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If you remember the feature covering GUS and Experian, placing the profits generated by Experian on a P/E of 20 arrived at a valuation roughly corresponding to the whole valuation of GUS. This P/E figure for Experian gives a far better indication of the relevant price-value equation of any potential Qualiport Experian purchase, rather than the overall GUS P/E.
On to the suggestions that have been proposed over on the Qualiport discussion board, leading to three more of my knee-jerk conclusions.
AngeloDim, in this post, put forward Comprehensive Business Services (LSE: CBS). Slightly worryingly, Angelo takes his lead from the Investors Chronicle, with the weekly investment publication suggesting that CBS has the potential to quintuple in five years. My caution grows further when Angelo opens with this line: "CBS floated last year as a cash shell".
The company has since acquired Brulines, a designer and manufacturer of systems that monitor the flow of draught beer. Apparently the systems could save £1b a year of alcohol. Anyway, CBS is currently capitalised at £21m, with the next set of profits expected to come in at around £0.9m. On a price to earnings (P/E) ratio of 22, we're not getting any bargain.
The trouble with CBS is the lack of any tangible growth record. Brulines was established in 1993, but the problem is trying to get enough information to judge the financial performance of this company. There's not even been a full set of annual figures from CBS that includes Brulines yet. CBS could be an interesting punt for those who trawl the AIM market, but without any proven and quoted financial record to go on, it's not Qualiport material.
Bullit12 puts forward Bell Group (LSE: BEL) in this message, signing off saying "I genuinely believe this is a good 'un!"
Bell design, supply and install hi-tech security systems. The company floated last year and, from the brief financial record available to me, doubled sales in the two years to 1998. The comments from Bell are appealing, the company stating after their maiden interim results that "the security market is expanding rapidly... we are well placed to reap the benefits. The long-term outlook is very positive."
On the surface, Bell look interesting. But the current valuation puts me off completely. At 387.5p, equating to a market value of £202m, the group trades on a very lofty P/E ratio of 53. Given that the Qualiport has been stung before by high P/E investing, I think we'd be crazy to consider Bell at the current share price level.
MLordBath, fresh from the Value discussion board, proposed Laird Group (LSE: LARD) as a potential Qualiport member. No qualms here about valuation: the automotive component supplier stands on a prospective P/E of under 6 at the current share price of 192p.
Laird falls down at the "proven past growth financial record" hurdle. Sales were flat in 1999 and over the last four years, revenues have compounded at an average annual rate of 6.3%, with acquisitions playing their part in this record. The latest return on average equity, adjusted for goodwill written off, is around 9%. All in all, it's not an inspiring history.
Laird looks enticing for the value investor, the company appearing cheap on a number of valuation measures. For any investment in Laird, a short-term value play must be the strategy. But Laird hasn't given any indication of being a superior long-term growth stock in the past, and so it isn't Qualiport material.
A Roundup of the Contenders
TMFJimmyC (James Carlisle) wrote an excellent feature on Smiths Industries (LSE: SMIN) last Friday, and after reading the article, I think Smiths wouldn't look at of place in any long-term investor's portfolio.
Bearing that in mind, there are four companies on the Qualiport shortlist at the moment -- Smiths Industries, Southnews (LSE: SNW), the Experian subsidiary of Great Universal Stores (LSE: GUS) and MMT Computing (LSE: MMT).
Here's how they stand in the prospective P/E valuation stakes.
Company Price (p) Prospective P/E
Smiths Industries 835.5 14.02
Experian (GUS) 413.5 20.00
Southnews 812.5 19.45
MMT Computing 710 15.09
Now, I'll concentrate on the four businesses and touch upon their recent financial performances, and try to place them into an order of preference. You may wish to refer back to the features covering Experian, Southnews, Smiths Industries and MMT Computing first though, for extra detail.
Brief thoughts on the four contenders:
Experian: I like this IT business and the long-term prospects. But getting a handle on past performance is difficult with big acquisitions and Experian only having a three-year record of growth within GUS. The overall problem with Experian is that any investment in the company is taking two considerations on trust. Firstly on the accounting side, because it's lumped together with underperforming retail operations, we'll be taking for granted that Experian has an overall superior financial performance. Secondly, we're also assuming that the underperforming retail operations won't continue to deteriorate and so offset the good work at Experian.
Southnews: I think the local newspaper publisher has the best financial characteristics. Few competitors, no capital expenditure and a great working capital profile all leads to plenty of cash at Southnews. But the cash can't be used for any organic expansion. Instead Southnews is constantly on the acquisition trail, gobbling up the smaller players in the industry. Will they run out of suitable purchases? The threat of advertisers migrating to the Internet is a large shadow over Southnews. The company may have had a sustainable advantage in the past, but that isn't so clear-cut any more.
Smiths Industries: I think there are two points that put me off Smiths. Firstly, it's a rather complicated businesses. It's difficult, well for me anyway, to get a grip on the quite intricate world of aeronautical, medical and general industrial equipment. But then again, I think that the complication is outweighed by the necessity of customers having to actually purchase the equipment. As James mentions in his feature: "The beauty of the products is that they have a very low cost relative to the importance of the job that they do". Without getting too deep, I suspect a lot of products offered by Smiths have a pretty sustainable advantage to fend off the competition.
The second point about Smiths is the return on average shareholders' equity. Adjusting for goodwill, the figure comes to 15.1%, the lowest of the four contenders. What's a little concerning is the fact that goodwill written off has risen from £560m to £815m, a 45% rise, in the last four years. So I get the distinct impression that acquisitions have fuelled the 10% compound growth in revenues over the same period.
MMT Computing: I like the IT industry and the prospects of significant IT consultancy growth in the future. But can MMT take advantage of that? Although the company has a long record of growth, there's nothing set in stone to suggest that MMT will continue the record. Whereas Smiths has durable advantages through its product patents, and Southnews has, perhaps, a sustainable advantage with its newspaper "franchises", MMT purely rests upon its management and reputation for survival.
After some considerable thought and a lot of "gut feel", bearing in mind the current valuations, financial history and all the associated pros and cons, I'm going to place the four candidates in order of preference. So, in reverse order: fourth is Experian, third is Southnews, second is Smiths Industries and first is MMT Computing.
At the end of the day, with a five to ten year horizon in view, I'm relying on the tailwind of the IT industry and the proven management skills at MMT to heave the company from the current post-Y2K mire. Out of the four contenders, I feel MMT, given its pretty sound financial history and relatively small size, has the best long-term opportunities for substantial organic growth. I believe these points just about balance the lack of any durable competitive advantage at MMT.
But... next Monday, I'm going to look at another potential Qualiport member. The company, just like MMT, has identifiable future prospects and languishes on an undemanding valuation after an operating hiccup. But this company appears to have a durable advantage and has grown without the need for acquisitions. Can it top MMT?
So, have I been too hasty in rejecting the three suggestions made on the Qualiport board? Have I made a mistake in my preference for MMT? Let me know over on the Qualiport discussion board.
Related Links
• TMFJimmyC -- Adding Value with Smiths Industries
• Southnews -- Qualiport Material?
• MMT Computing -- Qualiport Material?
• Extracting Value From Experian
Note
The Qualiport was launched on December 19th 1997 with an initial investment of £4040.63, all in Rentokil Initial. Further cash was added as holdings in Emap, Marks & Spencer and Unilever were bought during 1998. The vagaries of the value per share accounting method caused percentage return calculations for calendar 1998 to be somewhat distorted. To avoid confusion and somewhat misleading figures, the Qualiport's returns are being measured from 1/1/99, at which point the total portfolio value, including cash, stood at £16,809.60. An additional £2000 cash is added to the portfolio on April 1st and October 1st each year. The total cash investment in the portfolio to date has been £20,184.62. To access the Qualiport's total trade history, click here.