02 December 2019
By Maynard Paton
Results summary for Andrews Sykes (ASY):
- Revenue dropped 8% and operating profit dived 25% following lower demand for ASY’s heaters and boilers.
- European operations continue to represent almost a quarter of the business, with new depots opened recently in France.
- Accounts now affected by IFRS 16, although the fundamental attractions of decent margins (19%) and net cash (£20m) remain in place.
- Outlook comments appeared encouraging, with the company blog suggesting busy demand for pumps to combat flooding.
- The underlying P/E could be 16 and the yield is 3.9%. I continue to hold.
- Event link and share data
- Why I own ASY
- Results summary
- Revenue, profit and dividend
- IFRS 16
Event link and share data
Event: Interim results for the six months to 30 June 2019 published 27 September 2019
Shares in issue: 42,174,359
Market capitalisation: £261m
Why I own ASY
- Supplies air conditioners, portable heaters and industrial pumps for hire, with success based on a prompt 24/7 service, high-quality rental fleet and commercial-only customer base.
- Accounts regularly showcase high margins, generous cash flow, net cash and attractive returns on equity.
- Chairman and family are 90%/£234m shareholders and ensure management focuses on “long-term shareholder value creation”.
Revenue, profit and dividend
- ASY’s 2018 annual results had already hinted these first-half figures would not be that spectacular.
- The 2018 statement said: “The Board remains mindful of the favourable or adverse impact that the weather can have on our business.”
- However, the previous six annual statements had said (my bold): “The Board is therefore cautiously optimistic for further success in [the next year], always being mindful of the favourable or adverse impact that the weather can have on our business.”
- Management had deliberately removed the “cautiously optimistic for further success” part from the 2019 outlook.
- The absence of those words implied “further success” would be hard to achieve during 2019.
- Sure enough, this H1 witnessed revenue drop 8% and operating profit dive 25%:
|H1 2017||H2 2017||H1 2018||H2 2018||H1 2019|
|Operating profit (£k)||8,171||9,418||9,280||11,401||6,918|
- The shortfall was blamed on a milder winter that led to “less opportunities for… heating and boiler hire products”.
- I felt last year that the comparable H1 2018 figures were not that impressive, given the apparent scramble for portable heaters during the heavy snow and then for air conditioners during the subsequent heatwave.
- Following this H1 2019 performance, the comparable H1 2018 figures now appear much more impressive!
- This H1 performance was in fact the weakest since 2016.
- ASY revealed that UK sales of fuel for heaters and boilers plunged 40%. Total UK revenue slid 13%.
- The drier weather also meant lower demand for ASY’s pumps.
- The group’s European revenue fell 6% after mixed performances in Benelux, France, Italy and Switzerland.
- ASY reiterated that “start-up costs of the new businesses… continue to be expensed as incurred”.
- European depots still represent 23% of group revenue. The Middle East and Africa represent a further 17%.
- The profit slide did not lead to a divided cut. The 11.9p per share first-half payout has now been unchanged since 2014.
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- ASY’s financials were affected by the introduction of IFRS 16.
- IFRS 16 dictates how companies should now recognise, measure, present and disclose operating leases within their accounts.
- Before IFRS 16, lease costs were identified as an individual operating expense.
- For example, the 2018 annual report shows ASY spent £3.4m on property, plant and other operating leases:
- And at the end of 2018, ASY had total minimum lease obligations of £13.5m:
- Under IFRS 16, lease costs are now charged through a mix of depreciation on ‘right-of-use’ assets and interest on ‘right-of-use’ leases.
- The ‘right-of-use’ assets initially reflect the value of the ‘right-of-use’ leases — which represent the total obligation of future leases discounted back into today’s money.
- A simple example of pre- and post-IFRS 16 accounting is provided by Deloitte. The chart below compares paying £1m a year on a 20-year lease before IFRS 16 (red line) and under IFRS 16 (dark blue line).
- For ASY, this H1 witnessed a combined lease cost of £1.3m:
- ASY’s balance sheet shows right-of-use assets of £11.4m and ‘right-of-use’ leases of £11.5m:
- If lease costs were £3.4m during full-year 2018, the IFRS 16 lease cost of £1.3m for this H1 would appear low.
- That said, ASY claimed IFRS 16 had reduced pre-tax profit by only £50k during this H1 (my bold):
“As at 1 January 2019, the date of transition to IFRS 16, the group recognised additional right-of-use assets and liabilities of £11.4 million. An additional £1.1 million of new leases were capitalised and a depreciation expense of £1.1 million was recognised in the period. EBITDA was improved by approximately £1.2 million due to the removal of operating lease payments of this amount that would have been charged in accordance with the previous standards, and operating profit for the current period was improved by approximately £0.1 million. Overall profit before tax was reduced by approximately £0.05 million primarily due to the effect of charging more interest at the beginning of the lease term.”
- Perhaps the bulk of ASY’s lease costs will be recognised during the second half.
- The ‘right-of-use’ leases are classified as financial obligations.
- As such, ASY now subtracts lease obligations when calculating net funds:
- ASY’s accounts remain in good shape.
- Despite the profit setback, the H1 operating margin (including ‘right-of-use’ lease interest) was a worthwhile 19%.
- ASY’s full-year operating margin has impressively topped 20% since at least 2008.
- The second-half margin is almost always higher than the first-half margin due to the greater profitability of air conditioners hired during the summer.
- Earnings of £5.4m during this H1 converted into free cash flow of £2.4m. The main use of cash during the half was £3.9m invested into extra working capital:
- The working-capital investments typically reverse during the second half.
- ASY’s working capital has absorbed £12m between 2014 and 2018. Buying extra equipment to sell (rather than hire) has been the main working-capital demand:
|Operating profit (£k)||11,311||13,208||15,816||17,589||20,681||6,918|
|Trade and other receivables (£k)||284||(2,196)||(1,876)||563||(2,139)||(120)|
|Trade and other payables (£k)||686||139||1,970||(696)||529||(1,454)|
- The working-capital movements do not seem that untoward given the profit advance achieved during the same time.
- During this H1, free cash flow of £2.4m as well as £4.1m taken from existing cash resources funded dividends of £5.0m, reduced debt by £0.5m and reduced lease obligations by £1.0m.
- Cash finished the half at £23.8m, while bank debt was £4.0m.
- ASY’s defined-benefit pension scheme continues to enjoy an accounting surplus.
- The 2018 annual report showed benefits paid to the scheme’s members had jumped to £3.1m.
- At the end of 2018, scheme assets of £41.0m required a very ambitious 7.5% return to sustain paying benefits of £3.1m a year without eroding the capital. (How To Evaluate Pension Deficits outlines the theory behind these sums).
- However, the scheme’s benefits have now reduced to an annualised £1.7m:
- Paying benefits of £1.7m from scheme assets of £44.0m requires a more achievable investment return of 4.0%.
- ASY’s pension-fund contributions remain low at £120k.
- ASY appeared reasonably optimistic about the second half (my bold):
“Trading in the third quarter has started slightly more positively. In the UK the Pump hire revenue has shown a steady improvement and air conditioning hire revenue in mainland Europe has been strong, this has been driven by some extreme temperatures across the region, however the UK has not reached the very high levels we saw during the long hot summer of 2018. Once again activity in the Middle East has remained consistent through the summer period.”
- Since this H1 statement was announced, ASY has supplied pumps to flooded parts of South Yorkshire (my bold):
“It has been a particularly busy time for Sykes Pumps with businesses desperate to safeguard their premises and restrict the impact of flooding wherever possible. Our engineers have been working with a multinational infrastructural group by installing pump hire solutions to prevent further flooding in nearby locations that have been identified as high risk.”
- Management comments at the 2016 AGM indicated hiring out pumps was not as lucrative as hiring out air conditioners or heaters.
- ASY’s blog also reveals a “sizeable increase in the number of enquiries relating to heater hire for temporary storage applications”.
- ASY remains a tightly held share with a minimal free float and wide bid-offer spread.
- The 99-year-old chairman and his family own almost 90%, leaving approximately 10% for everybody else.
- A 620p mid-price values ASY at £261m and the free float at £27m.
- Subtract the £20m net cash position from the market cap and the underlying business could arguably be valued at approximately £232m or 573p per share.
- ASY has operated with net cash since 2010, and perhaps such cash is required to keep the business on a stable footing.
- Dividends before 2010 had been rather haphazard, due in part to significant levels of debt combining with the banking crash.
- My net cash figure excludes IFRS 16 lease obligations. However, my profit sums below are taken after the cost of the ‘right-of-use’ lease interest
- The trailing twelve-month operating profit is £18.2m. Bear in mind this £18.2m was buoyed by last year’s bumper H2 profit.
- Adding back a one-off £0.4m pension charge and applying tax at 19% gives earnings of 35.8p per share.
- The underlying P/E could therefore be 573p/35.8p = 16.0.
- The trailing 23.9p per share dividend supplies a 3.9% income at 620p.
- ASY’s valuation does not appear an obvious bargain. My sums (here and here) have pointed to a cash-adjusted P/E of 16 since at least October last year.
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Disclosure: Maynard owns shares in Andrews Sykes.