D-Day for Dart, Anite, Games Workshop

Confidence

Three companies in the Thrifty 30 have risen more than 50% since I added them to the portfolio, so it’s decision day. Should they stay, or should they go?

There’s nothing magical about 50% except it’s the minimum return I expect for holding a share for up to three years. Obviously these investments have ‘matured’ early, as the Thrifty 30 is little more than a year old.  If I am to keep them, I must believe they’re likely to rise another 50% in the next three years or so. In other words, they’re still undervalued by the market.

Otherwise I’d be better off finding new companies with the level of potential I’m seeking.

Games Workshop (GAW) manufactures and sells toy soldiers, models and rulebooks for its fantasy Warhammer and Lord of the Rings universes. When they breached my target price, the shares cost a titanic 18 times earnings averaged over the last ten years, though they’ve fallen very slightly since. I wouldn’t normally add a company at that kind of valuation. Expressed as a yield, it’s less than 6%.

But Games Workshop is a peculiar company, and it’s had a peculiar decade. Its Lord of the Rings game was a runaway success as the films were released, which encouraged the company to expand recklessly. If you buy management’s line, this was a serious misjudgement, which cost it almost all its profit between 2006 and 2009.

Tom Kirby, the architect of a decade of prosperity in the 90’s, and a decade of boom and bust in 2000’s, is now chairman. His replacement as chief executive, Mark Wells is even more hair-shirted in his evangelism for “The Hobby”. And this is the attraction of Games Workshop: if only it had stuck to meeting the needs of its war-gaming acolytes instead of chasing the mass market, it could have saved shareholders a lot of pain and remained consistently profitable throughout the last decade. That could be the story of the next ten years, it will be if Wells has his way, so average earnings over the last ten years may undervalue the company. Assuming this year’s earnings are more typical, the shares are still in bargain territory. Its PE is nine.

The justification for taking such an optimistic view is that Games Workshop doesn’t have much competition. In a broad sense it’s competing against computer games, and particularly online multiplayer war games. But if you accept, that there will always be people who enjoy battling each other in person, using models they’ve painted, then Games Workshop owns the market, at least for Warhammer and Lord of the Rings.

I’m sticking with it, which means I’ll next review it when it publishes its annual report next summer, or when the price reaches 655p, whichever happens first.

Dart (DTG) is another company I’ve grown to admire. Its market, air passengers and road freight, is more competitive, but under chairman, chief executive and majority shareholder Philip Meeson, it’s made fewer mistakes.

There can be few industries with profits more sensitive to changes in the rate of economic growth or contraction so I reckon Dart’s long-term average earnings are more pertinent than Games Workshop’s. Despite the fact it’s well run, its future profits are likely to be more variable. Dart shares cost 12 times average earnings, which is just outside bargain territory and though its a wrench to consider dropping the company from the team, I fear that time is coming. Although I said Dart was cheap less than two months ago, the price then was just 66p and the shares cost ten times earnings. Now it’s breached 84p, I’m not so confident.

It feels premature to bow out, though, so I’m going to hang on for around 125p.

You only need to read my last profile of Anite (AIE) to recognise that I’d added the share without realising how speculative its mobile ‘phone testing business is. To an insider, the coming of 4G LTE standard might be inevitable, and Anite’s role in testing the network and handsets secure, but technological change is normal in the industry, which adds risk, and now the company’s shares are not obviously cheap, they cost about twelve times average earnings over the last 10 years,  it’s a good time to get the Thrifty 30 out. I ejected them from the portfolio on Friday at a price of 52.5p.

Sometimes companies emerge from bargain territory in a nether region where they are not obviously cheap, but not expensive. That’s been the Thrifty 30’s experience with all three of these shares. The only companies worth owning at such a ‘fair’ price, are really good ones so that’s the subtle judgement I must make. Based on what I’ve read, mostly in the annual reports, I just don’t have the confidence in Anite that I have in Games Workshop and Dart.

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Dart: in for the long-haul

Boys’ toys

This is going to be a harder profile than usual to write objectively. I love Dart (DTG). It’s a great share for Dads to own. On any tedious trip, by road or by air, something rumbling and impressive, a huge articulated lorry with Fowler Welch-Coolchain emblazoned down the side, or a red and silver Jet2.com plane, gives you the excuse to tell the kids, "we own a bit of that company." Then there are promotional campaigns like this.

Dart carts produce around the country, and people around Europe. It’s a proper business, delivering the food you eat to Tesco Express, and taking you to all points, from Cork to Sharm el Sheikh and Tenerife to Krakow.

Last September I thought Dart was a consistently profitable airline with a smaller road haulage business in rude financial health. It’s not let the Thrifty 30 down. The shares are up about 17%, and it’s paid a small dividend with more to follow.

Dart’s annual report spans a year of recession to March 2010. Unsurprisingly the aviation business, which as well as the airline, operates a packaged tour company, charters aircraft and carries first class mail, suffered as demand for air flights fell and profit from aviation halved.

Fowler Welch-Coolchain, which brought in the remaining 40% of turnover and 55% of profit, had a better year, increasing turnover and profit. Overall, though, profits were down markedly on last year, but not catastrophically, especially in comparison to the ten year average.

When I added Dart I mentioned that despite its lack of debt, it has plenty of other liabilities, primarily deferred income, for example payments from customers for flights they’ve yet to take. This is by far Dart’s biggest source of finance, and its a good one, as it doesn’t have to pay interest on the money (in fact, in better times, it can earn it). But it’s variable, if fewer passengers book flights in say, the second dip of a double dip recession, and costs don’t fall it will have to meet those costs either from its own resources, or by raising money.

In a year of financial stress, Dart’s balance sheet strength, as measured by its ratio of equity to assets rose, near its historical high. I take comfort from this statistic because it means overall the company is less dependent on liabilities for funding (since the balance sheet equation is…

assets = liabilities+ shareholders equity

…equity has increased in importance, which means liabilities have decreased in importance). It’s no fortress of financial strength at that level, but judging by its historical record it looks strong enough.

£35m in non-cancellable operating lease payments due in the next five years, mostly on plant and machinery (presumably planes in the main), is not recorded as a liability on the balance sheet, though, just in a footnote. This is normal accounting practice, but rightly it looks as though that may change. £35m may sound a lot, but it’s fairly small beer. The company’s total liabilities (not including the leases) are £234m, and the value of the planes and engines it owns, £170m, is much greater.

There’s only one thing I’m thinking of when deciding whether a company still fits the Thrifty 30 template: Is it cheap, strong and competitive? OK, it’s three things really, and I still think Dart is all of them. At just under ten times ten year average earnings, the price is still (just) in bargain territory. Its F_Score of six out of nine shows strength, especially considering it was a year of recession, it’s remained profitable, and raised the dividend.

Meanwhile, Dart seems to have sidestepped a cloud of volcanic ash, the distribution business is expanding, the company has salted away cash from healthy-looking advanced bookings, and expects to grow this year.

In February, Mark Laurence, a non-executive director, fund manager, and former equity analyst, bought 100,000 shares at 45p, 9p less than the price when I added them to the portfolio. I think he got a bargain. I’d add Dart at the current price of 66p, if I hadn’t already done it.

See, I told you it would be difficult to be objective.

Vroom.

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Thrifty 30 updates

The current Thrifty 30 portfolio

Engineering contractor T Clarke buys DG Robson Mechanical Services. More diversification.

Dart still flying

In practice:

A bump in the night

Not one, but two charts grace today’s blog on Dart (DTG). The short-term price line describes a curious hump this summer. A 20% run-up in price coincided with the announcement of the company’s full year results on 30 July, and an announcement from a different company, Ryanair, sent the price tumbling back down again on 11 August.

Ryanair, which seems to have pinched British Airway’s slogan, ‘The World’s favourite airline’, is opening its 34th base at Leeds Bradford airport, Jet2.com’s home. Since Jet2.com, a low-cost airline based in six northern airports, is Dart’s principal business,investors probably fear competition.

Obviously there will be some, but I doubt this news is a challenge to the viability or long-term profitability of Jet2.com. Ryanair’s move into Leeds Bradford is probably no more significant than its move out of Manchester, where Jet2.com is adding routes. Low cost airlines seem to be flexible, opening and closing routes to meet demand or cut costs. Just as gamers move tokens around a board, you can’t tell the outcome from a single move.

For me, the results were more significant, because they described a consistently profitable airline in rude financial health. Last year, the company paid off its long-term debt, filled more of its planes (by flying fewer of them), and more accommodation, car hire, insurance, and new ‘extras’ we might once have taken for granted, like hold baggage, online seat assignment and leg room.

The results contrasted with the previous year when profits fell, as the company expanded but costs increased faster than sales.

Three quarters of sales and a bigger proportion of profits come from aviation, which includes Jet2.com, it’s two and-a-half year old package holiday company Jet2holidays.com, its charter business serving other tour operators, and freight. Dart juggles these services to maximise the use of its 30 planes, leasing more if it needs them.

It also owns Fowler Welch-Coolchain, a network of lorries, containers and warehouses that distributes prepared meats, ready meals, fruit juice and pasta aggregated into specific temperature groups. Last year turnover and profit fell as it lost customers to competitors, but the company says it has replaced the lost business and is seeking to grow Fowler Welch by acquisition too.

Dart’s F_Score, calculated from its last two annual reports, is a heroic eight out of nine, and it’s ten year price earnings ratio is nine, so judging by the numbers, it’s both financially strong and cheap.

Lack of debt is a necessity, though, as most of Dart’s finance comes from deferred income, presumably flights people have paid for but have yet to take.

It’s not a reliable source of finance in a recession though, because demand for flights is very sensitive to peoples’ incomes. If incomes fall, we fly less, and if we fly less airlines must find the money elsewhere, either from the bank or shareholders, or by reducing costs. Already indebted airlines may not be able to borrow more, or sell their planes, which explains why so many go bust in hard times.

This is why I think gearing, which usually includes only debt, is often an inadequate measure of a company’s financial position. Benjamin Graham proposed a much broader definition. That a company is financially sound if its total liabilities are less than half its assets, if it owns more than twice what it owes. Although Dart’s gearing is zero, and by that measure it owes nothing, it’s liabilities, including deferred income, are 68% of its assets, way over half.

I’m not as strict as Graham, partly because the F_Score is my main criteria for financial strength and because insisting that liabilities are less than 50% of assets would rule out many modern and successful companies. Dart is in good company. Easyjet’s liabilities are 72% of its assets and so are Tesco’s.

Chairman and chief executive Philip Meeson started Dart when he took over a Channel Island flower distributor in 1983. Judging by a very public ticking-off he gave staff at Manchester Airport, he’s either passionate about his customers, or a nutter who could run Michael O’Leary close in a ranting contest.

Probably a bit of both, which seems to be a requirement in the airline industry.

Meeson owns almost 40% of Dart. It doesn’t give him complete control, and it’s counterbalanced to a degree because 35% is owned by a handful of City institutions, but he’s a powerful figure who seems to be doing a good job.

Good enough, I think, to add Dart to the Thrifty 30 model portfolio at Friday’s close of 54p.

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This is how the Thrifty 30 portfolio looks now I’ve added Dart:

Notes:

• The first transaction in the portfolio was on 9 September 2009
• Cost includes £10 broker fee and £5 stamp duty
• Cash earns no interest
• Dividends and sale proceeds are credited to the cash balance

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In theory:

Why airlines are bad investments

Saj Karsan explains why airlines are bad value investments. Demand for flights is very sensitive to changes in income yet airlines must still pay aircraft leases or debt repayments.

Gregory Seicher discovers value investor Donald Yacktman, who invests in businesses as he would in bonds, by considering the rate of return they earn and the quality of the companies.