Southern Cross prelims - covenants further relaxed

As I expected last week, Southern Cross have announced a further relaxation in their bank covenants as part of their final results.  The fixed charge cover is now down to 1.1x.  No further news on a possible takeover, except to reiterate the earlier news that "the approaches are still preliminary in nature, and the Board continues to believe it to be in shareholders' interests to continue to hold exploratory discussions."


A fixed charge cover of 1.1x is pretty generous.  They only need to manage adjusted EBITDA of about £20m to hit that.  And they have about £30m of headroom in their revolving credit facility.  Perhaps the more important figure now is their cash-flow neutral point - I reckon they need at least £30m of adjusted EBITDA to be cash-flow positive.


I see no sign of this company going bust imminently - they seem to be within their covenants, they have headroom in their credit facility, and their bankers have repeatedly demonstrated their unwillingness to call in administrators.  But then I've just suffered a total wipeout with Rok, so what do I know?

De La Rue - fundamental value >905p per share?

I certainly seem to have picked a few exciting shares to buy recently.  My last 4 purchases were:

• (June) BP.  Down 15% at one point, now 27% above my purchase price.
• (August) Rok Group.  Bankrupt.
• (August) Southern Cross.  90% up within a week of purchase on a takeover approach, now down 13%.
• (September) De La Rue.  Down 20% at one point, now up 25% after a takeover approach.

Today has seen plenty of news for De La Rue shareholders to ponder.  First of all a belated announcement of a "highly preliminary and opportunistic" takeover approach, which drove the share price up to 780p.  Then confirmation that the bidder was Oberthur, a French rival - and the news that they had made an indicative offer of 905p in cash - that was enough for the shares to hit 840p.  Finally De La Rue responded with their justification for rejecting the offer (apparently it "in no way reflects the fundamental value of the Company").

In August I wrote an article about De La Rue where I said they were "worth in the region of 900p".  Perhaps I should become a full-time oracle?  Of course I also said "I think I‘ll sit this one out for now and hope for an opportunity to buy at 600p", which I singularly failed to do, taking a punt at 677p.

So what are De La Rue worth?  Oberthur obviously think >900p, otherwise they wouldn't be bidding at that level.  The board of De La Rue agree, otherwise they wouldn't have rejected the offer.  As for me, my valuation of 900p was based on De La Rue remaining independent - as part of a bigger company, dominating its industry, I can see it being worth a fair bit more.

I don't know how deep Oberthur's pockets are (and it's privately held, so I can't find out) but I suspect they probably have a bit of headroom for a higher offer - say 950p or 1000p, just enough for the board to capitulate and support it.  Whether a deal happens all comes down to De La Rue's big shareholders.  If they've been spooked by the recent quality problems and CEO resignation then they will probably be delighted to jump ship at this sort of price.

As for me, I'd be happy to sell my shares at 905p and take a quick 33% profit.  I'm in two minds whether to bail out now at 840p - but since my valuation was at 900p I suppose I should hold on for that.

Southern Cross update

I've posted an update on Southern Cross over at Shareworld.  There have been a few rumours flying around recently - the Sunday Times reported that their banks were willing to waive covenants (which is good, since I reckon they are within a whisker of breaching them), and the Sunday Telegraph thinks that Blackstone is considering a takeover bid.  That really would be news - Blackstone is the group that originally built the group and engineered the sale and leaseback that has left it with its present difficulties.

Their full year results are out on the 9th December, and I think we can probably expect some sort of update at that time.  In the meantime their shares will probably continue their rollercoaster ride.

Risk

After the recent Rok debacle I thought it might be a good time to look at the risk in my portfolio.  It may be shutting the stable door after the horse has bolted but, at the risk of stretching a metaphor too far, there are still 20 other horses in my stables and some of them are looking skittish.

I'm going to split my portfolio into a few broad areas.  From least risky upwards:

1. Safe.  No cause for concern
2. Solid.  Some concerns, but nothing major.
3. Speculative.  Known problems, but they should pull through.
4. Risky.  Acute problems - real risk of wipeout.

1.  Safe (36% of portfolio)

First into this category goes Berkshire Hathaway.  A book value of $150bn gives me a lot of confidence (even if $80bn of that is goodwill and "other").

NWBD is next on the list.  For this to suffer losses you would first have to assume that NatWest has gone bankrupt.  Then you would have to assume that its owner, RBS, would refuse to rescue it - i.e. either its losses are catastrophic, or RBS itself was bankrupt.  Given that didn't happen in 2008-2009, I'm happy that it is unlikely to happen in the future either.

LLPC follows close behind.  Although it is more exposed than NWBD (its dividends are currently suspended), it escaped the recent crisis with the loss of only 2 years' dividends - in the scheme of things that's peanuts.

Tesco makes it into this category thanks to its strong balance sheet (a fair amount of debt, but mostly long-term funding, backed with an extensive property portfolio), consistently strong profit margins, international diversification and a business that should be around for the long-run.

2.  Solid (31%)

British American Tobacco and Diageo make it into the top-end of this category.  They don't quite qualify for my top rank: BATS because worldwide tobacco use will eventually decline, and Diageo because of its heavy debt load.  Apart from those concerns, these are strong businesses with healthy profit margins, strong brands, loyal customers and international diversification.

I'm going to bundle in two of my 3 ETFs here: IDVY and IAPD.  These are both focused on high-yield shares, which I think on the whole gives you a pretty solid set of companies.  

GlaxoSmithKline looks, on the face of it, like a pretty healthy business, with massive margins, a decent balance sheet and good international diversification.  But they face reduced healthcare spending in developed countries, plus expiring patents and generic competition.

National Grid just about makes it into this category because of its reliable, regulated income stream.  My concern is that it has an enormous heap of debt, and I don't really understand the risks it could face.  

3.  Speculative (27%)

IEEM is definitely an ETF that fits better into the speculative category.  It invests primarily in large cap shares in emerging markets, and has historically been pretty volatile.

Greene King comes in at the solid end of my speculative category.  It has a lot of debt, and faces long-term headwinds in terms of fewer customers and higher taxes on alcohol sold in pubs.  But it makes a decent profit,  its debt is funded a long way out, and most of its pubs are transitioning well from "wet-led" to family-friendly pubs serving food.

BP has one big problem: the legal/political consequences of the GoM blowout.  Beyond that, it's a very solid, profitable business, with a strong balance sheet.

De La Rue is also a great business facing one problem - the loss of reputation/business from this year's quality issues.  Excluding that, it is consistently profitable, with good margins, a solid balance sheet, and is a world leader in their field.

I have a clutch of software companies that I think fall roughly here in my list: QDG, MXM and BDI.  QDG is not hugely profitable but has a solid balance sheet.  MXM has a very strong cashflow but quite a bit of debt.  BDI has a great product but is not massively profitable.

4.  Risky (6%)

Game Group comes at the more solid end of my risky category, but faces a number of issues: very low margins, a squeeze from supermarkets cherry-picking the most popular products, and online competition from the likes of Amazon and play.com.  Their balance sheet is not fantastic, so one bad Christmas could get them into rather a lot of trouble.

Carpathian is a business that will definitely be worthless in a year or so.  The only question is how much cash shareholders can extract in the meantime.  If they manage to sell their assets for the prices they expect, then shareholders should do OK - but a further deterioration in Eastern European property could rapidly see them become worthless.

Southern Cross comes right at the bottom of my list.  Tiny margins, declining occupancy, consistent unprofitability, hugely expensive rental contracts with guaranteed annual increases and reduced spending by local authorities all conspire to make this a share only for the brave.

Rok
So where would I have put Rok in my list if I'd written it a few weeks ago?  I think it would have gone in the Risky category, probably just above SCHE.  But that's why it was trading on a P/E ratio of less than 3.

Pan African Resources

Screening for some small, profitable, debt-free companies I recently came across Pan African Resources.  I've posted my thoughts on shareworld.  Since writing the article a week ago I've been dithering, and the share price is up more than 10% in the meantime.  I haven't yet decided whether to buy a few shares or hope for a better price.

Rok = Connaught

And here was I thinking Rok was a different kettle of fish to Connaught.  Turns out I was wrong.  1.2% of my portfolio disappears in a puff of smoke, and I have a new worst ever investment.

The next Warren Buffett?

Is Todd Combs the new Warren Buffett?