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By Bruce Jackson (TMFGoogly)
Baker Street, London -- Following on from Monday's Qualiport article, I thought I'd say a brief word about my impressions of the PizzaExpress (LSE: PIZ) management team. They are very confident in themselves, and in the future of the company, which is not surprising given their excellent record over the past 34 years, 5 of them as a public company. They are all very experienced -- Chairman David Page has been with PizzaExpress for 25 years, and Chief Executive Ian Eldridge has built up 16 years of service. Both are still in their 40s.
Yet, despite their confidence, they seem to be reasonably prudent business people. The roll-out of the international outlets is being done quite cautiously, with local partners taking some of the risk. In France, for example, they have initially gone down the franchise route. If and when the concept takes off, which it looks to be doing given that the first Paris restaurant is in the top 5 by sales in the whole company, PizzaExpress will then look to expand and build the brand name. There's probably a very good chance that sometime in the not too distant future, PizzaExpress will buy back the franchised outlets, a model they've already used here in the UK.
This route to market, in the long term, is ultimately less profitable than a straight company-owned assault on an unknown foreign market. But, the initial risk factor is much reduced, especially given there's no guarantee of success. How does PizzaExpress know whether the format is going to work in Russia, USA, France and Spain? In some it will be a hit, and others it will flop. But until you go into each of these markets, you'll never know. By putting all your eggs in one basket, by say attempting to take Spain by PizzaExpress storm, you are taking a big risk, and that's one the company are rightly not prepared to take.
The same goes for new brand Café Pasta. Rather than going for an aggressive nationwide roll-out, the company is first bent on establishing a brand name in London. But before that, they need to get the menu and restaurant layout sorted, and that's what they are now working on.
Being an accountant, I admire their prudence. Having built up a strong, profitable and growing company, I don't want to see them throw that all away by making some poor decisions. The PizzaExpress management seem firmly to have their eye on the long-term, and as a long-term shareholder, I can only applaud. After all, if whilst they are building these new domestic and international brands they can continue to grow at 20-25% per annum, that's good enough for me.
Having plugged the latest preliminary numbers into my spreadsheet, I was pleased to see most of the company's excellent ratios holding up. Here's the relevant ratios, as I see them.
1999 1998
Operating Margin 22.9% 22.2%
Return On Ave. Equity 23.8% 23.3%
ROIC 34.1% 36.6%
Cash Conversion Ratio 128.5% 124.1%
A couple of the above need further explanation. For those not familiar with Return On Equity (ROE), a simple link to the How To Value Shares series should suffice. Average ROE simply adds together the 1998 and 1999 shareholder's equity numbers, and divides them by two.
Return On Invested Capital (ROIC) is a measure I actually prefer when assessing a company, and its valuation. ROIC takes into account all the cash the company has invested in its balance sheet, and strips out all the interest-free loans that third parties have given the company. For more on ROIC, please follow this link to our US site.
Using PizzaExpress as an example, here's how I calculate invested capital. Some estimates have been used, as the company has so far only released preliminary numbers.
£m
Total Assets 143.3
Less cash (6.2)
Less accounts payable (4.0)
Less other creditors (25.0)
Less purchased goodwill (42.7)
Invested Capital 65.4
The cash conversion ratio is something I use to asses how well a company turns its accounting profits into cash profits. Accounting, being an art rather than a science, allows you to be rather flexible with your interpretation of certain items. Cash, on the other hand, is cash, is cash, is cash. It cannot be fudged.
Cash Conversion Ratio = Net Cash From Operations
------------------------
Operating Profit
You want to see this ratio sitting nicely above 100%. This gives you assurance that a company is not fiddling its books, and that all the accounting profits are being converted into cash profits. Obviously there will be some years, because of purely timing factors, where a company will have a cash conversion ratio of say 80%, but you would hope that may be followed by a year with a conversion ratio of say 130%. As with all ratios, this is just one thing to look at when assessing a company, but I believe it's one of the more important ones.
In fiscal 1999, PizzaExpress' cash conversion ratio was a heady 129% -- operating profit of £29.1m converted into net cash from operations of £37.4m. The non-cash depreciation charge of £5.4m obviously helps, as does the favourable movement in creditors of £3.5m.
More will follow on PizzaExpress, including some thoughts on its current valuation. But first.
Yesterday, Misys (LSE: MSY) had its Annual General Meeting (AGM), which was no doubt a riveting affair. In a briefish statement, the company reiterated that trading was in line with current expectations, which means the forecast May 2000 P/E of about 32. I estimate the company's long-term growth rate to be between 15-18%, based on nothing much except growth rates for the next two years. I rate the management highly.
Qualiport member EMAP (LSE: EMA) today sold their entire holding (almost 19%) in niche fellow media company Metal Bulletin (LSE: MTLB), raising just over £32.5 million in the process. In the statement, EMAP said they will look to invest the proceeds in their directly managed business, where they see good potential. You can take this one of two ways -- EMAP think Metal Bulletin are fully-valued, and don't see much upside from here, or EMAP really need the cash to invest in new ventures, possibly Internet-related.
This transaction is of particular interest to me, because I've recently sold my personal holding in Metal Bulletin. Although I'd held the shares for some period of time, I felt the upside potential was limited, particularly when compared to the downside potential. Metal Bulletin trades on a forecast December 2000 price to earnings ratio (P/E) of about 30, compared to a long-term earnings growth rate of between 12-15% per annum. Whilst this rating is not necessarily racy, especially when compared to some high-flying IT and Internet shares, in my view there's still a reasonably significant downside. At the same time, and this clinched the sale decision for me, Metal Bulletin's cash conversion ratio for the year ended December 1999 was 71%.
Value Shares - Minimise the Downside
Qualiport - When To Sell (scroll down the article)
Rob's back on Friday, and I'll see you on Monday. In the meantime, the Qualiport message board awaits your entry.
Company Change Bid DELL(US)-0.70 47.00 EMA +0.03 10.08 IIG -0.03 2.82 MSY -0.04 5.99 PIZ +0.02 8.22 RTO -0.04 2.34 ULVR -0.02 5.75 Qualiport Stocks Last Rec'd Total # Company Buy Current Change 27/10/98 755 Indep Ins 2.58 2.82 9.3% 27/01/99 74 Dell (US) 44.63 47.00 5.3% 22/04/99 347 Misys 5.76 5.99 4.0% 04/11/98 245 Pizza Exp 7.93 8.22 3.7% 19/12/97 783 Rentokil 2.55 2.34 (8.2%) 17/04/98 169 EMAP 11.34 10.08 (11.1%) 17/07/98 266 Unilever 7.53 5.75 (23.6%) Last Rec'd Total # Company In At Value Change 27/10/98 755 Indep Ins 1972.64 2129.10 156.46 27/01/99 74 Dell (US) 2007.42 2107.88 100.46 22/04/99 347 Misys 2028.71 2078.53 49.82 04/11/98 245 Pizza Exp 1966.34 2013.90 47.57 19/12/97 783 Rentokil 2046.53 1832.22 (214.31) 17/04/98 169 EMAP 2341.32 2036.16 (305.16) 17/07/98 266 Unilever 2052.00 1529.50 (522.50) Cash: £3,433.46 Current Total : £17,160.75 Total Invested: £18,184.62 Profit/(Loss) : (£1,023.87) Value Per Share Day Month Year Qualiport -0.54% 2.00% -8.75% FTSE 100 -0.79% -2.86% 3.15% FTSE All Share -0.93% -2.65% 7.00%