Ugly Ducklings . . . or Baby Swans?

In a recent trawl of several valuation screens, I keep seeing the same names appear again and again and again. They are an hodge podge collection of various small caps across Europe (are any of these baby swans, or are they perennial ugly ducklings). At first glance some of them look to have been stuck in the loserville for a very very long time (eg Psion and Agfa Gevaert) , whether any of them are in any way interesting for me to invest in.

I should say that after my last post regarding Total Produce, that I have taken a position in the stock in the region of 5% of my own fund.

Dart Group



Morgan Sindall

Agfa Gevaert



Grafton Group

 . . . and a host of UK Retailers and various banks across Europe.

As well as showing up in some screens, Kontron and Psion were were suggested to me by an acquaintance of mine. I have already studied Grafton and Morgan Sindall. I think that Morgan Sindall seems to be in much better shape from the point of view of  returns and cashflow but will to delve a bit deeper. I have no doubt in my mind that Grafton represents great value. I am worried that margins superior margins in the Irish business will not be achieved at any time over the next five years. However the UK business is a fine business. This stock will be of interest to me at some stage, just not now.

UK Retailers – the carnage continues, but does Mothercare present an opportunity?

Since I last posted, several more UK retailers have issued abysmal trading statements, that should by now be expected by the markets. Game Group in particular seems like a company at deaths door. It would not surprise me in the slightest if fixed charge cover slides below 1 by the next trading statement. If that  comes to pass then it is almost certainly goodnight for the retailer.  Game is HMV/JJB waiting to happen.

Mothercare issued its interim results on Nov 17th. In spite of the stock falling a further 18% (to bring the full year return to -75%), I actually find some comfort in the results. The company has written down goodwill and has taken a cash charge to accelerate the exit of 110 of its property portfolio. This is a brave move and one that I believe can pay dividends and create value for shareholders. If I was to part with hard cash for a UK retailer it would be Mothercare.  There is a growing and viable international business that is highly profitable. It alone is worth several times the market capitalisation of the entire group. In the run in to Christmas that UK sales will continue to get worse.

If only the management of Home Retail would bite the bullet and begin a net closure of stores. If they are not prepared to do this, I feel it is only a matter of time before either the market in terms of an activist or their creditors force them to do it. The present management team has no credibility in my eyes, that is what differentiates them from the Chairman of Mothercare in my opinion. Mothercare for me is a question of trying to decide when is the appropriate time to invest in this situation. If Mothercare was to completely write off the UK business and sell it for a minimal amount (a la Kesa with Comet), then I still believe the upside is significant (ie greater than 100%).

I am convinced that there is also significant upside to play for in Home Retail, but the stock needs a catalyst.

Market Valuation

The  fact thatmuch of the equities trading on attractive multiples tend to be found in generally poor companies or poor industries, suggests to me that the market is not such great value. There are exceptions such as integrated oils and large European cement & aggregates companies, but too often the value end of the market is monopolised by banks, utilities and an assorted collection of small cap misfits.

I recall that in Q1 2003 and again in Q1 2009, many very high quality companies traded at pretty distressed multiples. That is what I am am patiently waiting (and hoping) for. I want to be able to purchase a host of strong companies with attractive capital and income characteristics at or below book value on a cyclically adjusted PE of 10 or less. Why eat soggy chips now, when if I wait I could have the finest steak and lobster tail!!!

While the Eurozone equity markets are approaching levels of attractive valuation, the breadth of that valuation is pretty poor. This supports my view that from here compound returns in general will be poor over the next 3 years or so. I do believe that if this trend continues that the market will hit generational valuation lows in that time frame. The chart below of the trailing P/B of MSCI Europe goes some way of showing just how attractive Eurozone markets are. I am sure that the low valuation is driven in a lrage part due to the ewightings of banks, insurance and utilities in the market indices.

Ducks or Swans?

Kontron AG

Kontron claims to be a global leader in embedded computing technology. Quoted in Frankfurt with a market capitalisation of €288m. In the past few years, an activist investor (Warburg Pincus) has taken a 10% stake. Despite that Kontron seems to be a pretty mediocre company. In looking at ten years of financial data, it strikes me that (i) Net Operating cashflow fluctuates between 3.5% & 5.1% of revenue. (ii) FCF is volatile jumping between large negative and slight positives. In the past decade only €38m of FCF has been generated. (iii) Median RoE & RoA is a lowly 4.6%  & 6.4% respectively. 

Gross Margin: Median 32.8%. Range 27.9%-38.8% 

EBIT Margin: Median 6.3%. Range 0.5% – 8.5%

Average net operating cashflow has been 4.9% of revenue, with capital expenditure running at an average of 3.4% of revenue. All in all this is a company that when it gets things right, does not produce a significant amount of cashflow.

With 40% of employees engaged in R&D I would expect that returns and eventually cashflow to be much higher than they are, unless the company is engaged in early stage development.  This poor returns are maybe due to company specific factors (which maybe Warburg Pincus believe they can fix) or industry factors, which are less likely to be resolved.

Since 2000, there have been gains or losses that are non operational made in every year, with the sum total of these being a below the line cost of €39million.

The business is improving this year in that margins are up across the board. The top line is growing at 22%. While the order bookappears to be in resaonable shape, although down on last year. Gross margins declined by almost 1% to 29.2% but EBIT margins have moved from 4.5% to 6.6%. Despite the margin improvement in the 2010 annual report the management guided on EBIT margins in the range of 8%-9% for this year. Pretax margins increased significantly as losses last year were not repeated this year. These losses relate to a risk provision that was raised for a fraud that was alleged to occur in SE Asia.

All this time the shares have continued to sink.

Using a stylised FCF model, where I simply look at margin and working capital improvements I get an FCF statement that looks something like this

Stylised FCF  
EBITDA Margin 9.7%
Tax @ 26% 7.2%
Working Capital * -1.8%
Net Operating Cashflow 5.4%
Capex/Sales -3.4%
FCF (as % of sales) 2.0%
Asset Turnover 96.4%
Asset/Equity 147.0%
Sales 534.95
FCF 10.8
Cash RoA 5.2%
Cash RoE 7.7%
FCF Yield 3.7%
* Assumes Revenue growth at 5% and Working Capital to sales improves to 32%  

Now I have no idea why Warburg Pincus have started stake building. They obviously believe that  they can improve this business and release value. Best of luck to them. To have confidence that value exists one needs to believe that present improvements can continue to be improved upon and that these improvements are sustained. However, when I run a simulation that ramps up margins and runs down working capital, then this is simply not that interesting a business from a cash or returns point of view. Top line growth is great, but it mens very little unless it can be monitised.

For me to believe that there would be a significant compounding opportunity, then I have to envisage a future that has not happened at any time this company’s past. That is not something that I am good at.

If it walks like a duck, and quacks like a duck . . . then it is unlikely to be a swan!

Psion plc

Psion has a market cap of £73m and is listed on the London Stock Exchange. Similar to Kontron, an activist investor has recently taken a stake in the company. Psion is a market leader in hand held ciputing devices for industrial usage (predominantly the logistics and distribution sectors). The company trades below on EV/Sales of 0.23, an EV/EBITDA of 3.5, P/B of 0.4 and a 7% dividend yield. The company has net cash on the balance sheet that is equivalent to 45% of the market capitalisation. Finally the present value of Psion is 1.4x its net working capital. All of this is a long way from the tech bubble when the share price grew from 242p to 2792p. (Hopefully we will see that type of madness in the equity markets once more!!!).

Psion has had a pretty chequered history. The financials over the past decade look appauling. Revenue has grown over the decade, however gross profit remains unchanged as margins have fallen from 52.6% to 38.2%. Operating margins have expanded, but similar to Kontron, Psion is a low margain and low cash generative company. Very similar to Kontron, for me to have any interest in Psion, I must have confidence that the new growth can drive margins and cashflow. In saying that, Psion does appear to be cheaperthan Kontron. Cheap is appopriate here, as there is a significant difference between what is cheap and what is good value. Having not delved deeply I wonder does technological change in the mobile dvisices/computing market mean that (i) margins will always be under presseure as there will always be a declining legacy product of some description and (ii) other than having a rugged exterior, why do the devices offer that a smart phone/tablet couldnt offer?

My initial impression is that due to significant working capital and capital expenditure conditions, then in order to consitently deliver cashflow at a reasonable level, then the company needs operating margins in excess of 9% on my calculation.  I cannot find any time in its history that Psion has achieved this.

This has none of the characteristics of a swan.

Dart Group

Dart Company has a market capitalisation of £96m and is quoted in London on the AIM. The company has two distinct businesses

* An aviation business which is a low cost airline operator and charter airline specialist

* A distribution business which specialising in the transport of fresh food produce to UK supermarkets.

Dart Group is profitable and reasonably cash generative, and has been for much of its recent history as far as I can tell. The stock has had attention from other bloggers, namely Expecting Value and ValuehunterUK recently. The stock is attractively valued in that it trades at 0.62x tangible book value. In terms of more earnings based multiples , the company is trading on a trailing 12 month EV/EBITDA of 1.3x. Net cash on the balance sheet represents 63% of the market capitalisation. Also, the Chairman/CEO of the company owns 33% of the shares outstanding. Now it is nice to see such prudence on a balance sheet, but the hoarding of cash almost never creates shareholder value.

Dart operates to my mind in a business with very low barriers to entry. With 86% of profitability being generated by the aviation business then it is fair to compare Dart to Ryanair or Easyjet. Ryanair is a fantatsic business to my mind, and I have huge regard for how management have run the company in what is a dire industry for equity investors.  However Dart is trading at between a 60% and 90% discount to Ryanir on asset or earning multiples on initial analysis.

There are about £100m of operating lease committments that arise over the next 5 years, so I really should add these back to EV to get a more realistic appraisal of value. In this case, the company trades on an EV/EBITDAR of 2.8x. In terms of context Easy Jet and Ryanair trade on EBITDAR multiples of 4.0 and 6.0 respectively.

Given the cash genrative nature of the business, I will be doing some more work on this stock despite the highly competitive nature of the industry that they operate in. May actually be a swan, its not that ugly, is it?


Safestore is the largest UK provider of self storage and is the second largest self storage operator in Europe. The company is listed on the London Stock Exchange where it presentlty has a market capitalisation of £197million. The stock trades on a P/B of 0.72x. The company is reasonably highly geared at 178%. Not unexpected given that the underlying asset is property. Fixed charge cover would appear to be 2.1x.

The company is highly cash generative at the net operating cashflow line. Approximately 10-12% of net assets are generated as cashflow. In the past few years all of this cashflow has been spent on capital expenditure. Despite considerable capex in the past few years, there has been no expansion in revenue or profits. Now maybe capex is cyclical, if it is, then there is certainly opportunity in that 25% to 28% of revenue translates into net cash earnings. I see no reason why a company should have to spend a similar amount on a regular basis in capital expenditure. It is fair to expect that such an amount of expenditure should generate revenue, profits and ultimately cashflow. For me to be convinced that this is a viable investment, I would need to see a consistent cashflow stream after capital expenditure.

The opportunity with Safestore plc is that occupancy is only 59%. If this can be increased then cashflow will grow. I wonder why capex would be so high when occupancy is 59%. Now, I am assuming that with self storage depots that 90% plus occupancy rarely occurs – so I need to ascertain what is normal or achievable.

Morgan Sindall & Grafton

Morgan Sindall is a UK construction company that operates perdominantly in building regenration and affordable housing. I looked at the company previously and shied away, not on quality grounds but on the grounds that I was/am nervous of the dependency of many UK construction companies on affordable housing. Any area of business that reuires the Government to support your business could find itself the victim of the latest fashion of austerity for everybody, everywhere.

In saying that, I must confess that from all of the metrics that I have analysed, Morgan Sindall does appear to be a very successful company with a string track record in value creation.  Net cash is half of the market capitalisation. Over time the company has generated an RoE of 20% on average, on an ungeared balance sheet!!!

Net Cash RoA has averaged 9%. All of this for a company that presently trades on a P/B of 1.06 and a FCF yield of 12%. The company has a strong dividend policy and presently yields 7.6% on the basis of an admittedly high 60% payout ratio.

Grafton is an Irish quoted Builders merchant and DIY retailer. It is the leading player in Ireland and a top three player in the UK. Margins are well below long term history due to ongoing market difficulties. But this business screams operational leverage to me. Valuation in terms of longer term metrics is deeply depressed.

When I look at companies of the ilk of Morgan Sindall, I wonder why on ever do I bother to even do some work on the likes of Kontron etc. Morgan Sindall is no doubt a cyclical company in a cyclical sector. But it is not a ‘hope’ stock. Given its recent pull back and the paucity of higher quality companies in the value space, I will be focusing a lot of attention in the near future on both Morgan Sindall and Grafton Group once again.

Both of these companies are trading in my opinion on very much undeserved multiples. Both represent great value, one is more stable near term than the other. When I started re-investing in equities (investing as opposed to trading) at the tail end of the summer just passed, I started with the aim of seeking companies that could grow the valuation as earning and gearing grew back to normalised levels. Both Grafton and Morgan Sindall have this in spades – it is simply a timing issue. Kontron and Psion require me to hope and believe in a future that is significantly better than any past that they have had. I am sceptical of such situations. As a person who is inclined to believe that the glass is half empty, I just dont do optimism and hope all that well.


Agfa Gevaert

This stock has declined 73% in the past year, and has been a dog with fleas for the best part of a decade at the very least. Technical obsolesence is very difficult for any firm to deal with, unless one has a deeply diversified product portfolio. With a market capitalisation of €202 million and a working capital less net debt equal to €490, this stock represents a very rare Graham Net Net.

There was an equity issue in the past year to repair a highly leveraged balance sheet. Operating cashflow mproved very significantly during 2009 and 2010, but has deteriorated thus far in 2011. Valuation alone will compell me to do some more work on this issue.

Has spent much of its life behaving as an ugly duckling. More than likely not a swan, but the valuation seems to scream for further attention.


Value investing involves threading a fine line. There is a difference between assets that thrade on low multiples and are cheap, to assets that represent good value for a patient investor. I do not think that you can depend on hope for value to work. Hope is more in the realm of speculation, and I have that with my recent purchase of  Bank of Ireland and can add to it if I decide to go ahead and part with cash to buy Mothercare.

Having looked at a lot of screens that throw out deep value names, I find that there are may lowly priced equities but only a few to which I would suggest that have value characteristics. I aim to make a closer analysis of Morgan Sindall plc and Grafton Group plc. Morbid curiousity attracts me to doing some work on Agfa Gevaert.

Other than that, I aim to investigate just how much value there is in mage cap technology stocks. Several well known value investors have taken large stakes in companies such as Microsoft, Hewlett Packard and IBM. I want to see where they are in terms of their very long run valuation history. I also think that I will have a peak at just how sustainable some of those dividend yields in European telecom stocks are. Finally I have been mulling over Transocean recently. I like oil plays as a longer term story, and this infrastructure play seems to have suffered from a very significant level of multiple contraction.


7 Responses to “Ugly Ducklings . . . or Baby Swans?”

  1. 1 November 22, 2011 at 6:29 pm

    The biggest concern I have about Dart is how many value bloggers, myself included, have it in their model or actual portfolios! It doesn’t feel contrarian enough…

  2. 3 John Kingham (@UKValueInvestor) November 22, 2011 at 9:25 pm

    I think you’re probably right about Mothercare. Of those others you listed, Morgan Sindall is right at the top of my list and I’ve liked it for a while but already own a few construction related firms (although they are more international than UK based – Balfour and Interserve).

    Strangely enough my top retailer is good old M&S (although I haven’t looked in detail). It’s not exactly growing like a weed, but it’s probably as dependable as a retailer could be, has over 5% yield and is priced at only 10 times the 10 year earnings average. Seems fair enough to me. Not exactly exciting though but would probably be a fair investment.

  3. 5 Wexboy November 23, 2011 at 5:55 pm

    John, I’d just eaten lunch when I saw this…aah, too much to digest! Mmm, let’s just have a little sample:

    – Yep, I keep pondering Dart too…?!
    – Plenty of time still to wait on Grafton, I think
    – Looked at Mothercare a long time ago, wasn’t too excited about valuation, but your international angle is v v interesting, I must drill down
    – Love the self-storage sector (where the US leads, unfortunately everybody follows in the end…), but similarly puzzled by low occupancy and returns. Take a look at LOK, I much prefer it with lower valuation and gearing – and Laxey’s on board for 29% 🙂

    Thanks for the great post, I’ll keep chewing

  4. 6 jmcelligott November 23, 2011 at 7:03 pm

    I have been fascinated by self storage since I had call to use the services of a storage outfit back in 2006. LOK seems to have a better balance sheet and cashflow proposition that Safestore, so it is worth looking at. Thanks.

  1. 1 Dart Group PLC – Is this a bullseye stock? « valuestockinquisition Trackback on January 27, 2012 at 2:47 pm

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