David Holding unearths yet another eye-wateringly cheap share.
It's not easy being a contrarian investor. It's difficult to time things correctly and even harder to have the courage of your own convictions to average down your buying price if you're convinced you've got it right and the rest of the world is wrong.
One of the contrarian stock market sayings goes something like "buy when there's blood on the boardroom carpet" and the last time I bought into specialist engineering and construction services group Renew Holdings (LSE: RNWH) this was almost literally true.
History is one thing…
Five years ago, the company (then known by its former name Montpellier) was targeted by animal rights activists who protested and directly threatened some shareholders over the company's construction of a biomedical research facility for Oxford University -- which it pulled out of in July 2004.
This action came hot on the heels of a significant loss due to the terms of old construction contracts. The company did something of a "kitchen sink" job on the accounts and the share price halved in short order dipping under 20p.
But anyone who held on, or better still bought in the middle of the animal rights carnage, managed to pull a healthy rabbit from the hat. The shares recovered as the rejuvenated (now called Renew – geddit?) company went on from strength to strength peaking at over 120p in 2007.
The future's quite another…
Anyway, that's all water under the bridge of course. But it's relevant in that the price is back down to its lows of four years ago -- yet this isn't really reflected in the company's performance so much as market sentiment; the contrarian's delight! Of course, things have got tougher over the past two years, as the profits warning in March confirmed, but the sell-off looks way overdone.
At the current mid price of 34p, Renew is valued at a little over £20m. The broker has earnings per share of 8.9p for this year, falling to 6.4p for 2010. These figures were revised downwards after the warning -- but even the more pessimistic figure places the shares on a price-to-earnings ratio of just 5.3.
Defiant performance
And the interim results for the six months to the end of March were upbeat considering the economic backdrop. Renew made an underlying operating profit of £3.2m on revenues of £171.6m. This was down from the previous year, as one would expect, but not bad at all under the circumstances. Meanwhile, the order book stood at £221m, the company had a net cash balance of £17.5m and an overall debt free balance sheet. It also said it was repositioning itself to concentrate more on its specialist engineering services (nuclear, land remediation, water and rail infrastructure) which is expected to represent 40% of revenues going forward. Conversely, Renew has been reducing its specialist building capacity (social housing, retail, science & education, restoration and refurbishment) and this will provide annual savings of £7m.
As part of this strategy, Renew bought water pumping outfit C&A Pumps in October and specialist machining and fabrication business Mothersill Engineering in May.
The company felt confident enough to pay an interim dividend of a penny to add to the 2p it paid at the final stage. If maintained, this represents a huge yield of 8.8% at today's price.
What's the catch?
So what's the catch? Why are the shares so cheap?
Firstly, trading is difficult and companies like Renew generally work to very small margins. So it doesn't take much in a downturn to tip earnings into the red. Also, despite the very healthy cash position in relation to the market cap, Renew isn't really an asset play as trade creditors exceed debtors by £26m and the over net tangible asset value is around £6.7m.
Overall, however, the company does look significantly undervalued. If the value is to come out and the share price head north, then this will happen due to earnings growth going forward. Will it happen? This is the contrarian investor's decision to make -- but it's surely better to buy on temporary weakness than on strength?
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