Investing in companies with the ability to generate a lot of surplus cash can be a good strategy for beating the market. Today I’m going to look at two such firms.
Car dealership group Marshall Motor Holdings (LSE: MMH) rose by 7% on Tuesday morning, after the company’s half-year results came in ahead of analysts’ forecasts.
Although the board emphasised its “cautious” outlook for the car market, the group’s underlying pre-tax profit rose by 32.9% to £18.6m during the period. Shareholders were rewarded with a 19.4% increase in the interim dividend, which rose to 2.15p.
These figures were flattered by last year’s acquisition of rival Ridgeway. But even excluding this, like-for-like revenue rose by 6.7%.
Strong asset backing
Car dealership groups often rely on debt financing to purchase vehicles. Marshall is no exception, but the group’s adjusted net debt of £35.1m seems comfortable when set against trailing 12-month net profit of £23.2m.
The company also owns a portfolio of freehold and long leasehold property worth £112.5m, providing solid asset backing for this debt.
What could go wrong?
New cars carry very thin profit margins. Dealers make most of their profit from used cars and after-sales. One risk for investors is that the value of used cars will collapse. This could crush profits from leasing and used car sales.
In Tuesday’s results, management reported “margin pressure” on used car sales and “lower levels of disposal unit profitability” in its leasing business. To me, this suggests that used car values are falling, albeit slowly.
Too cheap to ignore?
This sector of the market is modestly valued. But even so, Marshall shares stand out for being unusually cheap. At the last-seen share price of 152p, the company’s stock trades on a 2017 forecast P/E of about 5.5, with a prospective yield of 4.1%.
In my view, this low valuation discounts quite a lot of risk. I believe the shares could be worth a closer look.
A mountain of cash
Global mining group Anglo American (LSE: AAL) has made a stunning comeback over the last year. But the firm’s shares still look very affordable to me.
Cash generation has rocketed and net debt has fallen by almost half to $6.2bn over the last year. As a result, Anglo has said it will resume dividend payments. A full-year payout of $0.76 per share is expected for 2017, giving a prospective yield of 4.7%.
Looking back over the last 12 months, Anglo stock now trades on a trailing P/E of 7 and a trailing price/free cash flow ratio of 5.2. Both figures seem very cheap to me.
However, analysts expect profits at all of the big miners to be lower in 2018 than in 2017. For Anglo, the forecast is for a 24% fall in earnings to $1.60 per share. That sounds quite drastic, but it still leaves the stock on a 2018 forecast P/E of 10, with a potential yield of 3.9%. These forecasts are also likely to change. Broker profit forecasts for 2018 rose by 7% last month. They could easily rise (or fall) again.
My view is that Anglo American’s modest valuation and strong cash generation could make the group a bid target. Even without this, the shares look good value to me.
Roland Head owns shares of Anglo American. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.