This is an investment idea that requires very little imagination. It is premised on four factors:
Northgate’s business is sound. Stepping back from the accounting presentation of the business helps to reveal the underlying mechanics of the business. The table below illustrates what happens on a cash basis in rolling 20 to 21 month periods. The key to performance is the utilization rate: 90% is good; 83% is what happens when a quarter of your vehicles are targeted to the Spanish construction industry when the bubble bursts.
The company's maintenance capex requirement is less than its depreciation rate. Subtracting growth capex (i.e. expenditure for fleet size growth and expenditure on goodwill & acquired intangibles) from total capex reveals that maintenance capex is about 62% of depreciation.
True earnings are therefore higher than may be perceived from a quick glance at the financial statements. In fact, at the current price, Northgate’s equity is yielding 34% on trailing earnings and 35% on average earnings over the past ten years.
As growth is interrupted - momentarily, at least - free cash begins to flow. In two years, Northgate’s debt has been reduced by 300 million. In another year it will be down to 200 million, an optimal level. The year after that, if the economic environment is as it is now, it can buy back 40% of its shares. Et cetera.
Nothgate's value exceeds 700p
Disclosure: I am long Northgate