Cube Midcap Report (24 Sep 2019) – AG Barr starts to fizz #BAG #CARD #CBG

Cube Midcap Report (24 Sep 2019) – AG Barr starts to fizz #BAG #CARD #CBG

Good morning,

It’s Roland here with today’s Midcap Report. The companies I’m planning to look at today are:

  • A. G. Barr (BAG) – half-year results from the Irn Bru maker, which warned on profits earlier this year
  • Close Brothers (CBG) – full-year results from this midcap merchant bank
  • Card Factory (CARD) – half-year results from this value giftware retailer

This report should be finished by about noon 1pm (apologies, I’ve been delayed)

AG Barr (BAG)

  • Share price: 634p (+8%)
  • Market cap: £716m

Half-year results

After July’s shock profit warning from the maker of Irn Bru, all eyes were on Barr this morning to see if the firm would serve up another short measure.

Happily that doesn’t seem to be the case. Full-year guidance has been left unchanged and the firm’s shares have risen by a fizzy 8% in the first hour of trading.

The company says that plans to address specific problems with the Rubicon and Rockstar ranges are in hand and should start to yield results during the second half. Comparatives for the second half are also easier as the effects of last summer’s heatwave fade out of the numbers.

Let’s start with a look at the key numbers from this firm, which I regard as a fairly high quality business.

Results summary

Barr’s profit warning was triggered by two factors. Last summer’s heatwave created strong demand for soft drinks. But the other factor was that the firm cut prices to support sales and offset the impact of the sugar tax and CO2 shortage.

Management then sought to recapture lost margin this year by putting prices up again, or “returning to our traditional pricing strategy”. Customers pushed back against this price increase, hitting sales.

The headline figures for the six months to 27 July certainly show some weakness:

  • Revenue down by 10.5% to £122.5m (H1 2018: £136.9m)
  • Pre-tax profit down by 23.6% to £13.9m (H1 2018: £18.2m)
  • Operating margin: 11.6% (H1 2018: 13.4%)
  • Earnings down 23% to 9.8p per share (H1 2018 12.7p)

Shareholders will still get an inflation-beating dividend increase of 2.6%, taking the interim dividend to 4p. My sums suggest this should remain covered comfortably by free cash flow and earnings, so I don’t see any problem with this.

Trading highlights: Barr’s revenue and profit remains dominated by its range of carbonated drinks, which is dominated by Irn Bru. However, pre-mixed cocktail brand Funkin is making good progress. This segmental breakdown shows the hit to sales of fizzy and still drinks versus last summer. But note that profits in the Other segment, which is mostly Funkin, are up by 14% to £4.8m.

BAG 1H19 segmental results

Funkin now accounts for nearly 10% of Barr’s gross profits and appears to be growing at a good pace. The company has just launched a range of ready-to-drink cocktails in cans which it says are being stocked by leading supermarkets and travel outlets. I note that each can is sized/mixed so that it represents 1 unit of alcohol — I can see these selling quite well.

My view

After July’s profit warning, I had some concerns that Barr might have become too dependent on Irn Bru, which I see as a fairly mature product.

However, I’m encouraged by progress at Funkin and the speed with which management claim to have steadied the ship.

This business has a strong balance sheet, good cash generation and history of high margins. Given this track record, I’m inclined to be optimistic about the outlook. However, with the shares trading on 23 times forecast earnings, I think the stock looks fairly priced for now.

This would be a stock I’d like to add to my portfolio during a market crash.

Close Brothers (CBG)

  • Share price: 1,356p (-1.4%)
  • Market cap: £2.1bn

Full-year results

I do believe that the big high street banks offer some value for big cap investors. But when I look at results from well-established smaller lenders such as Close Brothers, I start to wonder.

Consider the headline figures: Close Brothers’ banking activities generated a net interest margin of 7.9% during the year to 31 July.

In contrast Lloyds’ net interest margin is currently running at 2.9% — and that’s better than some of its peers.

Close Brothers’ specialist lending to commercial clients appears to be far more profitable than Lloyds’ mix of mortgages, car loans and credit card debt, which is biased towards consumers. So should we be buying this FTSE 250 merchant bank?

Results summary

The bank isn’t immune to growing macro pressures. Today’s results show that adjusted operating profit fell by 3% to £270.5m last year, while earnings were down by 2% to 133.5p per share.

The bank’s profitability suffered, too. Return on opening equity fell from 17% to 15.7% last year, although I would argue that is still a very attractive figure.

Happily, the bank’s bad debt ratio was unchanged, at 0.6%. So as yet there’s no sign of a surge in delinquencies.

CEO departure: One other point I think is worth mentioning is that long-term chief executive Preben Prebensen has decided to step down after 10 years in the hot seat. This appears to be an orderly transition — Mr Prebensen will remain with the group for up to 12 months to facilitate a handover.

However, I wonder if he feels that after a long and successful run at the bank, the economic tide may be turning. Successful bosses often seem to time their departures so they leave on a high…

My view

I see Close Brothers as a stock that would be suitable for a long-term income portfolio. However, I do feel that the firm’s focus on automotive, property and asset-backed lending carries significant cyclical risk.

I don’t expect the bank to blow up in the next recession. But I’m not sure that I see a huge amount of value in the stock at the moment. Close Brothers currently trades at about 1.5x book value and the dividend yield has dropped below 5%.

Profits are at post-2009 highs but return on equity is starting to slip. Broker forecasts suggest that earnings will be fairly flat this year.

If I held the shares I would certainly continue to do so. But as a potential buyer, I feel that better opportunities might be available over the next year or two.

Card Factory (CARD)

  • Share price: 167 (+3%)
  • Market cap: £565m

Half-year results

I last covered Card Factory in August, when I discussed my dislike for the firm’s leverage policy and noted that a Q2 slowdown in sales was a potential concern.

These factors don’t detract from my liking for this company’s high returns, strong free cash flow and impressive margins. But today’s half-year results confirm the view I formed last month. Profits are down sharply and leverage is up:

CARD 1H20 financial summary

Against this backdrop, the company has held its interim dividend at 2.9p per share and opted to pay another 5p special dividend. My sums suggest that this will cost about £27m, significantly greater than the free cash flow of £17m reported for the half year.

Leverage: With leverage close to the firm’s limit of 2x, I don’t agree with the board’s decision to pay out dividends that don’t appear to be covered by surplus cash flow. After all, if cash flow improves in H2, a special dividend could always be paid at a later point in the year.

I’d also note that in today’s results, the company points out that “net debt at the half and full year period ends is lower than intra year peaks”. This is typical of most businesses, but it would be good to know how much higher leverage is at peaks.

The company’s target is to maintain net debt at between 1.0x and 2.0x EBITDA. But if leverage is 1.93x EBITDA at the half-year end, will it rise above 2x at peak levels?

My view

My view remains that this is a good business that’s made needlessly risky by the board’s leverage policy. Given the risks of operating a 1,000+ chain of high street stores, I’d be far more tempted to invest if leverage was maintained below 1x EBITDA.

As things stand, I feel the outlook is getting riskier or at least less certain. I will remain on the sidelines for now.

That’s all for today, thanks for reading.


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Wordpress (3)
  • comment-avatar

    Thanks for another interesting midcap report. Nothing there to make me delve deeper and potentially push the BUY button. But oftentimes that’s a good thing.

  • comment-avatar

    Thanks Laughton,

    I agree that doing nothing is often the right decision. As Warren Buffett once said, “The stock market is a device for transferring money from the impatient to the patient.”

    Knowing companies well means you can buy them well when the opportunity presents. As it will, eventually.


  • comment-avatar

    Very informative ……great job.

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