Cube Midcap Report (26 June 2019) – BCA, SGC, WG, TLW
It’s Roland here with the Midcap Report. On my list for today are:
- BCA Marketplace (BCA) – full-year results from the car auction group, which has received a recommended takeover offer
- Stagecoach (SGC) – full-year results
- Wood Group (WG.) – year-end update from this heavily-shorted firm
Time permitting, I may also take a quick look at today’s update from Tullow Oil (TLW).
BCA Marketplace (BCA)
- Share price: 242p (+3%)
- Market cap: £1.9bn
Today’s preliminary results from car auctioneer BCA Marketplace — which owns WeBuyAnyCar.com — are overshadowed by news that it has received a recommended takeover offer worth 243p per share.
The buyer is private equity firm TDR Capital, so BCA will be returning to private equity ownership less than five years after joining the public markets. At least one major shareholder — Neil Woodford — is likely to be cheering this unexpected dose of liquidity.
The offer represents a 24.9% premium to closing price of 194.6p on 19 June, the day before this offer was first mooted. According to today’s statement, 44.02% of BCA shareholders have already indicated support for the bid, so it seems likely to go through. So congratulations to holders here.
However, I think it’s worth noting that BCA shares were trading at the level of this bid in the open market less than one year ago.
Since then, the share price has trended down. So although today’s results are largely academic for the company’s investors, I think they’re worth a quick look to see if we can understand more about the valuation of the bid and the outlook for this business.
Car market news over the last year has focused on the decline in new car sales, especially diesels. But the used market appears to have remained healthy. A number of dealership groups have reported an increased in users car sales and margins. Used car specialist Motorpoint (MOTR) recently issued a very solid set of figures, showing continued growth.
Today’s accounts from BCA suggest that it has also continued to prosper and expand. The group sold more than one million vehicles for the second consecutive year in 2018/19, generating some decent headline figures:
I’ve calculated a few other numbers myself to add to this list:
- Net cash from operating activities: £86.6m (£141.5m)
- Free cash flow (ex-acquisitions): £50m (2018: £118m)
- Operating profit margin: 3.3% (2018: 3.6%)
- Return on capital employed: 6.0% (2018: 5.3%)
What can we learn from these figures?
BCA’s performance can probably be characterised as stable and growing. But it appears to be a low-margin business that generates fairly unimpressive returns on capital employed. So why would a private buyer want to pay £1.9bn for this business — about 12.5x EBITDA or 19x operating profit?
Follow the cash
I think the figures I’ve listed above may be masking BCA’s true cash-generating ability for a well-funded private owner.
Although free cash flow appears to have deteriorated badly last year, management commentary suggests that both FY18 and FY19 may be outliers, due to various shifts in working capital, timing effects and a £20m Brexit inventory build.
Averaging free cash flow over the last two years gives me a figure of £84m. That’s equivalent to a free cash flow yield of about 4.4% on today’s offer value of £1,906m. That’s acceptable, I suppose, but certainly not outstanding.
However, I believe free cash flow available to a private owner could be significantly higher.
The reason for this is the contribution made by the firm’s BCA Partner Finance service, which provides credit to trade customers (car dealers).
This is an asset-backed facility that’s secured on dealers’ stock. So I’m assuming there’s no further recourse to BCA in the event of dealer defaults.
Usage of this service has expanded in recent years and BCA Partner Finance supported the purchase of nearly £1bn of vehicles last year.
As a result of continued drawdowns on this facility to fund dealer credit, BCA’s statutory operating cash flow has been depressed. However, if we strip out the effect of these cash flows, then we get a much-improved picture of free cash flow:
- FY19 free cash flow, ex-Partner Finance: £73.1m (FY18: £153.8m)
Averaging these figures over the last two years gives a figure of £113.5m. This equates to a free cash flow yield of 6% on today’s offer price. Better. But I think there’s still room for improvement.
I haven’t been able to find out much about the costs charged to dealer customers for using BCA Partner Finance. But I’ve seen an interest rate of 10% mentioned in a few places online, which sounds about right to me.
BCA’s says that this loan book was valued at £171.8m at the end of March. So one possibility might be that BCA’s new owner will choose to finance this service themselves, in order to benefit directly from this extra source of income.
I’ve watched BCA’s progress with interest since its flotation in 2014. Although I’ve admired the group’s growth, I’ve had some reservations about the interconnected nature of the empire that management have built.
The firm operates transport networks, auction halls, buys cars from the public, and finances trade sales to dealers. If the volume or value of the vehicles being handled were to fall, my view is that BCA’s already slim profit margins could be crushed. Long-term leases on auction sites could also become onerous.
This downcycle scenario hasn’t happened during BCA’s short reappearance as a listed company. So for (most) shareholders it’s been a good investment. It will be interesting to see how the group fares in private ownership — and whether it reappears on public markets during the next cycle.
- Share price: 119.4p (+1.5%)
- Market cap: £676.1m
Bus and rail operator Stagecoach has been engaged in a public spat with the Department for Transport recently over the bidding framework for rail franchises.
The firm’s three most recent rail franchise bids were all disqualified by the DfT because the company refused to accept potential liabilities relating to addressing the Railways Pension Scheme’s estimated £7.5bn deficit.
Stagecoach has since launched legal action against the DfT, so we’ll have to see where that leads. But in the meantime, the company has said it’s “highly unlikely” that it will bid for anymore rail franchises. I suspect a number of other rail operators may follow suit, which could lead to an interesting situation!
From a mid cap investor’s perspective, I don’t think this matters too much. Rail franchises have proved costly and problematic on a number of occasions in recent years. Running UK bus and coach services, as Stagecoach does, has proved a more reliable source of profits.
Today’s full-year results appear to be slightly ahead of consensus forecasts, with adjusted earnings of 22.1p versus Reuters consensus of 19.1p per share. The dividend has been left unchanged, at 7.7p, giving the stock a tempting yield of 6.5%.
The group’s underlying operating profit margin rose from 5.7% to 8.6% and there was a welcome reduction in net debt to £253.3m (FY18: £395.8m). That represents less than 1x EBITDA of £298.8m.
These improvements weren’t reflected in the group’s cash flow, which suffered due to some big working capital movements. But on balance, I think today’s results reflect an acceptable performance from Stagecoach.
Stagecoach appears to be shrinking back to its historic core business running UK bus and coach services. The firm has sold its North American division and expects to have exited all UK rail operations by November 2019.
Overheads are expected to fall and the firm will focus on opportunities in the UK, including investing in its fleet to reduce pollution.
Outlook unchanged: earnings set to fall?
Last year, UK bus operations generated an underlying operating profit of £127.7m. Rail generated just £26.4m. The company believes it can partially offset the loss of rail profits through organic growth and lower overheads.
Management expectations for earnings per share this year are unchanged, but broker forecasts suggest the group’s shrinking footprint will hit profits.
At the time of writing, consensus forecasts show adjusted earnings falling by about 30% to 15.3p per share in FY20. The dividend is expected to be held unchanged, again.
These forecast put the stock on a forward P/E of 7.7 with a yield of 6.5%.
I agree with the group’s strategic shift and can see some potential value at this level, although my top pick in this sector remains Go-Ahead Group, in which I have a long position.
Wood Group (WG.)
- Share price: 443p (+6%)
- Market cap: £3.0bn
I wanted to cover this oil services group because I regard it quite highly, but it’s consistently been one of the most-shorted companies in the UK in recent months. Checking today, FCA statistics show that 11.97% of the stock is loaned out to shorters, making Wood the second-most shorted stock on the London market.
From what I can tell, the bear case is that the company’s decision to acquire rival Amec Foster Wheeler in 2017 has left it with a debt mountain it’s struggling to repay. A bearish investor might also argue that the resultant diversification into areas such as nuclear energy may look good on paper, but is outside Wood’s core area of competence in oil and gas.
The bearish argument has gained strength over the last year, as the firm has admitted that it will take longer than originally expected to repay the debt resulting from the Amec deal.
Today’s half-year update suggests that there will be no further downgrades to guidance. Trading is said to be ahead of last year and debt and EBITDA guidance is unchanged — there’s plenty of detail in the RNS. The shares are up by 6% at the time of writing.
As an income investor, I’ve admired this company’s (historically) strong balance sheet and good cash generation. The dividend has risen every year since the firm’s flotation in 2002. Over that 17-year period, the payout has increased from 3p per share to 35p, a level at which it remains covered by earnings.
I can also see the merit in diversifying away from oil and gas. On the other hand, stock market history is littered with companies that failed to heed Peter Lynch’s warning about “diworsification” and suffered as a result.
On balance, my view is that the current level of debt (c. $1.6bn) is high, but not dangerously so, given that market conditions appear to be improving. With the stock trading on 9.4 times forecast earnings and offering a 6.7% yield, I think Wood could be worth a closer look for contrarian investors.
Tullow Oil (TLW)
- Share price: 210p (+1.4%)
- Market cap: £3.0bn
I’m afraid I’ve run out of time to cover Tullow Oil, except to say that today’s trading statement doesn’t appear to contain any surprises.
I’m not a massive fan of this firm, which I think remains heavily indebted and should not yet have restarted dividend distributions.
However, if market conditions remain supportive, I expect Tullow’s financial performance will continue to improve.
That’s all for today, thanks for reading!