Mountfield Group - A Difficult Valuation

http://www.mountfieldgroupplc.com/


Small cap companies are often difficult to value for a number of reasons. That often leads to disparities arising between what would appear 'reasonable' based on the financial situation of the company compared to what the market is willing to attribute. Mountfield Group, a "construction support and property services company" is an interesting example of such a situation, as the market capitalisation is a lowly £6.61m and there is a potential disconnect. At a glance, the forecast price-earnings ratio is relatively low compared to industry averages, but are the reasons to justify a low multiple, or does the current financial situation offer a buying opportunity, despite the impressive price rise over the past year?


The technical position of Mountfield remains fairly neutral since the share price is towards the middle of the horizontal range between 2.25p and 3.00p, having eased away from 2.8p in June. Although the share price has slipped below the 200-day moving average, there are still reasons to be optimistic, since the MACD has turned upwards, seemingly having formed a low. Despite the fact that volumes remain weak, any sustained breakout of the trading range is likely to attract investors (if to the upside), since the formation occurred over longer than six months. In other words, any breakout is likely to be significant compared to recent price movements. The spread on Mountfield is not particularly attractive - at times of low liquidity, it can widen to as much as 10%, although the tradable spread is often less than 7% and sometimes 5%.

The shareholder list is concentrated as a result of large director holdings - CEO Graham Reed holds nearly 33% of the shares in issue, Executive Director Andrew Collins holding a further 12.7% and the Executive Chairman holding just over 9%. Commerzbank is the only institutional holder of Mountfield, and they own comfortably over 5% of the group.

As a company, Mountfield would have struggled to pick a less inspiring time to list on AIM. The company entered the market just a few months before the major low in the market indexes in 2008, and that hardly helped the share price get off to a positive start. Having listed at 10p with a market capitalisation of circa £17m, the valuation has slipped considerably, as has the share price which stands at roughly a quarter of its IPO price. That led to the company ditching its growth plans and entering a period of damage limitation - clearly that damage has been far from limited, but there are reasons to be cautiously optimistic about the company's future, as will become clearer.

Mountfield is the parent company for three subsidiaries, each of which revolve around construction and associated activities. The company has an excellent track record and strong position within the construction and fit-out of data centres, although moves have been made over the past couple of years to diversify away from that sub-sector focus. The three businesses are below.

- Mountfield Building Group = Work includes data centre work and fit-out. Past customers include Colt and Cable & Wireless
- MBG Construction = Holds long-run contracts with larger industry players such as Interior Services Group and Skanska. Works on a range of projects across the size spectrum, and across a variety of projects including railway stations and commercial offices
- Connaught Access Flooring = As the name suggests, CAF provides and installs floors for a range of purposes including offices and universities. A speciality within is related to the installation of anti-static floors for data centre environments

Essentially, the company has excelled in providing a round package for setting up a data centre. As noted though, Mountfield has made inroads into related markets, in order to diversify revenue streams and build up a more rounded construction proposition, and also to ensure that profitability "is not predominantly dependent" on data centre related work. Impressively, the group now derives around 50% of its revenues from activities unrelated to data centres. In the latest financial report, the company noted that, "Although the requirement for additional major data centres has lessened, it has not reduced overall demand for adjacent construction services." Indeed, with an increasingly positive UK construction industry (where most revenues are derived), the company is provided with an encouraging backdrop, against which it can grow the top-line performance.

The growth profile the company has been embarking upon is not necessarily shown in the 2013 results, where there was actually a dip in revenues (I'll cover this later). However, the company has signed a number of material contracts over the past year, that have assisted in the share price re-rating, and help to cement revenues in future years. It cannot be overlooked that Mountfield is dependent upon winning a number of large contracts at the moment, as has been the trend in recent years. It can therefore be considered a 'lumpy' business, despite the positive outlook statements from the company, thus should be priced accordingly.

On the other hand, contract wins can have a material impact upon the share price and the 0-2 year outlook - that is why the market has been so receptive of contract wins over the past year and the share price has not really drifted. Over the past year alone, 4 separate contract win announcements cover well over £6m of business, and the market will obviously be attracted by those numbers, especially when compared to Mountfield's market capitalisation. Those contracts include a £1m contract with a global communications provider and a £1.5m contract extension for the refurbishment of an office building. Ultimately, more orders of similar magnitudes will be required if Mountfield is to pursue aggressive growth, and that could further boost the share price down the line.

In the 2013 financial results Chairman Peter Jay commented, "I am delighted to be able to report that, having returned to profit in 2012, the Group's turnaround gathered real momentum in 2013 and the Board is optimistic that the improvement is sustainable."

Indeed, the income statement of the 2013 results make for interesting and encouraging reading for investors:
- Net profitability jumped 350% to £765k from £219k
- That was despite a reduction in revenues from £13.6m to £12.3m
- Gross margins rose considerably, with operating margins tracking higher to 6.9% from 1.4%
The decrease in revenues may sound disappointing, but ultimately it is profit that matters, rather than revenues, and the sharp rise in gross margins gives plenty of reasons to be optimistic. However, there is an interesting point to be made on that front, and to appreciate it, you need to look back at the company's past track record.


Taking a look at the gross margin line, it is clear that the company is heavily reliant on the wider industry picture. Indeed, gross margins were crushed during 2009 as a result of the financial crisis - obviously that suggests a lack of pricing power, and that is down to the company winning a large number of its contracts through a competitive tender process. Whilst that does allow the company to showcase its experience, when competitors are undercutting you significantly, margins come under major pressure, and that is what happened in 2009. Margins have recovered significantly since, to the extent that the 2013 margins exceeded those posted in 2008.
But is that sustainable? The company noted that it could afford to be "more selective in the contracts it took on" in 2013 as a result of the more positive environment, and that no doubt would have assisted margins. 19.9% margins seem extremely high for the sector and that perhaps links to why the board are "optimistic" that the 2013 financial results are sustainable as opposed to 'confident'. The next set of financial results will be key in identifying whether that is actually the case, and whether or not the 2013 results were just down to a number of lucrative contracts that skewed the overall picture. If that is the case, then the growth will be derived from rising revenues, although the buoyant construction sector could keep margins historically high for now. Revenues remain well off those achieved in 2008 and even further off those achieved before that (as does profitability). Significantly higher revenues at a lower gross margin would still result in a better bottom-line result. On that point, the company is hopeful that rates of growth will increase "substantially" over the next few years.

The 2013 pre-tax profitability filtered down to post-tax profits of £503k, giving basic EPS of 0.22p and diluted EPS of 0.18p. A trailing price-earnings ratio (PER) of nearly 12 is not all that attractive for a small cap company, although growth rates are highly encouraging. That is even more the case as the 2013 results used the weighted average number of shares in issue (as it almost always the case). However, I prefer to back-adjust for the current number of shares in issue, in which case the trailing basic EPS drops down to 1.98p (Mountfield undertook a placing during the year). That is less attractive, and is too expensive on just a trailing measure. However, it is the forward metrics that are highly attractive. Broker WH Ireland are forecasting revenues of £14.1m, pre-tax profits of £1m and subsequent EPS of 0.35p for 2014 - that gives a prospective PER of 7.4, which is attractive on an income statement basis alone. The bullish nature of several company statements are the reason for that. A PER of 10 would suggest upside of well over 30%.

There is one real (and serious) problem I have with Mountfield though, and that can be seen if you scroll back and look at the NCA-NCL-D line of the earlier table. The company has very large negative current liabilities plus non-current debt. Despite the figure having fallen over the past couple of years, it remains highly material to the market cap and will undoubtedly deter many investors. At the last reading net current assets were only 63% of net current liabilities - ideally a company will have considerably more net current assets than current liabilities, so the company is certainly in a weak financial position, albeit it is cash generative.. There are also negative net tangible assets of nearly £5m, so the financial position really is very uncomfortable. Within those figures, there are net short-term borrowings of £770k and net payables of £1.32m and that is despite a £450k placing that was completed in H2 2013 at 1p/share.

On that trail of thought, it would be highly beneficial for the company to place at least a further £500k to help solidify the financial position, even if only for aesthetic purposes. I say aesthetic purposes because the actual position is slightly less serious than the numbers suggest. Much of the borrowings were given by the top directors of the company, and they certainly will not be intending to cut off that line of finance - indeed, the non-current portion of the debt was extended in 2013 from 2016 through to 2020, so Mountfield has plenty of time to sort out its financial position whilst keeping that debt on the balance sheet. Interest payments for that debt were also waived during the period.

Nonetheless, the financial position does remain weak and a real concern. On the other hand, a placing should definitely be able to be completed if necessary (especially since one was completed at 1p), so there is a slight margin of safety. The key question revolves around how the company intends to finance significant growth on current reserves, as more working capital will be required, and the cash generation may be continually eaten away by debt repayments, if not interest. There was around £500k of room on the Barclays bank overdraft facility at the latest reading, so that may be sufficient for working capital purposes for now. The board will likely be mindful of the low market capitalisation (compared to any potential fundraising) especially given their material stakes in the business.

That said, there is a really interesting point to consider - as per the earlier table, Mountfield's financial position has been weak since joining AIM, yet that did not stop the share price more than doubling in 2013. The low market capitalisation will undoubtedly act as an attraction for some investors, and those with higher risk tolerance levels would be comfortable with Mountfield's investment proposition. The current position is not too dissimilar to that of building services company, Northern Bear (LSE:NTBR) earlier this year, before it went on to rise well over 400% - NTBR had net current assets only at 77% of net current liabilities at the last reading. That does prove that the market is willing to back companies with weak balance sheets if the operational turnaround is significant above. The circumstances are different because NTBR had an even smaller market cap at the time and the subsequent earnings have been phenomenal, but the principle remains.

"These increased levels of activity enabled the Group to produce a trading profit in 2012 after three years of losses and those profits were further increased in 2013 as investors and developers decided that the recovery had a secure base. This has been further evidenced during the first part of 2014 by a level of new business enquiries and invitations to tender in both of our divisions that has not been seen by the Board since the middle of 2008. The Board regards this as being a longer lasting improvement in sentiment and confidence." (Peter Jay, 2013 Financial Results)

Notwithstanding the forecasts for solid growth in 2014 and potentially even beyond, combined with the low forward rating, the balance sheet is in too uncomfortable a state for me to be interested in adding Mountfield to the portfolio. I'd much rather invest at a higher price in the event that the company bolsters its financial position, rather than at the current point in time where there is a high financial risk. Indications for the future from the company are highly positive, which helps reduce concerns slightly, and there is plenty of scope for a higher share price over the next nine to twelve months if they hit targets, but the it is important to be comfortable in any investment, and the balance sheet does not allow for that in Mountfield's case. No Rating.

4 comments:

  1. Great evaluation and nice to have a near table at the start. Please continue!

    Kiral

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  2. I was looking at Mountfield two weeks ago and had the same conclusion after looking at your tutorials but had the same conclusion :0). Bit too riskey pour moi

    Solooiler

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  3. Good write. Keep up the great work and well done on the calls

    ReplyDelete
  4. Good write up. I actually did some work on this transaction prior to listing, didn't attract me then, and doesn't attract me much now!

    ReplyDelete