Andrews Sykes: FY 2019 Results Admit 50% Of UK Staff Are Furloughed Although Management Talks Of “Resilient” Trading And Even Declared A Final Dividend

16 June 2020
By Maynard Paton

Results summary for Andrews Sykes (ASY):

• Creditable full-year figures that showed revenue down 2% and profit down 7% due to less extreme weather. 

• The decision to furlough 50% of UK staff feels odd given management talks of “resilient” trading, kept company depots open during lockdown and has declared a final dividend.

• A commendable cash flow projection raises pandemic-profitability questions but suggests extra funding is not needed.

• An impressive second half ensured the accounts remained healthy with high margins and an appealing return on equity.  

• A possible P/E of 12-14 and yield of 4.5% does not seem expensive if indeed ASY does “return to normal levels of trading” for 2021. I continue to hold.

Contents

• Event links, share data and disclosure
• Why I own ASY
• Results summary
• Covid-19, furloughed employees and declaring dividends
• ‘Going concern’ cash flow projection
• 2019 revenue, profit and dividend
• H1 vs H2 and Europe
• IFRS 16
• Financials
• Valuation

Event links, share data and disclosure

Event: Preliminary results and annual report for the twelve months to 31 December 2019 published 12 May 2020.

Price: 500p
Shares in issue: 42,174,359
Market capitalisation: £211m

Disclosure: Maynard owns shares in Andrews Sykes. This blog post contains SharePad affiliate links.

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%/£189m shareholders and ensure management focuses on “long-term shareholder value creation”. 

Further reading: My ASY Buy report | All my ASY posts | ASY website

Results summary

Covid-19, furloughed employees and declaring dividends

• A late-March trading update had already hinted ASY may have escaped the worst effects of the pandemic:

“Compared to many sectors of the economy, such as hospitality and retail, the impact [of Covid-19] on the Company to date has not been severe…”

• The management narrative within this 2019 statement used the adjective “resilient”:

“Andrews Sykes Group plc (the “group”) remains resilient as sectors in which we trade have shown continuous demand whilst facing an unprecedented challenge in the form of the coronavirus pandemic. 

“Certain product lines are more resilient than others and we are experiencing an increase in demand in certain sectors, notably healthcare, emergency temporary hires to cover the breakdown of customer equipment and the hire of dewatering equipment in the UAE to enable construction work to continue.” 

• The business remained open during the lockdown and the very early impact did not appear catastrophic:

“In the UK we have temporarily closed some of our smaller depots, introduced social distancing measures in our larger depots and embraced at home working employees.

The impact on the business as of the end of March has been limited with trading levels close to expectation.”

• The company’s blog suggests ASY has been busy supplying equipment to hospitals:
  • Emergency boiler hire provides safe showering facilities at Nightingale hospital
  • Proud to support the NHS
  • Andrews Sykes helps convert former Ford factory into temporary hospital

“One hospital contacted [ASY] on Good Friday in the hope that we could provide some cooling relief to staff working on a COVID-contaminated ward. A regional expert arrived on site almost immediately to ascertain the size of the areas the estates team intended to address, pre-empting the creation of specific zones which staff could visit to cool down. This was handled with a great deal of urgency and the delivery of multiple Polar Wind portable air conditioning units followed later that same afternoon.”

• Given ASY’s “resilient” trading, I was surprised the results small-print revealed half of the domestic workforce had been furloughed:

“In the UK, approximately 50% of our employees are furloughed.” 

• The 2019 results made no reference to ASY receiving UK government help.

• However, many European ASY staff are seemingly receiving state support:

“In France, Italy, Belgium and Luxembourg we are currently working with significantly reduced staff levels, with the most of our staff enlisted to the appropriate government employment retention schemes.” 

• ASY declared a slightly reduced final dividend within these results.

• This dividend feels questionable to me given the apparent receipt of overseas government assistance.

• I suppose ASY could argue the final dividend relates to trading during the July-December 2019 period — and before Covid-19.

• Mind you, ASY is projecting further dividend payments for later this year:

“For the purposes of the cash forecast only, we have assumed that a normal level of dividends will be resumed in November 2020.” 

• I can only trust ASY stops collecting any government subsidies before making further payouts.

‘Going concern’ cash flow projection

• ASY commendably included a cash flow projection within the ‘going concern’ small print.

• Management described this “bottom-up”… cash flow forecast for the 24 months ending 31 December 2021 as “cautiously realistic”.

• The key estimate was:

“[T]he group’s net cash outflow in the nine months ending 31 December 2020 is forecast to be approximately £10 million.”

• The outflow calculation included dividends:

“For the purposes of the cash forecast only, we have assumed that a normal level of dividends will be resumed in November 2020.”

• The payment of the 2019 final dividend will cost £4.4m.

• If indeed a “a normal level of dividends will be resumed in November 2020”, then the November 2020 first-half payment will cost £5.0m.

• The net cash outflow before dividends could therefore be £0.6m (i.e. the £10m projection less dividends of £9.4m).

• That calculation implies the business may not be profitable or cash-generative during the nine months to 31 December 2020.

• I can’t fathom why a cash-flow forecast predicting a breakeven-ish business performance would also include dividend payments of £10m.

• Maybe I have misinterpreted the numbers. ASY claims the business should be profitable this year:

“Group turnover for the 12 months ending 31 December 2020 is forecast to be lower than 2019. Operating profit is therefore consequently likely to reduce, however the group still expects to produce a profit for 2020.”

• I suppose the business could report a profit but not generate much cash. ASY admitted:

“Our cash flow forecast assumes that cash collections will reduce over the next nine months as customers take longer to settle their debts.”

• Or perhaps the cash flow forecast was not meant to be a “cautiously realistic” projection to help guess 2020 earnings — but instead was purely a way of showing the balance sheet would not require extra funding.

• ASY implied its balance sheet would carry net cash of £17m at the 2020 year-end following the projected £10m cash outflow.

• ASY added the balance sheet would remain cash-positive were the business to suffer a bad 2021:

“Even in an extreme scenario and this trend continued throughout 2021 resulting in an additional cash outflow of c£12 million, the group would still have cash reserves* of c£5 million at 31 December 2021” 

• ASY does in fact believe 2021 may not be so bad:

“In 2021 we expect to return to normal levels of trading.”

• I can only really conclude the following from the projection small-print:
  • The balance sheet should not require extra funding, and;
  • Management aims to continue paying dividends.

2019 revenue, profit and dividend

• ASY’s comments on Covid-19 and the group’s prospects for 2020 naturally overshadowed these 2019 figures.

• Subdued first-half results due to a “milder winter” that provided “less opportunities for… heating and boiler hire products” meant the full-year outcome was never going to set any records.

• In the event, ASY reported a creditable performance:

Year to 31 December	2015	2016	2017	2018	2019
Revenue (£k)	60,058	65,389	71,300	78,563	77,246
Operating profit (£k)	13,208	15,816	17,589	20,681	19,268
Finance income (£k)	159	1,725	(304)	364	(738)
Other items (£k)	-	-	-	-	-
Pre-tax profit (£k)	13,367	17,541	17,285	21,045	18,560
Earnings per share (p)	25.6	34.3	33.4	40.4	35.6
Dividend per share (p)	23.8	23.8	23.8	23.8	22.0

• Revenue fell 2% while reported operating profit dropped 7%.

• ASY’s profit numbers were distorted slightly by IFRS 16, the new accounting standard that treats lease costs as a mix of depreciation and interest. 

• Operating profit would have declined by 8% on a consistent non-IFRS 16 basis.

• The 2019 performance was all the more satisfactory given the comparable year was bolstered by a scramble for ASY’s heaters during heavy snow and then for ASY’s air conditioners during the heatwave.

• ASY’s concerns about Covid-19 prompted the final dividend to be reduced by 12% to 10.5p per share to give a full-year payout of 22.4p per share.

• The annual dividend had been 23.9p per share since 2015.

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H1 vs H2 and Europe

• ASY’s second half was very impressive:

	H1 2018	H2 2018	FY 2018		H1 2019	H2 2019	FY 2019
Revenue (£k)	37,815	40,748	78,563		34,974	42,272	77,246
Operating profit (£k)	9,280	11,401	20,681		6,918	12,380	19,298

• H2 revenue and profit gained 4% and 9% respectively.

• The H2 2019 performance set a new H2 record — despite the comparable H2 2018 enjoying bumper demand for air conditioners during that year’s heatwave.

• ASY explained the improved H2:

“The wet weather in the final quarter enabled the pump hire business to recover after a slow start to the year and the results of our heating business were also better than expected. 

This [Middle East] result was driven by several large projects in the region including the 2020 Expo which is planned to be held in Dubai.” 

• ASY also cited a “long hot summer” in Europe.

• The annual report small-print reported encouraging performances throughout Europe:
  • The Netherlands: “performed well“;
  • Belgium: “strong performance“; 
  • Luxembourg: “produced growth“;
  • Italy: “another record result“;
  • France: “a region of potential growth“, and;
  • Switzerland: “another improved performance“.

• During H2, UK revenue was flat, European revenue gained 7% while Middle Eastern revenue advanced 19%. 

• Since 2014, annual overseas revenue has jumped 104% while UK revenue has climbed only 11%.

• Group revenue is now 59% represented by the UK, 24% represented by Europe and 17% represented by the Middle East.

• Expansion continues in France, with a depot opened in Nantes last month and a depot in Toulouse opened during January.

IFRS 16

• ASY’s financials were affected by the introduction of IFRS 16.  

• IFRS 16 dictates how companies should recognise, measure, present and disclose operating leases within their accounts.

• Before IFRS 16, lease costs were identified as an individual operating expense. 

• Under IFRS 16, lease costs are charged mostly through a mix of depreciation on ‘right-of-use’ assets and interest on ‘right-of-use’ leases.

• The ‘right-of-use’ assets reflect the ‘fair value’ of the leases while the ‘right-of-use’ leases represent the total future lease obligation discounted into today’s money.

• If the value of the ‘right-of-use’ assets is much lower than the value of the ‘right-of-use’ leases, then the company could have locked itself into expensive/onerous lease agreements.

• ASY’s balance sheet shows right-of-use assets of £11.5m and ‘right-of-use’ leases of £11.7m:

• The ‘right-of-use’ leases are classified as financial obligations.

• As such, ASY must subtract lease obligations when calculating net funds:

• I ignore lease obligations for net cash calculations, and therefore my version of net cash is £24m.

• ASY’s leases relate mostly to property rents for depots.

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Financials

• ASY’s accounts remain in good shape.

• Despite the lower profitability for 2019, margins and returns on equity continue to be attractive:

Year to 31 December	2015	2016	2017	2018	2019
Operating margin (%)	22.0	24.2	24.7	26.3	24.3
Return on average equity (%)	25.2	31.5	27.8	30.3	24.5

• The full-year operating margin has actually topped 20% since 2002.

• Before central costs, the main UK and European divisions reported a combined 28% operating margin for 2019. The Middle Eastern operation delivered a 24% margin. 

• My return on equity calculation in the table above does not adjust for ASY’s £24m net cash position.

• During the five years to 2019, ASY has lifted earnings by £5.7m and increased its shareholder equity by £21.4m. The resultant incremental return on equity is a super 27%.

• Earnings of £15m during 2019 converted into free cash flow of £11m after nearly £6m was invested into extra working capital:

Year to 31 December	2015	2016	2017	2018	2019
Operating profit (£k)	13,208	15,816	17,589	20,681	19,298
Depreciation and amortisation (£k)	4,959	5,310	5,917	6,666	7,203
Net capital expenditure (£k)	(4,523)	(4,719)	(4,929)	(6,198)	(5,522)
Working-capital movement (£k)	(3,090)	(2,157)	(1,155)	(4,292)	(5,592)
Net cash (£k)	14,558	17,673	20,293	23,381	23,897

• ASY’s working capital has absorbed £16m since 2015:

Year to 31 December	2015	2016	2017	2018	2019
Operating profit (£k)	13,208	15,816	17,589	20,681	19,298
Working-capital movements
Stocks (£k)	(1,024)	(2,251)	(1,022)	(2,682)	(3,834)
Trade and other receivables (£k)	(2,196)	(1,876)	563	(2,139)	(1,818)
Trade and other payables (£k)	139	1,970	(696)	529	60
Total (£k)	(3,081)	(2,157)	(1,155)	(4,292)	(5,592)

• The £16m absorbed is equivalent to a sizeable 19% of aggregate operating profit.

• Note that ASY’s books are complicated by the company acquiring stock and then capitalising a proportion of that stock into the hire fleet:

• Such stock-to-fixed-asset transfers are unusual, but presumably reflect ASY offering for hire any equipment that could not be sold direct.

• During 2017, 2018 and 2019, stock with an aggregate £6m value was re-classified into the hire fleet.

• This £6m is arguably capital expenditure rather than working-capital investment.

• The table below adjusts the working-capital movements and capital expenditure for the £6m:

Year to 31 December	2016	2017	2018	Total
Operating profit (£k)	15,815	17,589	20,681	54,086
Depreciation (£k)	5,310	5,917	6,666	17,893
Working-capital change (£K)	(2,157)	(1,155)	(4,292)	(7,604)
Stock transferred (£k)	2,156	1,460	2,407	6,023
Adjusted work-cap movement (£k)	(1)	305	(1,885)	(1,581)
Net capital expenditure (£k)	(4,719)	(4,929)	(6,198)	(15,846)
Stock transferred (£k)	(2,156)	(1,460)	(2,407)	(6,023)
Adjusted net capex (£k)	(6,875)	(6,389)	(8,605)	(21,869)

• ‘Underlying’ working capital absorbed cash of only £1.6m during those three years.

• ‘Underlying’ capital expenditure came to £22m — £4m more than the associated depreciation charge. 

• That £4m difference is not outrageous given operating profit was £54m during the same three years. 

• Free cash flow of £10.8m for 2019 funded dividends of £10m, reduced debt by £0.5m and added £0.3m to the bank balance.

• Cash finished the year at £27.9m while bank debt was £4.0m.

• ASY’s defined-benefit pension scheme continues to enjoy an accounting surplus. A deficit was last reported during 2007.

• I am pleased the benefits paid to the scheme’s members have reduced from £3.1m to £2.1m:

• Paying benefits of £2.1m from scheme assets of £44.0m requires an annual investment return of 4.8%. 

• I am not convinced employer contributions of £120k a year are enough to sustain benefits of £2.1m while preventing the erosion of the £44.0m scheme assets.

• A formal pension funding review is underway and may prompt additional company contributions:

“As explained in note 18 to the financial statements, a triennial funding valuation for the group defined benefit pension scheme is currently being prepared by the pension scheme trustees as at 31 December 2019. Management has received an estimate of the deficit as at that date and it has been assumed that this will be agreed and paid to the pension scheme by 31 December 2020.”

Valuation

• ASY revealed a £4.6m operating profit had been recorded during the three months to 31 March 2020. Net cash increased by £3.3m during the quarter. 

• ASY’s profitability during the remainder of 2020 sadly remains anyone’s guess.

• As a guide, operating profit less IFRS 16 interest costs for 2019 was £18.8m. 

• Applying tax at 19% gives earnings of 36.1p per share.

• ASY remains a tightly held share with a minimal free float and wide bid-offer spread.

• The 100-year-old chairman and his family own almost 90% of ASY, leaving approximately 10% for everybody else.

• A 500p mid-price values ASY at £211m and the free float at £22m.

• Subtract the £24m net cash position from the market cap and the underlying business could be valued at approximately £187m or 443p per share.

• That said, the aforementioned cash outflow forecast of £10m for 2020 may well mean the cash position is not ‘surplus to requirements’.

• Depending on your view of the cash position, the trailing P/E could be 12 or 14 or somewhere in between based on my earnings guess.

• My sums could be refined for ASY’s pension scheme and the capital expenditure not reflected by the depreciation charge.

• However, such alterations would be rather superfluous given ASY’s pandemic performance may create more significant profit issues.

• If in fact ASY does “return to normal levels of trading” during 2021 and earnings match those of 2019, then the 12-14x rating may not seem expensive.

• The trailing 22.4p per share dividend meanwhile supplies a 4.5% income at 500p.

Maynard Paton

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