Cranswick (CWK)

Questions of quality

I like Cranswick as a business. Much like Howden Joinery, it was one I bought back when I started the portfolio because it sort of fitted what I knew I was supposed to be looking for, but didn’t understand that well why. In hindsight, and having looked at quite a few more companies since then, it still strikes me as a company of significantly above average quality. (As a (sort of) economist, I can’t help but add that the previous sentence is home to all sorts of selection bias; I am a value investor, so I am probably more likely than most to be looking at poorer-quality companies and not the ingenious new startups.) Self-chiding aside, quality is all well and good, but it’s the price/quality that we really care about. I guess that’s what stuff like the P/E hopes to give you an indicator of – price vs. quality, in that ratio how much money it’s making. In those simple terms, what we’re really trying to do as investors is refine that ‘E’ so we get a picture of future cashflows far more intuitively and powerfully than just looking at last year’s net profit number.

The good

As I said, it’s a ‘quality’ company. To put numbers or intuition to it, it consistently earns returns above its cost of capital, as a big company, without overleveraging (either on debt or operating leases) and with reasonable consistency. It’s dipped since the recession, as could be anticipated, but still earns returns figures upwards of 20%, having capitalised operating leases. This, to me, is probably the simplest definition of quality. Where it comes from is another, more complex question, but by the simplest yardstick a company able to consistently grow and keep returning more than is required to fund that growth is a sound one. That seems obvious, but that point is sometimes in considerable doubt. I spend a good deal of time trying to decipher whether a company’s returns are just depressed for a idiosyncratic or cyclical reason, or whether it’s simply in terminal decline. Cranswick does not worry me with the same questions.

By the most obvious measure, it’s not hugely expensive, either. It trades on about 12 times forward or historic earnings, having grown consistently for the last 10 years. I’ll paste the same graph, from Cranswick Investor Relations, I’ve used before – just because it illustrates a point:

Note; we don’t know from the graph how much was genuine organic growth and how much was acquisitive – so take it with a pinch of salt. That’s the basic attractive premise, then; it’s not very expensive, it can grow and compound those supernormal returns,  and it seems pretty safe – both in financial profile and in operating history and reasonable demand patterns. People aren’t likely to stop eating sausages tomorrow, so it’s not a fad business that seems likely to fade away.

The bad

Without getting too carried away, then – I like to be dour after all – the simple fact is that the P/E ratio doesn’t tell us a huge amount about a company. It’s a nice indicator in cases like Cranswick, but we need to sort of drill one level deeper to get any real understanding. The PTBV gives a clue to this – near 4 – in that we are paying 4 times assets in what, at first, strikes me as a reasonably capital intensive business. We’re not getting a huge amount of bang for our buck in that sense. In reality, what we’re paying for is Cranswick – the ethereal entity. Something about Cranswick makes a pound inside Cranswick worth a lot more than its assets are worth. This is, of course, the corollary of previously discussing that the company earned strong returns.

That’s all well and good, of course, but for one little niggling question – where are those excess returns coming from? Sometimes, you can break it down. Red‘s posts are always elucidating on that point. With Cranswick, though, I can’t really figure out what about this company makes them so good at what they do; it’s not a very exciting industry, there’s not a huge amount of space for branding, and it’s essentially one up from a commodity. They’re squeezed by their customers, to which they’re in a rather lopsided relationship (two of the supermarkets account for 52% of their revenue) and tied into an agricultural supplier chain.

I really can’t find any specific reason as to why they avoid those two previous pitfalls and manage to consistently grow and return. I guess the simplest answer is that, generally, they’re just good at what they do. They do things efficiently, management are competent, and they have the requisite structures in place to allow effective decision making. The next thing I have to do is swill with mouthwash, though; the last sentence is essentially nothing more than a list of platitudes you’d expect to hear from a bad boss. It doesn’t really tell us anything.

The summary

My opinion on Cranswick’s valuation in a nutshell, then:

If we assume no growth, but a maintenance of the historical level of returns, we’re probably at about fair value – perhaps slightly over*.

If we assume a reasonable continutation of growth coupled with those strong returns, which feels unlikely given the mechanics, Cranswick could still offer great value.

If we assume some sort of tapering of returns – which strikes me as prudent until I find something which explains why they could continue to do so well – we’re overvalued, unless we assume some growth – which, again, seems reasonable. Then you more or less end up where we are today.

I think my assumptions verge on the cautious side, but I’m still erring on the sell. If I find something else to put my money in, I’ll be tempted to hop – the question currently is that I have a lot of potential sells and not too many potential buys.

 *edited from initial post, was under

18 Replies to “Cranswick (CWK)”

  1. red.

    By my calculations, going back to 2006, Cranswick earns ~11% returns on tangible operating capital. Your assessment, I think, is just right: it is a well-run business with no particular strategic advantage and with some customer concentration risk. Just from that description, one would expect a 10%-12% ROIC (or a 1%-2% spread on the cost of capital): that’s the return at which potential new competitors would decide it’s not worth the fight, and therefore the kind of return that one place confidence in going forward.

    The relationship between ROIC, Net Tangible Operating Assets, and cost of capital appears a bit precious, I know, but its advantage is that allows one to test the plausibility of the hypothesis that future earnings will be similar to past earnings: if ROIC is high (and meaningfully higher than the cost of capital), it demands explanation.

    Dart’s excess ROIC, for example, is, I think, almost wholly explained by the Royal Mail contract which allows it to use its planes at times when vacationers won’t fly, thereby allowing it to turn its assets more often, and therefore reduce the effective average cost of its most important cost — it’s aircraft. If that contract is lost, then ROIC will revert back to 11%ish and Dart’s intrinsic value will be cut by 40% or more.

    Cranswick’s spread is smaller — perhaps 2% — and I think appropriate given the generic risk that customer concentration implies. So EPS will grow faster than revenue but it’s probably fairly valued at this point.

    • Lewis

      Hey red, thanks for the comment.

      Quick question since there’s a glaring figure – how did you arrive at 11%? I get a number much higher. Perhaps I’ve missed something obvious..

    • Lewis

      MMI –

      Great post, thanks. Particularly enjoyed the comparison with Frosta – interesting to see that some of it seems to come down to scale/efficiency (fixed assets) and some down to working capital management. The regional monopoly one isn’t one I’d thought of, but seems plausible given the concentration of agriculture up in the green and pleasant lands up north.

    • Lewis

      Thanks – where you’re calculating working capital (L36), you’re summing assets and liabilities, i.e. cash + receivables + payables: is this as intended?

        • Lewis

          Ok – now we’re on the same wavelength!

          I guess the interesting question is whether:

          a) ROC coming down will be inevitable as it grows, given they can be expecting to gobble up all and any work above cost of capital at this point

          b) the ROC dip is temporary, as the (seemingly competent and reliable) management seem to be pointing towards, with unusually high input costs and slightly limper demand at the moment.

          The first is a weak explanation for the current downtrend, but may be expected in the future. The second is up in the air and I hold no strong opinion on.

          • red.

            I’m a structuralist, so my bias is to think that there’s no way that a business like Cranswick can super-normal profits over the long haul: if competitors don’t get them, then their customers will squeeze them. I think assuming 11% is fair and safe; assuming 17% requires strong justification…

            • memyselfandi007

              i think Cranswick has a certain local competitive advantage which cannot be copied so easily.

              The question is how long will this be the case ? Clearly, their move “up the chain” in the food ector is more risky.

              Nevertheles, I still think there is some upside (and relatively little downside) in the stock over the next 3-5 years.

              • Lewis

                I’m more wary that the downside could be returns continuing to come down, and upside for me is more difficult to quantify – since for me it seems mostly based in management continuing to produce above sectoral growth. That may even be likely, but still gives me pause for thought.

            • Lewis

              Yeah, the returns are what makes me sceptical. Any sort of reversion makes them look quite expensive, and given that (the thrust of what I was trying to get at above) I can’t see that strong justification you’re talking about, I’m a little nervous.

              On the other hand, it’s probably in some way a testament to management that their advantage has been so enduring when it has also been so difficult to quantify.

  2. Richard Beddard

    Hi Lewis, Cranswick isn’t the only company earning surprisingly high returns despite being in the supermarket supply chain. Take a look at meat packer Hilton Foods. Only two major customers, Tesco and Ahold. Traditionally such concentration is thought to be risky but if they’re really embedded, perhaps they’re more than a dispensable supplier. Perhaps there is value in the relationship.

    • Lewis

      “Perhaps there is value in the relationship.”

      You’ve just pointed to more evidence that there is value that I’m not recognising, so perhaps I should. I can’t help but feel such an uneven balance of power can’t end well for the smaller company in the agreement, though..

  3. John @ UK Value Investor

    [disclaimer first… I own Cranswick]
    I think they just do a good job. Coupled to that is that even in a commodity business there can be local barriers. I used to own Robert Wiseman Dairies, which supplied 30% of the fresh milk in Britain. With fresh milk it’s a localised commodity, so you can’t outsource to China. Therefore once the land, supply chain and other infrastructure (dairies etc) is in place it’s very hard for somebody to come in and compete at the top level. From memory it’s the same sort of thing with Cranswick, although of course there are no guarantees…

  4. Monevator

    @John — But Robert Wiseman Dairies was smacked for six by Tesco in its final year or so as a listed company, and one couldn’t help thinking it was because Tesco looked at its margins and thought “we’ll have some of that”. Shareholders were pretty much bailed out by its acquisition.

    RWD didn’t have any brands of note; I forget whether Cranswick does? From memory it does the Finest range but I may be making that up.

    I prefer Devro in the sausage space! But a bit pricey at current levels.

  5. Andy Blinston

    I bought Cranswick back in 2011 for 636p at which time I thought it was undervalued. Now at 970p I’m considering selling, mainly for the reasons discussed in this article. I think this is a great company and well managed, but at these prices I’m not thinking it’s such great value any more, there seems to be equal upside and downside risk imo. If they start getting up to 1100p I think I’ll be selling.

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