Blindfolded Monkey on the Oche

Blindfolded Monkey on the Oche

One theoretical test of your portfolio performance is whether it beats one selected by a blindfolded monkey throwing darts at the share listing page of the FT. I shall not be trying this (I don’t own a monkey).

But musing over this set me thinking. As I outlined a few days ago, there are something like 1,300 trading companies on the LSE. I probably know a reasonable amount – maybe 200 of them – having held them now or previously or having reviewed and rejected them in the past.

That is quite a pool of potential investments. So I decided to deploy my virtual blindfolded money to choose some to look into.

The target universe

I wanted to apply some sort of filter, so as not to generate wasted effort, so I chose:

Market Cap > £20 million, but < £2,000 million

Whilst I don’t totally reject micro-caps, a very significant number of them are story stocks or basket cases. At the top end, I don’t think I could add any value to what is in the public domain.

Sectors

I do not (at this stage) want to consider resource stocks (gaseous, liquid or solid). They do not really fit my analysis approach, and beside Joel is the inhouse expert here!

Also, I do not want to include Investment Companies (Trusts, Funds etc). Because at this stage I have chosen to use the classifications published by LSE; I took out all of “Financial Services” – this will exclude some companies that should be on my radar, so I may refine this in due course.

Finally, I want to avoid biotech and pharma, again because I think you largely have to view these through a different lens. The LSE classifications do not really allow you to hone in on this group, so I will have to eliminate these on a case by case basis by now.

The target universe.

Having applied these filters to the LSE list as of 30th August 2020, I had a target universe of only 653 shares out of the 2,010.

Bearing in mind that this will include biotechs that I will reject, this is quite a small number. Perhaps I know more about my potential investing universe than I thought? Or perhaps my exclusions are to strict? I will review this in due course.

Having set up my virtual dartboard, I deployed my virtual monkey.

Thunk – 4D Pharma PLC [LON:DDDD] – this fails on two counts. Firstly, it is a pharma and secondly, I do know a little bit about it, having been short previously.

Second dart – Thunk:

Polypipe Group PLC [LON:PLP]

This one passes, I am pretty sure that I have never previously looked at this company and they do not fall into any of my exclusions.

What do they do?

Their press releases tell us they are:

“a leading provider of sustainable water and climate management solutions for the built environment”

I understand all of the individual words, but put together in that particular order I am not totally sure what that means.

Reviewing their (well put together) investors website [https://investors.polypipe.com/] helps here.

“We are one of Europe’s largest and most innovative manufacturers of piping, underfloor heating and energy-efficient ventilation”

To probably grossly oversimplify; they make a range of different pipes (the clue is in the company name) supporting the construction industry, covering residential, commercial and civils (bridges, roads and such).

I do not need to know more at this stage, this helps me to understand what economic drivers they are exposed to. The spread of different types of construction is reassuring in that it should provide stability in different economic phases.

History

They were founded in 1980, listed in 1986, acquired, went through 2 private equity backed MBOs (2005 & 2007) and relisted in 2014. See here.

There is a bit of an amber flag for me – private equity likes to suck out lots of cash by piling the company up with debt before IPO-ing them. Often this debt is a serious ball and chain.

Sure enough, looking back to their 2015 results, they had gross debt of over £200m, compared against a book value of £260m.

Racing forwards to the 2019 accounts; gross debt had edged up to around £210m but book value had increased to £360m. So maybe (just maybe) sufficient time has passed for the private equity trap to have become inactive.

 Medium Term Performance

Depending on your point of view, you could see the recent performance as pedestrian or reassuringly stable.

I particularly like that cash flows look reliable and that consistently exceeds profits.

There was no major dilution over this period and as noted above, debt had risen only modestly, whilst book value had increased.

Whilst the balance sheet is stuffed full of goodwill/intangibles (tangible book value was still negative as of FY 19), this has not changed materially over the last five years, so perhaps those “virtual assets” are really worth what they are recorded at.

Trends

In a recent announcement, the company notes:

“The medium-term fundamentals in our markets remain as strong as ever with the ongoing structural housing shortage driving demand, increased drive for carbon zero construction, as well as an increased focus on general air quality and ventilation and Government investment in infrastructure in a post COVID-19 world.”

This sound plausible, although I would say that most companies can describe a particular economic mega trend that they believe powers the future for their company.

This does not read to me as a particular profound trend; so whilst you can take comfort from the fact that there is no indication that demand for their products may dry up, I do not believe we should expect and substantial uplift in demand.

Reassuringly stable, still seems an apt description.

Coronavirus

Of course, it is impossible to review companies they days without looking through the lens of Covid-19. Regular readers will be aware that I have three tests which I will come onto. Firstly however, I should note that they took some fairly prompt action.

Shoring up the balance sheet

In early May, alongside a Covid-19 update, they announced a placing to raise £120m  (gross) at a 7.7% discount, increasing the share count by 13.4%.

Looking back, this may have been an over-reaction; if so, they are not alone in this as nobody back then really knew how things were panning out. However, perhaps they were being opportunistic.

I mentioned above the legacy debt from their listing; the latest results show they have halved net debt and this now looks far more manageable.

Covid Liquidity threats

One of my three tests.

In the half year to 30th June (announced in the mid-September), covering therefore pretty much all of the core lockdown period, they recorded negative cashflow from operations of nearly £16m. Compared against the more that £100m raised in the placing together with the comparatively rapid recovery in construction I can see no issues here.

I will confess that I have not looked all the way through the detail as to whether they have deferred any taxes to bolster the cash position, but I do not seem any significant increase in payables. This though would be something to drill into further, before considering an investment.

Recovery from Covid

My second test.

I cited above a company outlook statement, suggesting that they might benefit from the Post-covid trends. I am cautious on that conclusion; however I would be comfortable to conclude that demand should fairly quickly return to near normal.

Polypipe passes this test, too (in my humble opinion).

Beaten up share price due to Covid?

At face value this looks to be the case. In mid-February the share price was trading above £6, for an enterprise value of around £1.3Bn.

A the time of writing the share price is £4.33 and the EV a shade below £1bn. Given the fund raise, EV is probably the best measure and this has fallen c. £300m for a financial hit that looks to be less than £50m (assuming a reasonably swift return to normal trading).

This looks like a pass as well, but read on.

Company conclusions.

I like what I see so far. We have a reliable and resilient business, that passes all of my Coronavirus tests and has a more rational balance sheet than before the crisis.

But it is just not that cheap. In the year ending December 2019, they made profit after tax of £49.6m. If they return to that ballpark next year (as the available forecasts seem to broadly suggest), that puts them on a PE ratio of around 20.

Given that they look more a plodder than a racehorse, that doesn’t look very tempting. How does this stack up against the share price fall of around one third since the crisis?

Looking further back though the share price chart, I see that Polypipe shares were trading around the current level back in November. They put on nearly 50% in the four months up to the crisis.

Pre-crisis, they were forecast to see 2020 earnings rise to in excess of £60m, which probably was deserving of the more racey valuation. However, they missed their projected 2019 numbers, so it is not clear to me that would have achieved that even without the crisis.

Once the dust has settled, it may be worth looking at why profits were projected to jump and whether that is a path still open to them. For now, though, a projected PE ratio of 20x and prospective dividend yield of around 3% does not excite me too much. Given the apparent stability of the business, however, they might be a candidate for a small position in a conservative diversified portfolio.

I will be keeping them on my watchlist now.

Format Conclusions

I have found this a useful exercise, to review a company from a completely blind start. I plan to do this again, so I would certainly welcome reader comments on other issues it would have been useful to look at. Also, if any readers have looked at Polypipe in more detail before – was there anything I missed?

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