Each month, Richard Beddard trawls through annual corporate results for candidates for his Watchlist and the Share Sleuth portfolio of companies that satisfy key valuation metrics.
Cohort (CHRT): defensive measures
Steady performance in terms of revenue and profit growth in recent years has hidden ructions at Cohort, a group of small businesses that supply technology and expertise to the armed forces, schools, councils and the police force. Flat revenue and modestly improved profit have come at the cost of the closure of one firm, the shrinkage of another and the acquisition of a third.
Cohort is the end result of a series of acquisitions since its original business, SCS, floated in 2006. SCS, a training consultancy, closed in 2016, the victim of cuts at the Ministry of Defence. By transferring its remaining contracts to other companies in the group, Cohort was able to retain some business and reduce management costs. Meanwhile, the acquisition of an 80 per cent stake in EID, a Portuguese supplier of communications equipment to the Portuguese and other national armed forces, made good the lost revenue and boosted profits.
The new financial year will bring more challenges. Cohort says orders are down across the board. Despite the acquisition of EID, Cohort’s businesses remain dependent on the Ministry of Defence for most of their revenue. Unfortunately, the ministry has delayed contract renewals and slowed the pace of work on contracts already awarded.
For example, SEA, another of Cohort’s businesses, is equipping the UK’s submarine fleet with external communications systems, but work on Astute class submarines has slowed and work on the Dreadnought class is not expected to start for 18 months. Cohort says MASS, its fourth and most profitable business, is a strong contender in the bidding for the lucrative contract to provide electronic warfare operational support, but a decision on the contract has been delayed.
Despite the uncertainty, Cohort has grown over the past five years of austerity. It says it is more nimble than larger rivals because its four businesses operate semi-autonomously. Their membership of a larger, well-financed group gives customers the confidence to partner with them for the long term.
Meanwhile, Cohort encourages subsidiaries to work together to address new markets. SEA, for example, which has expertise in UK requirements through its work on submarines, is working with EID, which has expertise in surface naval communications, to produce equipment for Royal Navy frigates.
While it may shake some investors’ confidence if Cohort fails to build up its order book in the current financial year, the company’s focus on innovation and product development should lead to more exports in the long run and lessen its dependence on the MoD.
Its shares look cheap. A share price of 400p values the enterprise at £165 million, about 13 times adjusted profit in the year to April 2018. The earnings yield is 8 per cent.
Colefax (CFX): profits squeeze
Colefax has decisively increased revenue over the past two years from £77 million in 2016 to £80 million in 2017 and £86 million in 2018, but this ‘good’ result is something of a mirage. The company owes much of the performance improvement to the weakness of the pound. Unfortunately, the revenue boost was not translated into profit, because Colefax bet against a strong dollar in 2016 through hedging contracts.
Colefax also owed its surge in revenue in the year to April 2018 to its decorating division, Sibyl Colefax & John Fowler, which finished a larger than usual number of decorating projects in the UK and Europe. The profitability of this division varies markedly from year to year, depending on the timing of payments from customers, typically wealthy people decorating their mansions.
Colefax’s decorating operation, though, is small beer, even in a good year, as is the company’s furniture manufacturer, Kingcome Sofas.
Colefax is a famous fabric designer. The business is profitable and reasonably stable – return on capital in 2018 was 9 per cent, a fraction below its long-term average of 10 per cent. However, rather than investing those profits in developing new brands or buying one of its many small rivals, Colefax is content to refresh its big-hitting brands each year and return surplus cash to shareholders through dividends and share buybacks.
Colefax’s biggest brand is Colefax & Fowler, a collection of traditional English brands, but it owns contemporary patterns too. They are all luxury brands, but some are more extravagant than others, and the spread of styles and price points insulates Colefax somewhat from shifting fashions and weak consumer confidence.
The biggest risk to profit is perhaps the state of the high-end property market, because customers tend to decorate when they buy houses. The elevated level of stamp duty on property transactions explains why demand for Colefax’s brands is weak in the UK. A decade of economic growth in the US explains why Colefax is doing well there.
A share price of 540p values the enterprise at £83 million, about 16 times adjusted profit in the year to April 2018. The earnings yield is 6 per cent. While the valuation is modest, perhaps our expectations of Colefax should be too, as the company’s conservative strategy limits its growth prospects.
At the annual general meeting in September, Colefax said revenue had grown once again in the US, where it does 60 per cent of its business, but contracted in the UK and Europe. It expects more of the same for the full year.
Dart (DTG): Airline going places
Dart, or more specifically its leisure airline Jet2.com, is one of the UK stock market’s unheralded success stories. The company, which also owns Fowler-Welch, a distributor of fresh produce, increased its revenue and profit substantially in the year to March 2018. Over the past 11 years Dart increased revenue by a factor of five and profit by a factor of six as it launched new family-friendly routes and package holidays.
In the year to March 2018, Dart earned an after-tax return on capital of 10 per cent, slightly below its long-term average of 11 per cent. Profitability may temporarily be depressed by higher costs as Jet2.com goes through a major expansion phase.
The company has invested in a fleet of new Boeing airliners, and 2018 was its first year of operating from Stansted and Birmingham.
New routes must be heavily promoted while the airline gets them established, and in the early days surplus capacity eats into profitability. Jet2.com has got off to a good start though, having flown more than a million passengers and 6,300 flights from Stansted in its first year and almost as many from Birmingham.
If you live in the south of England, the success of Jet2.com and its package holiday business Jet2holidays may come as a surprise, as the airline’s stealthy expansion from its original home at Leeds-Bradford airport has only just reached the home counties. However, in the north of England it has captured enough business to become the UK’s third-biggest airline and its second-biggest package tour operator after Tui. It is bigger even than the venerable Thomas Cook.
This surprise is understandable. Jet2.com focuses on the European family holiday market, unlike its competitors, which tend to cater to a wider range of customers and fly further afield as well. Founded in 2006, Jet2holidays, the most profitable part of the business, sells most of its flights and holidays direct over the internet and – unlike some of its rivals – doesn’t have a declining network of travel agencies to support. As an airline, it has more control of the product than other challengers, for instance On The Beach, that mostly package scheduled flights with hotel beds sourced from wholesalers.
At its AGM, Dart said its immediate prospects are good. In the medium term, Brexit and rising costs, particularly for jet fuel and wages, could reduce its profitability, but airlines with the strongest business models should prosper over the long term.
A share price of 980p values the firm at £2.1 billion, about 17 times adjusted profit in the year to March 2018. The earnings yield is 6 per cent.
Goodwin (GDWN): good time to buy
Unlike Dart, Goodwin will benefit from rising oil prices. The company makes giant valves used to control the flow of oil and gas in pipelines and oil terminals. It has remained profitable during four years of low oil prices through diversification.
Past investment in its refractory engineering business, which makes minerals used in the casting of jewellery, is paying off and the firm says recent investments in non-oil-related mechanical engineering product development is about to pay off too. Since oil-related orders are likely to increase now that oil prices have risen again, Goodwin is back on the front foot.
If the company’s confidence is justified by events, the year to April 2018 will be the year Goodwin stabilised. Revenue declined by 5 per cent, but adjusted profit increased by 19 per cent. Cash flooded into the business as the company turned the screws on customers and suppliers, allowing it to strengthen its finances.
Net borrowings have returned to a typical, and relatively low, level. Goodwin says a new $19.5 million contract with the US Navy will be the first of many for its mechanical engineering division, while orders for the high-integrity castings used in nuclear fuel reprocessing will follow.
Goodwin earns most of its profit from refractory engineering and it expects the division to continue growing, but it also expects mechanical engineering to return to top spot once investment by its oil and gas customers takes off, probably in a year or two.
A share price of 2,700p values the enterprise at £215 million, about 20 times adjusted profit in the year to April 2018. The earnings yield is 5 per cent. Profits are lower than they are likely to be in the future, so now may be a good time to buy shares in a strong business that, at what should prove to be a low point in its history, has still managed to eke out an 8 per cent return on capital.
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