As the bear market continues to roar on there were a few snippets of news from stocks that I have covered in the past. I'll keep it brief as no doubt you might want to get back to watching your portfolio, although that may not be good for your well being and blood pressure. First up we had an in line trading update from what is now just a car finance company S&U (SUS). This included a 19% increase in the dividend which is probably in line with forecasts, although this is a bit hard to discern due to the special dividend paid this year on the back of the disposal of their home collected credit business. This also means they have a strong balance sheet with only low gearing and therefore plenty of scope to grow their business and consider acquisitions. On acquisitions quite topically they said:
"We continue to examine potential acquisition and start up opportunities in a rigorous and painstaking way and have added to our development team. The recent reverses in stock market values have confirmed our impression of unrealistic pricing last year and may lead to better value in the coming months. Our search continues, but against a background of continuing investment in Advantage, and our determination to maintain shareholder returns in areas where we have experience and expertise."
Seems like a sensible and cautious approach and I would continue to trust the management to deliver value for shareholders. As such with that in mind the shares look good value having come back with the market recently and are close to potential support from lows in April / May last year. At around 2000p they now trade on around 12x with a 4%+ yield which seems fine to me, although if the market carries on falling then no doubt this one may be dragged down further with it.
Meanwhile Rolls Royce (RR) have announced their results and the on going restructuring being undertaken by the new CEO. As a result of this, probably unsurprisingly, they become the latest blue chip, after Rio Tinto (RIO) yesterday, to announce a dividend cut. In this case it is a 50% cut to this years final and next years interim. So looks like the turnaround here will be a long haul, but it does at least have a large order book to tide it over.
Finally I noticed that the recently appointed finance director at RM has picked up an initial 35,000 shares and a director of Matchtec (MTEC) seems to have done a bed and ISA transaction so probably nothing too significant in those. That's all for now, I hope your portfolio's are not being too badly hit by the current turmoil. If you are on the look out for bargains in the stock market flash sale then just to let you know the latest Scores are out today, right now where's my tin hat.
RM plc which features in the Compound Income Scores portfolio has announced final results for the period ending 30 November 2015. These showed the expected decline in turnover as they moved away from selling low margin computer hardware and focus on supplying software and services to educational establishments and exam boards etc. The turnover at £178.2m was down 12% as a result and seemed to be slightly behind forecasts which were for £179.6m according to Stockopedia. The earnings and dividends were however better than forecast a 16.2p v 15.6p and 5p v 4.8p respectively. It is also worth noting that the eps figure for this year was also ahead of the forecast of 16p for the current year suggesting that there may be some scope for upgrades to forecasts.
Aside from that the commentary was a bit mixed but generally seemed OK and it is encouraging that the margins have increased to 10.2% overall. There was no real outlook statement or comment on current trading so if you are interested then I suggest you read their announcement for the full details. The closest thing to an outlook statement was in the headline comments from the Chief Executive which seemed a bit downbeat when he said:
"Market conditions in the UK Education sector will continue to be subdued as a result of increased pressure on school budgets. Our strategy continues to focus on retaining a leading market position for all three businesses whilst maintaining our stronger operating margins."
Taking the results at face value and using the currently reported numbers and last weeks closing price of 162p puts them on a 10x PE with a 3.1% yield which is covered 3.2x by earnings. On an Enterprise Value basis deducting the £48.3m of cash they had at the year end from the current market cap of £133.9m gives an EV of £85.6m and given the margins would suggest an incredible EBIT / EV yield of 20%.
However, there is also a Pension deficit which at 30 November 2015 they say the IAS 19 scheme deficit (pre-tax) was £21.9 million (2014: £26.8 million) but they also said that on 11 December 2015, agreement was reached with the Trustee of the RM defined benefit pension scheme with regards to the triennial valuation as at 31 May 2015. The deficit was agreed at £41.8 million (31 May 2012: £53.5 million). Their deficit recovery plan comprises an initial cash contribution of £4.0 million into the Scheme and £4.0 million into the escrow account previously established for the purposes of further risk mitigation exercises, together with deficit recovery payments remaining at £3.6 million per annum until 2024 (previously 2027). These funding plans will be assessed at future triennial reviews.
So if you adjust for this conservatively, although as described above, they do have recovery plans in place, you could just ignore the cash as this is offset by the Pension liability. On this basis the EBIT / EV yield (Market cap. in this case) would still be a generous 13.6%. On an EV/ Sales basis or market cap to sales this comes in at 0.75x whereas with margins of over 10% I would have thought this should be closer to perhaps 1x which would give potential for 30%+ upside and could suggest a price target of 218p or so. If that were achieved this would leave it on 13.5x with a 2.5% yield based on this years forecast dividend of 5.5p and last years 16.2p of earnings and this would bring the EBIT / EV (Mkt cap) yield down to 10% all of which would seem reasonable to me. However, whether the market is prepared to re-rate this one remains to be seen as it has rather languished at its current levels for a few months now, although that has been against the background of a weak market so it has been showing some relative strength if not absolute price performance.
Thus continued patience will be required on this one if you should choose to invest in it, but it will remain in the CIS portfolio for now as it continues to look good value and scores well with a CIS of 95. Mr Market doesn't seem to like it though as he has marked the shares down by around 6 to 8% to around 150p and close to some potential support from lows about a year ago. This would also bring it closer to a zero growth type of rating which is perhaps not unreasonable given the history of this one. Perhaps the market is also disappointed by the market background comment, although this probably shouldn't be great surprise to anyone. But it does seems a bit harsh to me given the changing nature of the business and might therefore be a buying opportunity, but maybe I'm missing something?
Firstly as I am you may have noticed, if you live in the UK, it has been really mild recently for the time of year. For example I heard on the weather the other day that the overnight low was going to be around 12 c which is more like a night time in July not December. Mind you given our summers are sometimes like winter perhaps that's not so surprising!
This is normally bad for clothing retailers as their winter lines then fail to sell in the expected volumes. Thus today we have had the first, presumably of a few profits warnings, from clothing retailers. Bonmarche (BON) the Women's wear retailer in warning about their profits. said:
"In the Company's Interim Results report published on 23 November, the Board stated that, provided trading conditions normalised for the remainder of the financial year, its expectations for the full year would remain unchanged.
Trading conditions during December, particularly since "Black Friday" on 27 November, have been very challenging, and have not normalised. The Board's view is that these trading conditions are likely to continue for the remainder of the winter season and it has therefore revised its profit expectations for the current financial year. Given the ongoing volatility of trading conditions, the Board considers it likely that the PBT will be within the range of £10.5m to £12.0m.
Since they are also referring to Black Friday I guess this could also have wider implications for the retail sector beyond just clothing, but given the weather I'd expect other clothing retailers downgrading their expectations. This could include Next which features in the Compound Income Scores Portfolio (CIS) and I note they have been weak this month. While WH Smiths should be less exposed unless the Black Friday sales have really damaged the Christmas trade for everyone.
Meanwhile there was a really mild update today from another CIS Portfolio holding, RM Group (RM.). I say really mild because at least it wasn't a profits warning, but a very brief statement saying that they were trading in line with expectations. They also updated on their cash balances, which were up, as they had guided, to £48.3m versus the £43.1m that they last reported.
Against this they updated on their Pension deficit after the latest triennial review. They say this saw it fall from £53.5 in 2012 to £41.8m at the 31st May 2015, although strangely this is up from the £30m that they mentioned in their interims which were also to the 31st May 2015. I guess this reflects a more detailed look at the liabilities and perhaps some conservative changes to the assumptions underlying it. They also mentioned two payments of £4m so I guess £8m could come off the cash balances and the deficit recovery payments remain at £3.6m per annum up to 2024 rather than 2027 presumably reflecting the £8m they are putting in upfront.
So this is the main change since I last wrote this one up in detail and the higher deficit could therefore detract slightly from the value case. Since the new deficit figure and the remaining cash, after the recovery payments, should roughly match lets just look at it based on the market cap rather than a reduced enterprise value due to the cash. This is more conservative, although it could argued that if they had to wind the company and Pension fund up today that it would cost more than that, but it seems a reasonable compromise as it is still a going concern.
On this basis they have a market cap of around £140m and they are expected to have turnover this year of around £180m on which they are currently making margins of close to 10%. My rule of thumb on this is that each 1% of margin is usually worth around 0,1x on an EV/ Sales basis. So here taking the market cap. as the EV due to the pension deficit we get an EV/ Sales ratio of 0.8 suggesting that it could be perhaps 20 to 30% under valued on that measure.
Taking a possible operating profit of say £18m based on those turnover and margin assumptions gives a decent EBIT/EV yield (Mkt. Cap. in this case) of 12.85% and also suggests they are cheap. While more conventional measures such as PE and yield are around 11x and 3% at the current price of 165p or so. The share price and estimates are all pretty much unchanged since I did the detailed write up mentioned above, so it seems I was right to call it rather mundane, although to be fair the market is down by about 4% over the same time frame.
Thus, although the pension deficit is now slightly larger than at the interim stage, this is at least settled for the next three years until the next review and the cash payments etc. seem to have offset this effect. Even ignoring the cash to net off against the Pension liability still leaves them looking quite good value based on the metrics discussed above. It still scores 97 on the CIS & coincidentally the same on Stockopedia's Stock Ranking system.
However, despite this, the price is characteristically flat again this morning so it doesn't look as though the market is going to re-rate it any time soon, but I guess time will tell and it seems patience will be required with this one.
Another positive month in terms of performance as the value of the portfolio increased by 3.13%. However, as you may re-call from yesterday's market update this lagged slightly behind the total return from the FTSE All Share Index which saw a +4.69% total return.
This is the first month in which the portfolio has been behind the index, but this is no surprise as up to now it has benefited from its bias towards mid and small cap / AIM stocks and a corresponding underweight in FTSE 100 stocks and some of the main sectors like Oils and miners which led the way down over the summer. As we saw in the market review it was FTSE 100 and some of these commodity stocks that led the way back up in October, while mid and small cap stocks overall recovered to a much lesser extent having gone down less beforehand. So therefore as I say no surprise that the portfolio lagged behind this recovery.
However it was pleasing to see the portfolio up by 3.13% which was more than the returns seen by the Mid Cap and Smaller indices. The winners that drove this performance this month were:
+26.7% 32 Red (TTR) the online casino & gambling business - a stunning performance from one of this months new holdings after the latest quarterly review at the end of September.
This just seemed to reflect a re-rating possibly in a belated response to their interims towards the end of September rather than any particular news flow this month.
+11.2% WH Smiths (SMWH) after well received results in the month.
+10.8% Maintel (MAI) - this smaller telecoms provider continued to respond positively to its results announced in September and broke out successfully from its trading range as I hoped it might.
On the downside the biggest losers were:
=5.4% RM Group (RM.) the education software provider a more subdued performance from another of this quarters new holdings, which sagged on no news but this may just reflect it closing at the bid rather than the offer last month.
-4.2% Renishaw (RSW) continued its de-rating from last month which has left this quality metrology Company looking better value on a mid teens PE.
-3.8% Howden Joinery (HWDN) the kitchen and joinery specialist is also de-rating but was probably down this month in sympathy with other repair and maintenance stocks as some of these reported weaker trading in recent months.
Summary & Conclusion
Another positive month for the portfolio with a +3.13% total return even if it was behind the broader index. This leaves it up by 11.62% since inception in April 2015. This compares to -3.73% from the FTSE All Share over the same time frame for an outperformance of 15.35%.
So a great start to the life of this portfolio but it is important to remember that given it only consists of 20 holdings and is completely different in construction from the index that we should expect the performance to differ widely from that of the index both in a positive and negative fashion. However if the Compound Income Scores are good at identifying attractive stocks then hopefully this divergence should be in a positive direction over time, so so far so good, but as I always say time will tell.
Meanwhile I have uploaded the updated Portfolio which you can view via the menu at the top of the website or via the drop down menu to the left on mobiles and tablets or by clicking here if that is of interest to you. Of note if I were doing a re-screen this month, which I'm not, the sell candidates on the back of post results down grades would have been IG Group (IGG) and Utilitywise (UTW) with scores of 64 and 71 respectively.
Finally If you are a new or recent reader - welcome and if you are wondering what the Scores are all about and want to learn more about them, then see the Scores heading in the menus mentioned earlier or click here to read & see more about them and how you can access them.
Introduction & History
In the recent re-screening of the Compound Income Scores portfolio I mentioned that I was pretty biased against one of the stocks selected, given its share price has gone sideways for years. The stock concerned was RM which for example traded at 177p back in January 2005 which compares with today's price of 165p so very much a flat liner. To be fair though the broader stock market hasn't been much better, although they note they have underperformed the FTSE Small Cap Ex IT index in total return terms in the Directors Long Term Incentives section of the report and accounts. It has also been anything but a smooth ride for shareholders over the last ten years as you can see from the chart below the price has ranged between a high of around 230p and a low of around 60p during that time.
Along the way shareholders also had to suffer a dividend cut over a couple of years starting in 2011 from 7.13p down to 2.61p. From there is has grown back to 4p in 2014 and is forecast to grow quite strongly back to 5.5p in the year to November 2016. So some good growth is forecast and if they achieve that level of dividend next year then it will be on a yield of 3.3%. On the earnings front these are forecast to grow more modestly to 16p which would leave it on just over 10x (or more like 9x if you factor in some of the cash they have) which is quite a cheap rating and would cover the suggested dividend nearly 3x, thereby offering some reassurance on the security and sustainability of said dividend. To be fair it is also worth pointing out that they paid a special dividend of 16p in 2013 presumably after some disposals given they have been restructuring the business. So given the current cash on the balance sheet (see next section) then I guess another special is always possible but I wouldn't bank on it.
Talking of security lets take a quick look at the balance sheet which at the interim stage boasted Net cash of £43.1m and at that time they said that they expected the 2015 year-end cash position was likely to be ahead of current market expectations so presumably that means higher again but lets run with the £43m for now. Against that this one does have a pension deficit of £30 million or £24 million net of deferred tax also at the interim stage. Another triennial review of this is due which may lead to an increase but they do have a remaining £3.3m set aside in an escrow account which can be used to buy insurance and reduce liabilities (see annual report page 8 for details of this). The group has also been quite cash generative with £19.1m cash generated from operations last year for example (Source: Annual Report).
If we treat the current deficit as a debt / liability and net this off against the cash this would leave say £13m net cash which compares to a market cap. of £136m so would give an adjusted enterprise value of £123m or £93m if you ignore the pension fund. Taking their adjusted operating margin of 8.7% at the interim stage and applying this to full year turnover forecasts of around £180 million gives an EBIT of £15.66 million for an earnings yield on the pension adjusted EV of 12.73% which is pretty attractive. Without adjusting for the pension deficit this would be nearer to 17% so presumably the market is discounting this one to a certain extent to allow for the pension fund. However they seem to have addressed this with a recovery plan and planned payments over a number of years plus the remaining escrow account. So maybe I'm being overly cautious on this and it is also notable that other smaller UK companies with big pension funds and deficits deficits have nevertheless attracted bids despite this, with AGA being one notable example recently. Maybe Pearson might like to mop this one up perhaps now they are seemingly tidying up to focus more on Education?
Description of Business
So what is RM today and what are the prospects? Well what it does is probably best summarised with this extract from the Report and accounts as follows:
The RM plc group of businesses creates and maintains an extensive range of innovative solutions and services - all designed or selected to meet the specific needs of educational users.
The RM group comprises the following divisions:
This division comprises two operating businesses:
TTS and SpaceKraft. TTS provides a wide range of
resources for use in schools and other educational
settings. TTS is a leading provider of physical resources
to UK schools, with over 14,000 product lines and an
established leadership position in Primary and Early Years
age groups. SpaceKraft is a leading provider of resources
and immersive environments to meet the specific
requirements of learners with Special Educational Needs.
RM Results Formerly known as Assessment and Data Services,
RM Results supplies government ministries, exam
boards and professional awarding organisations with
technology and expertise to improve efficiency, accuracy
and clarity in the assessment cycle, both in the UK and
internationally. This includes the systems required to
provide the ‘league tables’ for English schools.
RM Results is a business that provides products and
services that include secure, innovative systems for
creating high-stakes exams and tests, on screen testing,
on screen marking and the management and analysis
of educational data.
RM Education Formerly known as Education Technology,
the division provides technology-based software
and services, specifically designed for UK schools
and other educational establishments, across the
Outsourcing, support and implementation services,
including managed services, on site support,
telephone support and consultancy services.
Network software, tools and infrastructure services,
such as the Community Connect network and device
management tools and virtualisation.
Digital Platforms and Content
Access to curriculum resources and school management
solutions, including RM Integris school management
systems, RM Unify ‘launch pad to the cloud’, RM Books
e-book system, RM Easimaths and RM Easiteach.
Internet The provision of broadband and e-safety solutions.
The group has been restructuring over the last few years and has exited from some of its lower margin hardware and other operations. As such it is now much more focussed on software and services to the educational sector primarily in the UK and as a result costs have been cut and margins increased although this has been at the expense of turnover which has fallen by around £200m from £380 million in 2010 to the expected £180 million or so this year. That's fine though as dear old Warren Buffet said "turnover is vanity, profit is sanity."
At the interim stage they suggested that they expect revenue (turnover) growth to resume in 2016 with all three divisions expected to show growth by 2017. They also suggested maintained strong margins in the Results and Resources divisions where they seem to make mid teens operating margins and this represented 54% of turnover at the interims and 70% of adjusted operating profits. They also suggested increased margins from Education as it focusses more on software and services and this made just over 7% operating margin on £36m of turnover so maybe they could double profits from this division if they can achieve the same kind of margins here as in the other divisions. So things seem to be on a recovery track operationally so lets finish up now as I'm sure you are getting bored with this now too.
Summary & Conclusion
Here we have a small (£100m or so enterprise value) company which has had something of a chequered past but which seems to be on an improving track in terms of the quality of its remaining businesses and prospects after a period of restructuring. They have a strong cash rich balance sheet and strong cash flow generation, although this is offset to a certain extent by a pension deficit of around £30m which is sizeable but probably manageable for them as they have a funded deficit reduction plan in place. But it will be worth watching out for the forthcoming triennial review of this.
The group is expected to show modest turnover and earnings growth next year after strong earning growth on declining turnover in prior years. This has allowed them to rebuild dividends with some strong growth after a cut a few years ago but does leave the currently forecast dividend well covered by expected earnings.
This has all left it looking quite good value on just over 10x for 2016, or 9x adjusted for the cash, with a 3.3% yield and a double digits earnings yield although I note on Stockopedia it only scores 66 for value given the other metrics they take into account. On the Compound Income Scores it gets a higher value score of 88 as I only use earnings yield and dividend yield. Looking at it another way the EV/ Sales seems low at around 0.5 - 0.55x compared to the operating margins which seem to be heading towards 10% or more. This could argue for a fairer EV/ Sales of closer to 1x which suggests the shares could double or more in the medium term on this basis.
Furthermore looking at the rating of 10x and 3.3% yield, perhaps if they can continue to deliver improved returns and the market starts to recognise and reward this more fully then maybe it could move onto a more average rating of say 14x. With next years earnings forecast at 16p this would equate to a price target of 224p which wouldn't be far off the highs of recent years which I guess might then act as resistance. I also note when it re-rated back in 2013 it moved up from a 60p to 100p range to a new range between 120p and 180p which it has been stuck in since. If it can break out of this range then this could also suggest a move up into a new range extending up to perhaps 240p.
Aside from that it scores well on most of the other factors I look at although operational quality is a low score of 35 reflecting the historically lower profitability but this seems to be on an improving track now. Despite this the overall CIS is 96 and the Stockopedia QVM Stock Rank comes in at 97 with stronger scores for Quality (97) and momentum (85). Talking of momentum I note that the 12 month price momentum, whilst positive, only ranks at 42 in the CIS universe of stock while the earnings momentum is stronger at 76 after recent upgrades and suggests that the market perhaps shares some of my scepticism on this one - but therein maybe lies the opportunity? Some good institutional investors seem to agree as Schroders have a 21% stake, Aberforth the highly regarded value investors, have just over 16% and Artemis have just over 10%.
So on the fundamental and technical picture I could see a potential upside of between 35 and 45% or lets say 40% taking the average of the two which gives a target of around 230p at which level the earnings yield would still be a reasonable but perhaps fairer 9% or so. While my back of the envelope EV/ Sales calculations suggest that it could even potentially double in price if they can deliver higher turnover with increased margins.
So given that the MCIS Portfolio has been doing well and the Scores have been quite good at identifying some good performers that are not necessarily that palatable and having done this work on this one, I have treated myself to a few too. Please don't follow me blindly and do your own research as this one could obviously still disappoint if they don't deliver the expected improvement in turnover and margins. If it does then I think the chances of a re-rating are quite good, although it seems there is no immediate catalyst for that. If you do decide to buy it you have to accept a fairly wide spread but at least it has come back from its recent highs.