On the edge of the Death Zone
Posted on October 10, 2008 by Richard Beddard
Filed Under Companies |
As stock markets fall, I’m slowly working through a list of companies that may recover strongly, companies that:
- Were profitable over the last five years, both in terms of cash profit (cash flow per share) and accounting profit (earnings per share), and…
- …Have long-term price earnings ratios (price to average earnings over at least five years) below the market median, currently 12*1.
Nearly 300 companies meet those criteria so I’m tackling the cheapest (those with the lowest long-term PE ratios) and most profitable (those with the highest average returns on capital employed) first.
By valuing a company using its average earnings over at least five years I hope to avoid the possibility that last year’s profits are a poor indication of its earning power because they were unusually high or low. Needless to say, against a backdrop of economic chaos, it seems likely that for most companies profit growth in future is unlikely to match the recent past.
Top of the list is Land of Leather (LAN). It shouldn’t be there because it floated just over three years ago, but its earnings go back further and I can’t resist because I’ve lost more money in the sofa business than any other*2. How poetic it would be, if I could make my money back.
I don’t think that will happen soon, though. While SCS Upholstery recently delisted leaving shareholders nothing, Land of Leather’s shareholders and management rescued it, buying £13.5m of new shares. They paid about 50p a share in June, but the price is down below 10p now. Adjusted for consolidations, it was, at its peak, £35! The current price is a tiny fraction of earnings, so investors have written this company off.
That’s because Land of Leather is in survival mode. Here are some notes from its results, announced on Wednesday:
- Sharp fall in like-for-like sales
- Small loss or a small profit, depending on how you measure it
- Executives deferring salaries
- No dividend this year or next (2008 or 2009)
- No new store openings, refurbishments halted
- Advertising cutbacks
- Suppliers still using credit insurance*3
- Principle concession partner (The Sleep Depot) went bust in April
- Filling empty space with more sofas
- £15m cash and no debt, but its bank requires £4.5m as security for processing credit card transactions, and £6.6m is in customer deposits.
So will Land of Leather make it? Obviously it depends on how long it is before enough people buy sofas again.
Piotroski’s F_score measures profitability, debt and working capital to grade a company’s chances of recovery. Land of Leather’s F_Score is three. The strongest companies, those most likely to survive a downturn and recover, score eight or nine. Companies at the bottom of the scale (zero or one) are least likely to recover.
Climbers describe altitudes above 7,600m, where the human body slowly dies from oxygen deprivation, as the Death Zone*4. Most summit and make it out of in time to recover, but a significant number don’t.
Land of Leather is teetering on the edge of the commercial Death Zone. There is the palpable risk of ruin. But, if it stages a recovery in next year’s results, or the year after, it will be worth a lot more than 9p a share.
That’s when I’d write the iBall script, the column in Moneywise or Money Observer, or even buy the shares.
Footnotes:
- When I started measuring the market’s cyclically adjusted (long-term) price earnings ratio last December it was nearly 19, so company shares are looking cheaper than they were.
- It pains me keep linking back to this post on SCS Upholstery.
- I’m not sure if this is good or bad news. It’s a sign of confidence, but if Land of Leather depends on favourable credit terms from its suppliers, it could go bust if insurers withdraw. That’s what happened to SCS.
- I’ve been reading Ranulph Feinnes’ autobiography ‘Mad Bad and Dangerous to Know’, not climbing Everest.
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2 Responses to “On the edge of the Death Zone”
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Good luck Richard.
I personally think there is still too much uncertainty for my tastes…
[...] why I’m working through a list of potential recovery stocks and why, though I sympathise with a comment left by Deborah*1, a financial blogger, saying… Good luck Richard. I personally think there [...]