Where are all the bargains?

Screening for ultimate bargains, is like catching Angel Fish in the River Thames

There are only three candidates in my ultimate bargain screen this month, none of which look particularly enticing:

NB: Here’s the spreadsheet, you can find a short description of the screen on the shortlists page, and here are descriptions of the two variables: Price to net working capital, and Piotroski’s F_Score.

Perennial bargain, Leeds Group is an investment company currently focused on textiles. I’ve profiled it in the past but not been tempted because of the poor investments it made in trying, and failing, to diversify from the undervalued business at its core.

Harvard International distributes consumer electronics, which as I’m finding with Armour, is a very tough market. That could spell opportunity, because expectations, and therefore prices, are very low. But Harvard’s F_Score of three out of nine suggests it’s getting into trouble, rather than getting out of it.

If Harvard’s three spells trouble, then Northamber’s F_Score of just two is doubly troubling as Northamber is already a member of the Thrifty 30 and although Sharelockholmes uses slightly different metrics to calculate the F_Score than the original paper published by Piotroski and, therefore me, we usually arrive at a similar figure.

Holding a company with an F_Score of two would difficult to justify unless most of the failures in the scoring system were marginal, but Northamber is an odd company. It appears to be slowly liquidating itself by continuing to pay a dividend. With its market price so low, its assets are worth more in our hands than in the company’s, so it might actually be one of those businesses Ben Graham cherished. Worth more dead than alive.

Despite August’s rout, this is a disappointing haul. That’s partly because I restrict my search to companies reporting in the last four months so I can base my analysis on a recent annual report. But it means in the second half of the year, when fewer companies report, there are fewer fish in the river.

The Peter Gyllenhammar story

Exclusive!

The story so far: Leeds Group shares are dirt cheap judging by conventional measures, but, although it has one main business importing fabrics to Germany, it’s an investment company run by two Swedish non-executive directors. I don’t like this arrangement because:

1. The company says it’s looking to make new investments, and I like to pick my own.
2. The two investments it has made under Johan Claesson and Peter Gyllenhammar outside of Hemmers-Itex, the fabric business, look particularly risky (a failed investment in residential mortgage backed securities during the credit crunch, and a stake in Dawson International, a struggling cashmere supplier with a large pension fund).

On the other hand, Leeds already owes money so its ability to make new investments seems constrained and by investing in a new warehouse for Hemmers-Itex and buying back large amounts of shares it’s constrained itself further. The words and deeds don’t match, and if actions speak louder than words, I like Leeds more.

Free Capital a soon-to-be published book profiling twelve UK investors who’ve accumulated £1m or more contains a chapter on Gyllenhammar. It doesn’t make particularly comfortable reading.

We already know his investment style because he owns stakes in a number of companies in the Thrifty 30 portfolio. In his own words, it’s to:

Pick up bombed-out shares trading at a large discount to net asset value. If they are badly managed or not managed in the best interests of all shareholders, then implement change. This typically takes you into operationally risky situations and some of the investments go bad, but the risk/reward in aggregate is attractive.

He parlayed £50K and a £2m credit line into tens of millions investing in UK small caps between 1996 and the early 2000’s, but his appetite for leverage has led him to go bust, twice.

In 1976 his investment company Trend Invest acquired nearly 50% of Fagersta, a steel company, with the intention of merging it with other steel interests. But Trend Invest was funded in part by money Gyllenhammar had borrowed and when Fagersta launched a deeply discounted rights issue Trend didn’t have the capital to take up its rights or withstand the subsequent drop in share price.

When his broker asked him what he was going to do about the £200,000 he’d lost, Gyllenhammar replied:

Clearly someone has lost £200,000. It can’t be me, because I never had £200,000. You’ve lost £200,000!

Instead he went to work for the broker, and subsequently became a partner.

In 1990 another Gyllenhammar investment vehicle, Mercurius, went bust when its twelve month rolling bank facility was called in as the Swedish banking crisis unravelled.

I had made some misjudgements about leverage,

Says Gyllenhammar

…but I was still confident about my ability as an analyst.

He went to work as a corporate financier for one of his previous backers, Ulf Lindén, the man who ultimately financed Gyllenhammar’s successful foray into British small-caps during the boom years of the late 1990’s.

The book also describes some of Gyllenhammar’s corporate engineering successes, Britannia and YJ Lovell in 1996, but success since 2003 has been harder to come by. The corporate engineering at Leeds has come and gone with the sale of Leeds Leasing and the investment of the money released by it, yet still the company trades at less than the value of its net working capital.

Like an investment trust with a poor track record, I think lack of faith in the investors who run Leeds is part of the reason for its low market valuation. Gyllenhammar takes big risks, although in the book he recognises the role of debt in past failures and says he’s less tolerant of highly indebted companies these days.

On the other hand, at the heart of Leeds is Hemmers-Itex, which looks like a perfectly viable business that has survived recession. Buy Leeds and you get Hemmers-Itex for less than the value of its net working capital.

I may well add Leeds to the portfolio, but I’m not in a hurry to because companies are reporting, and with limited cash available to the Thrifty 30 I want to see what other opportunities there are.

-

Free Capital should be an interesting book. Gyllenhammar is, perhaps, the best known investor of the twelve investors profiled, and the capital he has at his disposal allows him to build bigger stakes in companies, and therefore have more influence.

Like The Warren Buffett’s Next Door, Free Capital offers us the opportunity to learn from interviews with successful investors. It’s published later this month, and will be available at a discount in the Interactive Investor mothership’s bookshop.

Leeds by lines and numbers

Six out of nine

Having established Leeds (LDSG) shares value the company, an investment company with owns a textile importer based in Germany, at a fraction of its net working capital, I’ve typed some other numbers into my spreadsheet using annual reports going back seven years to 2004.

Seven years is significant, because:

1. Leeds only publishes reports since 2004 on its website
2. 2004 was the year Johan Claesson the first of the two Swedish investors who currently run the company joined the board. The second, Peter Gyllenhammar, joined in 2007.

Gyllenhammar at least has a reputation as an activist investor seeking to get himself, or somebody who works for him, on boards to agitate for change to release the true value he sees in companies. So far, the Swedes have not been very successful, which probably explains the share price (pink line):

That doesn’t mean they’ve been inactive though. Despite the credit crunch and the recession they’ve presided over a slight uplift in shareholder wealth (orange bars) and a substantial deleveraging of the company (blue bars). What hasn’t followed through particularly strongly is profitability (green lines).

I reckon they’ve done good and bad and the bad is a mixture of bad luck and bad judgement, or perhaps more harshly bad timing and bad judgement.

The improvement in Leeds’ finances stems from the sale of Leeds Leasing, a provider of lease finance to small businesses in the catering, hospitality and leisure industries. Bibby Financial Services bought the company at the beginning of the period and left Leeds Group debt free and focused on one remaining business, German textile importer Hemmers-Itex. The improvement in shareholder wealth happened because the company went from making a loss every year (if you include write-offs) to making a small profit most years and because Leeds has aggressively bought back shares, reducing the total number in issue by 10% since 2006. The buy backs increase per share net asset value, upon which my shareholder wealth figures are based (the company pays no dividends, which would also add to shareholder wealth).

A change of strategy around this time also lifted sales at Hemmers-Itex. Hitherto a supplier of short lengths of cloth to retailers, it also started supplying manufacturers with 60-80m long rolls.

That’s the good. The bad, is what they did with the loot. All of their investments including the new warehouse for Hemmers-Itex and a speculative looking stake in AIM listed Dawson Holdings, were initiated as the credit crunch unfolded. The third investment, which I described last week, was unequivocally bad, the stake in a fund heavily invested in residential mortgage backed securities. That has been sold now, and the losses written-off.

Still, judging by the numbers today, Leeds Group doesn’t look unworthy of a position in the Thrifty 30 portfolio.

My spreadsheet confirms that, despite having borrowed to build its warehouse, and thanks to profitable trading at Hemmers-Itex, Leeds is in reasonable health. It achieves six positive signals out of nine on Piotroski’s F_Score.

Of the three ‘failures’ two relate to the fact that in cash terms, as opposed to accounting terms, the company made a small loss this year. Operating cash outflows exceeded cash inflows because Leeds built up stocks towards the end of the year. If that were because Leeds couldn’t sell its cloth, it would be a bad thing, but the company says it was stockpiling ahead of cotton price rises. 

Although textiles is a very competitive business, and recession, exchange rates, and the price of cotton can wreak havoc on profit margins, Leeds, or at least Hemmers-Itex, looks more like a company heading out of trouble than one heading into it. The numbers, though, are for the year ending 30 Sept 2010 and since then the company has issued an equivocal trading statement.

As I said last week, there is also a wild-card. Leeds’ bosses are investors, not managers, and that makes Leeds a little more speculative than I’d like.

I’m going to post one final time, on one of those bosses, Peter Gyllenhammar, before making my decision.

Leeds: Money for old thread

Confused by the set-up, tempted by the payoff

Textile importer Leeds Group‘s market price is less than the book value of its current assets minus all its liabilities. It’s a fabled net-net.

The company’s share price bottomed in 2005 and has since crawled sideways.

When investors’ expectations are so low the market values a company at less than the cloth it owns even after deducting all its liabilities, they’ve collectively decided the company has no future. Perversely this can be the ultimate low-risk high reward situation since shareholders who buy at this level might even get their money back in a liquidation. If the company survives and prospers, they’re really in the money.

Here’s the basic calculation:

The market value of all the shares in Leeds is £5,416m

On 30 Sept 2010 it had current assets of £16,809m, including just over £2m in cash and the rest equally divided between inventory (textiles) and receivables (money owed by customers).

Total liabilities were £8,444, mostly debt, some incurred building a new warehouse in 2008.

So the company’s current assets net of all liabilities was:

16,809m – 8,444m = £8,365m

And the market values the company at:

( 5,416 / 8365 ) * 100 = 65%

Of the value of current assets less all liabilities

I’m not saying a liquidation is on the cards, Leeds made a tiny profit this year, I’m saying the market is giving the company a liquidation value, a good thing if you are a bargain hunter and especially if the company isn’t on the verge of collapse.

It could be one to add to the Thrifty 30 portfolio but before I confirm the story and the numbers I must check it’s a business I’d want to add even at a bargain price.

The reason for hesitation is Leeds is an investment holding company. It owns Hemmers-Itex, a German textile importer which supplies retailers, wholesalers and manufacturers with clothing and furniture fabrics. Hemmers-Itex is run by Jörg Hemmers, but he doesn’t sit on the Leeds board or own a significant shareholding. The board is two Swedish investors, Johan Claesson and Peter Gyllenhammar, both non-executives. They are fairly well known to UK investors, and Gyllenhammar has stakes in at least two Thrifty 30 companies, civil engineer Waterman, and fine art dealer Mallett.

The good news is between them they own 51% of the company, which means they’re surely going to take decisions they think will benefit shareholders. The bad news is they’re investors,  and I have an aversion to riding in someone else’s investment vehicle. I worry that instead of ploughing money into Hemmers-Itex, or returning money to shareholders, they’ll find some reckless investment to put it into.

Leeds doesn’t pay a dividend because its searching for investment opportunities. Meanwhile Hemmers, the man who runs the company, hasn’t got a visible stake, so his influence on Leeds’ strategy may be weak, and so may his incentive to run Hemmers for shareholders.

So far, the board’s investments look iffy. At last September’s valuation, Leeds has a £1.295m 29% stake in Dawson International a listed cashmere garment and bed linen manufacturer with large pension liabilities (the board thinks it’s undervalued, subject to the resolution of its pension situation), and last year it sold its investment in European Equity Tranche Limited at a loss. EET invests in residential mortgage backed securities (RMBS), the instrument that sparked the credit crunch. Leeds made the investments in 2008, when Gyllenhammar and Claesson were board members. They’ve been investors in the Leeds since 1999, so it’s been a poor investment for them too.

The odd thing is Leeds is slowly buying back shares, which seems contrary to its ambition to invest in new opportunities and is probably sensible if, as I suspect, the shares are undervalued. Also its capacity to invest in new opportunities is doubtful and the significance of its existing investment limited. In September Leeds already had £6.5m debt against £12m equity and its holding in Dawson is is worth little compared to Hemmers-Itex. Maybe I can ignore its status as an investment company and treat a holding in Leeds as the opportunity to buy a dollar of textiles for 65c.

I’m confused by the set-up, but beguiled by the pay-off. So few net-nets come along this one’s hard to ignore, especially at a 35% discount. I’m going to take a closer look at the numbers, and the company’s history.