12 February 2015
By Maynard Paton
So I’ve now reviewed every one of My Shares in my portfolio — see the list of names on the right-hand side of this page.
I’ve decided to adopt a question-and-answer template for My Watch List write-ups. That way I can easily pinpoint any worthwhile shares according to How I Invest.
I am looking for as many Yes answers as possible.
I’m starting today with Latchways (LTC).
Activity: Designer and manufacturer of safety equipment
Share price: 800p
Shares in issue: 11,235,695
Market capitalisation: £90m
Does the business boast a respectable track record?
Long term, yes.
Floated in 1997. Compound average growth rates of last 5, 10 and 15 years shown below:
|2010 to 2014||2005 to 2014||2000 to 2014|
|Operating profit CAGR||(4.8%)||6.9%||7.6%|
|Dividend per share CAGR||11.1%||15.0%||11.7%|
Operating profit setbacks occurred in 2002 (down 71%), 2009 (down 3%), 2010 down (13%) and 2014 (down 33%).
Track record shows a resilient performance during the 2008 banking crash.
Dividend never cut throughout time as a listed company.
However, progress has stalled in the last few years — profits for 2014 were below 2007 levels. October trading update signalled 2015 pre-tax profits falling further to c£5m. In comparison, profits for 2013 were almost £11m:
|Year to 31 March||2010||2011||2012||2013||2014|
|Operating profit (£k)||7,609||9,309||9,921||10,261||6,826|
|Finance income (£k)||6||16||13||4||(3)|
|Other items (£k)||-||-||-||671||-|
|Pre-tax profit (£k)||7,615||9,325||9,934||10,936||6,823|
|Earnings per share (p)||49.3||61.3||66.0||74.5||50.1|
|Dividend per share (p)||25.6||29.6||32.7||36.0||39.6|
|Special dividend per share (p)||-||-||40.0||-||-|
Track record not blighted by major or ongoing exceptional items.
Has the business grown mostly without acquisition?
Balance sheet shows goodwill of £4m versus net assets of £33m. Since 2000, £5m spent on acquisitions versus aggregate earnings of £67m.
Has the business mostly self-funded its growth?
Balance sheet shows net assets represented by issued share capital of £3m and retained earnings of £30m.
Does the business possess an asset-strong balance sheet?
Cash is £10m, debt is zero, there are no final-salary pension obligations and freeholds are £5m.
Does the business convert profits into cash?
|Total operating profit (£k)||43,926||80,032||93,251|
|Total depreciation and amortisation (£k)||5,145||9,061||11,023|
|Total cash capital expenditure (£k)||(8,131)||(12,814)||(15,958)|
|Total working-capital movement (£k)||(2,624)||(7,380)||(8,100)|
Since 2000, an extra c£5m has been spent on tangible assets over and above the deprecation and amortisation charged against profits. However, the majority of that related to freehold (i.e. expansionary) expenditure.
Working-capital movements do not seem alarming in relation to total profits either.
2014 annual report says company targets conversion of 90-100% of operating profit into cash.
Does the business enjoy a competitive advantage?
Company claims to be a world leader in the field of safety equipment for people working at height. Presumably reputation, brand and heritage offer some competitive strengths.
Margins of 20%-plus between 2005 and 2013 indicate some power over customers. Respectable margins of 17% achieved in a poor 2014.
Does the business produce a respectable return on equity?
Earnings as a proportion of average net assets during 2014 was 17%, or a decent 24% if the net cash is excluded. Something to consider — that 24% figure for 2014 was the lowest produced since 2002.
Does the business employ capable executives?
Chief executive David Hearson has been in charge since the flotation. Finance director Rex Orton and sales director Alastair Hogg were appointed to the board during 1999 and 2004 respectively. All three must therefore take credit for the company’s longer-term achievements.
Does the business employ value-for-money executives?
Chief executive David Hearson’s basic pay has surged from £89k to £316k since 2000, up a chunky 9.5% a year on average. But his pay hike is understandable given comparable dividend growth of almost 12%.
Only one annual bonus paid to chief executive in last six years (2011) seems a fair reflection of company’s recent (stalled) progress.
Company pension contributions for executives represent a mighty 20% of salary.
Does the business employ owner-orientated executives?
Special dividends of 30p (2007) and 40p (2012) suggest executives won’t risk cash pile with grandiose acquisitions.
Chief executive has £2.8m/3% stake, largely unchanged since 2006. Other executives carry token holdings.
Previous modest option grants all exercised, and no options currently in place.
Share count since 2000 has advanced from 10.8 million to just 11.2 million.
Does the business enjoy reasonable growth prospects?
Not in the short term.
2014 annual sales fell 9% and first half 2015 sales dropped 17%. Blamed pinned on weak construction markets in Europe and de-stocking by largest US customer.
Company says economic activity in Europe will “take time to recover” and firm is “looking elsewhere for growth”. US setback is “temporary”, apparently.
November’s interim results referred to “medium term” when citing “significant potential” of existing products — suggests wider sales improvement not imminent.
Trading update this week confirmed “trading conditions remain similar” and management claimed: “We look forward to the 2015-16 financial year with renewed confidence in our ability to restore the business to growth.”
Does the share price stand a good chance of becoming a bargain?
Possibly — assuming business can recover.
Share price down from £14 to 800p in last year or so. Company intends to maintain 39.6p dividend — gives 5.0% yield at 800p.
But near-term profits won’t cover payout. Forecast c£5m pre-tax profit equates to earnings of 37p after forecast 16% tax. Enterprise value (EV) is £79m or 707p less net cash of £10m/93p. Current P/E therefore 19.
Operating profits between 2010 and 2014 averaged £8.8m. Therefore 5-year average past earnings are 65.7p per share after 16% tax. P/E on EV would be 10.8 if EPS could return to 65.7p.
Assume recovery to 65.7p takes 3 years. Apply target P/E of 13 to 65.7p gives 853p. Plus net cash of 93p gives target price of 946p. Add 3x maintained 39.6p dividend of 119p gives target total return of 1,065p — equivalent to 10% annual return from 800p.
Demanding 15% annual returns gives 700p entry price.
Is Latchways worth watching?
Track record, finances and management indicate respectable company — and a profit recovery more likely than not. But further worries about the European economy could bring share price lower and allow a greater margin of safety for future returns.
Profit setbacks in 2002/03 and 2009/10 lasted up to 18 months before a turnaround emerged. Arguably current profit downturn has been running since April 2013. Interim results for 2015/16 (due November 2015) should herald start of earnings rebound — otherwise problems may be more deep-rooted.
Disclosure: Maynard does not own shares in Latchways.