Thursday, February 19, 2015

A UK Portfolio 2014 - 2016

This is the third in a series [2012 to 2014 is here and 2013 to 2015 is here].

The UK market is now an uncomfortable place to be and what follows will I suspect be of interest only to a few.

I have said my piece about about Lombard Risk and Lamprell and I don't have anything new to add. I am allocating 20% to cash. The opportunities and risks attached to Dolphin Capital and Goodwin are as you see them so I'll only sketch Hogg Robinson, Hargreaves Services, Findel, and Cambria.

Hogg Robinson

I own shares in Hogg Robinson, a travel management company catering to multinational organizations with large traveling populations (Volkswagen, for example), confederations with special travel needs (the NBA, Cricket Australia), as well as governments and inter-governmental bodies (UK, Canada; NATO).

Its financial statements look fairly placid but belie both the structural transformations playing out in the managed travel industry and the neurosis that periodically grips the market about HRG's ability to align its strategy and cost structure accordingly. (There is, of course, a whole subculture dedicated to forecasting what "Managed Travel 2.0" will look like. I recommend the white papers at the website of Carlson Wagonlit).

We get a better view of what's going on if we adjust for a few items.

First, it appears that HRG lost 8 million in revenue in H1 2015 due to the strength of sterling and, second, it lost 6 million as a result of reduced European travel for cyclical reasons.

I think it reasonable to add those back to get normalized figures and to account for cyclicality instead via the modesty of the 10x multiple applied to the resulting FCF (10x unlevered FCF is equivalent to 8x EBIT). 

The company has also begun the process of rationalizing its cost base -- it has incurred the special charges but the annualized benefits have obviously not yet shown up. I add those back too.

There has been a rise and an acceleration in self booking of travel tickets among the traveling populations in its client roster. Each 5% increase in self-booking appears to reduce revenue by 1 million. The share of tickets that are self-booked will continue to increase and might hit a wall at ~80%. That would reduce run rate revenue by 25 million. It is low quality revenue since the margins are necessarily thin -- but no matter.

HRG has indicated that it will cut another 20 million out of its cost structure by rationalizing offices and reducing headcount. I add that back in the 2018 figures.

So we are left with a slightly smaller but more profitable revenue base and a forward FCF yield that cannot be sustained.

SpendVision would, in other hands, be more valuable than HRG itself. It is a wild exaggeration to say that it is a mini Concur but there are similarities in its potential. The combined value of SpendVision's potential and Travel Management's cash generative properties would, I think, make this HRG attractive to private equity. It has, in fact, been taken private in the past. 

Things to pay special attention to:

Think about who you'd target if you ran a travel management company with six thousand staff and a presence in 120 countries.

First on your list, surely, would be large multinational corporations with complex travel needs -- that is, with employees who frequently travel to and from places with higher than average security risk; higher than average flight cancellation risk; and higher than average need for local knowledge about where to stay, how to get around in country, and what to do in case this or that happens. The oil majors and the ecosystem that supports them maybe would be the place to start.

This is what it says in the H1 2015 report:

    "Our focus of targeting the provision of specialised travel services to companies operating in the marine, offshore and energy sectors is paying off.  HRG's track record over many years of successfully managing complex travel has resulted in new business wins during the period with Baker Hughes, Orica and Subsea 7, adding to a roster that includes, amongst others, ConocoPhillips, DOF Marine, Statoil and Tullow Oil."

It is awfully perplexing that this should be a new idea in 2015. At the same time, one does feel mollified that there is something that approximates a strategy in the works.

Second, the pension deficit is more substantial than the company's market capitalization. If corporate bond yield fall further, the deficit will widen. If corporate bond yields rise by 2% or so, the deficit will disappear. That would add 60p in value to the shares and therefore renders them an okay way to hedge against the possibility of a rising interest rate environment.

Hargreaves Services

HSP is a mix of good and bad businesses. The bad businesses -- surface mining of coal in the UK and bulk trading of thermal coal throughout Europe -- are not always bad and in any case enable HSP to profit from the trading of specialty coals.

Pulling together the contents of HSP's latest filing lets us draw this picture:

and therefore

and finally


The thing to do with Findel is, I think, to temporarily set aside everything but the Express Gifts segment. Its closest publicly traded comparable is  N Brown.

The other segments may not, in the end net out to zero. Kitbag is under "strategic review" and has received multiple expressions of interest. The education business is probably more cyclical than structurally challenged. Nevertheless, if Findel's share price rises -- and stays -- above 479p 8.34 million convertible shares come into play and negate the benefits of an improvement in these businesses.

Something to pay attention to: Management has an economic interest reporting ever improving EPS figures. This can be good and it can also be bad. It can, in a business quite reliant on securitized receivables and in one targeted at (or is it targeted to? or, perhaps, "serving") the working poor, become quite tempting to engage in risky operating and accounting practices.

Cambria Automobiles

The business model of a car dealership is to sell cars in order earn a profit on the sale of aftersales products and services. It can be done well and it can be done badly. The people who run Cambria do it well. They buy underperforming dealerships and make them profitable. 2.5% to 3% EBIT margin  represents very good performance in the dealership business. Cambria's margins, at 2% on average, reflect a mix of dealerships under its buy and improve strategy. 

As is, Cambria could (should) be valued as follows: 

so that

although, of course, the latest IMS suggests that the performance of the very latest acquisitions is such that there will be a substantial advance in the group's revenue base so there may be upside beyond what I've suggested here.

If the pace of acquisitions slows and we see 2.5% margins the shares would be worth 130p. That is also what it would be worth to a private buyer.


Of course this exercise is fun only if y'all dig in for yourselves, use your own judgment, and push back where appropriate so I look forward to that. 

Disclosure: I own shares in Hogg Robinson