Monday 25 February 2019

Stock analysis: Telecoms


There has been a lot of noise about impending economic uncertainty, and likely stock market volatility so where might some of this roller coaster be avoided? Nice safe defensive stocks maybe? They don’t come much more defensive than utility/energy companies – providers of water, electricity etc. However, these come with increasing regulatory oversight, potentially squeezing profits, and the current Labour party have indicated a desire to nationalise such businesses. Another sector that has very similar defensive characteristics without the same restrictions and risks is telecoms – providers of mobile and internet infrastructure. Today these provide a service considered indispensable by most, so should have a very dependable income, and hopefully a nice safe investment. Lets find out.

There are 2 telecoms businesses listed on the FTSE 100:
·        BT Group (BT.A)
·        Vodafone (VOD)

And 2 listed on the FTSE 250:
·        Talktalk Telecom Group (TALK)
·        Telecom Plus (TEP)

Telecom Plus also provide a range of energy services so at least part of their business may end up subject to similar regulatory and political risks as other utilities/energy providers, and since nearly 80% of their 2018 revenue was generated by their Electricity and Gas segments I’m excluding them. They do, however, have a very interesting low capital business model, so I’ll be taking a closer look at them at some point. (If you're wondering why the link for TEP takes you to utilitywarehouse.co.uk, scroll to the bottom of the webpage and you'll see that it is a subsidiary of TEP.)

There are other telecoms businesses out there of course, I bought a few shares of MANX last month, but to keep this manageable I will start with these bigger businesses.

So, Vodafone, BT, and Talktalk... lets crunch a few numbers and see if any of them merit a closer look.

How big?
Since these 3 live in different indices, or in different parts of the same, let's first check out their respective sizes:

In terms of size (24th Feb 2019): 

Market Capitalisation
revenue
employees
% rev per employee
BT Group
£22629m
£23723m
105800
0.0009%
Talktalk
£1123m
£1708m
2226
0.0449%
Vodafone
£37889m
£41214m (€46571m)
104000
0.001%

For all financials I’ve taken the last 10yrs published accounts, from 2009 to 2018. It would be no fun if all 3 companies reported in sterling, so Vodafone report in Euros, so I’ve translated everything back into sterling using historical average exchange rates taken from here

Vodafone is clearly the largest company here, in terms of market cap or revenue. Both Vodafone and BT Group dwarf Talktalk in most cash and valuation measures, not to mention geographic coverage, however, Talktalk generates significantly more revenue per employee. Does this mean we have a hare and a couple of tortoises here? What would an historic investment in any of these companies have returned?

Don't look back in anger...
£1000 invested in these businesses 10yrs ago would have generated the following return (including dividends):

BT, Talktalk, Vodafone Historical Investment
BT, Talktalk, Vodafone Historical Investment

Well that's not overly inspiring. An investment in Talktalk would have peaked in 2015, and BT around 2016, dropping ever since. Vodafone was plugging away until last year, when it too decided to roll over. The best of the bunch is BT, which would have made a healthy 275% if you'd sold at the top (including dividend payouts). 


Capital
Total dividends
Total return
BT Group
1713
768
2481
Talktalk
920
851
1771
Vodafone
1097
760
1857


Even less inspiring when you look at the figures rather than the chart. Ignoring dividends, Vodafone would have made me £97 and Talktalk would have lost me £80. From a 10yr investment.

Careless talk
Talktalk have been in bother in for failing to look after data properly in the past, and it doesn't take long to find some disconcerting numbers with their performance over the years too:
Talktalk revenue, profit, fcf
Talktalk revenue, profit, fcf
Revenues and profits dipping, and not much cash flow. These are expensive businesses to run, with plenty of money needed for maintaining existing infrastructure, plus moving with the times and investing in new technology - rolling out 5G for example. I was expecting to find pedestrian growth, but I'm struggling to see any growth. Since the share price is flat, dividends must be a key component of the investment case here, but without enough free cash flow, they won't be secure either.

Good times ahead?
Maybe these have been some lean years for Talktalk (admittedly that's a lot of lean years). let's give them the benefit of the doubt, maybe it's all about to turn itself around. So let's take a quick look at Return on Capital Employed (ROCE), one of the preferred measures of how effective the business is at making money:
BT, Talktalk, Vodafone ROCE
BT, Talktalk, Vodafone ROCE
Whilst Vodafone might be starting to turn around, BT and Talktalk have been steadily getting less effective. At this point I need a reason to keep looking at Talktalk - as I mentioned above dividends seem to be the only reason to invest, how secure are they?
BT, Talktalk, Vodafone FCF/Dividend cover
BT, Talktalk, Vodafone FCF/Dividend cover
Cover for the the dividend at Talktalk has been slim to none for a while. So, this is a business struggling to increase revenues and profits, an investment that after 10ys would have seen my capital decrease, and it has an insecure dividend. Sorry TALK, I wish you well, but you're off the list.

BT isn't doing much better either - at least from what we can see in the above ROCE and dividend cover. Steadily worsening ROCE, dividend cover heading the wrong way...But an investment here 10 years ago, if dividends are included, would have increased by nearly 150%, I wonder what are the chances of this repeating over the next 10 years.

Borrowed time?
BT are not comparing favourably on efficiency (ROCE) or dividend security (FCF dividend cover). Do they at least have a well managed balance sheet?
BT, Vodafone debt vs. income
BT, Vodafone debt vs. income
Above is a ratio of the total debt (long term + short term borrowings) on the balance sheet, which I've divided by operating income. BT has been holding this ratio steady, Vodafone - not so much. A tick in the box for BT? Not if you include pension deficits as debt - and we should. Maynard Paton has an excellent pensions article on his blog. He even uses BT as an example of how a pension scheme might be a hidden timebomb. As can be seen from their annual report BT have a £6bn defined benefit pension deficit on the balance sheet:
BT balance sheet pension deficit
BT balance sheet pension deficit
Which grows to an unwieldy £11bn after all liabilities are calculated, which the pension trustees want paid back over the next 13 years:
BT pension repayment
BT pension repayment
None of which reassures me that BT has been managing it's debt obligations successfully. With £14bn debt on the balance sheet plus another £11bn owed to the pension fund, compared to earnings before interest and tax (EBIT) of around £4bn over the last few years, that's starting to look rather dubious, so unfortunately BT, you're also off the list of potentials.

And then there was 1
I was hoping Telecoms would provide me with a few options of nice safe, steady income stocks. Two of the three business above I certainly wouldn't view as a "safe" investment. So is Vodafone any better? The share price dropped around 30% in 2018, pushing the dividend yield up to over 9% at the time of writing, which I have to admit is tempting. Since the share price has dropped, is it a bargain? Or cheap for a reason?
Vodafone revenue, profit and fcf
Vodafone revenue, profit and fcf
Revenue, profits and cash flow have all flatlined over the last decade. Arguably FCF only increasing as a result of cost cutting. There has been a degree of commentary about the dividend, and at the last Vodafone trading update was even highlighted as being sustainable. Which it is. At the moment. Just. They have been generating around £5.2bn of fcf, with around £1.2bn expected to be spent on 5G spectrum bids over the next year, leaving £4bn for the dividend. Suspiciously neat. And it just doesn't leave a lot of wriggle room should anything unexpected turn up. And given Vodafone's fondness for borrowing, even something as bland as increased interest rates may cause a headache, particularly considering £43bn on the balance sheet compared to £4.3bn EBIT.

So unfortunately, it doesn't look like Vodafone will pass muster either - at least as an investment. I think there is a case to be made for taking a punt on it. If the board can do a little fancy footwork with the finances, cut costs, monetise their towers, spend a little less on 5G, the 9% dividend may turn out to be a bargain. 
Vodafone share price
Vodafone share price
It appears to be moving in a neat downwards channel, and may well be heading upwards and out of the channel. So the risk/reward may be worth a punt. I'm undecided.


Saturday 16 February 2019

Stock screening and analysis process

My typical day is spent at work, this is followed by a couple of hours with the family. Once the basic stuff of living is also built in, eating, cleaning, exercising, there isn't a whole lot of time left for analysing stocks. So to make this more manageable, over the last 6 months or so I've been building some stock screeners, and thinking hard about the most efficient analysis that I can do to enable me to isolate those stocks that I am interested in.

Since my analysis is going to be somewhat limited by time, my intention is to ensure my portfolio is diversified across industries, sectors, and geographies (starting portfolio here and here). My interest is more in quality defensive stocks paying a reasonable dividend, rather than highly cyclical businesses such as commodities. I also want to invest in a business that I understand (albeit a rather basic grasp of what's going on - based on the business' internal and external reporting). This diversification will hopefully remove some risk, but I will also be investing a small % of the portfolio into each stock, in the hope that should I make a mistake it's not going to cripple my returns.

So, limited by time, I've tried to develop some tools and a process that will help make this work. The idea is to push out the greater time investments until I've already done a few basic checks on the business...

Step 1 - 5yr screen
My screening process is going to be aimed at reducing risk, whilst trying to identify quality business. So my first step is my initial screen in which I ask a series of questions of a business based on a few figures from the past 5yrs accounts. This includes looking at some aspects of growth - e.g. are revenues and profits increasing, the consistency of that growth, debt, ROCE etc.. All of which is boiled down to a score out of 10.

5yr stock screener
5yr stock screener
Businesses at the end of a long upward cycle, such as house builders show up as having a high score, so I tend to disregard those highly cyclical stocks with a high score. Arguably those with a very low score are of more interest as they may be at the bottom of their cycle.

As you can see Mondi scores favourably, and whilst not a typically defensive stock, it has some defensive qualities, and has a couple of tailwinds from both ecommerce and a move away from plastic packaging, which prompted some of my interest to dig a bit more.

Inevitably I will screen out some good businesses doing this, but my hope is that I will also remove those I consider have risks that are too high.

Time to complete 5yr check: 0 minutes now the screen is built

Step 2 - 10yr numbers
Having found a stock in which I am interested, I then pull out a range of figures from the last 10yrs of accounts. I'm here trying to review and cross reference multiple data points to inform me about the health of the business, and also the extent to which it has been growing. I also dig into margins, ROCE, debt profile, acquisitions, capex etc. in a bit more detail. I like to be able to visualise what's going on so I throw in a few charts to help.
10yr stock screen - Mondi
Mondi debt vs cash


Again this is for Mondi - doesn't show much on it's own, but can be used with other measures to build up a picture of the health of the business.

Time to complete 10yr check: 20 mins

Step 3 - quality & price
If the stock makes it through the 10yr number crunching and still looks attractive -  or at least, not a basket case it gets added to the list of potential purchase candidates. A range of the results from the 10yr analysis are captured and compared to all of the other candidates.

Quality vs price - Mondi
Quality vs price - Mondi
From the various factors I've considered, Mondi, Next and Greggs all come out with a similar overall score, all very different businesses with different factors driving the scoring - in this case Next has better price vs cash flow, Greggs has less debt, Mondi has a higher dividend. By squashing many factors into a single result, I can get a view of potential investments assessed against the same benchmarks. And since price drives a number of these, such as PE, dividend yield etc. it has a significant bearing on how appealing the stock looks.

Time to complete quality vs price: 5 mins (most of the heavy lifting is already done)

Step 4 - qualitative review
Finally having got bamboozled by a load of numbers, I'll then wander off to do a bit of reading. I want to ask a whole lot of questions, related to how the business is run, how they make money, whether they are likely to continue to make money...all of which ends up in a completed checklist. But to complete this requires digging out specific details from the annual reports, company website, analyst views etc. which all ends in yet more scoring.

Qualitative checklist - Mondi
Qualitative checklist - Mondi

As with previous steps, this helps compare very different businesses against the same criteria. In this case - using Mondi as an example again, it's shown good growth and potential for continued growth, is relatively low risk, although I'm less happy with some of it's strategic elements.

Time to complete qualitative review: 3-4hrs

So there it is. All parts of this will need maintaining, review, refining, adapting...but I'm relatively happy with it. If there is a stock out there that does appeal that I can't do this with, I'll simply invest a smaller amount (e.g. my recent purchase of Manx Telecom), or I need to get equally comfortable via other means. Putting together these tools and process has already thrown up a number of surprises, stocks I'll be digging into which I wouldn't otherwise have looked at. Fun times...

(In case you're interested, Mondi is on the list of potentials and might well make it to the portfolio if it meets my preferred price.)


Friday 8 February 2019

Stock analysis: FTSE 100 Packaging and Paper


Ecommerce is here to stay, and I might have missed the huge initial growth that is now knocking lumps out of UK high street retailers. However, from my recent investment in BBOX, I’m hoping will generate a steady return from businesses seeking to capitalise on ecommerce. Other possible investments into the “infrastructure” of Ecommerce include logistics/ delivery, payments, online security and packaging. I’ll take a look at packaging, as I think this also plays into the theme of the circular economy and attempts to reduce our use of plastics.

There are 3 packaging businesses listed on the FTSE 100:
All three produce various types of packaging, mainly of paper and cardboard, and also some plastics.
Without poking around too much in the minutiae of the individual businesses, lets see if crunching a few numbers can give any indication of where to start.

For all financials I’ve taken the last 10yrs published accounts, which for MNDI and SKG are from 2008 to 2017, and from 2009 to 2018 for SMDS, so in the charts below I've just numbered the years to represent the last 10yrs data. Also just to make life awkward, MNDI and SKG report in Euros, and SMDS report in sterling, so I’ve translated everything back into sterling using historical average exchange rates taken from here.

Hindsight
With reference to investing, we're always told that the past is no guide to the future, but, it's one of the few bits of information that we have to work with. So I'm going to use it anyway. First of all, what would have happened if I had invested £1000 into these businesses 10yrs ago:

Mondi, Smurfit Kappa, DS Smith Historical Investment
Mondi, Smurfit Kappa, DS Smith Historical Investment
As we can see an investment in any of these businesses would have generated a nice return, with DS Smith ahead of the other two until the end of 2018 when the prices of all 3 dropped, leaving Mondi slightly ahead (this includes dividends taken as cash rather than reinvested). So in summary, £1000 invested would have done the following:

Capital increase
Total dividends
Total return
Mondi
£4725
£787
£5512
Smurfit Kappa
£4024
£543
£4567
DS Smith
£3804
£1162
£4966

Even with various assumptions, currency conversions, and general messiness constituting some degree of error this still looks like a fine return to me. What are the chances of it continuing?

Does size matter?
These three are in the FTSE 100 so they are big companies, and since we're told that "elephants don't gallop", size, based on market capitalisation as at 1st Feb 2019, and some info from the latest annual reports we have the following:


Market Capitalisation
revenue
employees
Mondi
£6805m
£6221m (€7096m)
26300
DS Smith
£4655m
£5765m
28500
Smurfit Kappa
£5247m
£7506m (€8562m)
46000
Mondi, Smurfit Kappa, DS Smith Revenues
Mondi, Smurfit Kappa, DS Smith Revenues
Depending on how you want to think about size, Mondi is worth more, Smurfit Kappa generates higher revenues, Smurfit Kappa also has more employees. Each has a wide geographic diversification, across several continents, but arguably not different enough to use as a factor to differentiate between them.

Efficiency
Combining a couple of those numbers in the table above, we can see that Mondi generates more revenue per employee than the other two which seems much more interesting as some measure of efficiency of the business.

Market Capitalisation
revenue
employees
% revenue per employee
Mondi
£6805m
£6221m (€7096m)
26300
0.0038%
DS Smith
£4655m
£5765m
28500
0.0035%
Smurfit Kappa
£5247m
£7506m (€8562m)
46000
0.0022%

These businesses require a fair degree of capital expenditure to keep their production plants running, and they require import of raw materials, and partly generate raw materials themselves – from home grown trees. In order to cut through some of that noise I’ve decided to look at just net margin. This seems like quite a nice simply measure – and essentially tells you how much of each pound/ euro is actually profit, in other words, 10% net margin means out of every pound the business makes, 10p is profit.

Mondi, Smurfit Kappa, DS Smith Net Margin
Mondi, Smurfit Kappa, DS Smith Net Margin
As margin is a proportion of revenue I haven't converted currencies, but the above is interesting, Mondi clearly doing a better job with margins.


What about Return on Capital Employed – another measure of efficiency, this time measuring how effective the businesses are at turning capital into profit, a ROCE of 10% means that for every pound/euro invested, the business makes 10p. 
Mondi, Smurfit Kappa, DS Smith ROCE
Mondi, Smurfit Kappa, DS Smith ROCE
As we found looking at margin above, Mondi seems to be more efficient than Smurfit Kappa and DS Smith at generating profits.

Returns
So what cash do these businesses generate, and importantly, as an investor interested in dividends, how much of that cash finds it's way to my bank account. I want my investments to pay dividends, I want those dividends to grow, and to be secure. To start to get a feel for this I’ve looked at the Free Cash Flow (FCF) to Dividend cover, rather than earnings cover. Dividends are paid out of cash left over once all other bills have been paid, bills are paid out of profits, so profits don’t necessarily tell what you need when it comes to understanding if dividends are appropriately secure. To find the FCF cover, FCF is divided by the dividend paid for the year, the magic number is 1, if cover is above this, then the business has made enough cash over the last year to pay the dividend, less than 1 indicates that this is not the case. It is usual to expect higher coverage, which leaves the business cash to invest in itself after paying dividends. Less than 1 isn’t a disaster, but it will mean the business is eating into cash reserves or borrowing to pay the dividend, neither of which is sustainable longer term.
Mondi, Smurfit Kappa, DS Smith FCF Dividend Cover
Mondi, Smurfit Kappa, DS Smith FCF Dividend Cover
As we can see DS Smith seems to bounce off of the line showing a coverage of 1 a few times, Smurfit Kappa looks to be dropping alarmingly and also missed a couple of payments in years past too, and Mondi once again looks like it’s doing a pretty good job.


Is it safe?
Each of these businesses has proved a reasonable investment over the past few years, but have generated cash with varying degrees of efficiency. Dividend to FCF has been a little flaky at Smurfit Kappa, but if I wanted to invest I'd want to get a view of the safety of each business through the lens of debt. I've done this by comparing the amount of debt on the balance sheet of each to their Operating Income (EBIT):
Mondi, Smurfit Kappa, DS Smith FCF Debt to Income
Mondi, Smurfit Kappa, DS Smith FCF Debt to Income
In this case Smurfit Kappa has seen it's debt reducing, but not as quickly as Mondi, whereas DS Smith is increasing it's borrowing compared to income.

Summary
So banging through a few numbers leaves me the following conclusions:
  • Mondi is a more efficient business judged on a number of measures
  • Mondi's dividend looks safer with greater FCF cover
  • Mondi has less lower debt compared to it's income
Well that's narrowed things down, Mondi looks like it's worth a bit of investigation, as it looks more likely to generate cash and has less risk associated with debt. Now to the important stuff, crack open the annual report and try to understand their business...

Tuesday 5 February 2019

January share purchase no.2: BBOX

My second purchase of January was Tritax Big Box (BBOX). This is a wonderfully dull business - they specialise in the provision of "...very large logistics facilities in the UK".  Having visited a couple of these facilities, I can attest to them being very large indeed. The BBOX IPO was in 2013 and they have seen impressive and pretty consistent growth since, at the time of writing their market cap is over £2bn. Their tenants make up a nice cross section of both UK and international businesses, including Screwfix, M&S, through to Amazon and Unilever.

The ecommerce goldrush is already is full swing (take your pick of stats here), but there's still gold in them hills, and as everyone knows the best way to make money in a goldrush is to sell shovels. Logistics being one type of shovel for the current day.

BBOX is a Real Estate Investment Trust, these are financial vehicles that came into being in the UK in 2006/7. In exchange for following certain rules around their design, these businesses avoid corporation tax and capital gains tax on their property portfolio, and are required to payout 90% of their income to investors. However, since they are paying out most of their cash, when it comes to investing in their business, and going after more properties, they will typically have to raise money through issuing more shares, or borrowing, neither of which is perfect. It's a convenient way of investing in property without all of the usual hassle that typically comes with actually buying property.

Based on their Q3 factsheet, issued in September 2018, the average lease had around 14 years to run, all assets were occupied. Their customers look, like a relative sound set of businesses, but with a couple of exceptions, most notably New Look, which appears to be struggling. Marks & Spencer and Dixons Carphone have also had their difficulties recently. However, apart from those 3, the remainder look like very solid businesses.

I've had my eye on this for while, but the price had moved steadily upwards, not offering a dip to buy into until the summer just past when the price started sliding. It kept sliding all the way to offering a discount of nearly 8% vs. NAV, which considering it had hardly offered any discount in it's history looked pretty tempting. Then just after the January trading update BBOX announced the acquisition of db Symmetry to add to the BBOX asset portfolio. Since the acquisition was viewed as dilutive, the share price took a dip from what I could gather the overall impact of the additional assets would outweigh this.

Now unfortunately I'm no expert on REITS, and I didn't feel as if my screeners, and excel number crunching tools could be applied, but I'm quite comfortable with this. I see it as a fairly defensive investment, that should pay a steady dividend and it adds some diversification to the portfolio too.

Sunday 3 February 2019

Portfolio housekeeping & 2018 performance

Having decided to try to get a bit more serious about my investments I thought the new year should start with some housekeeping. There were a few things irritating me about my record keeping:

  • drip feeding money in made it difficult to assess performance
  • automatic dividend reinvesting
  • tracking costs
Problem 1 - I've unitised the portfolio. There's a great post about this on Monevator, it's a lot easier than I thought and really helps to cut through the noise created by adding in funds.

Problem 2 - As I was lazy I was automatically investing dividend payments. This made keeping track of what I had invested a bit of a headache. Although a case can be made for thinking of this as pound cost averaging in a sense, it was pushing up costs, and purchasing small numbers of shares where on reflection I didn't necessarily want more invested. So that is now cancelled, and I will be reinvesting once a pot of dividends has accumulated.

Problem 3 - I was trying to separate all costs to track them, and to build them into tracking portfolio performance but this was complicated by problem 2. I've now decided to still keep a record of all costs, but I've now built this into the original price of the share. So the original price against which I'll track is price + costs, making life lots easier.

So having spent some time tidying up, getting ducks in a row, the 2018 performance ended up being -1.4%. Not great since objective 1 is to not lose money. However, it compares favourably to the FTSE All Share, I'm taking the Vanguard FTSE All Share Accumulation fund as my initial benchmark (maybe a global tracker would ultimately be more sensible...one thing at a time...), which ended the year -5.4%. A quick look at the monthly movements indicated that my portfolio is more stable, dropping and rising less than the index, which if it continues I'll be happy with.

Saturday 2 February 2019

January share purchase no.1 : MANX


The Alternative Investment Market is home to many weird and wonderful businesses, some of which are household names, and based on market capitalisation would comfortably sit in the FTSE 250, and even make a run at the FTSE 100 – just check out Burford Capital (BUR), Fevertree (FEVR) or ASOS (ASC). It has a lighter regulatory framework to the main market and therefore has greater regulatory wriggle room which could be exploited by badly run businesses, a quick Google search will reveal plenty of examples.

Manx Telecom (MANX) is a telecoms company operating on the Isle of Man (the clue is in the name 😊). They provide fixed line, broadband and mobile telecoms, run a couple of datacentres and are launching a new product to help mobile users with hearing difficulties. They were admitted to the AIM in February 2014.

So the first purchase of the year is a bit leftfield, falling into the speculative part of the portfolio, and therefore was a smaller purchase…

As a speculative investment, I’m not expecting them to meet my standard investment criteria. However, they are appealing for a couple of key points. As the leading comms provider on the Isle of Man there is clearly a “moat” around their business and their core revenues from the residents of the Isle are “sticky” – at least there is going to be a degree of cost involved in switching to an alternative supplier. And their new products, should they prove successful should act as a decent tailwind for the stock. They are a capital intensive business, with more debt than I would like, which is not ideal, but it is defensive in nature.

The share price has been in decline over the past few months and at the time of purchase it looked as if it was finding a bottom (hopefully I’ll not be posting something here in a few months about catching falling knives). Partly as a result of the share price fall, at the time of purchase the dividend yield was around 7%. Anything above 5% gets a big thumbs up, but given the new products, and potential investment required, I wouldn’t be surprised to see the dividend reduced. For 2017 the full dividend per share was 11.4p, adjusted earnings per share was 13.28p and cash flow per share around 10p per share (depending how you calculate it).