I’ve probably shredded my dignity with that subheading, but it’s a good song, anyway. If you’re wondering why it was chosen, you either have higher literary standards than me, or don’t know Northgate’s business – perhaps both. Northgate are a vehicle hire company operating mainly here in the UK and Spain – the largest in the UK by fleet size, their website proudly proclaims – and a value stock by a number of metrics. It’s trading at a discount to tangible book value, a single digit historic and forward P/E, and is highly cash generative. What’s not to like?
Take a look at the graph if you want that answered, and you’ll see one suggestion – they hardly sailed through the recession. 2009 saw an enormous hit to their stated profit, and it’s not difficult to guess what caused it – much like many companies, Northgate wrote down a chunk of asset values (goodwill in particular) after the economy tanked. Still, that’s a non-cash charge, so it’s not a dealbreaker for me. The knock on effect was a little more troublesome, as the already heavily indebted Northgate then began to look more precarious. That’s an issue of financing and rapid growth, though, and to the credit of Northgate’s business model they’ve not only survived, but paid down a great deal of debt in the process. See the chart below on the level of debt in the company.
One key thing to note is how they’ve achieved that debt reduction – notably by significantly reducing the size of their fleets in the UK and Spain. This props up profits and revenues now, but has the obvious effect of getting rid of a cashflow stream into the future. Nonetheless, if there’s one thing it indicates, it’s flexibility; a reduction in demand for hire vehicles over the last few years has seen Northgate doing a good job of keeping their asset and cost base under control, which is why you see pre-exceptional profit – which in this case I consider a fair reflection of the company’s underlying performance – sitting remarkably stable. Operating profit dropping isn’t a huge issue in this case anyway, since finance costs can probably be expected to come down over the next few years given the repayment of debt. I haven’t looked into the issue too deeply, but the company appears to be paying ~£38m interest on £380m of debt, which seems high given the asset backing in the group, but probably reflects the fact that they refinanced when things were looking ropey. In 2006, for contrast, they paid about £20m on £520m of loans.
Those assets are the vehicles inside the company, and the continuing theme of flexibility is more surprisingly evident here; because Nortgate depreciates vehicles over a 3-6 year period, sells a great deal of vehicles yearly, and is also forced to continually refresh and shift the focus of the fleet, this ‘fixed asset’ is probably less fixed than most. Flexibility, to me, is how quickly and for what cost assets can be transferred from one form to another; how static the business’s costs and assets are. £200m of Northgate’s ‘costs’ is depreciation. Look at the book value of those vehicles – £623m – and it’s easy to see just how quickly they’re able to shift the deployment of their capital.
I like Northgate. It’s trading at a low multiple of historic and forecast profits, you’re buying at a discount to tangible book value in a company that’s generating strong returns on capital, and I think that whatever happens their business model will allow them to remain profitable. Barring a complete collapse in demand for their services, of course; but in that vein, I don’t see any particular reason to think that the risks are to the downside instead of the upside. It’s hardly a boom time for vehicle rental and they’re doing well enough. The biggest risk is probably that substantial, though dwindling, exposure to Spain. On that story I probably repeat what I just said though with slightly less conviction. I still think you’re compensated for that little thorn at this price.
The portfolio doesn’t have any cash to burn after some rejigging and the inclusion of Trinity Mirror, so it’s a case of deiciding where I want to sell and buy up, or wait for an opportune moment.