Davis versus Johnson: Battle of the cleaners

Big not beautiful

Any way you measure it, Davis Service (DVSG) is a bigger, more successful company than Johnson Service, whose troubles I described last week. It’s bigger than its rival was before Johnson started flirted with insolvency, especially when you consider that laundering, renting and selling textiles (linen and clothing), is only part of Johnson’s business, but all of Davis’.

Davis’ market capitalisation is £705m, compared to Johnson’s £49m. In December 2009, Davis’ assets were worth £1.6bn compared to £211m for Johnson. And investors like Davis more. They’re paying fourteen times average earnings for the shares, while they’re not even prepared to pay an average year’s earnings for Johnson.

That is, of course, because Johnson has been through the mangle.

Davis claims to be the UK, and European market leader in textile maintenance, supplying washrooms, kitchens, operating theatres, and car dealerships, for example.

Originally, Davis was a car dealer and car rental company called Godfrey Davis but in 1987 it bought Sunlight, it’s UK operation, which started life as Fulham’s Sunlight Laundry in 1900. In 2002 Davis bought Berendsen, its European counterpart, which had started a textile business in 1973, having already spawned and listed Rentokil.

Along the way, Davis sold its automotive interests and bought and sold HSS, the tool hire company. Like Johnson Service, it’s been a hotchpotch of loosely related companies, but today it’s focused solely on textiles. By being more specialised, Davis says it can provide better service and achieve higher profit margins, and it’s expanding from the UK, Ireland and Scandinavia into the Baltic nations and central Europe.

It sounds like a reasonable strategy, but I’m worried about the same thing that almost sunk Johnson, debt. Its pernicious growth haunts this chart, where liabilities have become the main source of funding for Davis.

In 2000, money in theory belonging to shareholders funded 50% of the company, but today that figure is just 29%. Since total assets are equal to liabilities plus shareholders’ equity, 71% of funding comes from liabilities, all of it, in the broadest sense, debt.

This chart shows Davis’ long-term liabilities. It looks to me that Davis’ expansion has not achieved profit growth, but has used a lot of funding.

The recession is partly to blame for the fact that Davis did not build on its limited growth earlier in the decade, and Davis won’t implode under the weight of its debt like Johnson did, if its strategy works.

The directors must think big is beautiful. Davis’ new chief executive and non-executives have been buying Davis shares around the recent highs of about 400p. But, using my preferred measures, the ratio of shareholders equity to total assets and Piotroski’s F_Score, it’s not in much better financial shape than Johnson was before it got into trouble. Davis’ F_Score is five out of nine, the weakest I’d consider for the Thrifty 30.

Despite Johnson’s desperate past, I think there’s more risk, and less potential in Davis now. At 14 times average earnings over the last ten years, and 15 times this year’s earnings, Davis isn’t cheap, so it may well fall short of investors’ expectations. Meanwhile Johnson’s shareholders (and staff) have already paid for the sins of the past with a costly restructuring. If Davis has overreached itself, that pain has yet to come.

There will only be one cleaner in the Thrifty 30 portfolio, for now, and it’s probably no surprise it’s unfancied Johnson.

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