Lewis Robinson

_{Disclaimer: I have a material personal interest in Macfarlane shares. A portfolio I help to manage has a large weight in Macfarlane shares. Hence, I cannot help but be biased. Please do your own research – my projections are mine alone.}

How I Invest

As I described in my year-end post, to the extent I have a framework in investing, it is this:

• Buy companies which are cheap in absolute terms, and in any case cheaper than the market
• … which are more predictable than the market
• … which are higher quality than the market (as judged by prospective return on invested capital)
• … and have better growth prospects than the market

My order of priority is roughly as I’ve laid it out above.

To me, this is a common-sense way of investing. Look for cheap stuff which should be more highly valued.

So what determines whether a company should be highly valued? Why do some companies trade at 25x, and some at 5x?

Well, highly valued should come from a combination of:

• Predictability
  • Bonds trade at lower expected returns than mature stocks, which have lower expected returns than start-ups
  • The riskier an asset, the higher the necessary returns investors will demand , and the lower the ‘multiple’ the asset will trade on
• Quality
  • The higher the returns on invested capital, the more a business is worth. A growing business is worth nothing if that growth requires a huge amount of uneconomic capital
• Growth
  • Subject to the quality hurdle, more growth is better than less. Everyone knows fast growing business trade at better valuations

You can nuance this further. Some people would tell you that brilliant management or an aligned board should be prized. I agree. But these only matter to the extent they show through in one or more of the numbers above. Excellence at the top of a business should translate into excellence through the business and in the income statement.

Excellence in Action

Sticking with this theme, let me take a cherry-picked sample of some UK industrial/distribution businesses: Bunzl, Halma, Spirax-Sarco, Oxford Instruments, RS Group, Renishaw and Diploma.

These are all high-quality mid-cap industrials. Each of them has a decade of good growth behind them, strong returns on invested capital, and a highly predictable P&L. None of them has lost money in the last decade.  Look at the EPS progression in the chart below:

Continue reading“Macfarlane – Consistently Underrated”

_{Disclaimer: This is not investment research, and you should not consider it as such. It is commentary based on publicly available information. I have a very material personal interest in S&U Plc shares. A portfolio I help to manage has a very large weight in S&U Plc shares. Hence, I cannot help but be biased. Please do your own work – my projections are mine alone.}

I first wrote about S&U, the specialty finance business, two years ago. In that time the stock is up about 10%. This is a failure in performance terms – my hurdle rate is a lot higher than that – though I’ve received ~10% extra in dividends in that time.

Fundamentally, though, it’s far from being a failure. In fact, it’s been an unmitigated success:

• I had projected that the company would earn £22.9m in 2022. They actually earned £38.0m.
• I thought they would earn £30.2m in 2023. Brokers currently forecast that they’ll do £32.6m, 8% higher, and I’m pretty sure they’ll beat that.
• I thought they would earn £34.4m in 2024 and, again, I now suspect it’ll be more like £37-38m.

It’s not as if I was setting easy targets, either. My forecasts, at that time, were way ahead of the market. The sell-side was, predictably, panicking about economic impacts and doing what they do best – extrapolating short term trends indefinitely into the future.

We did have a brief interlude of sanity in this journey. S&U ran up from ~£16 to ~£29, but we’ve ended up right back where we started: with the market terrified that S&U’s days are numbered. It is the energy price crisis and the impending recession which has spooked everyone now.

This is a business which, I need not remind investors, grew profits through the GFC. That’s right – it’s a non-prime financial business that grew profits through the worst recession in living memory. Average net profit for 2021 and 2022, the two COVID-impacted years, was £26.3m: within spitting distance of the £28.4m they made in the two prior years. They are more resilient than the market gives them credit for.

You don’t even have to take my word for it: they released a trading update a few weeks ago, noting that:

“Although it is only just over two months since our last trading update, S&U is pleased to report that both its motor and property bridging divisions continue to outperform its expectations, both in transactions growth, and in the quality of its book and the new business it is writing. Current Group receivables now stand at approximately £370m against £340m in May, and profitability exceeds that of H1 last year. “

H1 last year was their best H1 ever. They are now beating that. The business is – if you’ll forgive the pun – motoring.

You have visibility for continued growth, too: those £370m of net receivables compare to £322.9m at the start of the year. Like any finance business, the more you lend, the more interest you earn. Without wanting to oversimplify, this is an excellent indicator that earnings will keep going in the right direction.

And I know, I know what you’re thinking: Lewis, it doesn’t matter that the business is growing. We’re about to go into a recession! Consumers are going bust! The energy crisis will cripple everyone!

Well… maybe. As I said, S&U’s average profits in the two-COVID impacted years were pretty similar to their prior profits. Anyone who tells me with a straight face that the current situation is as apocalyptic as a total shutdown of society is, in my view, completely bonkers.

Investors, who overwhelmingly come from quite a narrow strata of society, tend to have a rather fixed view of the sort of people who take out non-prime car loans. Obviously, they muse, they must be living hand to mouth, paycheck to paycheck, struggling to keep their heads above the parapet, with zero flexibility in their budgeting.

It’s a patronising assessment, frankly, and it’s also completely wrong. If you look at S&U’s historic results, you will see that the only thing that severely damages their repayment trends is rising unemployment. When people lose their jobs, they stop paying for their car, because they have no choice. If they have a job – and they need their car to get to work – they pay for it. People find a way to cut back and make priority payments.

This is, of course, leaving aside the fact that in the next six weeks we will get a bazooka of cash blasted at the people of Britain. Relief from record energy bills is too popular, and too politically attractive, not to happen. It is also – frankly – the right thing to do, unless we want to live with massive economic scarring from what is (hopefully) a temporary phenomenon.

Continue reading“S&U Plc – Can’t Get No Love”

_{Disclaimer: This is not investment research, and you should not consider it as such. It is commentary based on publicly available information. I have a very material personal interest in Quixant Plc shares. A portfolio I help to manage has a very large weight in Quixant Plc shares. Hence, I cannot help but be biased. Please do your own work – my projections are mine alone.}

Introduction

Quixant isn’t my usual type of investment. I tend to like non-cyclical businesses with very consistent earnings growth. I try to minimise the probability of negative surprises. Quixant doesn’t tick those boxes: its key division relies on a cyclical end market. It has, in the last few years, been beset by woes both market-driven and of its own making.

So if you’re looking for something safe, assured and consistent, you’ll probably prefer my posts on Macfarlane and S&U.

But if you’re willing to look past the scars of the last two years, let’s discuss Quixant Plc. It’s the only example I have in my portfolio of a real turnaround: the one case where I have enough faith in management to back them to come out the other side bigger, stronger and better.

Elevator Pitch

Quixant is an engineering led manufacturer. The bulk of the group’s profit comes from one vertical – gaming.

For this, Quixant produces computers powering the slot machines you will see in Vegas and around the world. Slot machine manufacturers recognise that the key to selling slots is writing compelling games. Building the physical PCs, and getting them through a lengthy regulatory approval process, is a tedious necessity.

So, they partner with Quixant, to our great success: from 2010 through to 2018, the group grew profits from ~$0.6m to ~$14.6m. The market loved the story, and the shares traded at almost 30x earnings.

Since then, though, we’ve had two major setbacks. The first was self-inflicted. The company had a heavy dependence on one customer which lost significant market share. The group failed to grapple with the size of the issue, and repeated profit warnings blew investor confidence.

The second was market driven: COVID. Slot machines represent discretionary and deferrable expenditure. Unsurprisingly, with the world’s casinos closed, Quixant’s customers turned off the taps: and it made a loss for the first time in its listed life.

So far, so gloomy. What is there to like?

Well, perhaps the last three years are not the best guide to the future. Perhaps we can look through one internal stumble and a big market implosion. Maybe Quixant is still a brilliant business underneath it all, trading at ~8x peak earnings.

Quixant has gained customers in this turmoil, and embedded itself deeper in existing ones. It is back making a profit in a very difficult supply environment, and I reckon they are at their highest ever level of order intake. I rate management and their conservatism exceptionally highly. I also think there are signs that they are managing to become relevant in markets outside of gaming.

There is a wide spread of outcomes here, but Quixant has all the ingredients to be a much bigger – and more profitable – business. If they execute, prior peak earnings may be a long way in the rear view mirror.

The gaming business

Quixant’s core business is gaming. It accounts for a large majority of profits in a typical year.

The genesis of Quixant came when the founding team were working together at another electronics business, Densitron. Their discussions with customers led them to a gap in the market: ‘all-in-one’ integrated computers for the gaming sector. Unfortunately, the Board reception for their pet project was rather lukewarm. So they backed their instincts, and left to create Quixant.

The pitch to customers is simple. Slot machine manufacturers don’t want to be developing hardware. It is not core to what makes a difference to their customers: the casinos. The ‘fairy dust’ is the game’s probability logic, which dictates odds and payouts. Get that right, and you’re golden: it’ll hook people in with the classic slot machine feeling that the win is ‘just around the corner’. The graphics and presentation of the game are also important: both internal and external. Fancy graphics on screen and a slick looking and bright cabinet will give the right first impression.

But the computer which runs the game, and the drivers which stitch together the various functions (bill accepters, regulatory modules) are irrelevant. Punters don’t see it, and casinos take it for granted.

The below chart has been in Quixant’s presentations for almost a decade, and it sums up the value proposition:

Continue reading“Quixant Plc – Grasp the Green Shoots”

_{Disclaimer: I have a very material personal interest in S&U Plc shares. A portfolio I help to manage has a very large weight in S&U Plc shares. Hence, I cannot help but be biased. Please do your own research – my projections are mine alone.}

Recap

If you’re new to the S&U story, I first wrote about the business last December, in a post called Credit Where Credit is Due.

It’s a long exposition of why I think S&U is a great business, with great management, and why it is a wonderful long-term hold for patient investors.

But better still, and hot off the press, I had a great time presenting S&U to the Stockopedia/PIWORLD Virtual Stockslam on Wednesday. It’s a virtual event where 10 private investors get three minutes to each pitch their favourite stock, and three minutes to answer questions from a discerning audience.

Where are we today?

So, in line with my thoughts at the StockSlam, I wanted to update the analysis I put together last December.

I still hold S&U and, indeed, I have been buying – not selling – since that 2020 blog post, despite seeing the share price rise from £18.20 to £29.00. Depending on your point of view, this highlights either my strong conviction or my startling lack of risk management.

In a nutshell, though, here’s why I remain so excited:

• Concerns people held last year – regarding viability, solvency, appropriateness of debt, whatever – have all melted away
  • Rightly or wrongly, people were panicky, and despite S&U’s very robust financial condition, investors I spoke to worried about potential risks in a small cap lending business. This is no longer the case now the world is looking rosy, high yield spreads are compressed, and borrowing costs in the economy remain low
• Existing loan performance is far ahead of even my bullish expectations
  • I thought there would be some ‘scarring’ effect for the coming years as a result of COVID. Instead, we have a business enjoying its best loan collection performance in years. As a consequence…
• The balance sheet looks exceptionally conservative, and provisions releases should boost profitability
  • Provisions made in 2020 were very high, to account for future non-payment of loans. They were made at uncertain times. In actuality, customers are paying very well; so I suspect these provisions will slowly revert to more ‘normal’ levels, giving us a few years of boosted profitability
• I have rarely seen management so openly optimistic on growth
  • My hunch is that the work ‘behind the scenes’ at Advantage to take more control of their own destiny – opening up new sales channels, and forging closer partnerships – is now paying off. Given how profitable this business is, growth is the single most important metric to accelerating returns

Continue reading“S&U Plc – Set Fair For Growth”

_{Disclaimer: I have a material personal interest in Macfarlane shares. A portfolio I help to manage has a large weight in Macfarlane shares. Hence, I cannot help but be biased. Please do your own research – my projections are mine alone.}

Elevator Pitch

Macfarlane is a packaging distributor with 26 core sites around the UK. It stocks boxes, wraps, tape and plenty more, and sells to customers like Dunelm, Halfords and Honeywell, as well as a raft of smaller businesses.

Boring, sure – but boring is often resilient. Customers avoid managing their own warehouses full of various dimensions of packaging. Macfarlane’s scale gives it buying economies, while manufacturers avoid having to deal with hundreds of small customers. A well-run distribution business is hard to dislodge, because for every party involved, the alternative is a world with a lot more hassle. It can be mismanaged, though, as long-standing CEO Peter Atkinson found in 2003 when he took the reins of a packaging empire stretching from Guadalajara to Glasgow.

Within two years Atkinson had steadied the ship, and from that baseline in 2005, Macfarlane has grown normalised earnings from ~£1.5m to my estimate of over £17m in 2021. Accounting for dilution, that’s an EPS CAGR of 14.0%, while paying dividends along the way. A substantially above-market return.

Better yet, the return I’ve just described isn’t obvious. Non-cash accounting charges other companies would routinely adjust aren’t mentioned. Property provisions for rationalising the network – which other management teams would call ‘one-off restructuring expenses’ – aren’t broken out. That’s an opportunity, as economic earnings are more than 20% higher than reported.

But perhaps the most compelling element here is the timing: Macfarlane just announced their best H1 ever by an enormous margin. The business is firing on all cylinders as eCommerce packaging demand drives significant growth, and the recovery in the group’s core industrial business is beginning. Careful expansion into Europe provides further upside.

The market earnings multiple in the UK is around 17x. I think you’re getting Macfarlane at about 12x earnings – a big discount, particularly considering Macfarlane is a far superior business to most. It is better managed, more resilient, more predictable and its growth plans simply require ‘more of the same’. Investors are getting a winner for a discount price.

The Business

So, first things first: let’s dive into the exciting world of packaging distribution.

Macfarlane buys packaging from the big manufacturers – Smurfit Kappa, for example – and holds it in their 26 distribution centres.   Smurfit doesn’t want to deal with Macfarlane’s 20,000 customers. Tinkering with delivery route optimisation and holding custom stock for rapid delivery is not their game. Hence, distribution is a win-win; it aggregates demand and reduces cost-of-service for manufacturers.

Customers – like Argos, Dunelm or Glasses Direct – place orders with Macfarlane, typically for next day delivery. These guys don’t want warehouses stuffed with huge amounts of packaging. They won’t get the best price from manufacturers compared to Macfarlane, which buys in serious volume. Nor are they experts in packaging, an unloved and unsexy part of the world of commerce. Having a consultative partner is a big help.

Of course, some big customers do go direct, and some use a mix of distribution and manufacturer. Ikea uses Macfarlane for part of their needs.  But Amazon doesn’t need them at all – Amazon is big enough and complex enough to negotiate and manage their own packaging supply chain. Luckily for us, we don’t care about Amazon anyway – incessantly squeezed margins and a lopsided relationship is no way to run a business. Dunelm and Ikea are meaty customers, and even small businesses offer plenty of margin potential.

Peter Atkinson, CEO, likes to point out that the actual cost of packaging is not that material in the grand scheme of things. Think about part breakage and damages. Or the nightmare of dealing with your own packaging logistics – likely in a facility that doesn’t have the space or the layout to effectively store these materials. If you’re a growing retailer, do you want your warehouse to be stocking your £25 candles, or do you want to be stocking bulky pieces of cardboard – which you could receive as you need from Macfarlane? Like any good salesperson- Macfarlane’s pitch is to persuade the customer to see that the price is not the primary concern:

Continue reading“Macfarlane – Ticking all the Boxes”