J Smart & Co: 20 Years Of Dividend Advances But Still Not For Me

10 July 2015
By Maynard Paton

Today I’m continuing my hunt for Watch List shares with a look at J Smart & Co (SMJ).

Here are the initial attractions that prompted this research:

Loyal management: The Smart family has controlled the business for decades
Dependable dividend: The payout has advanced every year since at least 1994
Interesting valuation: The shares trade at 52% of net asset value

As usual, I’m applying a question-and-answer template to help me pinpoint companies that match the criteria set out in How I Invest. I’m looking for as many Yes answers as possible.

Activity: Construction contractor, house builder and property landlord
Website: www.jsmart.co.uk
Share price: 100p
Shares in issue: 45,974,909
Market capitalisation: £46.0m

Does the business boast a respectable track record?

Yes and no.

SMJ was established in 1947 and has since evolved into a diversified construction firm that builds houses, undertakes civil-engineering contracts, develops commercial property and manufactures specialist concrete products.

SMJ floated during 1965 and, courtesy of the free information on the new Companies House beta website, my financial data stretches back to 1994. At that time, SMJ’s total revenue was £20.4m, its net asset value was £31.2m and the dividend was 1.7p per share.

By 2014, revenue had reached £28.1m, net asset value had grown to £88.5m while the dividend had advanced to 2.96p per share.

The growth rates over time have been very modest:

	5 years to 2014	10 years to 2014	15 years to 2014	20 years to 2014
Revenue CAGR	(2.0%)	1.8%	3.0%	1.6%
Dividend per share CAGR	1.3%	2.1%	2.3%	2.8%
Net asset value per share CAGR	0.6%	2.6%	5.0%	5.7%

Profits have bobbed up and down from year to year due to revaluations, devaluations, gains and losses relating to the group’s investment properties.

However, the dividend has been upped every year since at least 1994 while net asset value was lifted every year for at least 14 years up to 2008.

Notably, progress since the banking crash has not been great.

In particular, SMJ’s net asset value remains at a level lower than that seen during 2007 — in part due to consistent devaluations of the group’s investment property.

In fact, SMJ has devalued its own properties every year since 2008 — with the devaluations totalling an astonishing £22.3m (or roughly 49p per share).

What’s more, SMJ’s contracting businesses appear to have stagnated, with construction revenue for 2014 lower than the level seen in 2008. The division has at best recorded marginal profits since the banking crash and, somewhat worryingly, losses of £6m from construction activities have been racked up during the last two years.

The table below shows how SMJ’s property rental income has stalled during recent years as well:

Year to 31 July	2010	2011	2012	2013	2014
Construction revenue (£k)	21,022	17,001	22,586	18,381	22,811
Rental income (£k)	5,521	5,523	5,518	5,383	5,253
Operating profit (£k)	4,391	3,497	3,357	892	(109)
Profit from property sale (£k)	-	1,929	-	124	-
Revaluation of property (£k)	(604)	(5,336)	(4,042)	(3,127)	(782)
Joint venture profit (£k)	201	42	(15)	2,438	469
Investment income (£k)	89	140	128	138	143
Investment gains (£k)	95	-	34	8	1,299
Net finance income (£k)	(188)	384	593	60	187
Pre-tax profit (£k)	3,984	656	55	533	1,207
Earnings per share (p)	7.41	2.01	(1.06)	0.31	2.18
Dividend per share (p)	2.82	2.86	2.90	2.93	2.96
Net asset value (£k)	96,541	97,560	91,309	91,125	88,482
Net asset value per share (p)	192	194	185	193	189

Has the business grown mostly without acquisition?

Yes.

The last ten years have not witnessed any acquisition activity and the balance sheet does not carry any goodwill.

Has the business mostly self-funded its growth?

Yes.

The latest balance sheet displays share capital of £1m versus earnings retained by the business of £87m. Furthermore, no new shares have been issued since at least 1994.

Does the business possess an asset-strong balance sheet? 

Yes.

At the last count, cash stood at £21m and investment properties were valued at £63m. Meanwhile, bank loans were just £10m.

I should add SMJ operates a legacy defined-benefit pension scheme, which currently shows a £2m surplus but has in the past showed a deficit of £8m.

Does the business convert profits into free cash?

Yes.

Year to 31 July	2010	2011	2012	2013	2014
Operating profit (£k)	4,391	3,497	3,357	892	(109)
Depreciation (£k)	456	426	363	360	446
Net capital expenditure (£k)	(227)	(309)	(214)	(493)	(497)
Working-captial movement (£k)	1,716	(1,190)	(1,981)	(2,333)	7,508

On aggregate, the last five years have seen cash capital expenditure covered entirely by the depreciation charged against reported profits.

I also see working-capital movements have witnessed a total inflow of cash during the same time. That said, SMJ does tie up a lot of money in stocks and debtors — a total of £17m in the 2014 annual report versus total construction revenue and property rental income of £28m.

Does the business enjoy a competitive advantage?

I doubt it.

Margins at the construction division have been a woeful 4% or less since 2007 and do not suggest any significant competitive position. The aforementioned devaluations of the group’s property investments do not indicate these assets are anything special either.

Does the business produce a respectable return on equity?

No.

Return on average equity for 2014 was £1.0m/£89.8m = 1%. The same calculation has been below 5% since 2009 and below 10% since 2007.

Does the business employ capable executives?

Possibly.

Chairman and managing director John Smart has held the top job since 1988 and can therefore claim responsibility for the aforementioned run of dividend advances. However, Mr Smart must also take responsibility for SMJ’s distinct lack of progress since the banking crash.

Mr Smart is now in his 70s and looks likely to be succeeded by another member of the Smart family. Fellow executives include David Smart and another John Smart, both of whom are in their 40s.

Does the business employ good-value-for money executives?

Sort of.

Boss John Smart received a £109k basic salary during 2014 — which compares to £123k paid in 2013 and the £105k to be paid in 2015. I am guessing the reductions are due to the other Smart directors taking on greater executive responsibilities following their board appointments a few years ago.

I calculate Mr Smart’s pay has risen at a modest 4% per annum on average since 1996. I also note there is no executive bonus scheme in place.

Does the business employ owner-orientated executives?

Yes.

The Smart directors have a combined 54%/£25m shareholding and have held more than 50% of the share count since at least 1994. I also like the fact the directors can work without needing an option scheme.

One commendable feature of the managers is their willingness to waive their dividends and so leave the group with extra cash. Indeed, the Smarts have foregone dividends during 16 of the last 20 years — with payments taken only in 2009, 2010, 2011 and 2012.

That said, there is a possible downside to this generosity — perhaps SMJ actually requires that foregone dividend cash to sustain its operations. As such, you could argue the group’s ‘real’ dividend is in fact 50% lower than what is publicly declared.

Does the business enjoy reasonable growth prospects?

I’m not sure.

Published during March, SMJ”s interim results contained a very mixed outlook for the rest of the year:

“We have substantially more work in hand in contracting than at this time last year. Margins continue to be a challenge.

Private residential sales prospects are good.  However, sales numbers for the current financial year will be substantially less than the previous year.

Occupancy levels and letting prospects with regard to our industrial properties are healthy.  Void levels in our office properties remain unacceptably high although letting prospects here appear slightly brighter.

There are too many uncertainties to forecast the headline profit for the current year with any degree of accuracy.  However, I estimate that underlying profit for the year should at least approximate to last year’s underlying profit of £1,764,000.”

I’ve not read anything within SMJ’s recent results to suggest there are plans afoot to support a substantial operational improvement within the troublesome construction division.

Does the share price stand a good chance of becoming a bargain?

The share price already looks like a bargain.

The last results showed net assets at £88.2m or 192p per share. A share price of 100p therefore represents just 52% of the balance sheet.

Is it worth watching J Smart & Co?

No.

Sure, there are very few quoted businesses around that offer an unbroken 20-year run of dividend advances — let alone one where the family responsible for the record remains in charge.

Better still, the family in question boasts a significant shareholding and take home ‘thin-cat’ remuneration as well.

The shares trade well below book value, too.

And yet this share is still not for me.

For a start, there is certainly nothing appealing about this business — more so given its uninspiring performance since 2008. The general economics of the construction division look awful while the consistent devaluation of the property assets are somewhat unfathomable in the current economy.

It’s all meant returns on equity have been extremely poor, which is why the stock market does not believe in the value of the reported book value. I dare say the directors may be waiving their dividends for some time to come if the group extends its recent progress.

As you may know already — I am all for owning dull businesses with veteran management.

But there is no point holding dull businesses with veteran management if the underlying performance of the company is poor and unlikely to improve. My evaluation of past results indicates SMJ has never offered much in the way of attractive financials, and I feel there is a distinct chance of ending up in a value trap here.

All told, SMJ offers credible family managers that run a not-so-appealing operation. A price-to-book of 0.52 may seem very tempting, but a purchase today would be heavily biased towards ‘value’ rather than ‘quality’ and I’m keen to limit such investments — as all too often they go wrong for me!

Maynard Paton

Disclosure: Maynard does not own shares in J Smart & Co.