Casting around for value

In practice:

The contrarian’s sector

As contrarian ideas go, the auto industry is hard-core, yet, despite having added engineering consultancy Ricardo to the Thrifty 30 model portfolio last week I haven’t finished with the sector.

While some manufacturers have maintained their research and development efforts to design leaner, cleaner vehicles, shielding Ricardo from the worst of the recession, the market for castings, the lumps of iron in cars, and the parts machined from them, differentials and steering wheel knuckles for example, has collapsed.

Castings (CGS), the name of a company that manufactures castings and components, is operating at 50% of its full capacity. Perhaps one glimmer of optimism is that figure, announced at its Annual General Meeting in August, is up 10% since its final results in June.

It’s troubles are a case study in what recession can do to a manufacturing business. Financial commitments are sucking cash out of the company, while a collapse in the demand for cars and commercial vehicles means there’s less money coming in.

The company has yet to bring on-stream its new foundry, due to begin casting early this year, and has been forced to sell electricity it no longer needs, but agreed to buy, back to the market for £2.2m less than it originally paid. Meanwhile sales, mostly to struggling car and commercial vehicle manufacturers in the UK, Sweden and the rest of Europe, fell 13% in the year to March 2009.

That means profits, the difference between sales and costs, fell to levels the company has not experienced since the early 1990’s. Profitability, the return the company makes on its assets, declined from 17.2% in 2008 to just 6.6% in 2009 even if you ignore, as I have, the exceptional cost of making 350 employees redundant (£2.2m) and £3.8m the company believes it’s unlikely to retrieve from the administrators of various Icelandic banks.

It’s an unholy run of luck, and perhaps poor judgement, although its difficult to blame management for fixing electricity prices at a time when they were soaring, and increasing capacity at a time when demand was rising. It seems unreasonable for investors to expect companies to predict recessions, when we’re so bad at it.

These decisions would have been unforgiveable though, had they had mired the company in debt it would be unable to repay in the event of recession, but Castings had no debt at all, and £16m in cash at its year end in March.

Looking beyond its current problems, Castings seems to be a role model for British manufacturing. It’s been profitable throughout the last two decades, apparently by investing heavily in automating and modernising its foundries and machine shop. It’s not cut its dividend since my data started in 1992.

Since buying good companies going through rough patches is the modus operandi of the Thrifty 30 it ought to be a shoe-in for the portfolio but, investors appreciate Castings will probably endure and prosper again and so the shares aren’t dirt cheap. They cost 11 times its profits averaged over the last ten years, just outside bargain territory.

Although there are signs that demand is returning as vehicle manufacturers run out of stock, it won’t necessarily return to former levels soon. If, as many pundits predict our path out of recession will be just as bumpy, but much slower than our path into it, it could take years for Castings to recover the levels of profitability it experienced as recently as 2008.

I think it will though. Chairman and former chief executive, Brian Cooke, has been there since 1960 and owns 4.5% of the company, so he’s experience and motivated.

I’m adding Castings to the Thrifty 30 portfolio at Friday’s close of 191p.

Here’s the portfolio:

Notes:
First transaction: 9 September 2009
Valuation date: 16 October 2009
Cost includes £10 broker fee and £5 stamp duty
Cash earns no interest
Dividends and sale proceeds are credited to the cash balance

What I don’t know

Many of the companies are in business sectors that do particularly poorly in recessions. Dewhurst, which makes components for lifts, is another manufacturer. Holders Technology and Solid State supply manufacturers of electronics. Ricardo helps car manufacturers design better vehicles. Dart’s most important business, Jet2.com is an airline, perhaps the most exposed of all to the economy. OPD is a head hunter.

In theory, because these companies appear to have the financial strength to survive, the portfolio should explode into life as the economy recovers. Since I don’t know when that will be, or how long it will last, I’ve got to buy them now, or risk missing out. The price for prescience, is of course, that things might get worse before they get better, which is the curse of the value investor.

In theory:

Invest in the cheap and ugly

What a great interviewee Bruce Greenwald is. One question, all the answers on Ben Graham and value investing.

Investing in cheap stocks would have got you into trouble in the crash of 2008/9, but you would have saved yourself [a bit] , if you’d have been careful about balance sheets.

Whichever side of the fence you sit on, Michael Moore’s, or the investment banks’, you’d better be aware that the gap between rich and poor is increasing – around the World.

Yves Smith is on Moore’s side.

So is Alan Greenspan. The former chairman of the US Federal Reserve, hitherto famed for his laissez-faire approach to central banking, advocates breaking up the banks.

Alphaville reports that although Gold ETFs are glittering, they may not actually be invested in gold, which leaves the investor vulnerable in erm…. a meltdown.

Mark Hulbert says that even the best humans can’t improve on mechanical systems for market timing.

LOL Recovery is underway, because Google says so.