phil oakley’s weekly round-up - investors chronicle · currency movements this week haven’t...

www.investorschronicle.co.uktelephone: +44 (0)20 7873 3000 email: [email protected]© The Financial Times Limited 2019. Investors Chronicle is a trademark of The Financial Times Limited.

11

Currency movements this week haven’t helped the Fantasy Sipp portfolio, but I believe in quality companies for the long haul

The companies mentioned this week are:n WH Smithn Domino’s Pizzan Bellwayn Tristeln AO Worldn Marston’s

The Fantasy Sipp continues to retreat from its peak seen a few months ago, but continues to hold its own against some of the top-quality funds out there, while beating both the FTSE All-Share index and S&P 500.

The chief reason for the decline has been a sharp ap-preciation in the value of the pound. This has reduced the sterling value of the many US shares in the portfolio, while hitting the value of most of the UK shares that have

18 October 2019

Alpha Production Editor: Sameera Hai Baig

Phil Oakley’s Weekly Round-Upxxxxx

Fantasy Sipp performance Portfolio returns ( %) 1 month Year to date 1 year

Mid Wynd International Inv Trust -2.4 25.1 18.3

LF Blue Whale Growth Fund -2.8 23.1 15.9

Fundsmith Equity T Acc -1.9 22.8 18.5

Martin Currie Global Portfolio -2.5 22.4 17.1

Phil Oakley Fantasy Sipp -3.2 22.3 23.9Smithson Investment Trust -3.2 20.8 –

Lindsell Train Global Funds plc -4.1 20.7 19.7

Finsbury Growth & Income Trust -5.0 19.5 20.3

Vanguard S&P 500 ETF -3.4 18.8 9.4

Castlefield CFP SDL UK Buffettology Fund -0.6 13.7 8.6

FTSE All-Share – Total Return -1.4 11.9 6.7

Scottish Mortgage Investment Trust -5.3 5.4 0.1Source: SharePad


2

large overseas earnings.This does not worry me too much as you have to take the

rough with the smooth when it comes to exchange rates. The companies in the portfolio all have businesses that are currently performing well and growing profits, which is more important than anything else.

I’ve written recently about the pound and have said that $1.30-$1.40 is not beyond imagination, but we will see how things pan out. It will not force me to shift the portfo-lio towards UK earning stocks of inferior quality.

Over in the US, it seems that there is some desire to sort out the trade war with China. This should be positive for markets as it would remove a lot of uncertainty.

WH SmithWH Smith’s (SMWH) travel business is backed by very attractive fundamentals – captive customers, high footfall and pricing power. In my view, these positives offset the negatives of its dreary and declining high street stores. The growth prospects for travel remains the reason why WH Smith is a core holding in the Fantasy Sipp portfolio.

Full-year results released on Thursday show that this investment case remains intact. High-street profits were unchanged at £60m – which is a pretty good result – with Travel profits up by 14 per cent to £117m. Pre-tax profits for the company as a whole were slightly better than consensus forecasts at £155m, with an 8 per cent increase in the total dividend per share t0 58.2p.

The growth in travel profits mostly came from last year’s acquisition of InMotion in the US. That said, the busi-ness as a whole delivered like-for-like (LFL) sales growth of 3 per cent. UK profits increased by 5 per cent as gross margins rose by 70 basis points, helped by very strong LFL sales growth of 6 per cent from its hospital stores.

The prospects for future growth look good with 19 new units won in the UK and 45 internationally. However, the big news of the day was the company saying that it is buy-


3

ing US travel retailer Marshall Retail for $400m (£312m) on a cash-free and debt-free basis.

This is a big deal that will significantly increase the footprint of the business in the very important US market. At first glance, this looks like it could be a good deal that could enhance the long-term wealth of its shareholders.

The company is getting its hands on 170 stores of which 59 are in airports. It also has a resorts and tourism busi-ness, which is dominated by its presence in Las Vegas. Marshall makes the bulk of its money from selling news, gifts and convenience products. Its split of revenue for 2019 is shown below.

The business is not as profitable as the UK travel busi-ness, but has attractive margins nonetheless. I think it’s fair to say that WH Smith is paying a very full price for this business, but if all goes well, it should stack up financially for its investors.

Marshalls is expected to open 36 new stores between 2020 and 2024, and will add more than 75 per cent to its retail selling space in US airports, giving it a good source of future growth.

WH Smith reckons the deal will enhance earnings per share (EPS) by a mid-single-digit percentage in 2020 and by a double-digit percentage in 2021. The return on capital on the deal is expected to exceed its cost of capital after three years.

The company will pay for half of the cost by issuing £155m of new shares and still enhance EPS. This is a good use of equity financing and will make sure that debt levels do not go too high.

The deal will also shift the balance of company profits further towards travel and away from the UK high street, and that is undoubtedly a good thing that could possibly lead to an upwards rerating of WH Smith shares. I con-tinue to view the company as one of the best retail plays on the UK stock market.

Marshall Retail $mAirports 84

Resorts 68

Tourism 51

Total Revenue 203

Ebitda 31.5

margin 15.5%

Est cost savings 11

Ebitda after cost savings 42.5

Price Paid 400

EV/Ebitda before cost savings 12.7

EV/Ebitda after cost savings 9.4Source: WH Smith


4

Domino’s PizzaDomino’s Pizza (DOM) is a very profitable business. Its main challenge in recent years has been getting its UK business to grow in a healthy and sustainable way.

It hasn’t been able to do this. It is embroiled in a big row with its franchisees who think that Domino’s is making too much money at their expense. It is also pursuing a growth strategy of splitting its store territories – such as having a third store when there were previously two – which is also putting pressure on franchisee profit by cannibalising their existing business.

Therefore, a big conflict of interest exists between Domino’s and its franchisees. Domino’s makes the vast majority of its profits by selling ingredients to its fran-chisees. It therefore wins out from splitting territories if its means more pizzas are sold overall (its system sales).

This is borne out in its third-quarter trading statement where UK system sales were up by 3.9 per cent. LFL sales before the impact of splits was 3 per cent, but was only 1.4 per cent after splits which shows that there is a reasonable sales cannibalisation effect going on. In Ireland, cannibal-isation is going on as well, with LFL sales down by 0.7 per cent before splits and by 1.7 per cent after they are taken into account.

This cannibalisation will undoubtedly have an impact on franchisee profitability where cost inflation remains a major issue.

Something eventually is going to have to give. Domino’s business model, which is very profitable and capital-light, is reliant on franchisees. If franchisees feel that the eco-nomics of their stores is being undermined by Domino’s then they will not open more and Domino’s will struggle to sell more ingredients. I think it would be very disruptive and costly for Domino’s to abandon its franchise model and that moving to owning stores outright may not work and would totally change the economics of its business – not for the better.

WH Smith forecasts Year (£m) 2019 2020 2021

Turnover 1,397.90 1,474.00 1,517.80

Ebitda 204.9 222.1 233.1

Ebit 157.7 171.2 180.3

Pre-tax profit 154.1 165.3 175.2

Post-tax profit 123 133.9 141.5

EPS (p) 116.3 125.7 134.9

Dividend (p) 58.4 63.6 69.1

Capex 57.2 55.3 56.5

Free cash flow 109.3 131.6 140.7

Net borrowing 161.2 146 122.9Source: SharePad


5

If arguing with its franchisees was not bad enough, com-petition in the UK continues to ramp up. Thanks to ser-vices such as Just Eat, Deliveroo and UberEats, it is getting easier for consumers to find alternative places to get their takeaway pizza from.

The good news is that Domino’s has decided to get out of its European business which has been losing money. This will eventually boost group profits but does not address the key challenges in the UK.

BellwayI’ve thought for a few months now that the new-build housing market has peaked and is probably on its way down. The Help to Buy-fuelled boom in selling prices and new build premiums – the difference between the selling price of a new home compared with a similar existing one – has delivered huge windfall profits for housebuilders and this now looks to be over.

Bellway (BWY) delivered a decent set of full-year results this week, with revenues up by 8.6 per cent. Operating margins fell by 110 basis points, despite a benefit from the high-margin Nine Elms development in London which won’t be repeated in 2020.

The company has spooked investors by saying that margins are normalising – going down – but this should be expected. New-build home prices have become wildly overpriced and cannot increase by much more in many areas of the country. Build cost inflation continues at around 3-4 per cent, while volume growth expectations are coming down, as both Bellway and Barratt have mentioned this week.

Yet, I am not particularly bearish on builders at the moment. A UK recession will undoubtedly find them out as it has in the past, but these businesses are being cau-tiously managed. In most cases, they have relatively short land banks – four years of current sales volumes or less – strong finances and continue to pay good dividends. I

Domino’s Pizza forecasts

Year (£m) 2019 2020 2021

Turnover 611.9 642.7 681.2

Ebitda 105.2 114.2 122.3

Ebit 89.2 97.5 105

Pre-tax profit 86.4 93.7 102

Post-tax profit 68.3 73.7 81.5

EPS (p) 15 16.3 17.5

Dividend (p) 9.4 10.2 10.8

Capex 26.9 25 24.8

Free cash flow 47.3 67.5 74.5

Net borrowing 227 207.7 186.5Source: SharePad


6

just think that profits growth is going to get much more difficult going forward.

The main attraction for investors at the moment remains the prospect of receiving good levels of dividend income.

TristelI can’t quite make up my mind whether I like the business of Cambridge-based Tristel (TSTL) or not. The company sells disinfectant products such as wipes and solutions based on its own chlorine dioxide formulation.

The vast majority of its revenues come from selling its products to hospitals where they are used in disinfecting surgical instruments, surfaces, water and skin. As much as 95 per cent of its sales are repeat purchases, which means they tend to be very stable and predictable and that is a desirable characteristic in any business.

There are also barriers to competition. Tristel is the only provider of chlorine dioxide and has 277 patents registered in 36 countries, along with a stack of regula-tory approvals and compatibility with lots of applications. These are costly and time-consuming for any competitor to acquire.

As a result, Tristel makes very healthy profits with operating margins of 18 per cent last year.

It is also growing well, with organic revenue growth

Bellway forecasts Year (£m) 2019 2020 2021

Turnover 3,201.20 3,286.00 3,378.40

Ebitda 679.6 668.7 662.8

Ebit 677.3 658.6 664.7

Pre-tax profit 665 635 656

Post-tax profit 542.4 521.4 520.2

EPS (p) 437.6 421.5 435.4

Dividend (p) 147.6 151.7 166

Capex 4.4 4.3 4.8

Free cash flow 272.3 396.4 339.7

Net borrowing -192.7 -178 -541Source: SharePad

Housebuilder yieldsName Close fc Yield 2y fc Yield 3y fc YieldBarratt Developments 676.80 6.90 7.10 7.1

Bellway 3370 4.9 4.9 5.3

Berkeley Group Holdings (The) 4454 4.7 4.8 4.4

Bovis Homes Group 1213 8.6 8.5 7.8

Crest Nicholson Holdings Ltd 415.4 7.9 7.9 7.9

McCarthy & Stone 155.7 3.5 3.7 4.2

MJ Gleeson 782 4.6 4.8 5.1

Persimmon 2336 10.1 10.1 9.9

Redrow 639 4.9 6.7 6.3

Taylor Wimpey 164 11 11.2 11.6Source:SharePad


7

of 10 per cent last year, topped up by revenues from the acquisition of some of its European distributors, to give growth of 18 per cent overall to £26.2m. The core UK business saw very decent revenue growth of 9 per cent in what is a mature market, while overseas revenues in-creased by 26 per cent and now represent 55 per cent of total revenues.

Pre-tax profits after share-based payments – Tristel is a company which seems to think that these are not a real cost – increased by 17.5 per cent to £4.7m, while share-holders will be cheered by a 21 per cent increase in the annual dividend to 5.54p per share.

The company has very ambitious plans to grow. It wants to increase revenues by 10-15 per cent per year in the three years to 2022. It doesn’t say whether it wants to achieve this organically or with the help of buying companies. It does say that it wants to do so, while maintaining earn-ings before interest, tax, depreciation and amortisation (Ebitda) margins – before share-based payments – of 25 per cent.

There are some decent organic growth prospects from getting regulatory approval and patent protection for its products in the US, while the company is talking very op-timistically about the prospects for the ultrasound disin-fectant market where demand is currently buoyant.

So why can’t I make my mind up whether Tristel is a very good business or not?

I suppose it’s because rightly or wrongly I see disinfect-ant as a fairly commoditised product. I understand the patents and regulatory approvals and the protection they give, but high margins eventually attract competition. Health services across the world face tremendous and growing pressures to save money and my concern would be that profit margins have the scope to come down a lot.

Despite growing its profits, Tristel shares have traded in a range for the past two years and have not broken out of it. The shares used to command a very high valuation and that has come down a lot. A year ago, the shares were trading on a forecast PE of 27 times. At 292p, they still trade on a 2020F PE of just over 24 times.

I’m not sure I’d have the conviction to buy this for the long haul, despite some quality hallmarks. The company is doing well, but my worry is that the economic moat it seems to have now may not withstand a sustained attack.


8

AO WorldWhy would you want to own the shares of an electrical retailer? They are selling undifferentiated products at wafer thin margins and need to sell lots of them to stand a chance of making even modest profits.

AO World (AO.) set out its stall as a retail disruptor – an internet-only retailer which would compete on price, service and offer recycling services to carve out a profit-able slice of the market for home appliances and electrical goods. This is a business where size and the buying power that comes with it are all important.

The UK business is making an operating profit, but its European business has been losing significant amounts of money – and the losses have been going up – as well as burning lots of cash flow. The company may have been guilty of trying to run before it can walk. The business overall is currently loss-making, with the European business losing £30m and the UK business making around £15m.

The company’s share price is a sign of a business that is unwell and where people fear for its future health. At a share price of 65p, the business still has a stock market equity value of £312m. The big question is whether share-holders will have to stump more money to give the Euro-pean business a chance of breaking even in 2021.

Tristel forecasts Year (£m) 2019 2020

Turnover 26 30

Ebitda 7.2 8.4

Ebit 5.5 6.5

Pre-tax profit 5.5 6.5

Post-tax profit 4.6 5.5

EPS (p) 10.3 12.1

Dividend (p) 5.3 6.3

Capex 1.7 1.4

Free cash flow 4.6 5.6

Net borrowing -4.2 -7.2Source: SharePad

AO World forecasts Year (£m) 2020 2021 2022

Turnover 1,114.70 1,208.20 1,438.20

Ebitda 6 16.1 41.6

Ebit -2.7 7.7 34.6

Pre-tax profit -3.8 5.6 -

Post-tax profit -3.8 0.8 -

EPS (p) -0.8 1.7 -

Dividend (p) - - -

Capex 7 5 4

Free cash flow -7 -1 20.8

Net borrowing 18.1 -15.5 -10Source: SharePad


9

I purchased my first product from AO this week – a new washing machine – and have to say I was impressed with the service. Not so long ago, John Lewis would have been the destination for this purchase, but I must admit to hav-ing given up on them, as customer service levels seem to have taken a dive while the business tries to make itself profitable again.

After the Bosch repair man had broken the bad news that the Oakley washing machine had been half eaten by a mouse that the cat had brought in and with a week’s washing piling up, my wife was coming to the end of her tether. A new machine was duly ordered on the AO web-site at 1pm which price-matched the best price out there; guaranteed free next day delivery and to take our dead machine away to be recycled for an extra £20.

By 2pm it dawned on me that I had ordered the wrong machine – an integrated one instead of a free-standing one. This was put right very quickly with a call to customer services without losing the much needed next day delivery.

Then came a further five minutes or so of a very friendly, but pushy hard sell into trying to persuade me to buy an additional warranty. I expect this whenever I buy an ex-pensive electrical item, as they are very profitable for the retailers selling them.

Despite getting a two year manufacturer’s warranty, the AO woman was trying to get me to sign up to a care plan costing £7.95 per month that started immediately rather than after the manufacturer’s warranty had expired. She said I should go for it as it would pay out even if another mouse came in and ate our new machine.

I politely declined. The price was nothing short of a rip-off. My only previous experience of these kind of plans was nearly 20 years ago when a persuasive salesman in Curry’s offered me a hefty discount on a shop display tumble dryer and a free five-year warranty.

It was a good job he did because it broke down after a year – when the guarantee had run out – and was fixed by a man from the shop who spent an age going through the user manual to work out how to fix it. The tumble dryer is still going strong today, but since then I have only bought extended warranties from the manufacturer. I duly bought a three-year extended warranty – taking it to five years – for what I thought a very reasonable £90 from Bosch, as its customer repair service is first class.

This hard sell experience got me thinking how reliant AO is on warranty profits and how reliant the woman on the phone was on commission to supplement her pay.

The next morning I got a three-hour delivery slot emailed and texted to me. Two friendly people turned up


10

on time in the afternoon and duly plonked the new wash-ing machine on the kitchen floor – I won’t pay more to plumb it in as that’s not too difficult a task.

While they are unwrapping it for me, I get chatting to them and ask them how busy they are (I often do this if I am dealing with a stock exchange-listed company). The answer is that they are doing nine-hour shifts across Essex and Kent with 40 deliveries per day. I get a quick oveview on how slick AO’s distribution is – and apparently it is – and that the focus on customer service is the highest priority.

My customer experience may have been unique, but it was very good and I would use AO again. I have every reason to think there is a decent customer culture in this company which could allow it to keep taking market share from the likes of John Lewis and Curry’s in the UK.

But would I buy shares in AO?Probably not, as it doesn’t fit my long-term quality char-

acteristics. However, I can see the path to a higher share price. It needs to close down its European operations which have never really worked well for British electri-cal retailers – Comet and Carphone Warehouse spring to mind – and concentrate on the UK where it seems to be doing a better job.

Marston’sReaders on my magazine column in recent weeks will have seen that I have been studying the annual report and financial statements of Marston’s (MARS) in some depth. I think it is a business that is having quite a few problems, especially when it comes to growing the profits of its core managed pubs business.

Its balance sheet is loaded up with debt, its cash flow is poor and its profits and asset values look to be overstated. Its dividend payment looks somewhat dependent on the business raising cash from selling off a chunk of its pub estate every year.

Marstons forecasts Year (£m) 2019 2020 2021

Turnover 1,169.30 1,203.50 1,222.90

Ebitda 223.7 231.7 233.2

Ebit 181.3 187.9 188.8

Pre-tax profit 103.4 105.4 108.7

Post-tax profit 85.9 88.3 92.8

EPS (p) 13.6 13.8 14.2

Dividend (p) 7.5 7.5 7.5

Capex 123.1 80.4 79.9

Free cash flow 80.9 115.5 106.1

Net borrowing 1,394.20 1,336.20 1,288.00Source: SharePad


11

This week’s year-end trading update was not particu-larly encouraging. The performance of the Destination and Premium Pubs – a business into which Marston’s has invested significant amounts of money in recent years – is worrying, as there was virtually no growth in revenues last year. The tenanted pubs business is performing reasonably well and Brewing has built on a strong perfor-mance in 2018.

The bottom line is that Marston’s will make less money than last year – pre-tax profits of £101m – but what’s worse is that profits in 2020 are not expected to grow either.

In response to this scenario, the company will sell more pubs to get its debt levels down further. My concern remains that it will have to write down the value of its pubs by quite a significant amount to reflect their weak financial performance and low returns on capital em-ployed (ROCE). This could blow a big hole in its distribut-able reserves (retained profits are c£100m) and lead to a dividend cut.

Could Marston’s become a takeover target? The high debts might put bidders off, but most of the debt is se-cured against its tenanted pub assets. We have seen take-over interest in brewing assets this year with Fullers and Marston’s having some attractive brands that could attract interest. A break-up of the business cannot be ruled out, in my opinion.


12

© The Financial Times Limited 2019. Investors Chronicle is a trademark of The Finan-cial Times Limited. “Financial Times” and “FT” are registered trademarks and service marks of The Financial Times Limited. All rights reserved. No part of this publication or information contained within it may be commercially exploited in any way without prior permission in writing from the editor.

Permitted Use: By purchasing this magazine, you agree that the intellectual property rights (including copyright and database rights) in its content belong to The Financial Times Limited and/or its licensors. This magazine is for your own personal, non-com-mercial use. You must not use any of the content as part of any commercial product or service, including without limitation any which reduces the need for third parties to use the Investors Chronicle magazine and/or website, or which creates revenue from the content, or which is to the detriment of our own ability to generate revenues from that content. For example, you must not use any of our content in any syndica-tion, content aggregation, news aggregation, tips aggregation, library, archive or similar service, and you must not capture any such content, whether systematically, regularly or otherwise, in any form of database without our prior written permission. These contractual rights are without prejudice to our rights to protect our intellectual property rights under law.

Investors Chronicle adheres to a self-regulation regime under the FT Editorial Code of Practice: A link to the FT Editorial Code of Practice can be found at www.ft.com/editorialcode. Many of the charts in the magazine are based on material supplied by Thomson Datastream and S&P Capital IQ.

Material (including tips) contained in this magazine is for general information only and is not intended to be relied upon by individual readers in making (or refraining from making) any specific investment decision. Appropriate independent advice should be obtained before making any such decisions. The Financial Times Limited does not accept any liability for any loss suffered by any reader as a result of any such decision.

ISSN 0261-3115.

phil oakley’s weekly round-up - investors chronicle · currency movements this week haven’t...

Documents