Northern Bear: Me and the market are not on the same page

Disclosure: I have an interest in Northern Bear shares

Trading update

Northern Bear released a trading update today. It had three key notices:

  • Trading in the year to 31st March has been good – ‘at least in line with the prior year’.
  • Chirmarn, the group’s asbestos removal company, has had another bad year. It is loss making and drawing on group cash. As a consequence, it will be sold for £50k.
  • New bank facilities are in place, now for £3.5m, to replace the term loan expiring last week. These have a reduced interest rate (previously LIBOR+325bps) and a £1m overdraft facility. I think the group should be below £2m net debt at year end, so this does give significant flexibility.

The fun thing about investing in a company like Northern Bear is that no-one really knows what the stock will or should do on a results announcement. Trading volumes are incredibly thin. There are no institutions driving liquidity. There are no broker notes to set expectations or guide participants, so there is no uniform consensus of what constitutes a ‘surprise’.

Today, it was made more extreme by the fact that the stock had run up 10% last Friday after North Midland Construction’s results. People obviously expected a boom in northern construction-related activity, and when Northern Bear’s update wasn’t fireworks and party poppers the balloon deflated a little.

I read the RNS this morning at 7 am. I liked what I read. I was comfortable with my holding. I checked the broker bid/offer at market open and they opened at 55p – 60p, which is a bump up even from Friday’s trading. After a couple of hours, though, it was obvious that people weren’t seeing what I was seeing. The stock sunk below 50p, down over 10%.

Where I think ‘the market’ is wrong

It’s a little grandiose to talk about ‘the market’ when we’re talking about fewer than twenty trades, but here are the issues I think people are seeing:

  • They worry that trading is only ‘at least in line’ with last year, given the tough time they had last year by virtue of the dreadful weather.
  • They worry about the significant write-off Chirmarn will cause, and the loss of earnings power to the group.

I have a different perspective on both of these things.

On the first point, I note that the year-end for Northern Bear was three days ago. Small companies do not tend to have shiny accounting systems and well-greased finance departments, so I am very skeptical the company has anything like a full set of accounts together. They are probably working off of a bunch of different draft management accounts from all the subsidiaries, who are giving them rough figures and cash intakes.

The fact that the company is comfortable saying things are ‘in-line’ with last year is, to me, a bullish statement. It is not guidance that things will be a smidge better. It is just as big a statement as they are willing to make given that the year end was last Friday.

I could be wrong – they could be telling us exactly where things are. But on balance, I think this is a real positive. There are always things that can go wrong with companies like Northern Bear, so getting news that they haven’t gone wrong so should make one more comfortable.

(And besides, at 6x last year’s earnings, you could argue you don’t need too much to be happy.)

On the second point – Chirmarn – I am not as worried as some appear to be. I looked at the subsidiaries a little while ago (you can find them at Companies House) and Chirmarn, last year, contributed less than £100k of EBIT to the group. It was a real contributor in prior years – so it is a shame that it is gone – but I’m not sure one can really blame management if an asbestos removal company is structurally receiving less work than it was ten years ago. It’s not like they’re stuffing buildings full of it any more.

Chirmarn doesn’t owe much to the group either, at least of the last full accounts (March 2016). So it shouldn’t be too difficult or messy a disentanglement job.

Yes, it’s a hit, but it’s a hit that was already hurting as of the half-year. I don’t think there is really any read across for the rest of the business.

Summary

I think the trading news is good, the Chirmarn news is so-so and the note that the company has “a wider range of options for capital allocation in the future… [including] the Group’s progressive dividend policy”  is a nice step in the right direction. The dividend should be increased.

Holding out-of-favour microcaps is always a long slog. There is real inertia in valuations. People tend to look at the multiples first then reverse-justify it by looking at the negatives. But there are many worse, equally cyclical companies like Northern Bear trading at much higher valuations.

It’s in the higher risk bucket of my portfolio, but I am still holding with pleasure.

Addendum:

I had some fun last time around playing with the goodwill numbers inside the group and showing that, if the directors are genuinely thinking about the DCFs they are putting forward to support Northern Bear’s goodwill balances, the group is worth many multiples of the current price.

The fact Chirmarn last had almost £4m of goodwill attached to it just 12 months ago – and now is sold for £50k –  says something about those valuations.

My point then was more to highlight the difference between management’s stated valuation of the group and their suggestion the group might raise more equity. Still, the speed of the apparent deterioration does say something about how much elbow grease actually goes into these goodwill calculations…

5 Replies to “Northern Bear: Me and the market are not on the same page”

  1. Ed

    Very good analysis, borne out by recent trading updates. Yours is the only investor blog I’ve ever found that is any good.

    Lewis, do you have views on Epwin? Not dissimilar to NTBR in terms of value drivers. Very low valuation, buying up smaller businesses at low multiples, very cash generative, low debt.

    Lack of recent organic growth is probably the largest negative. Recent macro trends of weak sterling (hits imports) and cheap oil (plastic feedstocks) probably slightly positive on balance.

    • Lewis Robinson

      Hi Ed,

      I can’t say I’ve ever looked at Epwin. I know there were some question marks around the company around float time and shortly after, and I have a very high hurdle for management trust/believability if a company is executing a buy-and-build.

      So I never did any work.

      Looks interesting, but I would have to get comfortable with management/owners.

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