Qualiport
[ Wednesday, 10 March 1999 ]
Life After Rentokil
By Bruce Jackson (TMF Googly)
Kilburn, London -- Since Tuesday last week, when Rentokil Initial (RTO) just missed their self imposed 20% earnings growth target, the share price has tanked. Last week, it was the worst performing share in the FTSE 100, racking up a whopping 16% fall. To add insult to Qualiport injury, the second biggest loser was Marks & Spencer (MKS), with a 9% fall.
Given that Rentokil are our biggest holding, this wreaked havoc on the 1999 Qualiport returns. When I finally hung up my keyboard last Friday, the Qualiport was down 4.11% for the year, compared to the 5.49% advance in the FTSE 100 Index. At the time, the 9.6% gap looked as wide as the Grand Canyon.
Despite my mild case of depression, which lasted all of 5 minutes, it was not all doom and gloom. The share market had decided to penalise Rentokil for not making their earnings growth target, and there's nothing shareholders can do about that. In fact, Monday saw the shares fall a further 23p to 363p, as the short-term pain continued.
In the context of the valuation of Rentokil themselves, perhaps this was a rational market reaction. They had missed earnings estimates, and sales growth was minuscule. Chief Executive Sir Clive Thompson reiterated that the 20% growth target remained in force. Yet despite this, and despite the company's amazing track record, somehow the City didn't believe him.
With the shares at 400p, Rentokil traded on a trailing price to earnings (P/E) ratio of about 33. They are expected to grow earnings by a conservative (ish) 18% in 1999 and by 15% over the next few years.
On its own, as a valuation tool, I'm not a huge fan of the Fool ratio, or PEG. However, it does allow you to get a quick fix on relative valuations between different companies. For example:
P/E Growth PEG
FTSE 100 25 8% 3.1
Glaxo Wellcome 39 13% 3.0
BT 32 8% 4.0
Vodafone 60 25% 2.4
Rentokil Initial 33 18% 1.8
PizzaExpress 25 25% 1.0
This is not done to illustrate that Rentokil and PizzaExpress (PIZ) shares are cheap and that we should all be rushing out to buy them. Rentokil shares, to my naked eye, still don't look like they represent a huge amount of value. But nor does the market, or Glaxo Wellcome (GLXO) or BT (BT.A). And that doesn't mean that we are riding for a market crash. I'm a firm believer in buying a share in a company if, on its own, it represents value -- regardless of the valuation and general direction of the market.
But the fall in Rentokil has actually been somewhat of a blessing in deep, deep disguise for the Qualiport. No longer is Rentokil our runaway winner, upon which the returns of the Qualiport are very much dependent. At the beginning of 1999, they represented 21% of the total portfolio, with the next biggest shareholding, Unilever (ULVR), making up 11.9%. This was excluding cash, which represented 23.7% of the Qualiport, although that position didn't last too long into the new year.
Courtesy of this year's rights issue, and their 20%+ appreciation in 1999, EMAP (EMA) are now challenging Rentokil for top dog honours. In the past week, Independent Insurance (IIG) have surged a massive 36%, bringing them gloriously back into the black and taking more of the glory away from Rentokil. As for Marks & Spencer... how many years have we got?
Hopefully, the Qualiport is entering a new, post Rentokil, phase of development. Although it is a little disappointing to see the Rentokil share price falling whilst the market is rising, it is actually better for the portfolio that some of the other companies are starting to fire up. In fact, yesterday, in one glorious celebratory day, the Qualiport rose 3.26%, as the share prices of all seven companies rose. Today's follow on performance was also quite nice to see, putting us in the black for 1999 -- just.
This still leaves the Qualiport trailing the FTSE 100 by 5.67% in 1999 and still almost 15% shy of our aim of 15% per annum growth. However, our strategy is not going to change. We believe in the long term prospects of our companies -- yes, even Marks & Spencer. We've got a few bob in the bank, looking for a home, and we'll be adding some interest and another £2000 to that on April 1st. With that money, we can hopefully find ourselves another Rentokil.
As I mentioned above, Independent Insurance have been on fire over the past few days, so much so that we are well and truly into the black with them. Last Friday, we previewed the results, and any predictions I made were joyfully wrong. I'll have a closer look at the numbers and results on Friday.
Qualiwatch
I have done one final valuation model on Vodafone (VOD), which looks to forecast sales growth as well as changes in margins, taxes and shares in issue. Again, as with any valuation tool, there are many assumptions built into the model. Without going into any detail, it comes out with a current fair value per share of 1021p, which is not all that far away from Vodafone's current market price. For one thing, it's certainly closer than the Return on Equity (ROE) model valuation, where we would be waiting for the shares to fall to 700p before they jumped our 15% annual growth rate hurdle.
A discounted cash flow (DCF) valuation is not appropriate for a company like Vodafone. Net cash from operations easily exceeds accounting profits, largely because of the high non-cash depreciation charge that is deducted from accounting earnings. This gives shareholders some degree of comfort -- you don't want to see large amounts of cash being absorbed in expensive stocks and debtors.
Capital expenditure is quite high, meaning Vodafone generates relatively small amounts of what is known as free cash flow. However, Vodafone are absolutely correct to invest the money in capital expenditure, because they have plenty of growth opportunities and need to build their network. DCFs are usually best used on more mature companies.
I haven't looked at a combined Vodafone AirTouch company and its potential valuation. Vodafone effectively paid a P/E in the 80s for AirTouch, so at this stage I'm not thinking this is going to make the combined company look any cheaper.
Summing up Vodafone's valuation, for the time being, the following are the share prices we'd require in order to be interested in buying shares in Vodafone.
10 year EPS -- 1060p
ROE -- 700p
10 year sales & margin model -- 1021p
The ROE valuation is poles away from the other two, indicating that Vodafone will quite possibly see their long term ROE above the 28% I've assumed. If the share price dips to around 1000p-1025p, I may be interested in buying some Vodafone shares. That's not a million miles away from their current share price of 1108.5p. In the not too distant future, the company reports results for the year ended March 1999, and I will be interested to have a close look at those results.
In the meantime, I've noticed the two other possible Qualiwatch shares take flight -- Misys (MSY) and WPP Group (WPP). I may have missed a buying opportunity, but it is better to know about the company rather than buy it on a hunch.
See you Friday, or on the Qualiport message board.
Qualiport Numbers
10/03/99 Close
Company Change Bid
DELL -$1.25 $44.00
EMA 0.00 14.10
IIG +0.17 2.92
MKS +0.03 3.90
PIZ +0.07 7.42
RTO +0.15 3.93
ULVR -0.04 6.09
Qualiport Stocks
Last Rec'd Total # Company In At Current Change
19/12/97 783 Rentokil 2.55 3.93 54.1%
17/04/98 169 EMAP 11.34 14.10 24.3%
27/10/98 755 Indep Ins 2.58 2.92 13.2%
27/01/99 74 Dell (US) $44.63 $44.00 (1.4%)
04/11/98 245 Pizza Exp 7.93 7.42 (6.4%)
17/07/98 298 Unilever 6.72 6.09 (9.4%)
11/05/98 368 M & S 5.54 3.90 (29.5%)
Last Rec'd Total # Company In At Value Change
19/12/97 783 Rentokil 2046.53 3077.19 1030.66
17/04/98 169 EMAP 2052.57 2848.20 506.88
27/10/98 755 Indep Ins 1972.64 2204.60 231.96
27/01/99 37 Dell (US) 2007.42 1973.33 (34.08)
04/11/98 245 Pizza Exp 1966.34 1817.90 (148.44)
17/07/98 298 Unilever 2052.54 1814.82 (237.72)
11/05/98 368 M & S 2054.11 1435.20 (618.91)
Cash: £1,711.43
Current Total : £16,882.68
Total Invested: £16,184.62
Profit/(Loss) : £ 698.06
Value Per Share
Day Month Year
Qualiport 1.24% 3.12% 0.43%
FTSE 100 0.06% 1.08% 6.10%
FTSE All Share 0.16% 1.43% 7.18%
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