Swings and Roundabouts
Last post, I highlighted 5 stocks I was interested in taking a closer look at. Normally, my pace could best be described as leisurely – taking a few ups and downs in the share price in my stride – but Begbies Traynor, one of the more interesting ideas, jumped up and down begging (no pun intended) to be analysed quicker. Far from the ego-affirming price increases one is often tempted to buy off the back of, the stock actually slid down over 20% – making the metrics by which the business appeared cheap look even more unanimous.
It takes some steely nerves to buy off the back of such steep price declines, but some of the soundest advice I was given when considering stocks was by a colleague, when I quipped the old saying about being greedy when others are fearful and fearful when others are greedy. He hated the phrase, and rightly so – the markets aren’t a cohesive thing, they’re a sum of individual human thoughts. Attributing emotions, especially negative ones such as ‘greed’, is simply taking pride in your contrarian thinking – it is patting yourself on the back for remaining ‘logical’ while others are failing to be so. Likewise, it’s tempting to take some sort of bizarre pride in your steely nerves when buying a stock that’s bombing downwards. In reality, of course, all these issues are distracting – emotions should remain entirely separate from investment decisions. The price is simply a factor against which I can compare the business’s value – no more and no less.
Perhaps it’s just me that feels that misplaced sense of pleasure in being contrarian, but since I’m here to analyse and not to preach, I’ll note the practical implications of the price decline. The metrics above are based on a share price of 20p – the current price at the time of writing. I don’t normally need to note that, but stocks I talk about aren’t usually this volatile! Evidently the stock is extremely cheap – with the factors I talked about last piece (reproduced below) only highlighted by the further falls. I should also note that profits last year were actually dragged down to almost 0 by a number of exceptionals. As usual, I’ve excluded these as I don’t consider them indicative of future performance – though they are a down note.
Begbies Traynor look like a nice counter-cyclical play – potentially a good hedge for my portfolio, whose top three constituents (Barratt, Howden Joinery and N Brown Group) are very closely tied to the whims of the British consumer. They popped up on Twitter a while ago as a fellow tweeter asked for potential ‘recession’ stocks – ones that’d benefit from a double dip – and my off the cuff answer, sticking true to my value roots, was Begbies Traynor. This nature comes about from their business – insolvency, restructuring, liquidation and risk management. Essentially, their pool of business grows as the number of failing businesses grows. The balance sheet is surprisingly sound for a professional services firm (which usually have few assets and substantial borrowings) , cash flow looks strong, and profits both last year and forecast are good. Last year was marred by a number of exceptionals which more or less saw them breaking even, though, so that’d have to be an area for further investigation. Founder Ric Traynor still sits on the board with a substantial shareholding, which is nice to see, and the dividend richly rewards shareholders, though it was recently cut. Curiously, on the day of writing, the share price has fallen 11% on ostensibly no news. That may be the incentive I need to take a closer look – Communisis were a similar story, with one large and determined seller thumping the price down ~20% in one day. Of course, I need to be certain it’s not just a large piece of information I’ve missed!
The big question on my mind when looking back through the reports was how much the current environment actually helped Begbies Traynor. Given that counter-cyclical reasoning, and the likelihood that the worst of the recession is firmly behind us, perhaps the market is simply pricing in what’s likely to happen – a drop off in the volume of work as economic conditions improve. I’m not entirely happy with that logic, to be honest – I don’t think equity markets or economic forecasters are particularly bullish on the UK in the next couple of years, and so I don’t see the shining glimmer of recovery snubbing out Begbies’ profits. Forecasts for the business are very bullish, putting it on a 1y and 2y forward P/E of 3.4 and 3 respectively – though without knowing the macroeconomic assumptions they’ve used to make them, I’m even more cautious on them than usual.
Unfortunately, we don’t have a history of revenue and profits going back that far. Back in ’06, revenues were indeed much lower – but without a longer timeframe than 5 years, I’m unable to formulate any opinion as to how much was the macro situation and how much was company-specific growth – in future terms, how much is transient, and how much will endure. It seems unlikely that a rise in the pool of work could account for a doubling of revenues, so at least some is likely to be market share growth. Fortunately, I’ve managed to dig out some insolvency statistics from the BIS, a Government department. The chart below left shows these figures.
The chart above right attempts to make some loose comparison between Begbies Traynor’s revenues and the corporate insolvency statistics – though over such a short time span, the figures are rather noisy. I would say, though, that there is almost certainly some degree of market share improvement. While insolvencies peaked and have fallen significantly, BEG’s revenues haven’t – and they’re reporting figures this year in line with last. I suspect they may have a good degree of resilience to a drop off in the level of insolvencies going forward, though some declines are inevitable. Perhaps there is some truth to the broker forecasts, then!
I’m fairly positive on revenues, and can’t see any specific reasons for shifts in margin, so profit-wise I quite like BEG. I’m also curious about their balance sheet – on a PTBV on 1.4, they appear very cheap for a professional services firm – I’m far more used to seeing balance sheets propped up entirely by intangibles. Looking through, it appears nearly all of their assets are tied up in trade and other receivables – a line which had me stumped for a while. A balance of £43.2m in trade and other receivables against revenues of just over £60m is a red warning flag and certainly warrants some further investigation, as it implies creditors are taking over half a year to pay Begbies’s its due. Not unusually, it was a misunderstanding on my part, as running through the notes on the financial statements revealed that this balance wasn’t receivables in the sense I normally see. In fact, the number largely comprised of ‘recoverable income and costs on cases’ – presumably money they’re expecting to reclaim from companies they’re helping through insolvency. I imagine they’re in a better position than most to recover money owed to them! Debt wise they don’t look too bad, with £25m of long term borrowings, and the sale of two divisions (valued at ~£10m) may help bring this figure down further. This should help future profits if achieved, as £25m is hardly a small debt burden, and interest costs on it sit at £1m – surprisingly low, but presumably there is some seasonality to capital requirements. Overall, their financial situation is hardly rock solid, but compares favourably to other business service firms I’ve analysed.
Finally, a nod to my post on director and shareholder interests – Begbies Traynor weigh up fairly well in this regard, with the directors being fairly reasonably paid (£637k in total, 4 directors) along with Ric Traynor’s substantial ownership. He owns 29.6% of the group’s outstanding share capital, which is a great positive from a shareholder perspective, as it values his shareholding at over 20 times his yearly salary. Hence, the share price is important to him. The group also pays a generous dividend, though this was recently cut, and so is far from a certainty next year.
Overall, it’s obvious I like the business, but I have a few concerns – not least the management’s bearish tone. The group’s risk management division looks to be gowing nicely, which should provide some diversification of revenues going forward, but the sale of two divisions which previously offered diversity hints that perhaps they should stick to what they do best. I’d also need a better understanding of exactly what that receivables balance comprises – at two thirds of their total assets, I’m not comfortable with it – a situation exacerbated by the fact that my inexperience means it’s the first time I’ve seen such a large balance I can’t account for.
Begbies Traynor have also raised a few questions about my portfolio as a whole and the valuation of businesses within it. Next post, I’ll be looking to reconcile a few of these factors and formulate a more rounded view on the business and where it stands in relation to some of my other choices.