Friday, 30 January 2015

Vedanta (VED) ... in for a penny

Friday 30th January 2015

Vedanta (VED LN, mkt cap £1,021 million) has fallen by some 68% since its 2014 peak, to 371p/shr. In the twelve years or so since it floated, VED has been as high as near 3,000p/shr but is now right back down to below its IPO price from 2003.

Vedanta - share price since 2003 IPO
Source: Bloomberg
That Vedanta has fallen in recent times is probably no great surprise. After all, oil, iron ore, zinc, copper, you name it, have each fallen precipitously at various points during recent years. Whether this decline in general commodity prices is set to continue, I do not know. Momentum would suggest it is likely. But it's worth noting that some are now approaching the lows that were seen during 2008-09. Perhaps those lows will act as a some support? Perhaps they will be breached and demonstrate that the global troubles that erupted some seven years ago have yet to be adequately solved?

Commodity prices since 2000 - Iron ore, Oil, Copper, Zinc, and Aluminium
Source: Bloomberg
On the flip side, at some stage, the collapse in oil prices in particular, should prompt consumers to spend their fuel/energy related savings elsewhere. Deflation in non-discretionary goods might end up spurring inflation in discretionary items. Further, monetary conditions generally remain as loose as ever with regards to interest rates, although exchange rates are more volatile and tighter/looser for different regions.  

The principal risk to Vedanta and all other commodity based players is that the price of their goods continue to drop. But it's safe to say that commodity prices won't go to zero, so investors will have to take a view as to where the bottom is to be found.  

In for a penny

Where Vedanta differs to its peers is in the composition of its share holding. Some 89% of its share issue is in the hands of five holders. Just shy of 70% of the issue is held by its founder, Mr Anil Agarwal, through Volcan Investments.

Vedanta - share holder register
Source: Bloomberg
So while resource company valuations will depend on general investor appetite for risk and views on the outlook for commodities, Vedanta's may rest more heavily on the view of one individual; its chairman and major owner, Mr Anil Agarwal.

Mr Anil Agarwal's last big splurge on Vedanta was in February 2013. Back then he purchased over 5 million shares at around £12.50 per share; some c. £64 million worth. This nabbed him an additional 1.8% of the shares in issue. His timing was not great. £64 million today would get him an additional 6% of the shares. So two years later, he may well decide in for a penny in for a pound, or in for 70% in for the whole kit and caboodle. Were he to buy in the remainder of the shares in issue, this may be at a cost of between £350 to £470 million; or somewhere in the range of 370p to 500p per share. And why not?    

At its last set of interims to 30th September 2014, Vedanta reported net assets of $16.9 billion or c. £11 billion. I would add that this is also pretty much its tangible net asset value. This suggests that the shares currently trade at a 90% discount to its tangible NAV. Whether the value ascribed to its tangible assets is altogether accurate I am unsure, but a 90% discount does leave one with some margin for error.    

Of course, gross debt is remarkably high as compared to its market capitalisation. Gross debt was reported (this morning) to have totalled $16.8 billion (c. £11.1 billion) as at 31 December 2014. However, the group also has cash and liquid investments of $8.0 billion (c. £5.3 billion), meaning net debt stands at $8.8 billion (c. £5.8 billion).

And there is some market concern over the group's debt and its covenants. The covenants centre on meeting a fixed charge cover ratio, a net borrowing to EBITDA ratio, total net assets to borrowings ratio and net interest expense to EBITDA. However, the group has reported today that debt maturities total $1.273 billion for FY 2015 and $1.450 billion for FY2016. Further, that it has access to various sources of funding and no doubt potentially cheaper sources of funding than that which it presently services. Incidentally, EBITDA was down 7% YOY in the nine months to 31st December 2014, yet this is still a decent performance totalling $3,120 million.

Why the market has concern over the group's ability to service its debt and risk of refinancing is beyond me. Firstly, Vedanta is on track to haul in consensus EBITDA of $4,254 million for FY2015. And EBITDA has historically provided a good steer on operating cash flow. Secondly, free cash flow is forecast at $872 million for FY2015. This will come on the back of $1,096 million and $1,346 million free cash flow achieved in 2013 and 2014 respectively. And finally, does the market really reckon that Mr Anil Agarwal, with 70% of the equity nor for that matter likely the Indian State is going to come close to seeing Vedanta default on its debt?

Price to 2 year forward earnings - Vedanta, Rio, Vale, BHP, Anto
Source: Bloomberg
Price to book  - Vedanta, Rio, Vale, BHP, Anto
Source: Bloomberg

And another thing

Vedanta yields a whopping 11% on its prospective dividend. This is a chunky yield, yet comes at a cost of c. $173 million or c. £114 million. In the grand scheme of things, this is not a lot for it to pay.

Prospective dividend yields - Vedanta, Rio, Vale, BHP, Anto
Source: Bloomberg

And one more thing

I am reliably informed that the short interest stands at 2.3%. This is not in itself a high figure, yet if you recall, 70% of the issue is held with Volcan Investments, and a further 21.68% is held with seven institutions. One would imagine that these are unlikely to be sellers in great size at these levels. Hence, while the short interest may stand at 2.3%, there is likely to only be c. 8.5% of the outstanding available to cover. You might therefore conclude that short interest on that basis is closer to 27%.

I am long Vedanta from 390p/shr and added a few more today.

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog.

Tuesday, 20 January 2015

Flashback ... Connaught (CNT ... delisted)

Tuesday 20th January 2015

Aside from the increasing regularity and size of restructuring charges, ramp up in net debt, frequency of acquisitions, strange looking software capitalisation, and a few other items, one of the key flags pointing to trouble brewing at Connaught was ...

... the sudden rise in the amounts recoverable on contracts that began to be shoved in with non-current assets on its balance sheet. These actually constituted all of its trade receivables, which were classed as non-current.  
Connaught's amounts recoverable on contracts classed as non-current assets, £m
Source: Connaught annual reports
According to Connaught's 2009 annual report: 
Amounts recoverable on contracts represent the estimated amounts which have been earned or which valuation, under the terms of the respective contracts, have not yet been agreed with the customers. These amounts have been included at their estimated recoverable values. Included within accounts not yet due is £27.8m (2008: £12.6m) which reflects accounts which are recoverable over the period of the contracts to which they relate. Accounts which are over six months overdue and are still to be agreed by the customers are prudently valued at their estimated written down recoverable value.
Connaught's long term trade receivables pretty much went from zero at year end 2006, to £27.8 million in the three years to 2009.

Here is Mystery Company X's record of its amounts recoverable on contracts and other trade receivables classed as non-current over recent years. 

Mystery company X's amounts recoverable on contracts and other trade receivables classed as non-current, £m
Source: Mystery company X's annual reports
I am short Mystery Company X.

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog.

Wednesday, 14 January 2015

Ocado (OCDO) ... Obfuscation

Wednesday 14th January 2015

You can sometimes tell more from what a company doesn't tell you than what it does. Take for example, Ocado's (OCDO LN, mkt cap £2.4 bn) trading update for the Christmas 2014 period, released this morning.  

Ocado Trading Update for Christmas 2014
Source: Ocado
Now compare this to the trading update released around this time last year for the Christmas 2013 period. 
Ocado Trading Update for Christmas 2013
Source: Ocado
  • Last year's update contained a lot more information, particularly helpful information in pounds, shillings and pence. This year's not so much.

  • Last year's update mentions "several days of over £5 million sales" in the 7 days leading up to Christmas. This year "On our biggest day leading up to Christmas, sales were nearly £6m." Does that mean only one day out of the seven achieved sales of over £5 million as compared to "several days" last year?

  • Last year's update included helpful data on average orders per week and average order size. This year's did not.  

  • Last year Ocado indicated it was expecting "to continue growing broadly in line with, or slightly ahead of, the market." This year no mention whatsoever. 

Such obfuscation is usually employed for a reason. Either way, sales are slowing, its valuation is preposterous, and so I sold a few short at 402p/shr.     

Ocado share price
Source: Bloomberg
Ocado forward consensus EV/EBITDA multiple
Source: Bloomberg
Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog.

Tuesday, 13 January 2015

Mitie (MTO) ... my Mitie concerns

Tuesday 13th January 2015

Since 2008, Mitie has:
  • Seemingly spent almost its entire haul from reported operating cash on acquisitions, tangible and intangible capex and other investing related cash requirements.
  • Seen net debt rise by £225.7 million, to £233.8 million as of H1 2015.
  • Paid dividends in the same period totalling £219.2 million. 
Since 2010, Mitie has:
  • Reported total restructuring and business exit costs of £197.1 million. 
  • Used acquisitions to seemingly contribute the bulk of revenue growth. 
  • Seen prepayments and accrued income rise significantly since 2007; even more noticeably since 2010.
  • Seen accruals and deferred income rise significantly since 2007; even more noticeably since 2010.
It would appear that an increasing amount of revenue has been booked but yet to be invoiced. This has coincided with a rise in invoices for services, which have yet to be delivered and thus one presumes cash outflows will be incurred upon delivery. These balances combined have risen by £318.1 million, or 426% since 2007.  

Since March 2014, Mitie has:
  • De-rated and underperformed the wider Support Services Index by c. 14%.
  • In H1 2015, Mitie reported negative free cash flow of £23.5 million; the first negative performance since at least 2008.
I am short Mitie. 

I received a call from the Varlet on Monday last, enquiring about Mitie (MTO LN), the facilities, property and energy services provider. Mitie is capitalised at close to £1 billion. Varlet quizzed me on whether I reckon it worthy of a short sale.

In our discussion we observed the fact that Mitie regularly competes against Serco (and for that matter GFS) on a number of contracts, typically in the judicial and healthcare outsourcing markets. That begged the question, that if Serco had seemingly been low balling at uneconomic levels on certain contracts, then how had Mitie competed against that to win a few itself? So I took a closer look at Mitie and trawled through its accounts ...

Underperformed and de-rated as compared to wider Support Services Index


The charts below suggest that something has happened to Mitie in recent months to turn off investors relative to its peers. Its shares have underperformed the wider FTSE 350 Support Services Index by c. 14% since March 2014. This has seemingly been partly driven by a de-rating on a forward earnings multiple as compared to its peers. 

Mitie's share price since 1998
Source: Bloomberg
Mitie's performance as compared to wider
FTSE 350 Support Services Index, since 2008
 Source: Bloomberg
Mitie's recent signs of de-rating on forward P/E basis
as compared to wider FTSE 350 Support Services Index
Source: Bloomberg
Is this recent under-performance warranted? I reckon so and here might be why ... 
   

Sources and uses of cash


During the period 2008 to H1 2015, on my estimates from its annual reports, Mitie has generated a cumulative £16.2 million in cash from its combined operating, investing and financing cash flows. Cumulative net financing cash flows are a negligible £3.7 million inflow, whilst cumulative operating cash inflows total £533.8 million and cumulative investing cash outflows total £521.3 million. Put another way, whatever it has hauled in over the last seven and a half years through operating cash, has gone out the door, largely by way of capex, acquisition spend and debt service.

Mitie's cumulative cash flows by use/source, 2008 to H1 2015, £m
Source: Mitie annual and half year reports
Mitie's cash flows by use/source, 2007 to H1 2015
Source: Mitie annual and half year reports
Despite generating a fairly minor cumulative net £16.2 million in cash during this period, its net debt level has risen from £8.1 million at 2007 year end (March year end), to £233.8 million at end of H1 2015 (September 2014), or by £225.7 million during this period. 

Mitie's cumulative net cash flows 2008 to H1 2015
as compared to net debt level 2008 and H1 2015, £m
Source: Mitie annual and half year reports
Incidentally, the group has returned a cumulative £219.2 million to shareholders during this same period by way of dividends. Put another way, one could conclude that debt has risen by £225.7 million and been almost exclusively utilised to pay equity holders their dividends. Of course there are other conclusions, which may also be drawn from these circumstances. 

Mitie's increase in net debt from 2007 year end
as compared to cumulative dividends paid since 2007 year end, £m
Source: Mitie annual and half year reports

Free cash flow


Mitie's free cash flow (FCF) performance during the period H1 2008 to H1 2014 was good and broadly consistent.   
  • FCF has invariably been weaker in the first half and stronger in the second half of the year.
  • FCF has become generally weaker still in the first half of each consecutive year and consistently strengthened in the second half of each consecutive year. 
  • FCF seemingly peaked in H2 2013, with second half FCF totalling £86.7 million (on my estimates), and full year 2013 FCF of £87.7 million. However, this looks to have been somewhat bolstered by a sale and leaseback of some if its commercial van fleet, which was sold at a fair market value of £17.8 million. 
  • Nonetheless, FCF weakened in 2014, to £72 million, and was negative for the first time in H1 2015 at (£23.5 million). Of course the group may highlight that this was principally due to losses and closure costs on business(es) which were exited over recent years. But even so ...
Mitie's free cash flow performance on half year basis
and Bloomberg consensus implied expectation for H2 2015 (March year end), £m
Source: Mitie annual and half year reports, Bloomberg 

Restructuring and business exit costs


Restructuring and business exit costs have totalled £197.1 million during the period 2010 to H1 2015. Further, they have risen rapidly in the latter part of this period. 

The bulk of this is £71.1 million, which is reported to relate to exceptional charges in relation to design and build contracts in Mitie's Energy Solutions business. Amortisation of acquisition related intangibles is also relatively high at a cumulative £44.1 million during this period. 

Mitie's restructuring, acquisition related, and exit costs
or "other items" on half year basis, £m
Source: Mitie annual and half year reports

Acquisitions


Mitie has reported a cumulative cash outflow of £348.6 million on the purchase of subsidiary undertakings, net of cash acquired during the period 2008 to 2014. 

From year end 2007, Mitie's revenue increased from £1,228.8 million, to £2,142.6 million, or by £913.8 million. Its organic revenue growth is reported to have averaged 5.3% during this period (according to statements contained in its annual reports). Mitie currently trades at 0.55x EV to current year sales. Since 2008, this multiple has been as low as 0.35x and as high as 0.71x. It has averaged 0.51x. Assuming Mitie would have paid broadly the same multiple for acquired sales as that which it trades on itself, then that would suggest that Mitie should have received at least £684 million (£348.6 million cash spent / average of 0.51x EV/sales) in sales from its acquisitions since 2008.

Mitie EV to sales multiple since 2008
Source: Bloomberg
Acquisitions were relatively small in 2008 and 2009. The group reported a cash outflow of £26.9 million and £2.2 million in each year respectively, related to the purchase of subsidiary undertakings, net of cash acquired. 

The big acquisitions were in 2010 and 2013. 

In the 2010 financial year, the group bought 100% of Dalkia Energy and Technical Services Ltd and Parkersell Ltd, together Dalkia Technical Facilities Management (Dalkia FM), for a total consideration of up to £130 million on 12 August 2009. 

It also purchased 100% of Environmental Property Services Ltd (EPS Ltd) for a maximum consideration of £40.9 million, on 20 November 2009 with an initial consideration of £36.8 million.

Combined consideration on Dalkia FM and EPS Ltd was £170.9 million. The reported cash outflow in the year associated with purchase of subsidiary undertakings, net of cash acquired, was £157.9 million. 

Dalkia FM was reported to have contributed £160 million to revenue and £6.6 million to the group's operating profit before other items in 2010. EPS Ltd was reported to have contributed £30.1 million to revenue and £1.6 million to the group's operating profit before other items in 2010. Combined this was a contribution to revenue of £190.1 million and £8.2 million to operating profit.   

Headline revenue before other items (of which other items contributed nothing to total revenue in 2010 and 2009) was reported to be £1,720.1 million in 2010. This was £198.2 million higher than 2009 revenue of £1,521.9 million. Hence, organic growth was 0.5% YOY in 2010 and acquisitions contributed 12.5% to 2010 revenue. 

The group indicated in its 2010 annual report (note 29. Page 88) that had its 2010 financial year acquisitions taken place at the start of the year, then the group's revenue and operating profit before other items would have been approximately £1,870 million and £100 million respectively. Hence, this suggests that both Dalkia FM and EPS Ltd combined, would have reported c. £340 million in revenue during 2010 (£1,870 million less £1,720.1 million plus £190.1 million). Similarly, they would have reported c. £15.2 million in operating profit. This suggests that on the basis of combined consideration paid for both businesses of £170.9 million, that they were indeed purchased for c. 0.46x sales, i.e. broadly in line with Mitie's own multiple at that time. 

A similar exercise suggests that since and including 2010, that the group has on average paid 0.63x sales for acquired businesses (these are my estimates). Further, that these combined businesses would have contributed at least £509 million to revenue since 2010. 

So if since 2009, headline revenue had risen from £1,521.9 million in 2009 to £2,142.6 million in 2014, or by £620.7 million, and acquired businesses had been achieving a combined c. £509 million in revenue in each respective year they were bought since 2010, then I reckon this would imply that revenue growth from Mitie's existing operations has been pretty paltry.  

Mitie acquisitions and contribution to revenue
Source: Bloomberg

Prepayments and accrued income


Prepayments and accrued income have risen sharply over recent years, both in nominal terms and as a percentage of sales. For example, in 2007, prepayments and accrued income were reported as £23.3 million or 1.9% of sales. By 2014, this had risen by £146.8 million, to £170.1 million or 7.9% of sales. 
Mitie's prepayments and accrued income & as a percentage of sales, £m & %
Source: Mitie annual reports
I would reckon very little of this significant increase in nominal terms and as a percentage of sales has any bearing to prepayments and is altogether linked to revenue that may have been booked and yet to be invoiced.


Accruals and deferred income


Accruals and deferred income have also risen sharply over recent years, again both in nominal terms and as a percentage of sales. For example, in 2007 accruals and deferred income were reported as £51.3 million or 4.2% of sales. By 2014, this had risen by £171.3 million, to £222.6 million or 10.4% of sales. 
Mitie's accruals and deferred income & as a percentage of sales, £m & %
Source: Mitie annual reports
I would reckon very little of this significant increase in nominal terms and as a percentage of sales has any bearing to accruals and is altogether linked to cash costs associated with service to be delivered. 

Hence, it would appear that an increasing amount of revenue has been booked but yet to be invoiced. This has coincided with a rise in invoicing for services, which have yet to be delivered and thus one presumes cash outflows will be incurred upon delivery. These balances combined have risen by £318.1 million, or 426% since 2007. 

The combined increase in prepayments and accrued income and accruals and deferred income since 2007 is £318.1 million, and both now represent 18.3% of sales as compared to 6.1% in 2007. The fact that trade receivables as a percentage of sales have been relatively stable since 2007 - and in fact shown a slight reduction since 2011 - suggests that payment terms by customers have been largely unchanged during this period. 
Mitie's trade receivables and as a percentage of sales, £m & %
Source: Mitie annual reports

And so ...


I take the view that these factors above are likely to remain a concern for some time going forward and view the risks as being towards further matters of interest emerging. Further, on any occasion I sense I may have misjudged things, I will reflect upon the charts below ...

Mitie's net asset value per share (NAV)
as compared to NAV ex-goodwill & other intangibles per share, p
Source: Mitie annual reports
Mitie (MTO LN) share price as compared to Serco (SRP LN)
Source: Bloomberg
As experience with Serco has shown, when concerns become warranted, situations have a habit of unravelling quickly.

I'm short Mitie at 270p/shr.

See prior Serco views here:
Serco ... high fives and low 300s
Serco ... at it again?
Serco ... not much PECS appeal    

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog. 

Tuesday, 6 January 2015

Gaps Galore ...

Tuesday 6th January 2015

I am 
Long: Countrywide
Short: Aberdeen Asset Management, GKN, United Technologies

Pondering small shorts on Cash America, First Cash Financial Services, Experian, and Hays*.
*Will wait to see what Hays says this Thursday. 

Ashtead (AHT LN) vs United Rentals (URI US)
Source: Bloomberg
Experian (EXPN LN) vs Equifax (EFX US)
Source: Bloomberg
Aberdeen Asset Management (ADN LN) vs CitiFX Emerging Market Beta Index (CAFZBET4 Index)
Source: Bloomberg 
Countrywide (CWD LN) vs UK Household Goods & Home Construction Index (F3HOUGE Index)
Source: Bloomberg
Hays (HAS LN) vs Randstad (RAND NA)
Source: Bloomberg
Premier Farnell (PFL LN) vs Philadelphia Semiconductor Index (SOX Index)
Source: Bloomberg
GKN (GKN LN) vs Senior (SNR LN)
Source:Bloomberg
GKN (GKN LN) vs United Technologies (UTX US)
Source: Bloomberg
H&T (HAT LN) vs Cash America (CSH US)
Source: Bloomberg
H&T (HAT LN) vs First Cash Financial Services (FCFS US)
Source: Bloomberg
Cash America (CSH US) vs Gold (GOLDS)
Source: Bloomberg
First Cash Financial Services (FCFS US) vs Gold (GOLDS)
Source: Bloomberg
Royal Dutch Shell (RDSB LN) vs Exxon Mobil (XOM)
Source: Bloomberg
All currency adjusted. 

Disclaimer: The information, discussions or topics referred to on this blog should in no way be considered “advice” to buy or sell anything. The information which may be referred to is freely available in the public domain and where required the source of information is referenced to for verification. While every effort has been made to ensure the veracity of any information contained within this blog, the author accepts no responsibility for the accuracy of any information contained within this blog or for the sources of information which may be referred to. Readers are responsible for their own actions and interpretation of the information contained within this blog.