Airea falls at last hurdle

Sunk by the F_Score

The process of researching carpet manufacturer Airea has felt like death by a thousand cuts.

What started as a promising looking investment now leaves me feeling a little frustrated. The company is extraordinarily cheap according to the net current asset value calculation, one of the most demanding in the value investor’s toolbox, but an even more exacting and potentially more precise (but still approximate) calculation, suggests it’s trading around liquidation value.

Although not as cheap as I hoped, the price is very attractive if the company is still viable. So it passes the valuation test with two important caveats.

1. Airea has a large defined benefit pension obligation, which could mean large movements in the currently relatively small deficit, which in turn would make a mockery of the valuation.
2. I have to be confident Airea has a profitable future.

To pre-empt fellow blogger Mark Carter (aka Blippy), who likes to do this (metaphorically), if you put a gun to my head I still think the odds are Airea is a good investment.

The directors seem to be doing their best to control costs, although they can’t do much about the price of yarn and synthetic fibre, they’re revamping the range, and they’ve invested considerable sums themselves in the company.

But in managing the Thrifty 30, I aim to put safety first, and I’m not confident enough in its future earning power to stake the portfolio’s virtual money on Airea.

Even what looks to me like a consistently well financed, and well managed manufacturer, Victoria, struggles to generate decent returns in the carpet industry so it’s a very tough business.

And the final cut, the one that’s tipped me from being confident enough, to not confident enough, is Airea’s recent trading performance as viewed through the prism of the F_Score. Here’s the spreadsheet:

A middling F_Score of five out of nine isn’t catastrophic, but Airea only just made a profit last year, and in cash terms it made a loss. That tips the balance, because cash pays the bills.

Deducting net capital expenditure, money spent on increasing the capacity of its dye house and investment in new carpet ranges, and the free cash flow loss is over £700,000.

Putting safety first means identifying where things could go wrong and deciding whether the risk is significant. Broadly speaking two things can go wrong with any investment in a company.

1. The shares can be too expensive, driven up by investors unrealistic expectations. Although that’s most unlikely to be true of Airea, any valuation of the company is speculative because of the uncertainty introduced by the pension fund.
2. The business can be broken, and while I don’t think Airea is broken, I’m not confident in that judgement.

As I said to the ever so slightly mad Professor Professorson in the comments section, investing means compromise.

Bulletproof businesses at bargain prices don’t come along very often, maybe once or twice in a career. The rest of the time we’re looking for companies that are cheap enough, and strong enough and researching Airea has chipped away enough of my confidence to leave me unsure as to whether it is.

If it was recovering more strongly, this blog would have a different conclusion.

That leaves Victoria. I’m taking next week off, but will probably add it the portfolio when I’m back.

I’ll also be deciding on publisher Bloomsbury, which will have published its half-yearly results by then, and IT distributor Northamber when it publishes its annual report.

TTFN.