The Vultures are Circling – Woodford, Carpetright et al

With the demise of the Neil Woodford’s empire and the winding up of the Woodford Equity Income Fund, investors are looking for whom to blame – other than themselves of course for investing in his funds. One target is Hargreaves Lansdown (HL.) and other fund platforms who had it on their recommended or “best buy” lists, including long after the fund’s problems were apparent. Now lawyers are only too glad to help in such circumstances and at least two firms have suggested they can assist.

One is Slater & Gordon. They say they are investigating possible claims against HL. and that “We’re concerned to establish if there was any actionable wrongdoing or conflict of interest by Hargreaves Lansdown in continuing to include Woodford funds on their ‘Best Buy’ Lists if it had concerns as to their underlying investments. We’ll also be looking at the price achieved when buying and selling instruments, such as ordinary shares, on the Hargraves Lansdown platform and whether or not this represents Best Execution”. You can register your interest here: https://tinyurl.com/yyrhbfb3

Another legal firm looking at such a claim is Leigh Day who say they already have 500 investors interested in pursuing a case. See https://tinyurl.com/y6r2buav for more information.

Having been involved in a number of similar legal cases in the past, my advice is that there is no harm in registering an interest but do not pay money up front and certainly not until the basis of any legal claim is clear. In addition bear in mind that it would be very expensive to pursue such a claim and lawyers may be willing to do so simply in anticipation of high fees when there is no certainty of winning a case. How is the case to be financed is one question to ask? Funding such cases by private investors alone (the majority of HL. clients) is likely to be difficult so “litigation funding” is likely to be required which can be expensive and erode likely returns. Insurance to cover the risk of losing the case is also needed and expensive.

Yesterday saw news announcements from three companies I have held in the past but all sold some time ago. The most significant was from Carpetright (CPR) which I last sold in 2010 at about 800p. It’s been downhill ever since. The Daily Telegraph ran an article today suggesting that this was a zombie company and that it was a good time of year for zombie slaying. After the announcement of a trading update and possible bid yesterday the share price is now 5p.

The Board of Directors “believes that Carpetright is performing well….” and “the prolonged sales decline appears to be bottoming out….”, but the company has too much debt and needs refinancing. One of its major lenders and shareholders is Meditor who have proposed to make a cash offer of 5p per share for the company. The share price promptly halved to that level because it is likely that the offer will be accepted by enough shareholders to be approved. So it looks like we will have a company with revenues of £380 million (but no profits), sold for £15 million. Founder Lord Harris, who is long departed, must be crying over this turn of events. But it demonstrates that when a company is in hock to its bankers and dominant shareholders, minority investors should steer clear.

Another announcement was from Proactis Holdings (PHD) which I sold fortuitously in mid-2018. They announced Final Results yesterday. Revenues increased by 4% but a large loss of £26 million was reported due to a large impairment charge against its US operations. The business has undertaken an operational review and restructuring is in progress. It has also been put up for sale but there is little news on potential “expressions of interest”. Just too many uncertainties and debt way too high (now equal to market cap) in my opinion.

The third announcement was from Smartspace Software (SMRT) which I sold earlier this year at more than the current share price as progress seemed to be slow and I wanted to tidy up my over-large portfolio. It reported interim results where revenue was up 57% but there was a large loss reported (more than revenue). There were some positive noises from the CEO so the share price only fell 0.7%. The company has some interesting products for managing office space but it’s a typical “story” stock where the potential seems high but it has yet to prove it can run a profitable business.

I have also noticed lately that the fizz has gone out of the share price of Fevertree (FEVR). It’s been falling for some time. I sold it in 2018 at a much higher level. It still looks quite expensive on a prospective p/e basis. Overall revenue is still growing rapidly but the USA is still the big potential market yet to be proven. I like the business model and the management even if I don’t personally like the main product. But perhaps one to keep an eye on. But generally buying back into past investments can be a mistake.

Given my track record on the above, perhaps my next investment book should not be on choosing new investments but on choosing when to sell existing ones?

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

Safestore and Fundsmith AGMs

Today I attended the Annual General Meeting of Safestore Holdings Plc (SAFE) in Borehamwood. Their head office is next to one of their self-storage units. They now have 146 stores with a concentration in London/South-East England, and in major UK cities, plus some in Paris.

The Chairman, Alan Lewis, commenced the meeting with a very brief statement. He said 2018 was a good year with good strategic progress. He is confident value creation will continue. Note that Mr Lewis is stepping down as Chairman and they are looking for a replacement as he has now served for 9 years.

Safestore is a growing company in a growing sector. As people accumulate more junk, house sizes shrink and more people live in flats, they run out of space for their belongings. The demand is also driven by divorce and death. In addition to personal users, small businesses find such facilities useful to store goods, tools & equipment, or display material.

Revenue was up 11% last year, and earnings up 125% (or as this can be seen as a property company, EPRA earnings were up 15.5%). The dividend was increased by 13.8%. Self-storage companies can be perceived as property companies but they are best viewed as operating businesses in my view (the CEO seemed to agree with that). The market cap is way higher than the book value of the assets unlike in most property companies of late. Self-storage is one of the few growth areas in the property sector at present.

Page 8 of the Annual Report gives some information on the market for such facilities. Compared with say the USA, the UK storage space per head of population is only a small fraction of the USA. In other words, the UK market is relatively immature and to reach the same level as the USA would require another 12,000 stores!

I asked the Chairman why the company did not expand more rapidly if the potential is there? The response from the CEO was that there were problems with finding suitable new sites and with planning restrictions. They are also conservative on finance. A question on potential acquisitions arose as it is a fairly fragmented market in the UK but it seems few such opportunities are reasonably priced and meet the quality criteria they have. They did take over Alligator last year. Competitors don’t seem to be growing any more rapidly, and the CEO suggested they were gaining market share.

The main other question I raised was about their Remuneration scheme. At the 2017 AGM they only just managed to win the Remuneration Policy vote and at the 2018 AGM the Remuneration resolution was again just narrowly voted through. Remuneration Committee Chairperson Claire Balmforth explained that institutional investors were unhappy with the LTIP and the “quantum” of pay – that’s a polite way of saying it was too high. Indeed remuneration at this company is high in relation to the size of the business – the CEO received a total pay of £1.6 million last year (single figure remuneration). Even the Chairman received £135,000.

However it’s apparently all change after extensive conversations with institutional investors. The executive directors have agreed changes to the LTIP and a “more conventional” LTIP will be introduced in 2020. As a result they did better on the remuneration vote, and the votes on the re-election of Balmforth and Lewis, with the Remuneration resolution passing with 70% support.

It was not until later when I chatted to the directors that I discovered where I had come across Claire Balmforth before. She used to be HR Director, then Operations Director, at Carpetright when I held shares in that company.

Anyway I gave them my views on remuneration. Namely I don’t like LTIPs at all, particularly those that pay out more than 100% of base salary. I prefer directors are paid a higher basic salary with an annual bonus paid partly in cash, partly in shares.

Other than the pay issue, I was positively impressed as a result of attending the meeting.

One issue that arose was the poor turnout of shareholders at the meeting. There were more “suits” (i.e. advisors) than the 3 ordinary shareholders (two of those were me and son Alex). Now it happens that earlier in the day I was watching a recording of the annual meeting of Fundsmith Equity Fund which I had not been able to attend in person this year. Terry Smith was in his usual good form, and he said there were 1,300 investors at the meeting. That’s more than any other UK listed company or fund (most funds do not even have such meetings). An amusing and informative presentation helps enormously to attract investors of course. I wish all companies would bear that in mind.

You can watch the Fundsmith meeting recording here: https://www.fundsmith.co.uk/tv .

Anyone who wishes to learn how to make money in stock markets should watch it. Terry Smith has a remarkable record at Fundsmith. He said last year was not a vintage year as the fund was only up 2.2%. But that beat their benchmark and only 7.8% of UK funds generated positive returns last year. In the top 15 largest UK funds over 3 and 5 years, they are the clear winner.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.

It’s a Bleak Mid-Winter

It’s a bleak mid-winter, everybody is hunkering down against the icy winds, Royal Mail have given up delivering post even in the London suburbs, and retailers are suffering. Well no, actually it’s the second day of Spring but the first was the coldest one on record. It’s not surprising that many people have a jaundiced view of the science of global warming.

But the stock market is drifting down and the news from many companies is dire. Let’s review some of those to start with. Note: I hold or have held some of the companies mentioned.

Safestyle (SFE) sell replacement plastic windows. You would have thought households would be rushing to replace their tired and leaking windows in the bad weather but apparently not. On the 28th Feb they announced a profit warning and the share price fell 37% in the next two days. Is that because of difficulties in installing in the bad weather? No, that will come later no doubt. The problem was lack of order intake so far this year. The real problem is “the activities of an aggressive new market entrant” in an “already competitive landscape” – the latter presumably referring to consumers cutting back on big ticket items. Historically the company showed great return on capital and good profits but the old problem of lack of barriers to entry of competition seems to be the issue.

Carpetright (CPR) also issued a profit warning yesterday. They now expect a loss for the year and blame “continued weak consumer confidence”. It seems they need to have a chat with their bankers about their bank covenants, but the latter “remain fully supportive”. I suspect the real issue here is not consumers (most buyers replace carpet in one room at a time so they are not exactly big purchases) but competition, including from Lord Harris’s son (Phil Harris was the founder and Chairman of Carpetright for many years). Other carpet suppliers (such as Headlam which I hold) have not seen such a major impact, but perhaps they are not as operationally geared as Carpetright. Or the bad news will come later.

Many retailers have faced a changing market – the market never stands still, with internet sales impacting many. Both Toys-R-Us and Maplin have gone into administration. The latter have no doubt been particularly hit by the internet and Amazon, but they have also suffered by private equity gearing up their balance sheets with very high levels of debt. Neither seemed particularly adept at keeping up with fashion. Might just be a case of “tired” stores and dull merchandise ranges. But why would anyone buy from a Maplin store when they could order what they needed over the internet (from Maplin, Amazon or thousands of other on-line retailers) and get it delivered straight to their door in 24 hours? In addition, many such on-line suppliers avoid paying VAT so Maplin was going to suffer from price comparisons.

But there has been some better news. IDOX (IDOX) published their final results yesterday – well at least there was no more bad news. They issued previous profit warnings after a dreadful acquisition of a company named 6PM, and the CEO, Andrew Riley, then went AWOL on health grounds. In addition there were problems with inappropriate revenue recognition, a common issue in software companies. Mr Riley has now definitely departed permanently and former CEO Richard Kellett-Clarke continues to serve as interim CEO.

The latest financial figures report revenue up 16% for the year although some of the increase will be from acquisitions. The profit figures reported on the first page of the announcement are best ignored – they talk about EBITDA, indeed “adjusted EBITDA” and “adjusted earnings”. I simply skipped to the cash flow statement which indicated “net cash from operating activities” of £13.4 million. That compares with a market cap at the time of writing of £152 million, so the cash earnings yield might be viewed as 8.8%.

They did spend £24.3 million on “investing activities”, mainly financed by the issue of new shares, last year and much of that might effectively have been wasted. But cash flow going forward should improve. Unadjusted diluted earnings per share were very substantially reduced mainly due to increased overheads, higher amortisation and high restructuring and impairment costs. These certainly need to be tackled, but the dividend was increased which shows some confidence in the future.

The share price perked up after the results announcement but some commentators, such as my well-known correspondent Tom Winnifrith, focused on the balance sheet with comments such as “negative current assets” (i.e. current ratio less than one) and less polite phrases – he does not pull his punches.

Any accountant will tell you that a company with a current ratio (current assets divided by current liabilities) of less than 1.4 is likely to go bust simply because they risk running out of cash and will not be able to “meet their debts as they become due” (i.e. will become insolvent).

Am I concerned? No because examination of the balance sheet tells me that they have £19.8m of deferred income in the current liabilities (see note 18). This represents support charges which have been billed in advance for the year ahead. Such liabilities are never in fact crystalised in software companies. So deducting that from the current liabilities results in a current ratio that is a positive 1.7.

The balance sheet now does have substantial debt on it, offset by large amounts of “intangible” assets due to capitalisation of software development costs which many folks would ignore. The debt certainly needs to be reduced but that should be possible with current cash flow, and comments from the CEO about future prospects are positive. That is why the share price rose rather than fell I suggest on the announcement, plus the fact that no more accounting issues had been revealed.

There are promises of Spring next week, so let us hope that this will improve the market gloom that seems to be pervading investors of late. Even retailers may do better if shoppers can actually get to their shops. We just need the sun to come out for a few days and flower buds to start opening, for the mood to lighten but I fear my spring daffodils have been frozen to death.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

You can “follow” this blog by clicking on the bottom right.

© Copyright. Disclaimer: Read the About page before relying on any information in this post.