Thursday, 31 October 2013

Royal Dutch Shell 3rd qtr results

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Royal Dutch Shell a global group of energy and petrochemical companies. I have a holding in my income portfolio (epic code: RDSB).

Shell announced their third quarter results today and they made for disappointing reading.

Third quarter sales were $116.5bn up 3.9% although earnings, on a CCS basis, were $4.2bn showing a decline of 32%.  Earnings in the quarter were affected by a number of issues:

  • significantly weaker industry refining conditions resulting in lower margins,

  • increased Upstream operating expenses and exploration expenses,

  • production volume reductions from maintenance and asset replacement activities,

  • the impact of the challenging operating environment in Nigeria and

  • lower dividends from an LNG venture.

Sales for the nine months were $342bn down 2% with earnings on a CCS basis of $14.6bn down 26.3%.  Reported earnings for the nine months were $14.6bn down 27% and EPS $2.32 down 27%.

A dividend of $0.45 was declared an increase of 4.7% over last year and amounts to $1.33 for the nine months.  The Sterling equivalent of the $0.45 will be announced on 6 December and paid on 23 December (xd 13 November).   

Production in the third quarter was down 4% from the second quarter and showed a 1% decline in the nine months compared to last year. 

Net debt was $22.8bn an increase of $3.6bn from the year end and gearing increased from 10.2% at the year end to 12.7%.  FCF of $8.3bn ($13.3bn LY) was insufficient to pay for the dividend and share repurchases totalling $9.6bn.

This was a weak performance from Shell and follows uninspiring results at the interims.  Shell need to consider rationing their capital expenditure that was already running well in excess of $30bn, but is now expected to top $45bn for this year, up from around $25bn just a couple of years ago.  Some of these investments have been poor value and continue to erode equity with write-offs due to asset impairments ($234m written-off this quarter).

Reducing capital expenditure to below $30bn and using the capacity in the balance sheet (gearing currently 12.7%), would allow for a meaningful return of cash to shareholders.  It is not often that I push for substantial share repurchases, but with the share price to book value at around 1.2, this would give meaningful returns to shareholders.  It is worth noting that Shell has 39m more shares in issue than it did 5 years ago, the current long standing buy-back programme is essentially just offsetting the scrip dividend programme.

In another announcement today Shell announced their decision to proceed with its Carmon Creek project in Alberta, Canada, this is expected to produce up to 80,000 barrels of oil per day. Carmon Creek is 100 per cent owned by Shell and back in 2008 they took the decision to delay development of the tar sands due to the expense of extraction.  I hope that in the meantime they have discovered ways to reduce the cost of extraction and achieve a good return on what will be a considerable investment.

Exxon also announced results today with a 14% fall in EPS and like Shell have suffered from the lower margins in refining, but on a quick look appear to have performed better than Shell in other areas.

It will be of interest to see the approach that the new CEO Ben van Beurden takes when he replaces Peter Voser in the New Year.

Globo 3rd qtr update

A technology innovator delivering mobile, telecom and e-business software products and services. I have a holding in my growth portfolio (epic code: GBO).

Globo issued a third quarter update and some additional information that had been requested by investors.

Revenues for the nine months were up 58 per cent on last year to €50.01m, compared to growth at the half-year stage of 52% and sales of €32.03m.  Management state that this performance is ahead of their expectations.

They state that positive free cash flow (FCF) of €0.4m has been generated, resulting in a net cash position for the Group of €11.2m up from €10.8m at the half year.

The additional information re-confirmed that capitalisation of development is in accordance with IFRS, revenue recognition conforms to IFRS and follows the policies set out in its annual report and the rationale behind the disposal of 51% of its Greek facility.  The main new information disclosed - was that the Greek associate is on track and Globo is expecting to receive the second instalment of €500,000 principal plus interest by the end of this year and management also disclosed detailed payment terms for its various forms of trading, which can run for some considerable periods well in excess of 90 days.

Management recognise the risk they are exposed to in extended payment terms, but have stated that as they penetrate more mature markets this will improve the rate of collection of receivables.

There is not much new in the additional information and of course the continuing low level of FCF will still cause some concern, but not surprising in a high growth company with extended terms of payment. 

I cannot see an end to the highly volatile nature of the SP, but the investment case is not much changed from that of a high risk, but potentially high reward stock that requires managing accordingly.  The first rule for any long term investor is protection of capital; so locking in profits on a partial sale to protect your capital while maintaining an exposure is sensible.




Wednesday, 30 October 2013

Pearson IMS


An international media and education company, providing educational materials, technologies, assessments and related services to teachers and students.  Owner of The Financial Times and part owner (47%) of Penguin Random House.  I have a holding in my income portfolio (epic code: PSON).

Pearson issued their 9 month IMS today, stating that they have increased continuing sales by 4% at constant exchange rates (CER) in the first nine months of 2013 and 2% in underlying terms.  This is an improvement on the six month growth figures of 3% at CER and underlying growth of 1%. 

Management are reiterating their previous full-year outlook that adjusted EPS is expected to be broadly level with 2012 adjusted EPS of 82.6p.

The restructuring programme is on track and they expect to expense approximately £150m of gross restructuring charges in 2013, or £100m after cost savings achieved during the year. They state that the process to explore a possible sale of Mergermarket is progressing well.

Thursday, 24 October 2013

Unilever 3rd qtr results

Unilever Logo

A manufacturer and supplier of fast moving consumer goods, with more than 400 brands focused on health and wellbeing, 14 of which generate sales in excess of €1 billion a year. I have a holding in my income portfolio (epic code: ULVR).

Unilever updated the market on their 3rd quarter sales and since this follows closely on from their trading statement of 30 September, this was much as expected.

Underlying sales growth for the quarter was 3.2% with emerging markets up 5.95%.  Reported turnover decreased by -6.5% to €12.5bn due to a negative currency impact of -8.5% and the disposal of non-core businesses reducing turnover by -1.0%.

Underlying sales growth for the nine months was 4.4%, with emerging markets up 8.8%.  Reported turnover decreased -2.0% to €38.0bn including a negative currency impact of -5.0%.

The announcement on 30 September alerted the market to a decline in the emerging market growth.  Although Unilever's definition of emerging markets does not totally align with their geographical reporting, one can see the decline in growth from the Asia/AMET/RUB numbers:

                  Sales Growth
Asia/AMET/RUB*         USG         UVG          UPG
3rd qtr 2013 6.2% 4.5% 1.6%
2nd qtr 2013 9.2% 5.8% 3.1%
1st qtr 2013 9.2% 5.4% 3.7%
Total 2012 10.6% 5.7% 4.6%

* AMET includes Africa, Middle East & Turkey.  RUB includes Russia, Ukraine & Belarus.

The most marked decline is the reduction in sales growth due to pricing, where 4.6% growth in 2012 was attributed to price increases, declining to 1.6% in the 3rd quarter of this year.  This is substantially below the rate of inflation in these countries, although there are some low inflation countries such as Ukraine, Japan & Australia included here, some of the big markets such as Russia, India and Indonesia have inflation well above 5%.

Procter & Gamble will be announcing their first quarter numbers tomorrow, so it will be worth seeing how they have performed and whether any of the lower price growth is due to discounting by P&G.

The company announced a third quarter dividend of 22.8p, a 15.3% increase from last year, although almost a third of this increase is due to a 4% strengthening of the Euro against sterling, as the Euro dividend at €0.269 was up 10.7%.  Unilever have an excellent record of rewarding shareholders with increasing dividends above the rate of inflation and with the added benefit of a quarterly pay-out.

The management expect to report underlying sales growth in the fourth quarter with profitable volume growth ahead of their markets.  They also state that they expect an improvement in core operating margins and strong cash flow.


Wednesday, 23 October 2013

GlaxoSmithKline 3rd qtr results


GlaxoSmithKline a global healthcare company that develops, manufactures and markets pharmaceutical products, including vaccines, over-the-counter (OTC) medicines and health-related consumer products.  I have a holding in my income portfolio (epic code: GSK). 

Glaxo announced their 3rd quarter results today and in summary revealed that turnover for the quarter was up 1% to £6,510m, with turnover for the nine months being flat at £19,599m. Sales were up in all geographic areas in the quarter except EMAP, due to a 61% decline in China as a result of the on-going corruption investigations. 

Core operating profit was £2,059m, an 11% increase for the quarter and for the nine months flat at £5,927m.  Core EPS for the quarter was 28.9p an increase of 16% and for the nine months 82.1p an increase of 5%.

On a clean reported basis, EPS was 19.7p for the quarter down 11.3% and 60.3p for the nine months down 17.2%.  A 3rd quarter dividend has been declared of 19p an increase of 5.6%, which makes 55p for the nine months an increase to date of 5.8%.

Free cash flow (FCF) was stronger for the nine months than last year generating £3,557m compared to £2,026m.  Net debt has increased from £14,054m at the beginning of the year to £15,088m, due to payments from FCF of £2,816m in dividends, £905m in share repurchases, £588m to increase the shareholding in their Indian Consumer Healthcare subsidiary from 43.2% to 72.5% and the acquisition of Okairos AG for £205m.

It was good to see that Seretide/Advair (23% of pharma sales, 20% of group) is still holding up to generic competition with minor declines of 1% in USA and Europe.

Glaxo have been busy on the new drug approval front with four new approvals so far this year, from 6 identified at the beginning of the year as likely candidates. 

It is clear that although sales in China have historically accounted for less than 4% of Glaxo's sales, the corruption probe will create a negative back-drop to the share price, until the quantum of the potential liability is known.

Management have reiterated their guidance for the full year of core EPS growth of 3-4% and sales growth of around 1% using constant exchange rates.

Tuesday, 22 October 2013

Pennant new purchase


Pennant International provides a range of services that extend across e-Learning, Computer Based Training, Emulation and Simulation, Technical Documentation, Media Services, Cartography, Supportability Engineering Software products and related services. I have a holding in my growth portfolio (epic code: PEN) 

Since my analysis here back on 4 July Pennant had climbed from 72p to 89.5p and with a strong set of interims in early August, never looked like falling back below 80p - until last week.  This caught my attention as there seemed to be little reason for the fall back. 

There was an unusual announcement yesterday where the FD John Waller sold 91,875 shares at 72p from his holding of 1,566,875, with the company picking those shares up to be held in treasury.  Even if those shares had been sold in the market, management would still have held over 50% of the shares, so I'm at a loss as to why the company felt the need to do this.

Possibly it was this announcement that caused the SP to move down by 3.5p on the day, but either way I saw it as an opportunity and purchased some shares for my growth portfolio at 74p.

They closed today at 74.5p on 10.5x 2014's expected earnings that should be up 57% on 2012.  The outlook statement from their recent interims also provides encouragement:

"...The order book provides good visibility through 2014 and beyond. During the period there has been significant ongoing activity with a broad global spread of potential customers on a number of significant opportunities, particularly in the defence and rail sectors.
"The pipeline is robust and active and the Group's good relationships with its customers and strong balance sheet continue to provide a strong platform from which to build and to realize the opportunities arising..."

Bhp Billiton qtr1 operational review

BHP Billiton

A diversified natural resources company and among the world’s largest producers of major commodities, including aluminium, coal, copper, iron ore, manganese, nickel, silver and uranium, and has substantial interests in oil and gas.  I have a holding in my income portfolio (epic code: BLT).

BHP Billiton updated the market today on their first quarter.  They state that they have maintained strong momentum in the quarter with production increasing by 11% from last year.
By major resources:
Iron ore production has been raised by 23% over last year and optimisation of the WAIO supply chain continues to unlock substantial value with the 2014 financial year production guidance raised to 192 million tones (BLT’s share), compared to 170m tones last year and previous guidance of 188m tonnes. 
Total petroleum production for the quarter was a record 62.7m boe up 2% on last year.  Guidance of 250m boe remains unchanged for the year.
Although copper production rose by 6% on last year, it declined by 13% from the last quarter due to planned maintenance, industrial action and lower copper ore grades at Escondida. The expectation for the full year is for copper production to be at a similar level to last year at 1.2m tones for the year. 
Metallurgical coal production was up 14% on last year, but down 6% on last quarter due an extended outage at Dendrobium and a scheduled longwall move at West Cliff.
Guidance of 41m tonnes remains unchanged for the year.
Energy coal production was up 3% on last year.  Guidance of 73m tonnes remains unchanged for the year.
A solid review and the 2% uplift in the guidance for iron ore production provides good support for the SP.

Reckitt Benckiser 3rd qtr

Reckitt Benckiser Group is a manufacturer and marketer of branded products in household, health and personal care products, sold into nearly 200 countries from operations in over 60 countries.  I have a holding in my income portfolio (epic code: RB.) 

Reckitt Benckiser announced their third quarter update this morning.  There were some pleasing numbers given the recent trading update on Unilever commented on here, that warned the market of a slow down in their growth for emerging markets.

Reported year to date revenue was £7,542m up 6% on last year, with LFL net revenue growth of 4% and 5% if we exclude the Pharmaceutical business (RBP).

By territories plus Food LFL growth (excluding RBP) was:

Europe/North America +3%,
Latin America/Asia/Australia & New Zealand  +11%,
Russia/Middle East/Africa/Turkey +6%.
Food 0% 

Identical rates to those at the 6 month stage.

Management now believe that their full year net revenue growth for these territories, including the net impact of M&A will be at least 6% and they expect to maintain full year margins.

For RBP LFL revenue fell by -5% to £591m and the Q3 decline was -16%.   As they have previously mentioned, that sometime after the launch of generic tablets would be the right time to consider options for the RBP business, so they are therefore commencing a strategic review of the business.  Although this business is under pressure form generic tablets, their film product still has a share of above 60% volume of the US buprenorphine prescription market.  Sales and operating profits last year were £837m and £536m respectively, but I would expect this to be around £780m and say £470m this year.  A likely sale might therefore attract a price of £3-3.5bn approximately 10% of the current market cap.

Royal Dutch Shell successful bid

Royal Dutch Shell a global group of energy and petrochemical companies. I have a holding in my income portfolio (epic code: RDSB)

Shell announced yesterday that as part of a consortium of companies including, Petrobras, Total, CNPC and CNOOC, they won a 35-year production sharing contract to develop the giant Libra pre-salt oil discovery located in the Santos Basin, offshore Brazil.

The Brazilian regulator, Agência Nacional do Petróleo, estimates Libra's recoverable resources of between 8 to 12bn barrels of oil. The Libra oil discovery in Brazil is one of the largest deep water oil accumulations in the world and Shell holds 20% in the consortium.

As part of the winning bid, Shell will pay its 20-percent share of the total signing bonus which amounts to $1.4bn (R$3.0bn).  The total signing bonus of $7bn (R$15bn) would appear to be at the top end of equivalent payments around the world.

Sunday, 20 October 2013

Anite, IMI, Globo, Pan African, Spectris

During a week away five of my companies issued announcements last week:

Anite plc

Anite is a global provider of hardware and software solutions, systems integration and managed services within its core markets of Wireless and Travel. I have a holding in my growth portfolio (epic code: AIE).

Anite issued a trading update on 16 October warning of a continued shortfall of business in their Handset Testing division, consequently the expected shortfall in first half profits compared to last year will not be fully recovered in the second half and management has therefore reduced its expectations for the full year outcome. 

The expectation for the half year is that revenue in Handset Testing will be around 25% down on the comparative period last year when it reported £40.5m.  This will result in the Handset Testing business to be around break-even for the first half of this year compared with £11.4m last year.

Management have stated that they expect second half Handset Testing revenues to be broadly in line with the £46.5m achieved in the second half of last year. 

Trading in the smaller Network Testing and Travel businesses continues to be at least in line with expectations, with good year on year growth.  Management have previously stated that they expect growth in Network Testing and the Travel Business to be mid to high single digit growth and low to mid single digit growth respectively.

If I add these indications from management for the full year then I am expecting full year sales to be around £125m, compared with £132.5m last year.  Broken down by - Handset Testing £30.4m for the first half and £46.5m for the second half and assume Network Testing grows by 9% to £28.5m and Travel by 5% to £20.4m for the full year.

Since the higher margin Handset Testing has declined from the previous year, I'm assuming that full year margins will be in the region of 55% (59% LY) and underlying overhead costs to be around £48m (£44.7m LY); producing an underlying operating profit of about £21m.

I'm assuming net interest costs of £0.3m (£0.2m LY) and a tax charge similar to last year of 27%, that would produce underlying earnings of £15m and an EPS of 4.9p.  This values the business on Friday's closing price of 89p at a P/E of 18x.  The press lead us to believe that this is partly due to a potential acquirer in the form of Teledyne of the USA "running the ruler" over the company and partly due to the belief that this set-back in the Handset Testing business is temporary.


IMI is a global engineering group focused on the precise control and movement of fluids in critical applications and comprises five platform businesses - Severe Service, Fluid Power, Indoor Climate, Beverage Dispense & Merchandising. I have a holding in my income portfolio (epic code: IMI).

IMI made two announcements on 16 October, the first of these informed the market that they had disposed of their Beverage Dispense and Merchandising divisions for $1.1bn (£690m).  These were not core to the IMI strategy of owning fluid technology businesses that are market leaders in global niches that exhibit one or more of the following growth drivers dealing with - climate change; resource scarcity; urbanisation; ageing population.

IMI will use the proceeds to return £620m of cash to shareholders and £70m to the UK pension fund that had a net deficit of £109m at 31 December 2012.

The £620m return of capital (that can be taken as income or capital gains through a "B" & "C" share scheme) will equate close 200p per share, allowing for the continuation of the buyback programme that will likely reduce the number of shares in issue to around 310m.

The current value of IMI is 15.8x its Enterprise Value to EBIT (EV/EBIT), allowing for the use of the £690m proceeds and reduction in EBIT from the disposal, IMI's core business will have an EV of 17.7x EBIT.  Theoretically this should equate to a share price of approximately 1320p ex-distribution.

The second announcement related to their IMS that was brought forward due to the disposal announcement.  Management state that trading in the period is in line with management expectations and that revenues for the three months to the end of September on an organic basis are 3% ahead of last year and 1% lower year to date.  On a reported basis, revenues are 4% up for the three months to September and flat year to date.  Management remain confident that they will deliver full year results in line with current market expectations, which looks to be about 87p per share, including the businesses to be disposed.

A technology innovator delivering mobile, telecom and e-business software products and services. I have a holding in my growth portfolio (epic code: GBO).

Globo announced a placing on 16 October of about 10% additional shares at a price of 71p, raising £24m (€28m) gross.  This follows on from their recently agreed €20m revolving credit line and a small asset acquisition for $5m.

The price of the placing was equivalent to a discount of 11% on the SP of the previous 10 trading days, which is not unreasonable.  Although disappointingly three directors placed a total of 1m of their own shares at the placing price (this did not include the CEO).

As I have pointed out in a previous post, Globo is still burning cash, hence the need for these additional funds, as they seek growth in the important North American market.  It may be some time before Globo becomes a cash generating growth story.



A small South African based precious mining group that produces gold and platinum from high grade ore bodies at a low cash cost.  I have a holding in my growth portfolio (epic code: PAF).

Pan African Resources were responding to media speculation regarding their participation in the disposal process by AngloGold Ashanti Limited of its Navachab mine.  So on 18 October they stated that there can be no certainty that such participation will result in any transaction relating to Navachab.

Navavchab is a 74,000oz gold producing open pit mine in Namibia, which I believe would take PAF away from its core competency of underground gold and platinum mines in South Africa that they have operated so well.  The mine has an all in cash cost of $929 per oz.

It would appear that PAF are on the short list of bidders and are partnering with Giyana Gold.


Spectris develops and markets productivity-enhancing instrumentation and controls.  Operating in four segments - Materials Analysis, Test & Measurement, In-line Instrumentation and Industrial Controls.  I have a holding in my growth portfolio (epic code: SXS).


On 18 October Spectris issued their 3rd quarter IMS.  Sales for the three months ended 30th September 2013 were 5% higher than the comparable period last year, including a contribution of 1% each from acquisitions and currency, so therefore on a like-for-like basis sales increased by 3% for the quarter compared to last year. 
Management stated that operating cash-flow conversion continues to be strong with net debt at 30 September approximately £135 million, a reduction of around £119 million since the start of the year.
They mention that Customer activity remains strong and they are encouraged by quarterly sequential improvements in their short cycle businesses as well as in North America and Europe. However, overall trading conditions are mixed and the timing of recovery in the business to more normalised growth rates continues to be unpredictable. Based upon a current view, they anticipate EBITA performance for 2013 to be around the lower end of market expectations at £214m.

Saturday, 12 October 2013

Greggs reasons to remain invested

Greggs the Bakers

The leading bakery retailer in the UK, with almost 1,700 retail shops throughout the country.  I have a holding in my income portfolio (epic code: GRG).

I was prompted to produce this post after a comment from John Hulton (who writes this informative blog) on my last Greggs post here.  He wrote on 9 October:

"...Following the recent warning on profits, I decided there were better opportunities elsewhere and sold out.
I am not particularly convinced by the new ceo and feel there may be more disappointing announcements to come over the next year or two. As you say, the company are unlikely to make much headway with increasing the dividend and I would not be surprised to see the share price slump.
My general feeling is the current strategy of moving to compete in the highly competitive food-on-the-go area is the wrong direction..."

The Background
These are valid comments and I can understand why investors might seek alternative opportunities, but two views make a market.  I am prepared to accept a difficult 12-18 months on the basis that I believe they have the correct strategy, have investment plans for the right projects and with a continuous 28 year history of increasing their dividend, do not intend to cut it.

Greggs have consistently returned around 25% on the capital employed in the business, compared to a WACC of about 9%.  This margin between the two is the value that management are adding to the business and for a retail or food manufacturing business is very good.  So if management can add to this with a higher growth profile, it would be very attractive.

The market
As we know, all is not well at Greggs.  The market is changing and over many years the company's sales mix has moved from a purveyor of breads and rolls (55% of sales in 1978) to mainly sandwiches and savoury products (64% of sales in 2012, bread and rolls were just 6% last year), this is typical fayre for the Food On The Go (FOTG) customer - in fact 50% of the FOTG market is accounted for by sandwiches.

Greggs already believe that 72% of the visitors to their shops are FOTG customers, their market share though is only around 8% and whilst the market has been growing at 9% pa, Gregg's growth has been half of this over the past 5 years.  They believe that their lack of focus on this market, operating as a bakery retailer that just happened to sell to FOTG customers, was the reason behind their lower performance.

Future plans & the competition
As part of their plans to focus more effectively on this market, they are:
  • closing/relocating some stores that do not fit with the footfall of FOTG customers,
  • undertaking shop refits to better attract the FOTG customer,
  • expanding their food offering to items such as pizza slices,
  • extending their opening hours and
  • introducing loyalty schemes.

They also need to update and improve their processes and systems that will cost £25m over the next 5 years, but management believe the improvements will produce benefits of £38m over the same period.

The main competitors in the FOTG market (representing the 92%) are:
  • supermarkets such as Sainsbury's & Tesco, where they are supplied with the product from companies such as Greencore the convenience food supplier - 22% market share,
  • Cafes and sandwich bars, such as Pret A Manger, Subway and Costa Coffee - 23%
  • Other retail bakeries such as Sayers & Cooplands - 9%
  • Various canteens both in-house and public, some operated by companies such as Compass Group - 14%
  • Other - 24%  
This is a difficult market to compete in, but Greggs are already selling in to it in an unfocused way and, they should have the added benefit of their USP as the country's leading retail baker supplying own sourced freshly baked produce.

Although management have stated that there will be limited net additions in the estate over the next 2-3 years, due to the concentration on refits and relocations, they do believe that there is eventual scope for an additional 600 (+35%) shops to their current number of 1,693 as they believe that 50% of the UK population do not have easy access to a Greggs shop.  Further confirmation of how realistic a 600 shop increase is comes from Subway, who had 1,423 shops in 2012 and were planning to open 600 within 3 years (the speed of expansion is greater with a franchise operation).  It is worth noting that Greggs opened 303 shops (including 10 franchises) over the past 5 years to December 2012.  So I have assumed within my valuation model below a similar rate of new shop openings of 60 shops pa. being well within management's capability.

Next based on the assumptions detailed above I'll look at the intrinsic value of Greggs, by discounting the estimated free cash flows of the business.  As a base I will use the current year assuming that the trailing twelve months (second half of last year plus the first half of this year) is a conservative indication of how the year might turn out.

Early years of valuation 2013 2014 2015
Operating cash flow 67 70 73
Capital expenditure -45 -50 -52
Free cash flow (FCF) 22 20 21
Dividends -20 -20 -21
Opening net cash 19.4 21.4 21.4
Closing net cash 21.4 21.4 21.4

Capital expenditure has been uplifted in 2014 & 2015 for the addition £5m of process and system investment needed.  I have assumed flat operational cash flow for 2014 & 2015, but a £3m benefit pa from the process and system improvements.

For the following 10 years I have assumed an expansion plan of 60 shops pa, delivering growth of 3.5% pa. and organic growth of say 5.5% to achieve the expected market growth of 9% pa.  This should produce an operating cash flow growth of 5.4% pa assuming 60% margins and I have reduced this by a further 1% to allow for increased working capital/overheads linked to growth, but for the years 2016-2018 I have taken the remaining £32m benefits from the process and systems improvements.  Capital expenditure has been increased by 3% pa to reflect the increasing costs of fit-outs and refits, but discontinued the £25m process and systems improvement project in 2018 as planned by management.  This should produce FCF by 2025 of £55m, a CAGR of just over 10% pa. from 2015.

Using a 2.5% FCF growth in perpetuity and a discount factor of 9% (cost of GRG's equity) the intrinsic value of Greggs is about 520p a 19% premium to Friday's close of 437p.  More importantly to an income investor Greggs will have the capacity to increase dividends during the 10 years of 2016 to 2025 by well over 10% pa.

The main risk is execution.  With so much change being undertaken on refits, relocations and improvements to processes and systems, they have made a wise decision not to increase the number of shops over the next 2-3 years, but it is here where the plan may fall apart.

The new CEO Roger Whiteside, who took over in February from Ken McMeikan,  has a good track record in retail, having started his career in M&S - he was there for 20 years at one time as head of their food business and for four years to 2004 was joint MD of Ocado.  He joined Threshers in 2004 and by 2007 turned the off-licence chain around.  Punch Taverns where he had been for the last 5 years was less successful, although he seemed to have inherited a company in poor shape but this may cast some doubts about his judgement.

On balance, I believe the current share price is somewhat discounting the risk and the prospect of substantial dividend increases over a good many years keeps me invested.  Although patience is required, as I am assuming a freeze in the dividends this year and next.  Clearly though Greggs have the capacity to continue with their dividend growth record despite the current problems; it will certainly be a big decision to call a halt to that 28 year record.

Thursday, 10 October 2013

BAE Systems IMS

A global defence, aerospace and security company. BAE Systems delivers a range of products and services for air, land and naval forces, as well as advanced electronics, security, information technology solutions and support services.  I have a holding in my income portfolio (epic code: BA.)


BAE released an interim management statement stating that trading for the period has been consistent with management expectations.

Management state that they expect double-digit growth in underlying EPS for 2013, this includes the effect of the share repurchase programme and reductions due to the US defence budgets. This guidance also anticipates a satisfactory completion to the Salam pricing negotiations by the year-end.  If negotiations extend beyond the year end, EPS for 2013 would be affected by approximately 6-7p.

In commenting on the current US government shut down, they state that the action has not had a material effect on financial performance, although if the action became protracted then the government shutdown would start to reduce earnings.

There was positive news from international markets outside of the UK and the US, where activity remains vibrant and multiple opportunities are being pursued.  This includes prospects in the UAE for the supply of Typhoon aircraft and other capabilities. Management state £5bn of non-UK/US orders were received in the year to date, this compares to £5.2bn for the whole of 2012, which in itself was up 59% on 2011.

In addition to the US shutdown, the other concerns I have are the resignation (announced on 20 August) of Linda Hudson the CEO of the US division, who has an excellent track record.  Her replacement will be one of the key decisions over the next 6 months.  I am always concerned when directors embark on a share buy-back programme, where the price to book value is substantially above 1.2.  BAE's P/BV is currently 3.4 and buy-backs at this price do not look good value, with owner's earnings (book value growth plus dividends) taking many years to recover the equity depletion.

The current SP of 448p at about 10.5x this year's expected earnings and delivering an expected yield of 4.6% looks good value, but there are a few obstacles that may trip them up along the way.