Begbies Traynor - A Reasonable Valuation

http://www.begbies-traynorgroup.com/

With the UK emerging from the economic downturn caused by the financial crash in 2008/2009, it would be reasonable to think that an insolvency practitioner would have thrived; generating profits as financially weak businesses exited the marketplace. Although there was a significant initial uplift, it has not been quite as simple as that for AIM listed Begbies Traynor, with the group reporting either challenging conditions or constrained insolvency levels since December 2010. The lengthy period of high insolvency levels has not exactly come to fruition, and that has meant Begbies' recovery has not performed as buoyantly as many expected post-crisis. The outlook appears no clearer.

Technicals


The technical outlook for Begbies is bearish on balance, with a likely breakdown through 44p towards 40p, as evidenced on Friday by an intra-day drop to 42.5p. That outlook is not helped by the lack of liquidity though, so there are minor reasons to be optimistic should 44p hold; the likelihood is that it will now, and will drift back towards that lower support (after 45p support failed to hold). That very near-term outlook appears backed up by a MACD that is showing signs of having 'topped', and a recent trend change confirmation as the 50dSMA crossed below the 200dSMA. 40p would appear to be solid support though, and (backed up by fundamentals) would likely hold.

As mentioned, liquidity can be an issue, and although the spread is currently 43p -> 45p, that followed a jump from 42.5p -> 44p during the closing auction in trading on Friday, so the actual spread is wider than that.

Director holdings are immaterial with the exception of Ric Traynor (Executive Chairman) who holds circa 29% of the share capital. Several institutions also hold stakes (which represents the well-run and high quality nature of the underlying operations), with a couple of names being Fidelity (9.1%) and Allianz (6.4%). In total, the top five non-director holdings total around a third of the share capital, so combined with the directors holdings, the shares held by large holders amounts to 62% of the shares in issue. That explains the liquidity situation. Canaccord Genuity track the company, and have a 53p target price, suggesting potential upside of around 20%.

Operations

Begbies Traynor is the UK's leading insolvency practitioner, and is the only listed company of its sort. Employing approximately 450 staff across 35 UK operations and working with 17 UK banks, Begbies in its enlarged form was formed in 1989 and listed on AIM in 2004, so it is certainly not a new investment case for investors to look at.

The services offered span a few key areas, including Investigative Options (e.g. forensic accounting), Personal Solvency Options and Advisory services across a range of segments such as restructuring, liquidation and pensions. The group has not been shy to grow acquisitively over the past few years, absorbing Cooper Williams for £0.9m in 2013 and Ian Franses Associates for an initial payment of £0.6m in H1 this year. Compared to the market capitalisation of the drop, these are not material transactions, rather sensible bolt-on acquisitions.

Investors often have ethics concerns regarding investing in Begbies. After all, as an insolvency practitioner, the company benefits when many businesses enter insolvency proceedings (i.e. when many UK businesses are performing badly and closing down). Although that is something to bear in mind and will put off some investors, that's not a material factor for me given that Begbies itself has no bearing on the amount of insolvencies and ultimately they are only providing a service. That is where Begbies differs to a company such as British American Tobacco or Imperial Tobacco; each of them directly cause the problem, rather than just offering a service associated to what you might ethically object to (the creation of tobacco products).

So why haven't insolvencies tracked higher in the years following 2009? The reasoning is multi-fold, but a core reason relates to the presence of "zombie companies". These are companies where their assets are significantly short of their liabilities, and whilst in some cases that does not mean that the company is at a real threat of closing down, the number of zombie companies can be used as a proxy for that metric. The number of zombie companies estimated to be operating in the UK has soared since 2009 to well over 250,000, yet the number of companies entering insolvency proceedings has been falling. Indeed, The Insolvency Service released figures showing a 13.4% drop year-on-year, with one attributable reason being that many companies are opting to be struck off the Companies House list rather than entering those proceedings.

The more major reason attributable to that lack of companies entering insolvency proceedings is because of record low interest rates (0.5%); Begbies noted that the low interest rate "continues to provide a very benign financing environment." Many banks/lenders have been taking a particularly lenient approach to collecting debts in order to delay damage to their balance sheets and financial results, as writing off debts is far more financially painful than letting them continue to trade and 'hope' that they will see improvements in their business such that they can repay debts.

Although that does mean that Begbies will probably see an uplift in trading once interest rates are hiked, the noises from the Bank of England suggest small and incremental rises, and the date for those rises has continually been pushed back over the past six months, which is dampening the medium-term outlook for trading.

On a smaller scale, the company can benefit from sector weakness, albeit that is unlikely to have a material impact on trading. On that note, Begbies released a report in October looking at the UK's food retailing industry (one of the few under considerable strain at present). The note suggested that many companies were in financial distress, including multiple large companies. At the other end of the line, there are many small food suppliers that are being squeezed as a result of the supermarket price war. Since small suppliers have a lack of pricing power, that leaves them vulnerable to having their (generally single digit) profit margins strained further. However, as said, sector weakness (unless on a massive scale), is unlikely to assist Begbies' operations substantially.

Financials

The main set of financials to look at are the half-year results released just yesterday. The headline results are shown in the table below.


Clearly the headline results do not show an attractive growth play. Revenues declined marginally (partly the result of discontinuing a small set of business activities), and pre-tax profits were down considerably, translating through to adjusted EPS around a quarter lower at 1.6p. Net debt remains high relative to the market cap, which will be limiting a progressive dividend policy from taking place, and as a result the Enterprise Value stands at £56.5m; a materially difficult figure to the circa £40m market cap. The £16.2m of debt was recorded after £1.4m paid out in acquisitions and CAPEX, but with gearing at 28%, interest repayments only totalling ~£500k, and an interest cover of 4.7x, the debt pile does not appear particularly damaging.

That said, the results were in line with expectations, and the company noted "continued difficult trading conditions ... with a lower number of UK corporate insolvencies in H1". The balance sheet is in good shape, with current assets at 4.33x current liabilities, and current assets still at 1.11x total liabilities (reflecting the high levels of borrowing). The one point to draw upon is that the current assets are particularly high due to a high and fairly level of receivables at £36.3m. That also means that cash generation is largely dependent upon working capital changes, and as a result of unfavourable movements, free cash flow was negative on the back of one-off CAPEX spend.

Executive Chairman Ric Traynor said, "Despite a challenging trading period for our profession, with reductions in national insolvency volumes to the lowest level since 2007, we have continued to trade profitably, with results in line with market expectations.  We have mitigated the full impact of market conditions through acquisitions completed in the current and prior year and continued cost discipline, and we have retained our market-leading position in terms of number of insolvency appointments.
 
We anticipate some improvement in trading levels in the second half of the financial year, over the traditionally busier winter months as we experienced in the previous financial year.  The last four months of the financial year will also benefit from the post-acquisition trading profits from the Eddisons acquisition announced today, which is expected to be earnings enhancing in the current financial year."
 
Given the results were in line, the bigger news was that Begbies had continued along its acquisition trail and purchased Eddisons, which is a company of much larger scale than the previous two purchases. Eddisons is a UK business of surveyors specialising in valuing and selling commercial property and business assets. The acquisition price was an initial £5m, with up to an extra £3.5m earn-out dependent upon performance; the entire £3.5m being released should average EBITA hit £2.8m, implying an uplift of circa £1.5m on the figures of the trailing two years. As a result, the acquisition looks a smart move as Eddisons delivered profit-after-tax of £1.1m last year, so the purchase price represents a low 4.8x profits (including transactions costs).
 
However, the acquisition was completed through a £5m vendor placing and small associated £0.3m to fund the transaction costs. That means there are no major EPS changes in the forthcoming years as Canaccord have slightly upgraded their forecasts by a few per cent. 4.09p in EPS are forecast for 2015 translating to a PER of 10.8, and 4.9p EPS in 2016 (based on a jump to sales of £60.3m on the back of Eddisons) translates to a PER of 8.99. Given the dividend is also forecast to amount to 2.2p (for a yield of 5%), those figures sound attractive.
 
The catch is that once you've factored in the spread, and the debt pile, the metrics are not so attractive. Excluding the acquisition, organic growth is forecast to be mid-single digits going into FY2016. Using the end-FY15 net debt forecast of £12.8m, the PERs rise to 14.2 and 11.8 respectively, which is far less attractive given the business model and fairly uncertain outlook.
 
Ric Traynor commented, "We are pleased to announce the acquisition of Eddisons today; it brings expertise in the valuation and disposal of property and business assets for insolvency, which is intrinsic to the Group's core insolvency practice; over recent years Eddisons has been appointed as receiver to over 200 property insolvencies per annum.
 
"The acquisition will enable the Group to utilise Eddisons' expertise on its existing caseload rather than subcontractors, together with marketing the Group's enhanced competencies and service offerings to the combined client base, including banks and other financial institutions. The transaction is expected to be earnings enhancing in the current financial year."

Current valuation looks fair

On balance, once the debt pile is factored in, the bottom line is that the valuation for Begbies Traynor looks fair at the current level. The lack of visibility over an interest rate rise will likely cap the upside potential given the reliance on the quantity of insolvencies, although the attractive 5% dividend yield means that downside is also likely to be restricted to the low 40p level over the medium-term (barring a decline in business and cutting of forecasts). Acquisitions remain a path to unlock growth and the acquisition of Eddisons is proof that there are complementary additions to Begbies' core, available at attractive prices. On the other hand, it often also signals that the company is trading against a (currently) unfavourable backdrop, and that external growth is required in order to prevent flatlining or declining earnings. In this case, upside appears too slim at the moment to justify an open position, when accounting for the spread. No Rating.

5 comments:

  1. Thanks for the review! Have a good xmas break

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  2. Thanks el1te. the problem with insolvency firms is that insolvencies come like buses. You wait 15 minutes for only 1, and then you get 3 at the same time.

    When the market shifts to begbies favour, it will be great for them imho. Downside is that it could be 2017 before theres headway

    CraigJ

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    1. It will probably be when the Eurozone recovers, and god knows when that will be. have you seen the index charts for the ATHEX recently? Absolutely plummeted 13% a few days ago and that's because of country problems. The Eurozone is all of a bit of a mess frankly and the ECB has to cater for all of the companies under its umbrella. Isnt it true that monetary policy will never be suitable for all of them and many can't use fiscal policy to equalise because of debt. Could be 2017 before an interest rise

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  3. Hi El1te - Thanks for pointing out the difference between this company and non-ethical companies such as gambling and tobacco ones. I had until then tarred them all with the same brush. I do like to make a profit but not at the expense of encouraging life destroying addiction.

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    Replies
    1. I agree! :0) Any company that makes profit through addiction should be avoided :0). Im not sure whether to put Molins with that as they make tobacco machinery, but they are only providing a service for the tobacco manufacturers (who are the real culprits?). :0S

      Id be more worried about legislation

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