Philip O'Sullivan's Market Musings

Financial analysis from Dublin, Ireland

Archive for the ‘Sector Focus’ Category

Hanging up the keyboard

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I have been appointed Chief Economist at NCB Stockbrokers, which has recently become part of the Investec family.


Due to the time commitments that my new role entails, I will no longer be able to post updates on this blog.


I’d like to take this opportunity to thank  those of you who visited this site – I hope that you found it to be of value.


Should you wish to keep up with my ‘musings’, these can be read on the NCB website.

Written by Philip O'Sullivan

October 6, 2012 at 9:48 am

Posted in Sector Focus

Daily Mail and General Trust (DMGT.L) – Making The Right Choices

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At DMGT’s investor day last April, the group’s finance director, Stephen Daintith, outlined the investment case for the group. He said that it offered investors:


  • [An] opportunity to invest in a global portfolio of diversified market-leading media assets
  • Good organic growth opportunities – strong B2B pipeline, fast emerging consumer digital businesses and resilient national newspapers
  • [A group that is] highly cash generative
  • [A track record of] investment of strong cash flow and active portfolio management to drive sustainable earnings growth
  • [An] impressive track record of real dividend growth


(Disclaimer: I am a shareholder in Trinity Mirror plc and Independent News & Media plc)  In this piece I will examine all of these stated claims in turn, and also make a few observations comparing DMGT to its principal quoted peers in the UK and Ireland (which I have previously profiled e.g. Independent News & Media, Trinity Mirror and Johnston Press).


To start with, DMGT is correct to say that it offers “a global portfolio of diversified market-leading media assets”. While most people will be familiar with its national Daily Mail newspaper title, far fewer people will know that national media operations account for only 43% of group revenues. Indeed, DMGT’s combined national and local media units contributed only 55% of group revenues in FY11, down from 65% in FY06. The diminished importance of its core media base is further highlighted when underlying profits are examined, contributing just 29% of the group total in 2011, from 60% five years earlier.  Outside of national and local media assets, the group’s other businesses are: (i) RMS, or Risk Management Solutions, which provides “products, services and expertise for the quantification and management of catastrophe risk”. In 2011 this contributed 8% of revenues and generated margins of 29.9%; (ii) Business Information, which provides B2B “information to the property, financial, energy, and educational recruitment markets”. In 2011 this contributed 12% of revenues and generated margins of 19.7%; (iii) Events, which organises exhibitions and conferences, and which contributed 7% of revenues and enjoyed margins of 29.4% in 2011; and (iv) Euromoney, described as “a leading international business-to-business media group focused primarily on the international finance, metals and commodities sectors”, which contributed 18% of group revenues and achieved margins of 25.6% in 2011. These high-margin businesses stand out in contrast to the traditional base, namely the national media (margins of 8.8% in 2011) and local media (margins of 7.2% in 2011). It should be noted that these units do not solely comprise print assets, as they are also home to a number of digital business, including the wildly successful (and profitable) Mail Online.


In terms of growth opportunities, DMGT has excelled throughout the downturn. While the headline figures are distorted by the impact of the portfolio management measures discussed below, overall margins in the newer business areas have trended higher during the recession, while the topline performance has also been very resilient. In the case of the legacy businesses, these have experienced pressures similar to the rest of the sector. The national media operation has seen reported revenues and operating profits fall by 10% and 24% respectively between 2006 and 2011, while for local media the decline has been 48% and 81% respectively over the same period. The latter has been the subject of speculation in recent times about a possible disposal, with acquirers ranging from private equity to Trinity Mirror reportedly in the frame. I will discuss the merits of such a deal towards the end of this piece.


Switching to DMGT’s cash generation, this is a key bull point around the stock. Over the past 6 years the group has generated over £1.6bn in cumulative free cash flow, or circa 90% of its current market capitalisation. This has funded considerable investment in growing the business, with £908m of this cash used on acquisitions, £362m on gross capex and a further £63m invested in associates and JVs.  DMGT also paid out £332m in dividends over that period.


This brings us on to the next point, about portfolio management. As noted above, the group has been an active acquirer of assets, but it is not shy to divest non-core businesses. It recently concluded the sale of its Australian radio business, but this has only been one of a number of disposals in recent years (see slide 16). It is clear that DMGT is focused on increasing its exposure to high-margin, high-growth business sectors, and given the high margins and resilient sales in the ‘newer’ business areas noted above, who could blame it?


Lastly, DMGT distinguishes itself from the other listed UK and Irish companies who derive the majority of their revenues from media assets in that it is the only one that pays a dividend. Investors have seen dividends per share grow 25% between 2006 and 2011 – with no break in the payouts over that period – which is a remarkable achievement considering the economic backdrop. Dividend cover is very healthy, approaching 3x in 2011.


So, Mr. Daintith is clearly on the money with what he says. The questions that remain for me are: (i) What is DMGT to do next? and (ii) Is DMGT worth investing in?


To tackle them in order, one would be forgiven for thinking that ‘keep going’ would be reasonable advice for Rothermere et al. The company has clearly made the right choices in terms of diversification, investing in highly profitable and growing segments. The balance sheet is in a strong condition, with reported net debt falling from £1.05bn in FY09 to £720m by the end of last year (2x EBITDA). In the absence of any large acquisitions DMGT could very easily be debt free within 3 years. So, it has the luxury of not being compelled to do anything. However, given the portfolio management steps noted above, I imagine that sitting still is not something the management team is keen on. Further investments in growing the high-margin segments are surely to be expected, while for the legacy businesses we are unlikely to see much by way of acquisition activity given both the concentrated media ownership at a national level (and lack of obvious sellers) and the muted organic growth outlook for local papers. The group also has a number of joint ventures and associates that it may be tempted to fully buy-out / spin-off over time.


While DMGT is by no means under any pressure to do so, I suspect that we are likely to see the group divest the local media business, Northcliffe Media, over the medium term. It is an increasingly peripheral asset, accounting for only 5% of group underlying profits last year. Management are over a third of the way through a three-year restructuring plan for the division, and it will be interesting to see if it is still under DMGT ownership by the scheduled conclusion date of it. Whatever about its performance relative to the rest of the DMGT family, it is underperforming its listed peers, with operating margins of 7.2% in FY11 comparing unfavourably to Trinity Mirror’s 13.8% and Johnston Press’ 17.3%. I wonder (emphasis) if developments such as a recent advertising partnership indicate that DMGT would be open to resuming its previous reported talks with Trinity Mirror about a merger of their local newspaper titles (DMGT’s assets are profiled here, while TNI’s are profiled here). This could open up possibilities for cost take-outs in areas such as procurement, distribution, content syndication and editorial. Given both firms’ balance sheets, an all-share deal could be the best scenario for both as it would allow Trinity Mirror to continue its deleveraging drive while DMGT, which has no pressing need for extra funds, could share in the theoretical upside once the cost synergies noted above are implemented. Of course, this is clearly ‘fantasy M&A’, but it would offer an elegant solution for both companies. In terms of other speculated ‘interested bidders’, I would be surprised if private equity was seriously interested in DMGT’s local newspaper titles given their muted growth outlook, unless other large groups became available that would permit the achievement of serious synergies such as those mentioned above.


In terms of my investment conclusion on DMGT, I note that analyst opinion on the stock is divided. Of the 15 analysts who follow the stock 5 rate it a ‘buy’, 5 are neutral and 5 recommend that it be sold. This may be because the stock is not exactly cheap, trading on around 10x prospective earnings based on where the ‘A’ shares closed at this evening (488.5p). Recent updates from the company have been solid, with the Q3 IMS reiterating full-year guidance. For me, I view the DMGT story as one of a group that: (i) is on a solid financial footing + (ii) is mainly exposed to high-growth, high-margin business areas + (iii) has an enviable track record – on this note, I was impressed to see that it has not made a capital call on its shareholders since 1933 + (iv) has plenty of strategic options be they acquisition/investment/alliance/divestment to enhance shareholder value. Were the shares more cheaply rated, I would be tempted by it. However, for now I think I’ll hold back and wait for a more attractive entry level.

Written by Philip O'Sullivan

September 17, 2012 at 7:08 pm

STV Group (STVG.L) – Tidied Up, So What’s Next?

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Back in 2006 STV was a diversified media group, with a presence in television, outdoor advertising, radio and cinema advertising. Its total group turnover that year was £191.2m, underlying operating profits were £18.4m, net debt was £157.3m and total assets were £313.4m. Despite the strong asset backing, debt was an uncomfortable multiple of cashflow, prompting management to take action to fix the balance sheet.


Since then, the group has sold its outdoor business, Primesight, radio unit, Virgin Radio and cinema business, Pearl & Dean. These disposals produced gross cash inflows totaling £94.2m. STV raised a further £91m from a rights issue in 2007. However, the significant restructuring did not come cheaply, with the group seeing a cash outlay of £35m on exceptional and other one-off items, while a net £14m in cash was expended on discontinued operations over the period to the end of 2011. Net debt was reduced by two-thirds since the end of 2006, to £54.5m at the end of last year.


So, the group now is a slimmed down operation focused on television. It holds two of the 15 Channel 3 licences, covering northern and central Scotland. The other franchises are held by UTV Media plc (one, Ulster) and ITV plc (the other 12). In 2011 it generated turnover of £102m (consumer £93.6m / productions £8.4m) and EBIT of £15m. That year it tidied up a legacy legal dispute over content with ITV, while this improved relationship was further cemented with a new networking agreement signed this year between the three Channel 3 licence holders.


So, with the business simplified and legacy issues resolved, where next for STV? As slide 26 of this presentation shows, it aims to grow ‘non-broadcast’ (digital and production) earnings to represent a third of group earnings, double STV Productions’ revenues, be the most used digital service in Scotland, launch two new market-leading digital consumer propositions and maintain its position as the “Voice of Scotland”. These are, as STV itself says, “ambitious but achievable” goals. Digital enjoyed margins of 33% in H1 2012, producing operating profits of £1m, or 12.5% of the group total. Given Productions’ low revenue base, doubling it should not prove too big an ask. Moreover, while advertising conditions remain challenging in the UK, any improvement over time should have a positive effect on earnings given the operating leverage inherent in the broadcasting business.


But will it have time to implement these goals? Last year ITV bought Channel Television, which held one of the 15 Channel 3 licences. This gave rise to speculation (such as here and here) that it could move to buy out the remaining ‘independents’. ITV certainly has the resources to do so, given that at the end of 2011 it had gross cash of £801m and net cash of £45m. But would a deal make financial sense? I note that in 2011 ITV generated an impressive ROCE of 18.6%. Assuming that it would want at least that from a deal with STV, this would imply an enterprise value for STV of £80.5m (based off STV’s EBIT of £15m). Strip out STV’s end-FY11 net debt and pension deficit (£54.5m and £30.9m respectively) and you’re left with effectively nothing for the equity. However, this doesn’t include the likely synergies that would arise from such a tie up. If you assume ITV could eliminate 10% of STV’s costs (that sounds punchy, but in cash terms it’s less than £9m) and also save on the £1.4m in directors’ emoluments, you can get to an equity valuation of circa £50m, or £1.26 a share – that’s around 50% upside to where the shares are currently trading at (£0.842). Moreover, as the company continues to pay down debt, there will be a further transfer of value from debt holders to equity holders (its underlying operating cashflow is circa £10m a year, or around a third of its market cap). My estimates do not look demanding at all, given that Numis (140p) and Peel Hunt (216p) have far higher price targets.


If a deal fails to materialise, investors in STV will be left with a stock that is trading on a forward PE of just 2.5x that: (i) with the ITV litigation out of the way is now poised to seriously start to pay down debt (net debt / EBITDA was 3.2x in FY11); (ii) offers a good possibility of dividends being reinstated (an update on dividend policy is guided for February) to compensate shareholders for their loyalty; and (iii) is well-placed to benefit from an eventual recovery in advertising markets.


So, either way it seems the outlook is positive for STV. You can look at this as a story of either: (a) debt paydown and a future recovery in advertising markets driving an eventual re-rating off a low base; or (b) an opportunity to get in cheap for what could very easily become a takeover candidate for ITV. I like the look of this one, and I think I’ll add it to my portfolio.

Written by Philip O'Sullivan

September 12, 2012 at 11:18 am

Posted in Sector Focus

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Johnston Press (JPR.L) – Negative Equity

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As everyone who invested in Irish property over the past decade or so knows, equity is the difference between the value of your total assets and the value of your total liabilities. Another thing that every Irish property owner knows is that while the ‘value’ of your total assets can often be subject to wild swings either to the upside or downside, liabilities are much stickier. And as it is with property, so goes the traditional print media space, where investors have seen accountants significantly write down once extremely valuable newspaper assets, while debt levels have proven immune to such accounting adjustments.


(Disclaimer: I am a shareholder in Trinity Mirror plc and Independent News & Media plc) I have previously profiled two newspaper groups with a presence in the UK and Ireland, Trinity Mirror and Independent News & Media, in detail. In both cases, concerns around debt levels and extremely challenging (due to both cyclical – the economy – and structural – the threat of new media) market conditions have been to the fore. While the economy remains a headwind, both have made significant progress in improving their balance sheets. Trinity Mirror is the exemplar in this regard, cutting net debt by a third between FY09 and FY11 (to £201m), without recourse to its shareholders, while over the same period its net assets have risen by 38% to £675m. Over the same period INM has cut its underlying net debt by 26% to €427m (its movement in net assets is not particularly meaningful due to the impact of the deconsolidation of its Australasian business and other disposals).


Today I look at one of their peers, Johnston Press (JPR), which has faced similar balance sheet and economic pressures in recent years. The group publishes 13 daily newspapers, ‘more than 230’ weekly newspapers, ‘glossy monthly lifestyle magazines’ and 223 local websites in the UK and Ireland. Its flagship brands are The Scotsman and the Yorkshire Post, while Irish followers of this blog will be familiar with titles such as the Leinster Leader and Kilkenny People.


It has faced what can only be described as savage pressure on revenues due to the recession. Between 2007 and 2011 its total advertising revenues declined by 47% to £231m. All categories have been impacted by this, with employment advertising -75%, property -62%, motors -49%, ‘other classified’ -26%, display -24% and Ireland -63% over that period. Revenue from newspaper sales has held up much better, falling only 7% to £96m, while over the same period its very profitable contract printing business has seen revenues fall 23%.


In total, the group saw revenues fall £234m over the 4 years to 2011. Half of this was offset through reduced operating expenses, but the remainder hit the bottom line, with operating profits falling over 60% over the period to £65m. The diminished profit outlook has seen JPR book impairments against its intangibles (chiefly, the print assets) totaling £720m since the start of 2006.


This brings us back to the housing analogy of the opening paragraph. Due mainly to the impairments noted above, the book value of JPR’s assets has fallen by nearly half – from £1.9bn to just under £1.0bn – since the end of 2007. At the same time, the company’s level of gearing has risen from 98% in FY07 to 126% at the end of last year. It should be noted that net debt, in absolute terms, has been falling (FY07: £671m, FY11: £359m), helped by share sales totaling £207m over the past 4 years. Despite that decline, at the end of last year net debt stood at 4.1x EBITDA, which is an uncomfortably high multiple.


Earlier this year the group agreed the amendment and extension of its finance facilities until 30 September 2015. While this facility reduces the near-term risks around the group, it does not come cheap, as shown in this extract from JPR’s H112 results release:


The maximum cash margin in the case of the bank facilities is LIBOR plus 5.0% and in the case of the loan notes, a
cash interest coupon of up to 10.3%. In addition to the cash margin, a payment-in-kind (PIK) margin of a maximum
rate of 4.0% will accumulate and is payable at the end of the facility. If the loan facilities are fully repaid prior to
31 December 2014, the rate at which the PIK margin accrued throughout the period of the agreement will be
recalculated at a substantially reduced rate.


Looking through JPR’s accounts shows the diminished flexibility imposed on the group by its borrowings. Between 2009 and 2011 it generated some £227m in operating cash flows, but of this 37% went on interest payments and another 58% on repaying borrowings, loan notes and reducing the bank overdraft. This leaves very little for investment, and I was unsurprised to see capex average only £3m per annum over the period, down from an average of £40m per annum over the preceding 3 years. Given the ‘incentive’ to repay (or, as seems more likely, refinance) the facilities before the end of 2014, I would expect to see more of the same over the coming years. Which means no dividends (extremely unlikely in any event given the large stock of debt outstanding), no (meaningful, at least) acquisitions and limited resources (as I see it) for the group to effectively execute its digital-led strategy. On that note, while digital represents the great hope for traditional media, monetising it is proving a challenging task – in FY11 digital advertising contributed only £18.4m of JPR’s revenues, a rise of circa 20% on 2007 levels.


In terms of the valuation, at first glance Johnston Press appears very cheap, trading on less than 2x prospective earnings at its current share price (5.85 pence). However, it is important to note that the group comes with considerable net debt (£332m at the end of July) and a large pension deficit (£102m at the end of June). I ran a DCF valuation on the group using my usual 10% discount rate and applied a -2% terminal growth rate, which produced a negative equity value of -27.5 pence a share. However, it should be noted that this estimate is extremely susceptible to changes in the inputs – for example, every £10m move in the pension deficit moves my equity value by 1.6p. Excluding the pension deficit altogether (I always include it in my DCF calculations) produces a valuation of circa -11p a share. But if Johnston Press really has a negative equity value (in practice, zero, given that a share price can’t go below that!), then why is the share price at 5.85p and not closer to zero? I imagine that investors are betting on an eventual cyclical recovery in advertising, and I can understand why they would be making that bet – as I note above, while advertising revenue has effectively halved from the peak, newspaper sales has fallen by less than a tenth over the same time period, which to me indicates significant operating leverage that could accelerate debt paydown and transform the share price outlook if advertising was to stage a recovery.


Overall, my sense is this – if there is life in traditional print media (and I believe there is, hence why I’m long two stocks in the sector), Johnston Press represents a very high risk way of playing that theme. I feel that its hands are tied by its legacy debts, which limits the scope for investment, and there is a danger that equity investors could be significantly diluted (the firm has already agreed to issue warrants totaling 12.5% of its share capital to its lenders). Of course, were the outlook to improve, then the implied equity valuation would recover in tandem with that. However, at this time I see nothing in JPR to justify adding it to my portfolio either instead of or alongside my existing UK print media holding, Trinity Mirror. Both stocks are exposed to the same macro trends, but their balance sheet positions are fundamentally different – at the end of FY11, JPR’s net debt / EBITDA was 4.1x, while for Trinity Mirror it was just 1.6x. My thesis for some time, given the structural long-term decline that is underway in the print media sector, is that the financially strongest will be able to mitigate against a shrinking revenue pie with market share gains as weaker competitors close underperforming titles. Given that stance, I am happy to be a shareholder in the UK’s biggest regional press publisher, and not in the third biggest one.

Written by Philip O'Sullivan

September 9, 2012 at 6:02 pm

Harvey Nash (HVN.L) – Recruiting Shareholders

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(This is the eighteenth installment in my series of case studies on the shares that have featured in my portfolio. To see the other seventeen articles, on Smurfit Kappa GroupBank of IrelandAIBRBSMarston’sFrance TelecomRyanairPetroNeftIrish Continental GroupIndependent News & MediaTotal ProduceAbbeyGlanbiaIrish Life & PermanentDatalexTrinity Mirror and Datong, click on the company names. I remain an investor in all of the above stocks, save for Marston’s and Glanbia)


One of the most interesting market sectors for me is recruitment. As with other professional services’ business models, it has some unusual characteristics – its principal assets walk out the door each evening, it has minimal capex requirements (a rented office, phone line and computer will suffice for most employees where tangible assets are concerned) and while its core business is, clearly, very cyclical, companies in the space can reduce volatility through measures such as diversification across different segments of the labour market or by adding recurring revenue offerings such as managed services (payroll etc.) to clients.


I’ve held two UK listed recruitment stocks in the past, namely Imprint (which is no longer quoted) and Harvey Nash. I sold out of the latter last year when its shares were trading above 70p. With the price now back in the low 50s, I figured that it was time to update the model and investigate whether or not I should be buying back into it.


To start, let’s look at Harvey Nash’s business model. To say it is a diversified one wouldn’t quite cover it – the group has 40 offices in Europe, North America and Asia. As slides 24 through 26 of this presentation show, just under half of its gross profits come from Europe, with 39% from the UK (which includes Asia!) and 12% coming from the US. Outside of geographic diversity, it is also quite diverse where sectoral exposure is concerned. Some 22% of gross profits come from executive search, 17% from permanent recruitment, 34% from contract & temporary, 19% from offshoring & outsourcing and 8% from managed services. The latter three are clearly ‘stickier’ than the first two, which are more reliant on one-off revenues. The group also operates across a wide range of industries. So, with different revenue streams across multiple industries in three continents, Harvey Nash doesn’t have anything like the degree of volatility a staffer focused on just one or two segments and/or markets would have.


Turning to its performance in recent years, I should mention that I don’t look at staffers’ revenues when analysing their performance, as this can be distorted significantly by mix effects due to the different treatment of monies received for placing permanent and temporary / contract candidates. So, skipping down to the more meaningful profit lines reveals a resilient performance over the past 5 years. Gross profits in the year ending 31 January 2012 were 63% higher than in the year ended 31 January 2007, while over the same period operating profits grew 33%. Harvey Nash’s operating profits for the 12 months to the end of January 2012 (€9m) were double those achieved at the low point of the cycle (the financial year ended 31/1/10). Despite the economic headwinds, the group has retained a prudent balance sheet policy, reporting net cash in each of the previous 5 years. Loyal investors have also been rewarded by a dividend that has increased by a total of 166% over the past 5 years.


In terms of returns metrics, there are some interesting takeaways from these. Between FY07 and FY09, ROCE and ROE were very stable, consistently standing at circa 17% and circa 11% respectively. Once the downturn hit, these unsurprisingly nosedived in tandem with profits, to reach troughs of 2.9% and 1.4% respectively in FY10. Over the past two years these have started to recover back towards cyclical highs, reaching 13.9% and 9.2% in the 12 months to the end of January. Given that these are still some way off pre-economic crisis highs, I think this is a good point in the cycle to be revisiting the story.


So, with Harvey Nash’s track record where earnings, dividends and returns are concerned out of the way, what has the company been saying recently? Obviously, conditions are far from optimal, but the company has nonetheless sustained its positive momentum. In its June trading update, management said it was ‘delighted’ with the group’s performance in Q1 of its financial year, with revenues +18% and underlying operating profits +10%. More recently, in an update provided in the middle of August ahead of the release of H1 numbers on September 28, the company said it expects to ‘confirm a robust performance’ in H1, guiding a 15% rise in revenues and 7%+ uplift in operating profits. Another development revealed in that update was the revelation that the company has swung into a modest (£13m) net debt position, having had net cash of £5.2m at the end of January. This reversal is due to: (i) a £2.2m one-off spend on a new consolidated facility for its London operation; (ii) the €1.8m cost of a business acquired in Belgium; and (iii) investment in working capital to support the temporary labour business. None of these factors give me any cause for concern as: (i) the London facility will trim costs by £0.8m per annum, so a less than 3 year payback; (ii) the Belgian business was acquired for less than 3x PBT, which again points to a likely short payback period; and (iii) Harvey Nash guides that working capital investment will “return to more normalised levels over the next 18 months”. Moreover, the £13m net debt compares with existing bank facilities of £41m, which gives me more comfort.


In terms of the valuation, based on consensus EPS forecasts and this evening’s closing price (51.75p), Harvey Nash trades on 7.5x forward earnings. This compares very favourably with its UK quoted peers – Hays (13.2x), Robert Walters (26.4x) and Michael Page International (24.8x).


One of the key problems with staffers is forecasting their likely performance, given the short-term visibility that is inherent to the permanent hiring business. In my own model, in which I’ve plugged in what to me look like conservative assumptions, I can get to a valuation above £1 (£1.056 to be precise), or about double where Harvey Nash is now. Is that an unrealistic valuation? Well, when you look at the multiples its peers trade on, I don’t think it is at all. Also, while past performance is by no means a guarantee of future returns, HVN’s shares traded as high as 97p in mid-2011. Moreover, if I simply plug in the £13m net debt reported in the recent statement into the DCF-based model and ignore the expected unwinding of this, it spits out an 81p price target, which is close to 60% above where the shares now trade. The key near-term risk is, obviously, the macro backdrop, but three things make me relaxed about this, namely: (i) Harvey Nash is cheap in both absolute and relative terms; (ii) if the outlook deteriorates, the investment in working capital is likely to unwind faster, which would see the balance sheet strengthen as the income statement softens; and (iii) based on where the shares are trading now, the stock offers a well covered dividend of 5.6%.


In summary, I view Harvey Nash as a case of strong track record+ diversified business model + attractive, well-covered dividend + inexpensive (both in absolute terms & relative to its peers) valuation. To this end, I have bought back into the stock today.

Written by Philip O'Sullivan

September 3, 2012 at 4:25 pm

Posted in Sector Focus

Tagged with ,

162 Group (BOD.L/CON.L/PET.L/CLON.L)

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Earlier this week I met with the team at 162 Group, one of Ireland’s most entrepreneurial businesses. Led by Dr. John Teeling, it has an impressive track record of building start-up ventures, mainly in natural resources. While these are inherently high-risk plays, recent exits from its portfolio highlights the potential upside when these things work out – since the start of 2010 shareholders have received over $250m in cash and shares from the disposals of Cooley Distillery, Swala Resources, African Diamonds, Pan Andean Resources and Stellar Diamonds. While past performance is of course no guarantee of future returns, I figured that it would be worth running the slide rule over what is left in the 162 portfolio to see what the team is presently developing.


There are three strands to the 162 Group today. The Industrial business comprises unlisted businesses in the renewable energy and beverage sectors, along with a minority shareholding in Norish plc. My main focus in this piece is on 162 Group’s Mining and Oil units, where the firm manages four AIM listed companies, namely: Botswana Diamonds, Connemara Mining, Petrel Resources and Clontarf Energy. I profile each of these in turn below.


  • Botswana Diamonds (Ticker BOD.L, Market Cap £3m). Through this vehicle 162 aims to replicate the success it had with African Diamonds. The firm holds exploration licences in Botswana and Cameroon as well as early-stage diamond licence applications in Zimbabwe. Its main activities are in Botswana, which has been described as the ‘Switzerland of Africa’ due to the stable political backdrop and business-friendly climate. In addition, Botswana is the world’s largest producer of diamonds by value. The firm’s latest presentation gives a good overview of its activities and plans.  While not exactly flush with cash, management’s strong track record in diamonds and industry relationships should prove helpful in agreeing partnerships to exploit any high-potential opportunities the firm manages to identify.
  • Connemara Mining (Ticker CON.L, Market Cap £3m). This business holds 34 prospecting licences in Ireland, with a focus on zinc (Ireland produces 25% of Western Europe’s zinc) and gold. Connemara has agreed joint ventures with Teck (the world’s third biggest zinc producer) in respect of 21 of its licences (zinc and lead prospects) and with the privately-owned Hendrick Resources for another 5 (gold prospects). Its sole venture licences are mainly located close to established zinc and lead hotspots (e.g. Lisheen, Galmoy and Silvermines). The partnerships help bring financial muscle and technical expertise to Connemara’s prospects. In its recent results release management said the company “has adequate funds for all proposed expenditure in the next year“.
  • Petrel Resources (Ticker PET.L, Market Cap £4m). This oil stock has three strings to its bow – firstly, in Ireland, it has license options for two packages of blocks in the Porcupine Basin, and with interest in offshore Ireland on the rise after recent positive exploration news from the likes of Providence Resources, this could prove to be a very interesting asset. In Ghana it is awaiting ratification (a decision is expected in Q4 of this year) for a high potential spot relatively close to previous Tullow Oil finds. Finally, in Iraq it has some early stage assets. It does trade at a modest discount to its end-2011 net cash, but of course developing its assets will not come cheap.
  • Clontarf Energy (Ticker CLON.L, Market Cap £4m). This firm offers a mix of production (stakes in two gas producing fields in Bolivia) and exploration (Peru and Ghana) assets. The Ghanaian interest looks particularly attractive – assuming ratification is received (it is hoped before the end of the year) it will comprise a 60% stake in the field Petrel Resources is similarly awaiting approval to acquire a 30% interest in that is relatively close to Tullow Oil’s finds in that country.


Overall, to me the listed companies in the 162 portfolio are all reminiscent of options – the very low market capitalisation relative to the potential upside from a successful commercialisation of their asset bases means that the potential (emphasis) returns are very high. Of course, so are the risks, not least in terms of potential dilutions through farm-outs or placings. So, these are not, for now at least, the type of stocks you’d recommend to widows or orphans. At the same time, for more adventurous investors looking for a high-risk punt, all four of these appear worthy of doing some more work on. It should also be noted that management are significant investors in each of the four listed companies, which points to aligned management and shareholder interests.

Written by Philip O'Sullivan

August 25, 2012 at 10:37 am

Bank of Ireland: H1 Results Thoughts

with 3 comments

(Disclaimer: I am a shareholder in Bank of Ireland plc and AIB plc) The main news, at least from an Irish plc perspective, today is Bank of Ireland’s interim results. Six months ago, when the group issued its FY2011 numbers, I wrote that: “[The] results are a bit of a mixed bag, and to tell the truth, they are a little bit worse than what I had expected“. This morning’s interim numbers have produced a similar reaction from me.


It should be noted that, particularly at this troubled time, but it’s also generally true, that banks’ results are always subject to a certain degree of volatility given the vast number of moving parts at play. This makes forecasting numbers with a high degree of accuracy a challenging task – how, to take two examples, is one supposed to adequately model for either: (i) the accounting impact of fair value movements in derivatives that economically hedge the Group’s balance sheet; or (ii) economic assumption changes for Bank of Ireland’s life assurance unit. These two items combined had a €59m positive impact on Bank of Ireland’s bottom line, and were indeed equal to circa 100% of its H1 2012 pre-provision profits!


With this in mind, when I look at the Irish banks I run through a check-list of five key items to see how they are performing against all of them. I find that a more useful method of evaluating their performance than simply focusing on headline numbers that can be heavily influenced by accounting adjustments, such as those mentioned above, that have limited read-through for the underlying performance of the group. Obviously, in the longer term the headline numbers themselves will take on more relevance, but given the present volatility their usefulness is, in my view, somewhat limited.


The five key areas of interest to me are: (i) Trends in pre-provision profits; (ii) Trends in deposits; (iii) Trends in the net interest margin; (iv) Progress on deleveraging; and (v) Trends in impairments. Below I evaluate Bank of Ireland’s performance on all five metrics.


To start with trends in pre-provision profits – here Bank of Ireland saw a 65% decline to €58m relative to H12011. This was all down to the margin. Net interest income slid by €177m (-17%), which more than offset the positive trends seen in all of the other line items between it and pre-provision profits, namely: government guarantee fees (a €25m reduction year-on-year), net other income (a €43m improvement year-on-year), operating expenses (a €1m reduction year-on-year). The conclusion from me from examining the trend in pre-provision profits is that Bank of Ireland is doing a good job on the levers it has control over.


Next we look at deposits. Earlier this month AIB said that its customer deposits rose €2.9bn (+5%) in H1 2012. I would have expected at least the same again from Bank of Ireland. However, BKIR’s Irish retail deposits have actually fallen by €1bn in the first six months of the year. This was more than offset by a €2bn rise in UK retail deposits, while other deposit headings remain stable. This relative underperformance may well be explained by Bank of Ireland having recently taken (necessary) steps to lead price reductions in deposit rates here, so there could be an element of savers ‘shopping around’ going on. With other banks having followed BKIR’s lead, hopefully it will win back some of this money over time. However, my conclusion from Bank of Ireland’s deposit trends is that, while not a major cause for concern, they will need to improve their performance here to help strengthen its funding base.


The net interest margin is a source of disappointment to me. At 1.20% it is 13bps lower than year-earlier levels and below the 1.24% reported by AIB in the first half of 2012. Action to reduce the level of deposits covered by the Irish government’s ELG scheme means that margins after taking that into account are 0.88% for Bank of Ireland and 0.90% for AIB. Given that Bank of Ireland has a arguably superior mix of loan exposures to AIB, this margin underperformance is as surprising as it is disappointing.


Deleveraging is something that will, thankfully, no longer be an area of particular attention come 2013. Bank of Ireland has already met its PCAR targets, having offloaded €10bn of loans more than a year ahead of target. The other pillar bank, AIB, in contrast, is only 70% of the way through this process. So, top marks to Bank of Ireland here.


Impairments are clearly an area of focus for the Irish banks. Given the heroic achievements of Katie Taylor in yesterday’s Olympic boxing final, you’ll forgive me for the analogy that our financial system has suffered a ‘one-two combo’ in terms of being smacked first by land and development loans (now mainly housed in NAMA) up front and then a second blow from mortgage losses as unemployment has moved upwards. Total loan impairments in H1 2012 for Bank of Ireland were €941m versus €842m in H1 2011. Mortgages were to blame here, as impairments in that area rose to €310m from €159m a year ago. Consumer and SME impairments saw an improvement, while property and construction losses were flat. Given the troubled economic backdrop, I would imagine that losses will get worse before they get better, although I note management says: “While the Irish economy remains challenging and our impairment charges remain elevated, we expect the impairment charges to reduce from this level, trending to a more normalised level as the Irish economy recovers“. The ultimate impairment bill is, to use Mr. Rumsfeld’s parlance, a key ‘known unknown‘ for Bank of Ireland.


In all, as I said in the opening the results are a bit of a mixed bag, but overall the key negatives (deposits and margin)  outweigh the positives (good work on costs, no major surprises on the impairment front). I’m not surprised, therefore, to see the shares open weaker this morning. In terms of how I approach Bank of Ireland as an investment case, I think the market has already priced in a lot of the risks it faces, with the shares trading on less than half its expected end-2013 NAV per share. However, the regular occurrences of either flare-ups or grounds for optimism in the Eurozone crisis means that, for high-beta stocks like Bank of Ireland, the near-term outlook for its share price remains volatile. I remain of the view that there is longer-term upside in this name for patient investors, while for short-term traders its elevated levels of both liquidity (especially by Irish standards) and volatility makes it a great trading stock to punt around on in the intervening period. Mind you, this also means, in my opinion, that it’s not really one for widows and orphans!

Written by Philip O'Sullivan

August 10, 2012 at 9:21 am

Smurfit Kappa Group (SKG.I) – Think Inside The Box

with one comment

(This is the seventeenth installment in my series of case studies on the shares that make up my portfolio. To see the other sixteen articles, on Bank of IrelandAIBRBSMarston’sFrance TelecomRyanairPetroNeftIrish Continental GroupIndependent News & MediaTotal ProduceAbbeyGlanbiaIrish Life & PermanentDatalexTrinity Mirror and Datong, click on the company names. I remain an investor in all of the above stocks, save for Glanbia, which I sold earlier this year)


Smurfit Kappa Group (SKG) is one of the leading integrated producers of paper-based packaging in the world. It is the largest European containerboard (paper specially manufactured for the production of corrugated board) and corrugated (two outer layers of paper with an intermediate layer of fluting) producer, with a circa 17% share of capacity. In Latin America, which accounted for 18% of revenues in 2011, SKG is ranked #1 for corrugated and #2 for containerboard across the 9 countries it has a presence in. The group, which generated revenue and EBITDA of €7.4bn and €1.0bn respectively in 2011, has 331 operating facilities across 30 countries, employing 38,000 people.


In this piece I look at its business model, performance since its 2007 IPO and outline why I believe its shares offer great value at current levels.


SKG’s business model has a number of attractive qualities. Firstly, as an integrated producer, this provides a competitive advantage due to its control of supply of a critical input — Smurfit is the world’s second-largest recovered paper user. This is particularly valuable given that rising Chinese demand in recent years (in 2010 some 13% of recovered paper collected in Europe was exported to China) has impacted the availability and pricing of this commodity. A second big advantage for SKG is its scale — given that 60% of its customers are in the fast-moving consumer goods segment, the group has the capability to support some of the biggest firms in this area due to its wide geographic coverage. On this point, 18% of SKG’s customers by volume are described as ‘Pan European’, with a further 16% classified as multinational. In addition, SKG has a considerable breadth of product offering, which allows it to meet a wide variety of customer needs.


The group had its IPO in March 2007, just before the economic storm hit. The shares, which were initially priced at €16.50 apiece, soon came under severe pressure due to a combination of wider economic concerns and the firm’s level indebtedness at the time. At the end of fiscal year 2007, SKG had net debt of €3.40 billion, or 3.2x that year’s Ebitda (€1.06 billion).


The firm’s response to these pressures has been impressive. The group focused on maximising cash flow by reducing working capital, suspending dividends, implementing significant cost takeout measures and minimizing capex (the ratio of capex to depreciation fell from 98% in fiscal year 2007 to 67% in 2009). These efforts helped offset the pressures on profitability, and net debt, which fell to €2.75 billion by the end of 2011 (a 19% reduction in four years), represented only 2.7x that year’s Ebitda. This has been done without any recourse to shareholders (the number of shares in issue has increased by only 8.4% in the five and a quarter years since the IPO).


In terms of recent milestones, since the start of 2012 the group has announced a successful extension of its debt maturities, which pushed the weighted average debt maturity out to over five years and left the group with no significant maturities until 2015. This gives the group greatly enhanced financial flexibility.


In March, one of the private equity vehicles that had retained an investment in Smurfit post its IPO had placed nearly €150 million worth of stock. While this applied downward pressure to SKG in the short-term, in the longer-term SKG will benefit from the improvement in the free-float (the placing increased SKG’s free-float from 65.4% to 75.1%). Clearly, the potential for further placings cannot be ruled out, but for reasons set out below I believe that this is more than factored into the current share price.


SKG’s Q1 results, released in May, surprised on the upside, with Ebitda of €246 million coming in comfortably ahead of the top of the range of sell-side estimates (€181-233 million). At the time, management said it expects: “to deliver an Ebitda performance broadly similar to that achieved in 2011” (i.e. €1 billion) this year.


Since then, we have seen further turmoil in the euro zone, coupled with some pressure on containerboard prices, which may put this guidance under threat. Against that, SKG does have a lot of levers on the cost side that it can use to counter these developments. The firm’s next set of quarterly results, due on August 1, will presumably provide more clarity on this.


Tying it all together, in terms of the investment case for Smurfit, the company represents a very attractive way of playing the European packaging sector, given: (i) its competitive advantage on the input side; (ii) its breadth (both geographic and product); (iii) its relentless focus on cash flow generation; and (iv) its cheap valuation. On the final point, based on last night’s closing price (€5.40), SKG is capitalized at €1.20 billion. Considering that the group is presently guiding Ebitda of €1 billion for this year, I see potential for a significant re-rating as debt is paid down. On this note, SKG exited 2011 with net debt of €2.75 billion and an employee benefits liability of €0.65 billion. Keeping things simple, its EV (based on the last audited figures and the current market cap, along with taking the pension into account) is €4.60 billion. By the end of 2012, net debt will have reduced further given the impressive cash generation of the business (over the past 4 years SKG has reduced net debt by an average of €163 million per annum). In my model I forecast that net debt will fall to €2.5 billion by year-end. This puts the group on a prospective EV/Ebitda of 4.2x, while the shares yield 4.2% at these levels. This is cheap both in absolute terms and also relative to its sector peers.


There are, of course, some threats to the company, such as the challenging economic conditions across much of Europe and the possibility of further placings. However, given the low multiple of what are far from peak earnings (SKG’s Ebitda margin of 13.9% in fiscal year 2011 is 70bps below 2007 levels, despite the significant cost takeout measures undertaken since then) the company trades on I would contend that this is priced in. Furthermore, I note that the current share price is roughly 25% below where the recent placing occurred.


In all, I view SKG as a story of industry leader + significant operating leverage from an eventual recovery in the European economy + attractive emerging economy assets + a de-risked balance sheet (given the recent refinancing deal) + cheap rating + debt paydown driving a significant re-rating over time. I like this stock a lot, hence I hold it in my own portfolio.


Note: This is an edited version of an article that I wrote for Marketwatch yesterday

Written by Philip O'Sullivan

July 11, 2012 at 7:53 am

Posted in Sector Focus

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Twelve for 2012 – Interim Report

with 4 comments

Just before Christmas I wrote about my twelve preferred investments for 2012. I broke them down into two parts – my core ‘conviction picks‘ and a higher risk ‘speculative six‘ portfolio. In this blog I look at how they have performed, and examine what lessons are there to learn from this.


But first, here are the 12 I picked and their price performance – for simplicity I’m ignoring currency movements and dividends.


  1. Origin Enterprises (was €3.05, now €3.60) +18%
  2. DCC (was €18.53, now €18.29) -1%
  3. Total Produce (was €0.38, now €0.40) +5%
  4. ICG (was €14.71, now €15.20) +3%
  5. Ryanair (was €3.75, now €4.00) +7%
  6. Gold (was $1608, now $1598.4) -1%
  7. PetroNeft (was 18.11p, now 6.95p) -62%
  8. Marston’s (was 89.85p, now £1.039) +16%
  9. Bank of Ireland (was 8c, now 10c) +25%
  10. Petroceltic (was 8.25p, now 6.65p) -19%
  11. Ladbrokes (was £1.234, now £1.572) +27%
  12. Aer Lingus (was €0.65, now €1.01) +55%


(Disclaimer: Of the listed companies mentioned above I own shares in Total Produce, ICG, Ryanair, PetroNeft, Marston’s and Bank of Ireland).


On average, my 12 picks gained 6.1% (core +5.2% / speculative +7.1%). This compares with the 1.3% rise the FTSE All-Share posted over the period but is below the 8.5% rise in the year to date for the ISEQ (Irish Stock Exchange). Overall I’m pleased with how the picks have performed, given the challenging backdrop.


Taking the two groups in turn, of the conviction picks Ryanair, Origin Enterprises and ICG have proven to be the most interesting. The past few quarters have been very encouraging for Ryanair, which will pay a special dividend of 34c (that’s an 8.5% yield on where the shares are currently trading) in November. The recent pullback in the oil price and the exiting of a number of rivals from the European airline space bode well for the carrier. ICG saw a sizeable secondary placing of stock a fortnight ago which removed the last overhang on the share register following the protracted (and ultimately unsuccessful) takeover battle from a few years back. This should improve the liquidity in the stock and presumably lead to some index-buying as its free-float has increased. Origin Enterprises has surged by 18% due to a combination of solid trading updates and, as I said in my original ‘Twelve for 2012’ post, it was due a re-rating given its anomalously cheap valuation.


For the more speculative picks, it was no surprise to see the huge range (from -62% to +55%) of price returns given the riskier nature of those stocks. Disappointing production figures and concerns around funding have had a severe effect on investor sentiment towards PetroNeft. Hopes of a resolution of the pension uncertainty and a takeover approach from Ryanair has propelled Aer Lingus shares higher. Positive updates from the UK pub sector and hopes of good performances from the Jubilee, Euro 2012 and the London Olympics have benefited Marston’s. Bank of Ireland shares have gyrated violently throughout the first six months of the year, tipping 15c in early February (a near 90% improvement over the 6 weeks after their inclusion on my list!).


In terms of my conclusions from this review, looking ahead to the second half of 2012 I see no reason to change the investment tactics I’ve deployed so far this year. In my opening comments for 2012, I identified five characteristics to look for when buying stocks – a strong balance sheet; a preference for defensives over cyclicals; significant non-Eurozone exposure; political/inflation risk hedging qualities; and attractive and well-covered dividends. I don’t see any merit in modifying those filters, particularly given how much volatility there is in the markets (my own portfolio rose 299bps yesterday alone!).

Written by Philip O'Sullivan

June 30, 2012 at 1:34 pm

Posted in Sector Focus

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Bank of Ireland (BKIR.I) – Ireland’s Good Bank?

with 11 comments

(This is the sixteenth installment in my series of case studies on the shares that make up my portfolio. To see the other fifteen articles, on AIBRBSMarston’sFrance TelecomRyanairPetroNeftIrish Continental GroupIndependent News & MediaTotal ProduceAbbeyGlanbiaIrish Life & PermanentDatalexTrinity Mirror and Datong, click on the company names. I remain an investor in all of the above stocks, save for Glanbia, which I sold earlier this year)


I suppose it isn’t hard to be classified as Ireland’s ‘Good Bank’ when your domestic competitors heading into Ireland’s economic catastrophe comprised the now-nationalised Anglo Irish Bank and Irish Nationwide Building Society, the now 99.8% State-owned AIB and EBS, and the now 99.2% State-owned Permanent TSB. However, that is not to say that the past few years have been easy for Bank of Ireland. Over the past five years shareholders in the only domestic bank not under majority State ownership (the State has a 15% stake in the Bank) have seen the value of their investment decimated by heavy losses and dilutive capital raisings. In this piece I examine the key events that have affected the Bank in recent years, and explore what value there is in the stock at current levels.


Turning the clock back to June of 2007, Bank of Ireland gave an upbeat presentation at a conference organised that month by stockbrokers Merrion. In its previous financial year (12 months to end-March 2007), the group had delivered a 22% increase in profits, impairment losses stood at only 0.09% of its loanbook, return on equity was an impressive 23% and Tier 1 capital was a strong (at that time) 8.2%. The group was relatively well diversified, with Ireland delivering 60% of its profits, the UK 29% and the rest of the world 11%. Management saw “significant growth potential across the group”, noting a “positive longer-term outlook” in Ireland, while it targeted growing its international operations to the point where they would contribute over half of group earnings in time.


Just 12 months later, the tone was remarkably different. At a Goldman Sachs conference in Berlin in June 2008, Richie Boucher (now group CEO) delivered a presentation entitled: “Shifting the focus to deposits”. There were clear signs at this stage that the Irish economy was in trouble. Bank of Ireland’s impairments in the year to end-March 2008 had doubled to 17bps, reported PBT growth had stalled (-1% yoy) and ROE had softened to 21%. The group highlighted its strong funding base, with 47% of its balance sheet funded by €86bn of customer deposits. However, with a loan-to-deposit ratio standing at a worryingly high 157%, it was no wonder that the organisation was focused on deposits.


By the time of the next full-year reporting period (12 months to end-March 2009), Ireland’s economic woes were having a severe effect on Bank of Ireland’s performance. Impairments rose from 17bps to 102bps, ROE slumped by three-quarters to just 5%, and the LDR had increased to 161%, with deposits flat at €86bn. The government introduced the Bank Guarantee in September 2008 in an attempt to reassure depositors and the debt markets. In March 2009 the State handed over €3.5bn in exchange for preference shares in Bank of Ireland to help boost the latter’s core tier 1 capital.


Following the first recap Bank of Ireland commenced transferring some of its problem loans to NAMA. The haircut applied on these loans was 41%, significantly better than the range of haircuts (55-61%) applied to loans transferred by its domestic peers (slide 43). At the time management outlined plans to shrink its loanbook from €135bn to €89bn – €12bn of this reduction was to come from the NAMA transfers, with up to €34bn of non-core loans targeted for sale. The group changed its financial year end to December, and its results for the 9 months to the end of December 2009 saw impairments shoot up to €4.1bn – just over double the charge in the 12 months to the end of March 2009.


The removal of the NAMA loans had seen the LDR fall to 141% by the end of 2009, but difficult funding conditions was to see it rebound to 175% in 2010, as the benefits of deleveraging were offset by a slump in corporate deposits from €29bn at end-2009 to €9.5bn at end-2010 – ratings-sensitive corporate deposits across the six ‘guaranteed’ domestic banks collapsed in 2010 to €32bn from €80bn at end-2009. Importantly, the group guided that the “impairment charge on non-NAMA loans and advances to customers [was] expected to have peaked in 2009 –with further anticipated reductions expected in subsequent years”. This has been proven correct, up to now at least. Excluding NAMA loans, Bank of Ireland’s impairments were €2.37bn in FY09, €2.03bn in FY2010 and €1.96bn in FY11.


Another important milestone for Bank of Ireland that year was the 2010 capital raising, which raised €3.4bn from a placing, a 3 for 2 rights issue at 55c and an LME  exercise. The government also converted €1.7bn of the 2009 preference shares into ordinary share capital. However, post the PCAR and PLAR reviews, the Bank was ordered to raise another €4.2bn in 2011. This was achieved through the combination of a rights issue, an LME and a €1.1bn investment in the group by heavyweight investors including Fairfax Financial Holdings, WL Ross, The Capital Group, Fidelity Investments and Kennedy Wilson. As a result of all of these changes, Bank of Ireland’s shares in issue have increased from 988m in the year to end-March 2009 to 30.1bn today.


Outside of the completion of the €4.2bn recap, 2011 was also a year of progress on a number of different fronts. The capital position was strong, with a core tier 1 capital (bolstered to absorb future losses) ratio of 15.1% at the end of last year. Some 86% of the 2011-13 asset deleveraging plan was successfully executed, with the haircuts on the disposed assets below PCAR assumptions. Critically, deposit flows turned strongly positive, with the group’s total customer deposits increasing from €65.4bn at end-2010 to €70.5bn at end-2011. Reliance on funding from the monetary authorities was reduced over the year from €33bn to €23bn. Pre-tax losses improved to -€190m from -€950m in 2010.


With the (abridged!) recent history of Bank of Ireland out of the way, it’s time to look at where we’re at today. The Bank, of course, is someway off being master of its own destiny at the moment, having been set a number of targets. The Central Bank has ordered it to cut its LDR to 122.5% by end-2013. At the end of 2011 the LDR stood at 140%, having improved from 176% in the previous year. Data compiled by the Central Bank  (table A.4.2) show positive private sector deposit flows into the covered banks, which if this trend continues should help Bank of Ireland meet its LDR target. Bank of Ireland has been directed to cut its net loans to customers from 2010’s €115.3bn to €84.1bn by end-2013 (slide 54). At the end of 2011 net loans were €99.3bn, putting Bank of Ireland roughly 1/2 of the way to meeting that target only 1/3 of the way through that timeframe. The Bank’s recent interim management statement revealed details of further deleveraging and an improvement in the LDR.


In all, for me Bank of Ireland has been delivering against all the odds (given the challenging macroeconomic backdrop) of late. Management is to be commended for a good job in improving the funding profile and offloading non-core assets at better-than-expected prices. In addition, while impairments are set to remain elevated, management has guided that non-NAMA impairments will fall for a third consecutive year in 2012. So, in terms of the factors it has influence over, it’s doing the right things. However, the elephant in the room is of course the factors that it doesn’t have control over. Continued troubling developments in the Eurozone means that punting on a bank stock with significant exposure to one of the PIIGS (56.1% of Bank of Ireland’s loanbook at end-2011 was exposed to Ireland) economies at this time requires courage to say the least. The Irish domestic economy remains under severe pressure, which could lead to further problems in Bank of Ireland’s loanbook. Further capital raisings cannot be ruled out, with the Bank holding a call option over the government’s 10.25% 1.837bn 2009 preference stock that allow it to buy it back for €1/share up to 2014 and €1.25/share thereafter. Given the chunky coupon on these, I suspect the Bank will look to buy them back at the earliest possible opportunity, which may require some new equity depending on the strength of the recovery in profits from here and the state of the debt markets. So, this is a stock that is not without significant risks. Against that, I note that, at last night’s closing price of 9.8c it trades on a trailing P/TNAV of only 0.3x, compared to the 2.4x that its fellow ‘pillar bank’ AIB trades on, which suggests that a lot of these risks are priced in where BKIR is concerned.


My analysis began with a look back at a presentation Bank of Ireland gave to an Irish stockbroker’s conference, so it’s appropriate that I end with another one. In February of this year CEO Richie Boucher presented to clients of NCB and it was notable, to me at least, just how forward looking this was compared to many of its investor presentations over the preceding couple of years that were focused on fire-fighting within the loanbook. Bank of Ireland is now first or second by market share in each of the key segments it serves in its home market, while its UK operation, built around a jv with the post office, looks to be a good franchise with exposure to FX services, insurance, mortgages and the all-important deposit gathering. Deposits are on the rise and capital levels are strong, while impairments look to have peaked. As noted above, however, the bank is vulnerable to a lot of factors over which it has limited control. As I state above, I suspect this is reflected in its low P/TNAV multiple and its recent sharp share price decline from the 2012 highs. I would go even further and argue that Bank of Ireland is the only Irish bank worth contemplating an investment in at the moment given that AIB appears to be significantly overvalued, while the major surgery being performed on Permanent TSB (not to mentioned the prolonged pain it still has to endure from its mortgage-heavy loanbook) at the moment means, in my view, that attempting to value that stock now is a pointless exercise given so many ‘known unknowns’ (see my previous case studies on both, linked at the top of this post, for more information).


Despite that, given the present elevated fears around Spain and Greece I wouldn’t be rushing to top up my position in Bank of Ireland in the short-term. Taking a longer-term view, assuming the euro survives I see significant upside potential in Bank of Ireland and would amend my exposure to the stock to reflect this – but, as indicated above, I would need to see a comforting resolution of the Eurozone’s troubles (including clear signs of a strengthening in Ireland’s domestic economy) before I’d be willing to take such a stance.

Written by Philip O'Sullivan

June 9, 2012 at 9:44 am

Posted in Sector Focus

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