will rise from £10m to (from memory) about £30m in a year or two. Not a…

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Jardine

1st Aug '13

Good morning Paul,

What concerns me with Portmeirion (LON:PMP) is that for the last four years the stock report shows the free cash flow generated per share is significantly less than the EPS. A very brief look at their accounts suggests they are using more working capital to support a relatively small increase in turnover each year. I just wondered if you had looked at this in more detail, and if in your view this was a cause for concern or not?

Andrew

Boros10

Excellent analysis this morning Paul. A real pleasure to read.

bsharman

Hi Paul. Would it be possible at some point in the future for you to write a little about what you take into consideration when deciding to take some profits or sell. Do you have a strategy such as if the price rises by say 25% do you then sell 25% of your holding, likewise at 50% or 100% - to take some risk off the table. I'm probably not alone in saying that I find it very easy knowing when to buy but find it very hard to know when to sell - and quite often I end up selling way too early! Any thoughts would be appreciated. I'm currently thinking of taking some profit in Vislink after a hearty rise.. (25%) Thanks.

6502

Re the Trinity pension deficit, note 12 sets things out in quite some detail. Far from starting to improve, the actuarial assumptions have continued to deteriorate.

The discount rate has increased slightly but the inflation expectations by considerably more, so over the last 6 months the real (wrt RPI) discount rate has shrunk from 1.7% to 1.25%.

According to the sensitivity information given, the deficit has benefited by £39m from the discount rate rising but suffered by £72m from the increased inflation assumptions in the last 6m.

it_trader

Paul, I know you don't usually touch resource stocks and mainly only UK based stock etc, but take a look at CIC Capital, and yesterdays report.

Looks decidedly dodgy to me.

Leven

Hi Paul - a good read as ever. I am a big fan of Portmeirion (LON:PMP). My wife, unbeknown to me, ordered a load of 'Sophie Conran for Portmeirion' tableware recently - obviously I was happy to see it arrive - the quality is very good and she is very happy with it. Let's hope online sales take off in the US as they have the UK!

I also like management's explicit support of the dividend policy below. These sort of statements give me a warm feeling in that they tend to suggest management are looking at shareholder returns and not just their own remuneration. Also much better than the share buyback brigade!

The Board is committed to a progressive dividend policy; our aim is to maintain a sustainable level of dividend cover and to try to increase dividends whenever our prudent forecasts of future trading conditions and business cash needs allow us so to do.

Progressive dividend payments to shareholders are a fundamental goal at Portmeirion.

SevenPillars

A few weeks ago the share price of Communisis spiked over 20% in a day on the back of a 10 year contract win from Lloyds described as huge and significant by the company and the largest of its kind available in the UK. No numbers mentioned accept it would result in substantial revenues for the company. There's a lot of good news already in the price which might explain why it has sold off a little since then. I suppose until some numbers start coming in the jury will be out on how significant and substantial it actually is and what effect it will have on the balance sheet.

cig

So they're using a 1.25% real rate expectation? Seems a bit generous at the moment, I may buy some if someone was giving me 1.25 long term risk free linkers...

These actuarial valuations are really a problem, lot of wishful thinking involved and you never know how far off (or which side of far off) from reality you are...

It may be better to have it marked to market: get 3 quotes from insurers for taking over the pension liabilities (and assets) and the average is your net liability (or asset if there's a surplus). I'd be curious to know if enough information is available to infer the approximate quotes you might get from insurers just from published information...

The discount rate certainly isn't a risk free rate. I think it's their anticipated rate of return on their portfolio (whose composition is also given). In fact over the last year their investment returns were £78m ahead of the discount rate. But that good investment performance has been wiped out by their assumptions becoming more pessimistic.

CantEatValue

TLDR version: I think the pension deficit is overstated and no where near as bad as it appears. For more detail, read my long boring post about accounting :)

I think the pension deficit accounting is one of the most incredibly misunderstood bits of financial accounting. Some of the newspaper articles I read about TNI's pension deficit "black hole" are just laughable, but I like this, as this widespread misunderstanding is what is keeping the shares so cheap. The big assumptions in pension accounting are 1) how long will the members live (I assume that they have this about right) 2) what will inflation be and 3) what should the real return on assets be, again, over the long run.

I maintain a spreadsheet where I track the assets they have invested in and hence back-calculate, given the discount rate stated, what the assets they have need to return - and this is the key phrase people forget - over the long run, in order for the stated liability to be the real liability. Where they say the discount rate is 4.65% what this means is "if the assets earn, on average, 4.65% over their lifetimes then the net liability, discounted back at that rate, is as stated." If the assets earn a greater return than that, then the liability is much less. If the assets earn less than that, then the liability is more. The key message here is that the stated "liability" is very, very sensitive to what discount rate is used.

Using my spreadsheet I can see that in order for the average return to equal 4.65%, equities have to earn 6%, property has to earn 4.6%, corporate bonds need to earn 3.9% and gilts need to earn 2.4%. The big question then is do you bet over/under those figures over the next few decades? Well, the interesting thing is that all those figures are under the expected returns stated for the assets in the annual report!* They say the figures are 6.9%/5.3%/4.5%/2.7% - which actually averages out to 5.4% given their current allocations. 5.4% is 0.73% above the stated discount rate of 4.65%, hence using the figure of £65m change per 0.25% discount rate change implies that, if the assets return the stated expected amount in the annual report, the deficit should only be around £110m instead of £300m. In fact, the averaged asset returns only need to 5.8% (nominal returns, remember) for there to be no deficit at all!

Personally I'm very impressed with TNI's asset allocation. They are big in equities (which seem the best of a bad bunch to me) and corporate bonds (which are shorter duration than gilts, so less interest rate risk). At a time when most pension funds are piling in to stupidly overpriced long-term gilts, TNI would actually benefit hugely from a rising interest rate environment. My personal view is that real interest rates right now being negative is a function of nothing other than financial repression by the central bank - something I don't think can last forever. Given the very long term horizon on pension funds it makes sense to hold out of long duration assets (except maybe equities, which have high risk premiums) and wait for rates to rise such that the real interest rate becomes positive again (at a minimum). When that happens, even a 5.8% long term return won't seem that ridiculous (you should have seen what the expected return on pension funds was back in 2000 - approaching double digits!) and the current expected 4.65% will seem laughable.

To summarise: I think the pension deficit risk is hugely overstated here and I think it'll turn out to be much less worse than the stated balance sheet figure.

*This gets a bit technical - 'expected returns' aren't used in the calculation of the liability figure - they are used for something else you probably aren't interested in. If you are interested in how they are used, you're probably a sad accountant and already know.

Paul Scott

2nd Aug '13

Hi bsharman,

Good idea. I'll put my thinking cap on about writing an article on when to sell.
Although it should be said on this that, like most value-leaning investors, my track record is of selling usually too early. So it would be a good area for me to re-visit in terms of polishing up my own performance.

Cheers, Paul.

Edward Croft

Bsharman - There's a couple of useful selling articles that Dave wrote on the site - a fundamental perspective here and a more technical perspective here .

There's some good debate on whether or not to use stop losses and some insights from Philip Fisher, Bill ONeil and others.

It's often said that value investors tend to get in too early and sell too early - but you have to sell to someone and normally that's the more optimistic growth investors who tend to like to pay that bit more.

clissold345

Hi Andrew

Regarding PMP.

I think you raise a good point. According to Digital Look, Operating Cash Flow per Share was in the forties for two years but has been in the twenties for the last two years. I dont know details of PMP. Are they spending a good deal of money now on developing new products? If Operating Cash Flow per Share is still in the twenties next year it may be a sign that they are finding growth difficult (which is what I think you are suggesting).

Regards,

Chris.

3rd Aug '13

Hi Chris

I like a share that turns all, or more, of the EPS each year into free cash flow because as investors that is what we want, cash to either payout to shareholders or reinvest to grow the business. If the business has a demand for cash simply to stand still then you can be misguided by looking simply at the earnings as a measure of how the business performs. It is a good reason to look at the relationship of the share price to free cash flow per share as well as the relationship of share price to earnings per share.

In the case of Portmeirion (LON:PMP) their turnover has grown by 8% between 2010 and 2012, but over the same period the working capital required to support that turnover has gone up from £10.1 m to £15.5 m, an increase of over 50%. Inventories have gone up, partly apparently to support a sales push in USA, but at the same time trade receivables have risen, meaning they are allowing customers longer to pay, and trade payables have fallen, meaning they are paying their bills quicker, presumably to get better settlement discounts.

To me this seems like a business that is finding it very hard indeed even to stand still.

At least the inventory does not deteriorate though!

Andrew

You don't necessarily need complicated rules for sales. I have two:

1) if a position gets above my max allocation, I top slice to 2/3 of the max allocation or lower, with no exceptions. My limits are in the vicinity of 2% of net worth for all financial positions, and 1% for risky ones. (Warning: with such limits nothing exciting ever happens.)

2) for full exit, I just re-use the same analysis I use for entry: would I buy this stock if I didn't have it now? If not, sell, if yes hold; with a bit of hysteresis to avoid flip-flops, that is for borderline cases, don't buy if you don't hold, don't sell if you do.

5th Aug '13

Hi Andrew

Thanks for your reply.

Regarding the relationship between working capital and turnover over two or more years, in the case of PMP I dont think your point applies since working capital seems to go up or down from year to year without apparent pattern. For example, in 2008 working capital was reported as £10.27M+£6.20M-£4.32M=£12.15M.

I agree with you about the importance of free cash flow. For 2012 Operating Profit/(Loss) was £6.66M but Net Cash Flow From Operating Activities was only £2.95M. I presume (as you point out) this is partly because PMP are allowing customers longer to pay.

In the RNS dated 1st August 2013 PMP report exceptional growth in Korea. In 2012 Korea accounted for 22% of revenue. My guess (based on a very basic knowledge of PMP) is that PMP's steady growth will continue.

Regards,

Chris.

Hi Jardine,

I've had a look into the points you mention, and I don't think there is anything to worry about with Portmeirion (LON:PMP). The business has expanded (its turnover) by 74% from 2007 to 2012, so as you would expect that has required additional working capital. Stock & Debtors have indeed risen, but they are fine in relation to turnover.

I've punched the numbers into a spreadsheet, and you can see what I mean, the figures look fine when taken in the context of a growing business. My spreadsheet is publicly available on GoogleDrive by clicking this link.

Or here is a screenshot: https://images.stockopedia.com/user-images/node-75968-3UyRv.png

6th Aug '13

Hi Paul,

Thank you for taking the time to do this analysis, and set it out so clearly. It's much appreciated. I was looking at the figures for just the last two years but as you have shown, over the longer period back to 2007, the working capital ratios look fine. The dividend growth and cash figures look excellent. With my reservations now dealt with I will probably buy a few shares.

Regards

Andrew

7th Aug '13

Hi Andrew,

You're welcome. I thought it was important to look into your points closely, just to make sure I hadn't missed something important. I agree that the dividend growth & cash are very attractive, and that was certainly one of the main reasons for me buying into Portmeirion (LON:PMP).

Note that they have spent about half the cash pile post year-end, buying out the long lease on their HQ site, but this will have a cash benefit of saving £306k p.a. rent, which is a better use of the cash than having it sit on the Bal Sheet earning close to zero in interest.

Cheers, Paul.

4th Sep '13

Communisis is now down to around 55p, which was the price just before it announced its "colossal" contract win with Lloyds which shot the share price up to just under 70p. Current downtrend looks pretty ugly, but you do wonder what the fuss was all about to push the price up on the contract win if its now back to where it started and could fall further. Companies don't often use the word colossal to to describe a contract win that often unless it really is significant to them, so it will be interesting to see if the market is pricing this wrong. Looks like a classic case of smaller company share price drift during a period of little or no news.

Small Cap Value Report (1 Aug) - TNI, PMP, UTW, CAP, CMS

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Paul Scott

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