Dart Group Plc -- Air Transport & Supply Chain Logistics

The UK's Dart Group operates a supermarket logistics business (Fowler Welch) and a holiday airline serving the UK market north of the Midlands (Jet2). 

It is a favorite of the value blogosphere. It has been comprehensively covered here, here, here, and even here.  

This is the bird's eye view of Dart:

It seems extravagantly mispriced at a market capitalization of £107 million. 

Some thoughts:

LoJack -- Tracking & Recovery of Mobile Assets

LoJack provides a set of products and services that aid in the tracking and recovery of stolen vehicles, motorcycles, construction equipment, cargo, laptops, and people at risk. 

The Lojack RF locator system in the United States uses an FCC-allocated frequency designated for use by state and local law enforcement agencies for this purpose.

The barriers to entry are these: 

In the US and Italian markets (but not in the Canadian market), an entrant must obtain the cooperation of state and local law enforcement agencies for implementation of its tracking and recovery system before starting to sell units in that jurisdiction: they must agree to it, they must install it in their police stations, and they must be trained in it.  This is a time- and cost-intensive process, and Lojack has long ago borne those costs in the 29 States where it currently operates; and

Units are mostly sold at the dealerships where consumers buy their cars. The unit needs to be well hidden -- a particular strength of the Lojack unit is that it can be well hidden without compromising its effectiveness -- and therefore professionally installed. Lojack has longstanding relationships with automobile dealers in its operating territories, relarionships wherein the dealers essentially act as commissioned sales staff for the product.

Not the tallest barriers to entry, it must be said, but perhaps high enough given the small size of the market.

Given the close relationship between car sales, especially new car sales, and Lojack sales, Lojack’s financial performance is necessarily cyclical, though not as cyclical as auto sales themselves:

Lojack’s most winning characteristic is its asset-light business model, so asset-light, in fact, that it operates on negative net operating assets. 

This makes ROIC x IC tricky to calculate, so instead I’ll capitalize average 10-year economic profit at a 9% discount rate:

The no-growth value is $9, give or take a nickel. Revenue hasn't grown faster than inflation in the last ten years, so this is an appropriate, realistic valuation. It's hard to see how the share price can avoid appreciating up to that level. 

A bonus: despite Lojack's lackluster trailing revenue growth rate, there are reasons to suppose that it might grow in the future:  the cargo and elderly tracking segments are new and show promise; the auto market, especially in emerging markets, will grow, and auto theft will probably not fall. These options are free.

Disclosure: I don't have a position in Lojack

Update (7/28/2012): I have added some thoughts in the comments section; the reader questions provoking that commentary are particularly worth reading for anyone interested in this stock.

Update on Hawaiian Holdings

Readers who are interested in investigating Hawaiian further may be interested to know that the company reported earnings after the bell today. 

In my reading, the seasonally adjusted and annualized after-tax operating profit indicated by these results is approximately $167 million, and the corresponding owner earnings figure is about $128 million, or $2.45 per share.

Hawaiian traditionally generates 47% of its revenue and 32% of its operating profit in the first half of the year.

Hawaiian Holdings - Air Transport

Hawaiian Holdings, owner of Hawaiian Airlines (Hawaiian), is in the business of transporting people and cargo to, from, and between the Hawaiian Islands. 

There are no substitutes for Hawaiian’s value proposition: if you want to go to Hawaii, or if you want to get away from it, you either fly or you swim. Whether you choose to fly with Hawaiian rather than with one of its competitors is, in a commodified and competitive arena like air travel, going to depend on price, which itself is going to depend on cost. 

An investment in Hawaiian, therefore, can only be premised on the belief that Hawaiian is – and will remain – the lowest cost airline in its market, a proposition that the remainder of this post will defend.

“Economies of scale” exist when indivisible costs are an important share of total cost, and when the assets represented by those indivisible costs are specific to the market in which the business operates – an increased volume of business will reduce average cost. It doesn’t exist when they’re not. The concept of economies of scale is not so much about size as it is about density – a better term would be “economies of concentration”. 

In the airline business, indivisible costs are those that do not change when new routes are added.  In Hawaiian’s case, those costs are gates, terminals, and runways in Hawaii; management and other overhead expense; and the infrastructure for aircraft maintenance, also in Hawaii.

No other airline has such a concentration of fixed costs in Hawaii. Hawaiian has 47% market share – they call it “seat share” in the airline business – in and out of Honolulu and Kahului; by contrast, the next largest competitors, JAL and United have ~7.5% seat share each.   

The effect is even more pronounced in inter-island flights, in which Hawaiian has 87% seat share. 

Every additional flight, wherever the provenance or destination, has at least one leg in Hawaii, and therefore reduces Hawaiian’s fixed costs per unit – and average cost per unit – even further. 

One would therefore expect Hawaiian to be the lowest cost airline flying to Hawaii, and one of the lowest cost airlines in the United States, and it is:

(Note: Spirit doesn't operate in Hawaii; Allegiant flies to Hawaii but doesn't operate regular scheduled passenger service -- it is more tour operator than airline).

Hawaiian's competitive position appears even better when viewed from the perspective of the interplay between the three distinct markets in which it operates. 

The Interisland market is Hawaiian's stronghold. Demand largely consists of business travelers, on the one hand, and transfer passengers from outside Hawaii, on the other. Virtually every airline that ferries passengers to Hawaii feeds their traffic automatically into Hawaiian's interisland route network. They don't really have a choice.  Demand in this segment is therefore is inelastic, and when inelasticity in demand meets monopoly in supply, it is reasonable to suppose that economic profits are in the offing.

The West Coast segment is Hawaiian's firewall: it is surely  the most contested airline market in the United States. There is no fat in the fares on these routes and Hawaiian flies them at cost, earning a slight premium only in those few city-pairs where it has dominant market share. If Hawaiian is flying these routes at cost, it must be true that other airlines are operating them at a loss. It can be in no-one's interest to lower prices even further, and so prices in this segment have remained relatively stable.

Although this West Coast segment earns no economic profit, it nevertheless serves Hawaiian's strategic purposes in two ways:  first, it ensures that no other airline has an economic interest in establishing a substantial beachhead in Hawaii; and second, the low West Coast fares feed high numbers of passengers into Hawaiian's profitable interisland segment. 

These two segments, then, are interdependent: West Coast erects the barriers to entry and allows Interisland to profit; Interisland puts the fixed assets to heavy use and allows West Coast to be an effective barrier to entry. This interdependence coheres so well that it might even constitute a business model.


An ancillary benefit is that Hawaiian, facing an inelastic demand curve in its interisland market, is able to pass on increased fuel costs without discomfort, thereby improving its cost leadership in the West Coast market.

This has been the happy balance since 2008, when Aloha Airlines, the other Hawaiian airline, fell into bankruptcy,  liquidated, and saw its 30% market share immediately assumed by its old rival. 


Hawaiian's financial performance in this period is a hymn to the blessings of muted rivalry:  

and, from the perspective of owner earnings:

Hawaiian's management, recognizing that this yogic balance between the West Coast and Interisland markets represents a solid foundation, is in the process of assembling a high yield, high demand international segment -- Japan and Korea, in particular, but also Australia and New Zealand -- to lay on top.

Source: my calculations from US DOT data


At an average margin contribution of eight cents per available seat mile, the additional 3.3 billion seat miles in capacity can be expected to contribute at least $100 million in additional annual after tax profit, or approximately $2 per share.


Turning now to the matter of valuation. Hawaiian's Interisland and West Coast markets -- the base -- can be counted on for $161 million in annual normalized operating profit: an average return of 11.5% on installed operating assets of $1,398 million. These two segments alone value Hawaiian's equity at $854 million, or $16.84 per share. (I have used an 11% cost of capital, even though Hawaiian's pretax cost of debt is 5.15%, because, let's face it, it's an airline).

If the international segment can be relied on for an additional $100 million in operating profit, and I think that is a low estimate, then the equity is worth $19 per share. This valuation implies a multiple of less than 4x on forward owner earnings which, even for an airline, is conservative.


Disclosure: I have a position in Hawaiian.

On Waiting

The stock picker rummages through his list of business models, and selects this one:

he sifts through his files, looking for businesses employing that model, and finds this:

he then calculates this:

and waits, hopefully expectantly.

Grenobloise d’Electronique et d’Automatisme - Toll Collection

Grenobloise d’Electronique et d’Automatisme (GEA) is, at its core, a manufacturer of highway toll collection systems. It is a small, family-owned business headquartered in Meylan, the village near Grenoble where I spent the substantial share of my gap year.

GEA’s products are installed in 80% of tolled highways in France and the company has used this track record to develop close subcontractor type relationships with some of France’s major infrastructure companies – Vinci, Bouygues, Thales, Egis, Albertis and Eiffage.

This relationship building has had two benefits: GEA has been contracted to install and maintain ticketing and collection equipment for parking lots/garages owned and operated by these companies; and GEA has followed these companies in their work abroad, installing toll collection systems in more than 30 countries around the world.

This is GEA’s financial history in the past 7 years:

The results before 2008 are poor; the results after 2007 are somewhat special. The question, therefore, is: what happened? 

GEA’s Annual Reports and regulatory filings attribute the improved performance to a reorganization of the manufacturing process instituted in 2006. This seems to me an  unlikely, or incomplete, explanation for the kind of performance improvement seen over the last four years. GEA actually makes its own products and if it has discovered a  manufacturing process that can triple its asset turns and earn 100% returns on its operating capital, it would be far better off licensing that discovery to Toyota and Boeing than it would be installing machines in parking garages in Nimes -- especially as the improvements seem not to have cost anything to institute. 

A better explanation lies in the increasing proportion of international work, and of service contracts, in GEA's revenue mix. 

It is likely that GEA's domestic revenue earns ~40% gross margins, while its international work -- as a subcontractor to a large infrastructure firm that itself charges cost-x-multiple to its clients, and is therefore price insensitive -- earns ~60% gross margins. In addition, service work earns 100% gross margins and requires no operating assets. Together, these two trends would explain a substantial share of GEA's performance improvement over this time period, as shown below:

The remainder may well be explained by the performance improvements that GEA's management cites, especially in its management of working capital.

That, then is the first proposition: GEA's performance depends on the share of revenues derived from international work and from maintenance services.

The second proposition is that international and maintenance work is likely to constitute an ever larger share of GEA's revenue mix, partly because the market in France is saturated, and partly because tolls roads are a growth business worldwide, as shown in this graphic prepared for one of GEA's competitors, the Austrian company Kapsch Traffic Control:

As a result, I think it reasonable to expect that GEA's future will resemble 2008-2011 far more than it will resemble 2004-2007. 

Turning now to valuation. At the low end, I capitalise operating profit over the last seven years at 10% to get the value of the enterprise, and add net non-operating assets to arrive at the value of equity, as below:

At the high end, I capitalize average operating profit over the last three years -- "the new normal" -- at 10%, and add net non-operating assets at arrive at the value of the equity:

In both scenarios, I use 10% as the appropriate discount rate because GEA has no debt, and is largely dependent on others for its revenue. 


Growth seems probable and the incremental value of that growth, not accounted for here, would be a bonus. Kapsch Traffic Control, mentioned earlier and with similar margins as GEA, is trading at an EV/EBITDA multiple of 10x, implying that GEA's shares would be worth €155. 

Disclosure: I have a position in GEA

X-Ray of the Nifty 30 - Part 1

I've been spending some time going through the Thrifty 30 portfolio curated by Richard Beddard's alter ego, The Human Screen. I thought it might be interesting to post graphical representations of the value-and-price trajectories of each member of the portfolio  -- x-rays that illustrate the different ways in which Mr. Market catches up with, and runs away from, reality.


UPDATE: Value = "normal ROIC"/R x Invested Capital, where R = 4% above the after-tax cost of debt. 
Forward growth is built in.  Equity = EV less after-tax non-operating liabilities plus cash.  Leases have been capitalized and pension liabilities taken into account. 


Here's the first batch:

CEGID Group S.A. - Business Software

CEGID Group (Cegid) is a 29 year old business that has grown to become one of Europe's leading business software firms. The core of the business is its dominance in management software solutions for certified public accounting firms, a dominance made possible by its long-term strategic partnership with the CPA profession in France. (Indeed, the software suite was developed in partnership with CPAs).

Cegid took advantage of its mastery of this niche to expand into adjacent markets: taxation, treasury functions, and financial reporting, mostly for middle-market companies. It now has 36% market share in those adjacent markets.

Using these services as an introduction to its wares, it has expanded further, into branded, modular enterprise management software suites that encompass human resource management, merchandise management, procurement, logistics, loyalty program tracking, and so forth. 

Today, Cegid has an installed base of more than 95,000 customers, spread among eight business lines and comprising companies of every size. The original certified public accountant market accounts for just 26% of Cegid’s revenue, while custom in the retail, restaurant, hotel/resort, manufacturing, and public sectors account for the remainder. 

Half of Cegid's sales consist of recurrent revenue, and the transition to SaaS among its installed customer base is growing fast. A non-random sampling of Cegid’s clients includes L’Occitane, Longchamp, Quiksilver, Devanlay Lacoste, Billabong, Calvin Klein Jeans, Club Med, Darjeeling, Guess, L’Oreal, and Habitat.

This is a summary of Cegid’s operating performance over the last 7 years:

Revenue growth has been in the region of 7.6% per year, compounded; operating profit has grown a slightly faster at 8.5% per year; and the marginal return on invested capital –  growth in operating profit per euro growth in operating assets – is 25.7%.

Whereas the competitive position of James Halstead is almost entirely premised on neo-Ricardian principles, Cegid's competitive position relies on that combination of specialization, customization and installation known collectively as "switching costs".  The uncertainty is in the original sale; after that, the customer is, more or less, locked in. Switching from one product or provider to another has costs – in re-training, disrupted systems, installation fees, and so on – that, unless Cegid makes a catastrophic mistake or is resolutely unresponsive, won’t be borne quickly or easily by its customer base. Such a defensive line -- more Passchendaele than Maginot -- is not easily breached by competitors.

How much, then, is this business worth?

Although Cegid has grown at a reasonably brisk pace over the past ten years, there is, I think, no particular reason to believe that it must grow – despite management’s wish that it continue to do so. Indeed, because of the effectiveness of switching costs as a barrier to entry in the enterprise software space, most of Cegid's growth has been acquired rather than organic. I am therefore reluctant to place a value on growth.

There is, however, strong justification for believing that the franchise -- that is, the stream of profits that will flow from servicing the already installed base of customers -- is reasonably secure.  The nature of the barriers to entry, as well as Cegid’s history of retaining clients, argues for that.  

I venture, then, that it’s reasonable to assign a 7% discount rate to Cegid’s normalized profit – an unlevered operating P/E ratio of 14.5x. (Some readers may have more faith in EV/EBITDA than I do; for them, the corresponding EV/EBITDA multiple is 5.13x).

Applying that multiple to Cegid's normal after-tax operating profit values the enterprise at  €335 million, and the equity €253 million. The 8.81 million shares therefore worth in the neighborhood of €29 each, 100% above where they're trading at the time of writing. 

Disclosure: I have a position in Cegid.

James Halstead Plc - Specialist Flooring

James Halstead (JHD) manufactures and distributes upscale branded flooring products for commercial, contract and domestic use – in hospitals, laboratories, hotels, retail stores, offices, swimming pools, buses, offices, and homes.   The business is managed and majority-owned by the fourth generation of the founding Halstead family.

The company is small, unlevered, consistent, profitable, and growing. It is a specialist operator that seems likely to benefit both from three long-term market trends: an increasing preference for hard flooring over carpets; the displacement of basic hard flooring by luxury, high-performance, and aesthetic varieties; and the increasing demand for “green” products.

There are flooring products manufacturers many times JHD's size, but their focus is diffuse, their commitment to research and development unsteady, their debt burdens large, and their strategic ambitions likely to be limited to the quest for solvency, cost-containment and scale.  

Contrasting the financial statements of Mohawk Industries or Armstrong Worldwide, the two largest flooring products manufacturers, with those of James Halstead will bear out the intuition that, in the contest between the specialist and the generalist, the specialist will hold its own – it will have higher quality products, higher margins, lower costs, better relationships with distributors and buyers, shorter cash conversion cycles, and stickier business.  

And, with each iteration of the competitive cycle, the specialist's advantage should widen: the brand's reputation strengthens, sales rise, third party distributors  move their inventory faster, pricing power improves, cash conversion accelerates, R&D is better funded, technically superior products are manufactured, and the cycle begins anew.

This is James Halstead's ten year history:

and this is the relative performance of the three firms over the last business cycle:

Consistent with this portrait of success, James Halstead's management projects confidence: in the last ten years, it has paid out 60% of operating profit to shareholders, and invested the remainder, harvesting 45% annual returns on that incremental investment.  


If JHD does only maintenance business from now on, it can be relied on for £37 million per year in operating profit: normal ROIC of 45.8% x £81.4 million installed operating capital.


Given the quality of James Halstead's business model, the predictability of its financial results, and the size and steadiness of its payouts to shareholders, normalized profit should be capitalized using a 7% rate to place value of £529 million on the enterprise. (Another way of saying this is that JHD deserves an unlevered operating P/E of 14.5x; as a point of  reference, the UK’s PE-10 is 15x).  


After subtracting £25.5 million in debt equivalents and adding back both the £34 million in cash and the £10 million tax shield on debt, the equity is worth £546 million, or 530p per share. 


Revenue growth would add substantial value: a 5% rate of growth in revenue over the next ten years adds £339 million to the present value of the enterprise -- a 64% upside; 10% growth, in line with the prior decade, adds  £740 million -- a 140% upside. 


Disclosure: I have a position in JHD