Dewhurst, a hidden champion

Painful though it is, I’m thinking of Alex Ferguson

By coincidence, I’ve been reading Hermann Simon’s ‘Hidden Champions of the Twenty First Century’ as I’ve researched lift component manufacturer Dewhurst (DWHT).

The book highlights the role of small to medium-sized businesses in driving globalisation. Typically these companies are low profile. They are significant in niche markets, often hidden from public appreciation because they make bits of things, rather than end products. Most of them are companies with long histories of stable management. They’re unusually profitable, they’re export titans, and, typically, they’re German.

Dewhurst seems to differ from that prescription in one respect, it’s British.

If you follow this blog, you already know I like Dewhurst. I picked it for my Share Sleuth column in Money Observer magazine in February 2009 (pdf), and it was one of the first companies I added to the Thrifty 30 portfolio in September 2009 (and I reaffirmed its position in the Thrifty 30 a year ago). It’s price has risen 104% since that first article, but I still think the shares may be cheap. That opinion, though, depends on recognising the quality of Dewhurst’s business, qualities I think Simon would recognise.

First of all, the stats are so consistent. Over the last ten years, Dewhurst has been very profitable. Return on equity (green lines) is typically between 15% and 20%, and not much of that return is due to debt. The company has no bank debt, and although it has a rather large pension fund, which is in deficit, total assets (blue bars) remain about 1.5 times equity.

The good news about the pension fund from a shareholder’s perspective is that the company has now closed it to future accruals. Although that won’t have an immediate impact on the level of Dewhurst’s liabilities, at least it removes the prospect of a seemingly ever-widening chasm to be filled by Dewhurst’s profits.

Don’t be fooled by the chart showing a small slump in the remorseless growth of shareholder wealth  back in 2005 (orange and yellow bars), that was due to a change in accounting standards which recognised Dewhurst’s pension deficit and reduced net assets. Dewhurst has grown remorselessly, and the rate of growth in the dividend and net asset values, without even adjusting for accounting changes, was 10% a year.

Dewhurst has other qualities it shares with ‘hidden champions’, its prosaic products, pushbuttons and controllers for lifts, keypads for ATMs, and traffic signs, bollards and street-light pillars. Its largest market is the UK but the majority (65%) of sales, and an even bigger proportion of profit, in the USA, Austrasia, Europe, and Asia.

It has a low-profile for a listed company too. According to Sharescope only one analyst follows it, quite possibly the company’s broker.

Neither are you likely to have heard of its chairman, Richard Dewhurst, or its managing director David Dewhurst, but they’ve both been at the company since the 1980’s. Financial Director Jared Sinclair joined in 1997 and together these men have guided the company through years of expansion. Although the Dewhurst family has a controlling interest in the company (50% of the shares belong to major shareholders, most of them family members) that’s surely a good thing if it secures their services, and means they profit more than anybody if they continue running the company as well as they have done.

Stability at the top is often a marker for success. I know it’s painful, but think of Alex Ferguson, or less painfully Arsene Wenger, or, if the football analogies are lost on you, try this one from Simon’s book. SAP, the German software company, has graduated from his original list of hidden giants because it is no longer hidden. You can’t hide revenues of $14bn. It’s had three chief executives in its 36 year history.

One final similarity between Dewhurst and the hidden champs. Hidden Champions increase market share in times of adversity. Although Dewhurst doesn’t mention market share, profit and turnover now, after two years of recession in the construction industry, are at record highs. It achieved that performance, while buying Cortest, and stakes in two US lift component manufacturers (it has agreed to buy the companies outright in due course) and preparing to purchase new premises for its headquarters and UK factory.

Because Dewhurst’s lift components are used late in building projects, it’s late to feel the full force of recession, and late to come out of it. 2011 will be a risky year for the company then. Moving could lead to operational problems while its still facing tough markets.

But I prefer to think about the longer-term, and I think this company is one of a few I wouldn’t want to sell unless the market made me a silly offer. The shares are no bargain, costing considerably more than ten times average earnings over the last ten years.

But using long-term earnings discriminates against growth companies, something I’m usually quite happy to do on the grounds that growth rarely persists, and though 14 times earnings is not obviously cheap, it’s not obviously expensive either. Crudely, it implies a 7% return if Dewhurst relapses to its average earnings.

Its one year PE is below 10, implying a greater than 10% return if 2010’s earnings are typical. Any growth’s a bonus.

I’ve put more of the portfolio’s money on a prosperous future at Dewhurst, nearly £1,250 more to be precise, at a price of 382p per share, the actual price quoted by a broker and 12p more than my estimate of the current sale price. I’ve also deducted £10 commission, and £6.15 stamp duty. I reckon the whole transaction cost the portfolio almost £65. Its the (high) price of capitalism.

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Profitability adds value

Another Buffett archive.

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Geoff Gannon’s on overdrive. Here he is on: competitive advantage, why buying the stocks Buffett does won’t make you as much money as they make Berkshire Hathaway, and the most important equation of them all.

UK Value Investor demonstrates a record of profitability adds value.

Dewhurst still pushes the buttons

Keeping the faith.

I first spotted Dewhurst (DWHT), a year ago when its shares cost 185p. The company featured in the February 2009 edition of my Share Sleuth column (PDF) in Money Observer, and they were in the first group of shares included in the Thrifty 30 portfolio when I started it in September, added at a price of 238p.

The publication of its 2009 annual report is an opportunity to revisit the reasons for favouring Dewhurst and see if they still apply at the current price of 250p. As with all Thrifty 30 companies, the basic case is it looks like a good company, at a cheap price.

In particular I liked its:

1. Price. At 185p the shares cost eight times average earnings over the previous ten years, well within bargain territory.
2. Financial strength. With an F_Score of seven out of nine and no debt at the end of the year it looked like it was in recession busting good health.
3. Profitability. Dewhurst had been profitable for 28 years. Instead of succumbing to the low cost competition from abroad it relocated some of its manufacturing to Hungary and found a way to compete on quality and price.
4. Prosaic products. Lift buttons, keypads for ATMs and traffic bollards aren’t as exciting as iPhones but there’s a big, established and unglamorous market for them.

This chart sums up the first part of the case for Dewhurst, that it is a good company:

It takes two elementary measures, earnings per share for the company’s performance, and the ratio of shareholders’ equity to total assets for financial strength, and plots them on the same chart. Profits have increased by 200% over the last decade, despite, or rather because of the relocation and modernisation of its factories, and Dewhurst’s done it without taking out a huge mortgage. In fact the company owns more than twice what it owes (shareholders’ equity is 64% of total assets, therefore liabilities are only 36% of total assets), much the same as in 2000.

Although average profits rose (because 2009’s profits replaced 1999’s, which were much lower), Dewhurst’s price rose too and the shares are no longer as cheap as they were. At 250p they cost 10.5 times average earnings, right on the upper limit of bargain territory.

Meanwhile its other virtues are intact. It’s still churning out buttons. It’s latest being the weatherproof US97-EN Pushbutton (left) and the antibacterial US95-AB Compact 3 Pushbutton.

It’s been profitable for 29 years now. The company celebrated its 90th birthday in November, although it traces the most recent phase in its history back to the acquisition of Thames Valley Lift Company in 1994.

And frankly, it’s a relief to read an annual report in which a company clearly explains what it actually does. Dewhurst is about producing better, cheaper buttons and other lift components more quickly. It’s not the most glamorous of niches, but Dewhurst is dedicated to it.

If we were to go by the numbers alone, Dewhurst is a textbook Thrifty 30 company, which is why I like it so much. But there are two nasties, and one of them has got worse. It has a defined-benefit pension deficit, a liability that escapes the F_Score, my preferred method of testing financial strength, that has risen from £4m to over £6m.

The value of pension funds, and the obligations they must meet are a bit of black box, governed by complex actuarial calculations that are beyond me. My own rule of thumb is not to worry if a company’s other liabilities are small, unless the overall size of its pension obligation is bigger than the market value of the company itself. That’s not a recognised red flag, just a personal reminder not to ignore big pension deficits.

Dewhurst’s pension obligation now stands at £24m, while its market value is about £19m. The company could make its shares more attractive by closing its defined benefit scheme, but five of the directors are members so that would be a bit like turkeys voting for Christmas because nasty number two is 71% of the shares are not in public hands.

By persisting with a defined benefit scheme, management may be acting in its own interests rather than minority shareholders’, but in most respects its done a fine job. So fine, in fact, that I’m happily overlooking the pension fund and the immediate outlook which in the words of Richard Dewhurst, its chairman and biggest shareholder, sounds dismal:

…short term 2010 is likely to be more challenging than 2009. The economic climate means there is no let up on the pressure on prices and costs. Project related demand is beginning to tail off as few new projects have been started in the last year. We are also likely to be affected by the coming squeeze in UK public finances, as directly and indirectly the public sector is an important proportion of our UK sales, but it is difficult to predict the degree and the timing of the impact.

The problem is that even if the construction industry picks up, Dewhurst is likely to be a late beneficiary as lifts are installed towards the end of projects.

The discipline of value investing is to stick with good companies until the market recognises them and the value comes out. We may have to be patient with Dewhurst if 2010 turns out as tough as it sounds, but that’s no reason to dump the shares now.

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Decline of deep value

Blll Mott says manufacturing is benefitting from the weak pound, but the sector is too small to turn the economy around.

Is it a sign of the times? Deep value is getting thin on the ground so Greenback’d is spreading his wings.

Step forward… The real Thrifty 30

In practice:

I name this portfolio…

Regular readers will be familiar with my Thrifty 30 portfolios. They are portfolios of thirty shares in financially strong companies at cheap prices. I first tried it on this blog, then I had a go for Money Observer [pdf]. Up to now, though, I have not maintained a Thrifty 30 portfolio.

Today, I’m starting a new experiment. I’m going to choose the first companies for a Thrifty 30 portfolio to be updated on this blog. If a share ceases to be thrifty I’ll “sell” it and replace it with a new thriftier company, if I can find one. I’ll track the performance of the portfolio too, but not obsessively.

Although It’s not a real portfolio of shares, these are my best ideas so it’s likely I’ll own many of them. I don’t, however, buy or sell shares for myself when I’m writing about them, or have just written about them, and I do inform Interactive Investor’s editor-in-chief when I file an article about a company I already own, in line with the Press Complaints Commission’s code of practice.

In short, I won’t profit from short-term price movements that might result from something I’ve written.

In my opinion the share prices of all the companies in the Thrifty 30 are temporarily depressed. Judging by their past records of profitability, their financial strength, and their reasonable prospects, shares in these companies should be worth more than their current stockmarket valuation.

If you’ve been reading this blog, you’ll know I identify these companies using simple quantitative measures, the long-term price earnings ratio and Piotroski’s F_Score primarily. The rest, the bit I’m least confident about, is common sense! For the sake of space and readability I won’t include the figures in these short profiles, but you can look most of them up in this table compiled from the Sharelockholmes database:

You’ll also know that I’d never buy shares in a company without checking the facts and the reasoning, so please don’t invest in the Thrifty 30 blindly. Use it as a source of ideas for your own, equally nattily named portfolio.

Value investors focus on what could go wrong. If nothing goes wrong, then very likely the share will make money. Looking at the companies I’ve selected, the biggest risk in the T30 is also a strength, size.

Cheap companies, tend to be small, and easily overlooked by the stockmarket. Often they have controlling shareholders who may not always act in the interests of smaller investors.

In the recent bear market, founders and majority owners took advantage of low share prices to take companies private. They said, with justification, that there was very little interest in their companies. Loyal shareholders, though, were fleeced.

Since few investors want to own shares in an unlisted company, a delisting is tantamount to compulsory purchase and if the share price is only temporarily low, smaller shareholders are deprived of the recovery that would give them their return.

I take some comfort from the fact that companies I’ve selected, like Dewhurst and Haynes, have been listed for decades, and more from the fact that in a portfolio of thirty companies the actions of one group of managers can’t make too much of an impact.

However, the holy grail, is not just a financially sound company at a cheap price. It’s a liquid, financially sound company at a cheap price.

Dewhurst (DWHT)

Dewhurst, which makes pushbuttons for lifts and ATMs, is a consistently profitable UK manufacturer. Although it appears to be growing through the recession, it could yet suffer a lag as we pull out of it because its components are required late-on in new construction projects.

Holders Technology (HDT)

On the face of it, Holders is probably the least attractive stock of these six. It produces materials for printed circuit boards, an industry in severe recession. It’s very cheap, though, and management has seen out previous semiconductor cycles.

Games Workshop (GAW)

Games Workshop experienced a stockmarket bubble of its own making after it launched a war gaming format based on the Lord of the Rings novels. Investors got over-excited, and so did management, but now they have all learned a hard lesson the shares seem reasonably cheap again.

Haynes Publishing (HYNS)

Although Haynes is selling fewer manuals because cars are more reliable these days, and we’re less inclined to fix them ourselves, it took a big step into garage workshops when it bought Vivid, a digital supplier of motor data and schematics.

OPD (OPD)

I shied away from head-hunter OPD in May. Management showed all the signs of overconfidence, flashy acquisitions and pay packets to match, and few signs of having learned the lesson of subsequent write-offs and a crash in the share price. Added to the recession, which affects recruiters disproportionately, it was just too risky. It looks more interesting now two directors have stepped down from the main board, Peter Hearn, the chairman, has failed to take the company private, and fund manager Schroders owns enough shares to act as a counterbalance to his majority stake.

Printing.com (PDC)

Although printing business cards, stationery and flyers, is a competitive business suffering a bad recession, Printing.com appears to have a low cost business model (all the printing is done in a centralised factory) and strong finances.

These are the first six members of the Thrifty 30. I shall invest an imaginary £1,000 in each, at Tuesday’s closing price, assuming fees and tax of £15. I’ll keep the remaining £24,000 for purchases in the months ahead. From the Thrifty 30 I expect at least a positive real return (i.e. taking inflation into account) over any five year period.

Of course, that wouldn’t be adequate reward for all my hard work. Over five years or more, I hope to achieve an average annual return of 15%. Benjamin Graham, the father of value investing, thought 15% was achievable when he outlined a system that inspired the Thrifty 30, and Warren Buffet, frequently hailed as the world’s greatest investor, says that’s what he aims for.

If it’s good enough for them, it’s more than good enough for me.

Over the next few weeks I’ll add more thrifty stocks and reveal the not-so thrifty. Companies that seemed to fit the template but, for one reason or another, I haven’t included in the portfolio.

You might not agree…

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Do WHA/T?

The ‘A’’s have it

Say you read February’s Share Sleuth article, the column I write for Money Observer magazine, which will be on Dewhurst. You like the sound of the company. You do your own research. You still like the sound of the company. Which shares do you buy?

Dewhurst is one of, I believe, a diminishing band of companies with more than one class of share. It has ordinary shares, and it has non-voting ‘A’ ordinaries. Both are listed on the stockmarket, the ordinaries are DWHT and the ‘A’’s are DWHA.

Both have the same rights, they rank pari passu, except the holders of ‘A’ Ordinaries are disenfranchised. They cannot vote on company resolutions. Companies often issued non-voting shares when the existing owners wanted to raise money, without relinquishing control.

It’s worth considering control. Their small shareholdings buy small shareholders very little control, especially where, as in the case of Dewhurst, 71% of the shares are owned by major shareholders, a list headed by the company’s chairman and chief executive.

But that worthless vote comes at a price, about 30p a share, because DWHT shares cost 185p, and DWHA shares cost only 155p.

Since the two classes of shares are otherwise equal, they receive the same dividend. Shareholders of either stripe will receive a total dividend of 5.76p per share for 2008, and, since you can buy more non-voting DWHA’s with the same amount of money, DWHA holders will be the wealthier for it. The dividend yield on the ordinaries is 3.1%, while the dividend yield on the ‘A’s is 3.7%.

Company law protects non-voting shareholders, so ordinary shareholders can’t just table a resolution to vote them out of existence or take away their right to a dividend, not, at least, without their agreement, which would be a bit like the proverbial turkey voting for Christmas, or banker turning down a bonus.

Decades ago, unconventional share classes were more common, at companies like Whitbread and Young’s. Investing in the non-voting shares was the norm. Many people owned Young’s shares for the perks that came with ownership, one of which was a seat at the AGM, a massive piss-up, which moved to the Grosvenor Hotel in its glory days.

Peter Temple remembers his days as a brewery analyst fondly. He says John Young would chair the meeting in a white suit and at the first sign of a tricky question he’d reply,

“Well that’s a very interesting question, but I’m getting very thirsty. Aren’t you?”

It was a phrase shareholders greeted with a roar of approval and interpreted as a signal to adjourn to the bar.

Sadly for the AGM, Dewhurst doesn’t make beer, it makes pushbuttons for lifts, but if, as is the wider trend, Dewhurst were to enfranchise its non-voting shareholders that would, presumably boost the value of ‘A’ shareholdings at the expense of the ordinaries, so, for a number of reasons, none involving beer, it seems like the ‘A’’s have it.

Dewhurst: not perfect, but…

Dewhurst pushes most of the right buttons

Before I talk about this week’s shares tomorrow, I promised more on Dewhurst (DWHT), last week’s pick of the week.

There’s a funny story in a novel I’ve just read, ‘The Marriage Bureau for Rich People’*¹. Irshad, the number one valve salesman in Southern India, complains that none of the marriage bureau’s prospects shows any interest once he’s met them. It turns out he can’t stop talking about valves, which are tremendously important in engineering, but not perhaps to potential wives and their mothers.

Dewhurst is a kind of corporate Irshad. It makes pushbuttons. The kind you find in lifts and on cash machines, and is moving into traffic bollards. They’re prosaic products that probably don’t excite glory-seeking investors but…

Likes:

…Dewhurst fits my template almost perfectly.  It’s financially strong, it has no debt and an F_Score of 7, and a long record of rising earnings, with the odd setback along the way. It’s been profitable for at least 17 years, and probably much longer. Dewhurst’s long-term price earnings ratio is about 8, not a bargain in the current market but certainly not expensive. The average for the whole stockmarket is about 10. Last year was a record year for profits, although in 2009 they’re likely to be crunched, slightly.

Dislikes:

Two factors that escape basic analysis, but bedevil smaller companies in established industries, are increasingly frustrating me. One is the size of their pension funds and the other is ownership.

1. Dewhurst is socking away £500,000 a year plugging a £4m hole in its pension fund, which its actuaries value at £16m.
2. Ever since I was squeezed out of Northern Recruitment, I’ve been more sceptical about family controlled businesses. Major shareholders own 71% of Dewhurst, which is almost enough to vote through almost anything at company meetings, if they all acted together. The biggest individual shareholder, though, is Richard Dewhurst, who owns nearly 15% of the shares, so at least one individual is not in control.

Not the perfect share, then, but I feel I’ve moved a step closer in Dewhurst. I’d consider buying shares in it, notwithstanding a more difficult year ahead, as part of a portfolio of sound companies.

Footnotes:

1. It’s an uplifting, and easy read. I loved it, though it’s getting surprisingly poor reviews on Amazon.