For stocks in sectors highly geared to the economic cycle, I tend to favour a value investing approach of buying low and selling high. UK recessions have averaged one a decade since World War II, and with a possibly economically-damaging Brexit just around the corner, there aren’t too many cyclical businesses I’d be happy to buy today and hold through the turmoil.
However, there are some exceptions. Henry Boot (LSE: BOOT), which released its half-year results today, is one. Here, I’ll explain why I see value in buying this stock right now and holding it for the long term.
When the tide goes out
Warren Buffett famously wrote of the unfolding financial crisis and economic slump in 2008: “You only learn who has been swimming naked when the tide goes out.” For highly cyclical businesses, economic stress can produce a collapse in earnings and expose weak balance sheets. Some companies may even go bust.
Henry Boot owns a number of businesses in land promotion, property investment & development, and construction. As such, and with a UK focus, it’s sensitive to the performance of the domestic economy. However, the company ticks positive boxes for me in terms of management, balance sheet and resilience through economic cycles.
Multi-generational survival and success
Boot was established over 130 years ago, and descendents of the founder remain prominent in the boardroom and among senior management, as well as on the register of shareholders. It’s a company that’s been carefully stewarded for multi-generational survival and success, and its current market capitalisation is £320m.
Today’s results showed group revenue 3.7% down on the same period last year. Increased construction activity and strategic land sales were offset by lower property development activity, as a major £333m contract moved towards completion. Lower group revenue fed down to an 8% decline in pre-tax profit and a 9.6% fall in earnings per share.
Management described this as “a very resilient result,” given “the uncertainties affecting the UK economy.” It added that trading in the second half has started well and it remains confident of meeting full-year expectations.
I see this confidence reflected in the board’s decision to lift the interim dividend by 15.6%, albeit it cautioned “some uncertainty remains regarding the UK’s exit from the EU and how this may affect future trading conditions.”
Win-win situation
On the subject of the all-important balance sheet, I was disconcerted to read among the headline numbers that net debt at the period end was £50.3m, 93.5% higher than a year ago. However, the company has £43.5m investment properties classified as ‘held for sale’ on the balance sheet. It expects to conclude these sales in the second half, “resulting in the group having no debt approaching the end of the year.”
The shares are trading at 240p, up 2.6% on the day, but remain down from their 52-week high of over 300p. This, together with a trailing price-to-earnings ratio of just 9 and a 4% yield on a 2.8-times-covered dividend, suggests the market’s priced-in a fair bit of downside earnings risk.
I see a potential re-rating in the event of an orderly Brexit. In the event of an economic downturn on a no-deal outcome, Boot can use its soon-to-be-debt-free balance sheet to enhance its longer-term prospects, “should any competitively priced assets become available to us.” I see it as a win-win situation.
