Investment research into UK Stocks by Walbrock Research

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Old Jul 7, 2017, 9:17am   #17
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Joined Nov 2016
9 Red Flags of RM2 International that Investors Should Question

Walbrock Research started this thread Reposted here on TLF with permission of the original copyright holder.

When you got an experienced management team, as well as independent directors such as Paul Walsh from Diageo and Lord Rose (formerly Stuart Rose from M&S), along with a famous investor in Neil Woodford, whom fund holds the biggest stake in the company (35%).
You think you are on a winner.
Instead, RM2 is one of the worst performers in the market. Since January 2014, the shares collapsed from 88 pence to 14 pence.
Worse still, the company wasted hundreds of millions of pounds by initially pursuing the wrong strategy. Despite this, it needs hundreds of millions of pounds to meet the terms of agreements with their new outsourcing partners.

If you think the share price of 14 pence is cheap, do some research before taking a punt on this stock.

Here are nine to consider: -

An ONE Product Company (Red Flag No. 1)

RM2 has one “high-tech” pallet product called BLOCKPal. However, high-tech this product possesses it’s still a pallet. Secondly, the price of industrial pallets aren’t expensive, you can buy pallets on eBay and on Alibaba.
With prices at single digits, this makes BLOCKPal pallet (with a tracking device) looks expensive to rent and buy.
On top of that, RM2 is in collaboration with AT&T to develop a new tracking device pallet called ELIoT pallets.
We know the product is real, but can they sell enough of it to make RM2 a self-sufficient business.

Manufacture First without Testing the Market (Red Flag No. 2)

When the company raise £130.8m in net proceeds, investors should question the business model.
As a fan of Shark Tank (the U.S. version of Dragons Den), the one question they always ask “wannabe” entrepreneurs are: “What are you going to do with my money?”
And, if the reply is: “I will use it to manufacture and stock up on goods.”
Then, the reply is always the same: “Do you have the orders coming in?”
And, if this turns out to be NO, the sharks will start ripping into their business model (no pun intended).
Apparently, that was the mistake RM2 International has made and they paid a price with their reputation, along with going down the drain.
Even worse, they decided to manufacture the pallets themselves for a time, before outsourcing it to China and Mexico (Q3 2017).

Instead, management should have outsourced their product in the first place, which was obviously the cheaper option!! These actions strike me as suspicious, given the “quality” of their board members.
They should have known better!

Not a Very “HI-TECH” company (Red Flag No. 3)

Looking at the IPO admission, the R&D Spending on developing the pallet is minimal.
From 2010-2013, R&D totals less than $1m or £700,000 (before the company discontinued reporting R&D separately).
So, much for the proprietary technology!

Now, on the fundamentals of the company.

Big Losses are No Surprise (Red Flag No. 4)

The initial decision to self-manufacture didn’t help the company finances. Since 2012, capital investment totalled $68.5m (£52m), however, the real loss came from business strategy to stock up on pallets. That caused total operational losses of $257m or £200m in the same period.
How does it make business sense to build-up inventory without having enough customers to sell to?
That’s the real question. Also, this strategy makes it hard for analysts to project the break-even point, which is why no analysts are covering the stock.
Given the change to outsourcing, expect lower operating costs in the future.

The Curious Case of High Staff Costs (Red Flag No. 5)

The costs per employee are $74,000 last year, or £57,000. These salaries are what software employees get paid for, not manufacturers of pallets.
Here is the trend: -

Click the image to open in full size.

If you working for RM2 then you are getting paid out up until last year (employees number cut from 500 to 180, due to outsourcing).
Lesson: - Analysts need to recognise if the skill-level is sophisticated enough to warrant higher pay. Right now, this isn’t warranted.

Paying Off Your Suppliers (Red Flag No. 6)

When trade payables ballooned to $12m in 2015 (which was more than their sales) it is not surprising to see RM2 pay off their suppliers the following year, as payables collapsed to $2.7m.

Furthermore, it wouldn’t surprise if the suppliers’ excuse was RM2 doesn’t generate enough sales, so, therefore, we are shortening their credit period.
If you look at RM2 average payment period, it fell from 77 days to 27 days. Below, it shows the “over-manufacturing” when you are paying your suppliers five times more than you generate in sales.

Click the image to open in full size.

All the Risks are with RM2 (Red Flag No. 7)

In 2016, it outsourced manufacturing to two partners in Jabil Circuit Inc. and Zhenshi (of China).
However, there is serious risks and exposure to RM2.
Jabil Circuit Inc. agreement
The agreement is to acquire at least 188k pallets per quarter over a five-year period. That is 752k pallets per year, a total of 3.76m pallets.
There is a penalty of USD 5.68 per pallet ordered below 143k pallets per quarter. So, if it failed to order pallets for one full quarter, RM2 is liable for a maximum of $812,240 fine.
The penalty applies from April 2017, as they started production in March.
The 143k pallets per quarter equate to 572,000 pallets per year or 47,666 pallets per month. The rate of production in June close to 30k per month.
Also, it will be responsible for excess and obsolete material and inventory.

Zhenshi Holding Group agreement
RM2 agreed to purchase twice as much from their Chinese manufacturer of at least 1.5m pallets per year. Further details of this agreement are kept secret.

These agreements may be normal terms for other businesses, but the projection of manufacturing 2.3m pallets per annum looks unrealistic if they don’t have the sales to back this up.

Double Accounting in financial statements (Red Flag No. 8)

Read their cash flow statement and will notice that Interest Paid and Finance Income, which are both reported on the operating section, also appeared in their investing and financing section.
That is called “double-counting”, and distort the numbers. Here is the screenshot: -

Click the image to open in full size.

And continues here: -

Click the image to open in full size.

Selling price and Rental lease per pallet (NOT RED FLAG)
In 2015, it sold of circa 30,000 pallets which generated $3.7m in revenue. That works out as over $120 per pallet. Also, it rented out 230,000 pallets, which created $2.7m in sales or $11.74 per pellet (though most of these pallets weren’t rented for the full-year).

So, in 2016, the number of pallets rented went up by 35k to 265,000. This generated rental sales of $5.7m, or $21.51 per pallet. However, pallet sales fell to $400,000 with the number of pallets sold being undisclosed.
Renting these pallets are five times cheaper than buying.

The following information is interpreted as I understand with some assumptions made. Please critique and offer your interpretations.

Expect lower cash burn

Before it outsourced manufacturing, the cash burn was $1.9m per month in the last six months of 2016. However, that fell to $1.4m per month in the first five months of 2017, but expect cash burn to increase to $1.7m per month, as it includes the wind-down from their Canadian operations. A total of $18.9m.
Add in one-time costs of $5.1m and $0.6m on Luxembourg VAT.

Forecast Sales
I wish the company would draw up a table to illustrate future orders.
According to the 2016’s annual report, here is their outlook for 2017: -
1. Annual full-year production is expected at 467,000 pellets.
2. The company acquires minimum funding of USD 34.0m to cover issued purchase orders and forecasts orders.
3. It will shortly undertake negotiations to arrange a larger additional financing which is expected to amount to at least USD 65.0m or £50m.
4. It says it has 1.6m pallet opportunities constitute the current commercial pipeline, of which 9% represent straight sales and 91% rentals (either flat fee or per trip) and of which 62% are ELIoT pallets and 38% are BLOCKPal pallets.
Despite all that, there aren’t any projection of 2017’s sales, only the costs of manufacturing.

Management Not So Confident (Red Flag No. 9)

Management didn’t appear confident in the business and made several suggestions that the purchase orders were dependent on the success of external funding.
When looking beyond 2017, management made funding concerns their number one major factor.
To anyone, it is sending a clear signal that funding is no guarantee.
Despite these long-term uncertainties, in the short-term, the business remains operational until the end of this year.
That’s not good enough for long-term investors!!

Convertible Preferred Shares (NOT RED FLAG)

Of the total 92,487,729 Convertible Preferred Shares to be issued, the following were issued as follows: -
No. of shares Type Price Financing (£m)
4,591,743 Class B £0.35 1.6
41,580,215 Normal £0.16125 6.76
46,315771 Normal £0.16125 7.53

A total of £15.9m or $20m.
That will to further dilution to the share price, but more worryingly is the further fundraising at the end of this year. The size is as big as £50m.

Valuation and Strategy (NOT RED FLAG)
The current market valuation of £52m at 14 pence is too high given that it destroyed hundreds of millions of pounds in value by pursuing the wrong business strategy.

What should you do?
If you are new to this company, then I suggest you wait for them to deliver their results.
Take their 1.6m pallets pipeline and using their assumptions. That is 91% rental sales at $22 per unit. It would give a sale forecast of $32m with the remaining outright sales of $110 per unit makes it $15.84m, giving a grand total of $48m in revenue.
That is only achieved in a few years’ time.
Leaving you to ponder, if this represents breakeven. If not, then the current valuation of £52m looks too high.
Also, people shouldn’t forget about the future rise of shares outstanding and dilute the share price. For example, the company can be worth £52m, and trades at 5 pence per share, just because of the increase in the share count.

The best strategy is to observe it for two years and see if it genuinely has a business worth investing. More importantly, is to avoid investing at current levels because the risk of dilution is at 100% and there is a real potential of failure.

Verdict: - Best avoid for a few years.
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The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.
Finally, the writer does not own the company’s stock, unless stated otherwise.
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Old Jul 8, 2017, 1:43am   #18
Joined Jun 2012
i still have about 1200 shares of wh smith bought about 4-6 pounds per share many years ago ,about 25 pounds per share will be the the peak, i think , i also had next about 5-8 pounds per share sold around 28 pound's.i never think UK shares will be easily reach 50 pounds per share what a shame .failed on M$ RR but not that bad
I bought FB 2013 paypal last year and worldpay just few day ago what a surprise movement. a good understanding of share movement is very important.
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Old Jul 19, 2017, 8:01am   #19
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Joined Nov 2016
As Inflation returns, will we see a recovery in the share price of Sainsbury, Morriso

Walbrock Research started this thread After three years in the doldrums that has even caught Warren Buffett out (his Tesco’s stake cost him a lot of money).

Is this the time to consider investing in Sainsbury’s, Morrisons and Tesco?
Or, will we see further problems ahead?

To be fair, both Sainsbury and Tesco’s share price saw stabilisation, while Morrison’s shares are up 70% from their lows of £1.39.

But for a sustainable recovery, we need to understand the factors that are driving the UK grocery market.

Let’s get started.

UK Grocery Market – Identifying the Driving Force

Inflation, Inflation and Inflation!

Inflation plays an important role for grocers because they can raise prices to earn themselves higher margins than normal. But the past three years saw consumer inflation fall close to zero, but food prices went into deflation and are recovering.

Click the image to open in full size.

Food inflation is currently at 2.1% and is a big factor in the recovery of like-for-like sales to the big supermarkets.

Click the image to open in full size.

Whether this is a temporary recovery or a permanent recovery, it is too early to tell. In the past rising food prices resulted in profits bonanza for the “BIG FOUR” UK supermarkets. Now, the game has changed.

New Players in Town

Well, these new players have been operating in the UK since the 1990s. Only recently, and I mean four or five years have they made a dent to the big supermarkets by eating away their market share. (See Below)

Table 1: - UK Grocery Market Share

Click the image to open in full size.

For both Aldi and Lidl, they now account for 11.9% of the UK grocery market and have gained 7.3% in market share from 4.6%, more than a decade ago.

To put this in perspective, both Aldi and Lidl have achieved average market share growth of 10% and 8.4% per year for the past ten years, while Waitrose grew 2.4% per year.

Meanwhile, the BIG FOUR saw average market share decline of between 0% and 1.1% per year.

This market share growth doesn’t come from growing sales at existing stores, but from opening new ones.

Aldi is opening 70 new stores in the UK, but their long-term ambition lies in opening 1,000 new stores to total 2,500 stores, which would rival Tesco. For Lidl, they are looking at opening 60 new stores per year.

That strategy will encroach upon the existing stores of the “Big Four” and will cannibalise their sales. At the same time, it forces them to lower prices to match discounters’ prices, putting pressure on margins.

Will the size of the UK Grocery market save the “BIG FOUR”?

Sales aren’t the issue. For instance, Tesco had 31.1% market share in 2006 with UK revenue at £29.9bn. Eleven years later, Tesco grew UK revenue to £43.5bn, but market share fell to 27.5%.
That’s down to the growth in overall UK grocery market (and the demise of non-food businesses). In that period, the UK grocery market has increased by £51.3bn or 40% increase.

Click the image to open in full size.

If this continues in the next decade, the UK Grocery market could reach £240bn to £250bn a year. Then you could conclude that the pie is big enough for all players.
That is the wrong conclusion because sales aren’t the issue, it is cash earnings. It raises this question:
How much margins are they sacrificing for sales?
If the “making money” part doesn’t exist, then it is not worth being in business.

Now, for the fundamentals.

Companies Fundamentals

Before we get into the fundamentals. Here are some brief backgrounds: -

1. Sainsbury’s has retaken second place from Asda in 2016 by performing less badly. Also, they recently bought Argos owner The Home Retail Group for over £1bn, which extends their non-food products availability.

2. The UK biggest grocer Tesco is dealing with the fallout of an accounting scandal that saw shareholders get compensated for £85m.
In order to restore some reputation, they decided to write down their assets causing them to report the biggest accounting loss (£6.4bn) in history from a UK retailer.
Tesco’s market share fell from 31.3% to 27.5% in the past eight years.

3. Morrison’s share price recovery from their lows in 2016 is down to rumours of a takeover from a private equity firm.

But a better takeover rumour could come from Amazon because both companies have a partnership deal to supply Amazon Fresh. Given Amazon takeover of Whole Foods, this is becoming a real possibility. Meanwhile, their partnership could increase profits by £50m to £100m.

However, investors aren’t happy with management pay structure, with more than half voting against big bonus increases from long-term performances (an increase from 240% to 300% of basic salary). Also, EPS performance target is lower to 5-10% from 6-13% growth.

Staff Productivity

Supermarkets employ a lot of people (Tesco’s 218k, Morrison’s 77k and Sainsbury’s 119k full-time equivalent UK employees), therefore relevant to operational performances.

Using the average “full-time” employee data we depict the following:
Initially, both Sainsbury and Tesco produces more than Morrisons (£30k to £40k more sales per staff).

Over time, Morrisons has caught up.

Meanwhile, Tesco’s sales maturity turned into a decline with sales per staff falling below £200k.

Click the image to open in full size.

(P.S. Tesco’s figures are based on their UK business.)
With sales per staff stagnating, how will the grocers manage to keep costs low and maintain margins?

The answer is they couldn’t (see below).

Using normalised earnings, all three grocers saw profit per staff falling.
Tesco was the biggest faller, as it fell below their rivals.

Click the image to open in full size.

The reason is down to staff costs rising per person. For example, Sainsbury’s staff costs rose from £18k to £24k in ten years. The problem began when sales per staff stall, while wages rose a further £1.3k (£24k minus £22.7k).
Still, employee data is a lagging indicator, unless you are Tesco!

Cash Cycle

All three register negative cash cycles. After all, customers were paying for food in cash.

Click the image to open in full size.

However, a closer look would see analysts pick Morrisons as the odd one out.

Morrisons minus 32 days, compared Sainsbury’s minus 11 days and Tesco’s minus 12 days helps reduce working capital requirements, but this leads to delaying payments to suppliers. The 10-year average is 35 days and currently, stands at 50 days. Both Sainsbury and Tesco payable period are 38 days and 34 days.

Also, Morrisons trade payables have doubled, compared with sales growing by 35% in the same period, another way of checking payment delays.

Tesco accounting scandal is due to delaying payments to suppliers to bolster cash earnings. I’m not saying Morrisons is guilty of that, but it warrants further investigation.
Meanwhile, Sainsbury deteriorating cash cycle is due to their acquisition of Argos.

Capex and Assets

Supermarkets are “asset heavy” businesses, despite the growth in online shopping. Therefore, it’s a good idea to examine the value placed on these assets and spot changes to capex spending.

Below is an overall look:

Click the image to open in full size.

The first obvious trend is the slowdown capital spending as capex to depreciation fell to either 1.1 or 1.2, a big drop from their ten-year average of 1.8 to 2.4 times. It barely sustaining their business size.

While this is going on, Morrisons and Sainsbury are saving a few hundreds of millions in capex, whereas Tesco saved around £2bn to £2.5bn each year for the past two years.

Low spending won’t last for long. Already, Tesco is eyeing a purchase of Booker for £3.7bn (if successful).

Sales growth for all three averages 3%-4% per year, compared with double-digit growth from Lidl and Aldi.

Looking at assets valuation, Tesco overall assets are at 54% of original costs, compared with the average 70%, due to the writedowns of between £4bn and £4.5bn. When compared to Sainsbury’s and Morrisons, Tesco’s assets are 10% and 14% lower respectively.

Now, let’s see the compositions of the overall assets.

Click the image to open in full size.

To make things simple, let’s divide this into two sections:

Land and Building/Freehold and Leasehold

Both Tesco and Morrisons are valuing their prized assets at less than 70% of original costs, whereas Sainsbury’s is putting a value of 76%.
On their ten-year average, all three grocers had these assets above 80% of original costs.

Revaluation, a probability?

Take Tesco, for example. If business returns back to normal, they can revalue their assets back above 80% and could potentially realise a £3bn in accounting gain. Or, Tesco could revalue their assets slowly plug any shortfall of earnings over a number of years.

Fixtures and Equipment

In 2015, Morrisons wrote off £1.5bn of assets. (See annual report 2016) Although they reported £1.1bn of impairments, they didn’t revalue the net book value (the number that gets reported in the balance sheet) causing it to register 60% of original costs, rather than the average of 36%.

Normally, writedowns are reflected on the balance sheet.
That resulted in shareholders’ equity being £300m to £400m higher.
Instead of Morrison reporting 2016’s equity of £3.75bn, it should be around £3.3bn to £3.35bn.

Unlike, Tesco, Morrisons won’t see improvements in profits from revaluations.
Again, Tesco has written-off more of their fixtures with NBV at 23.5% of original costs.

Overall, Tesco will see asset value realisations, if business gets back to normal. That remains a distant dream for the traditional supermarkets.


All three supermarkets saw improvements in their net debt positions with Tesco seeing the largest.

Click the image to open in full size.

But, what if these improvements are slightly exaggerated?
For the diligent analysts, another appropriate measure is what I term “Real Net Debt.”

It includes:

Original net debt;
Trade Receivables (minus);
Trade Payables (plus) and
Pension deficits/surplus (plus/minus).

It resulted in this chart.

Click the image to open in full size.

Improvements not that noticeable, also it reflects a shift in borrowing strategy to “non-interest” credit lines.

Still, these figures are better than 2015.

Some of the debt reductions are down to disposal and sales and leaseback.
For instance, Tesco sold their South Korean business Homeplus for £4.2bn, Dobbies Garden Centres for £200m, Lazada stake for £90m, Private jets for £66m, and Harris + Hoole coffee shops for an undisclosed sum.

Meanwhile, Morrisons net debt improvements are due to increasing transactions of its sales and leaseback, which saw operating lease growing rapidly (see section: Operating Lease). Anyone who studied Tesco diligently knows this method is short-term and leads to long-term problems.

Making sense of net debt and real net debt

Comparing it to sales and assets paint a picture on the proportion to the size of the business.

Table 2: - Debt, compared to Sales and Assets

Click the image to open in full size.

When it came to net debt, all three saw big improvements, but real net debt exposes Tesco and Morrisons (current figures above ten-year averages), while Sainsbury produces the best improvement.

For proof, look no further than “net interest costs”, where Sainsbury is falling, while Tesco and Morrisons are rising.

Click the image to open in full size.

Table 3: - Debt against Normalised Earnings

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Again, Sainsbury made the best improvements, while Tesco and Morrisons saw high multiples.
To be fair, Sainsbury has been highly-leveraged in the past, that is now seeing slight improvements.


The effect of the UK interest rate being close to zero and the stock market at record highs resulted in lower Gilts yield and dividends yield. That has caused pensions assets to return money every year (in proportion to pension assets size).

Click the image to open in full size.

Here are some interesting data, when comparing pension assets in 2006 to today: -

Sainsbury’s pension assets grew by 167%, but the absolute returns increase a measly 30%, which currently yields 2.78%, a far cry from 5.74%.

Tesco grew their pension assets by 283% to achieve 84.2% in expected returns. Current yield is at 2.92% from over 6%.

Meanwhile, Morrisons increased their assets by 204% to increase expected returns by 74%, while it is currently yielding above 3%.

With the continuation of low returns, these grocers have to contribute more of their profits to pay for past employees’ retirements.

This trend affects all businesses that have established pension schemes.

That leads to another problem, which is pension liabilities accounting for a greater proportion of company’s sales.

Table 4: - Pension’s Liabilities as % of Sales

Click the image to open in full size.

Tesco saw the biggest increase in their pension liabilities and is second behind Sainsbury.

Tesco saw pension liabilities increased by 24% percentage points, compared with Morrison’s 10.8% and Sainsbury’s 14%.

You would think a growing pension liabilities lead to higher pension deficits. This isn’t the case for Sainsbury and Morrisons, but I’m no actuarial. So, a further investigation is needed.

Operating Lease

In the past, Tesco is guilty of using sales and leaseback to book non-core profits. That quick fix to boost EPS, and not focusing on core business has cost them a lot of money in wasted investment. Now they are deleveraging through disposals.
On the other hand, Morrisons been engaging in sales and leaseback that resulted in £500m of property sales in the past.

Click the image to open in full size.

Despite the size of Tesco’s operating lease its net rental expense as % of sales have fallen below that of Sainsbury. At 1.87%, it is lower than Sainsbury’s 2.49%, while Morrisons rents account for 0.7%.

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A look at total operating lease against sales gives the reason why Sainsbury pays more in rent.

Table 5: - Operating Leases

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Sainsbury’s operating lease accounts for 40% of sales making it the highest, but they operated at this level for a while.
The deleveraging of leasing is apparent in Tesco, as it saw operating lease account for 22% of sales, having peaked at 27% in 2012.

Despite, seeing low operating lease from Morrisons, theirs have increased from 4-5% to 15%. That is alarming, but unsurprising as bosses choose the easy route to realise value.

Given the low levels of rental expenses, does this pose a threat to companies’ distribution of earnings? Apparently, it does, if we use the fixed charge coverage ratio.

The coverage from earnings has all but collapsed. And it has affected their ability to pay dividends with Tesco cancelling them altogether. Both Morrisons and Sainsbury saw some big dividends reduction.

Click the image to open in full size.

Cumulative Free Cash Flow

Free cash flow is an important indicator of a competitive business it is also volatile, which depends on the levels of capex spending.

The solution is to cumulate all cash inflows and cash outflows over a period of time to work out the resultant free cash flow. This method would smooth out some volatilities and give an accurate reading.

Click the image to open in full size.

This makes for some interesting reading.

Overall, Morrisons is likely to convert post-tax earnings into free cash flow at an average rate of 37.73%. This means it produces an average free cash flow of £200m per annum enough to pay their annual dividend, which average £196m.

Sainsbury registers a negative free cash flow of £319m.

Tesco has registered cumulative free cash flow of £3.2bn, equivalent to 11% of free cash flow. Like I said before, it depends on capex spending and for Tesco, they saved £5bn in two years!

Supermarket’s Valuations

Companies with huge debts and a pension deficit require a conservative numerator. Normally, I would use Enterprise Value, but I will adjust the EV to include receivables, payables and pension deficits. (Known as Adjusted-EV)

Using five widely used measurements, we get this: -

Click the image to open in full size.

Sainsbury is the cheapest company when compared to their 10-year average. Also, Sainsbury has a much lower valuation overall.
However, these valuations are very volatile and the numbers are inconsistent given the growing threat from new competition.
But, most importantly, these basic valuations can’t tell you if the shares are a buy or sell!

One other method is to use the Earnings Power Value.

Earnings Power Value/ Cash Earnings Power Value

The logic behind earnings power of a company is to look at the profits of a business over a long period of time and then estimating what the average profits would be when taking into account all likely business conditions.
To see how I calculate Earnings Power Value (EPV) and to learn more, read this article by Phil Oakley.

For those sceptical about accounting earnings, I also include the use of after-cash tax operating cash flow measure.

The general rule is to buy shares when (EPV) per share is above 100% of current share price because the market is discounting the fundamentals. And like every valuation tool it fails to recognise external threats and internal failings.
Another issue is choosing the right interest rate, this lead to Phil Oakley’s guide to choosing interest rate.

• Large and less risky companies (FTSE 350) - 7% to 9%
• Smaller and more risky (lots of debt or volatile profits) - 10 to 12%
• Very small and very risky - 15% or more

(P.S. The higher the interest rate chosen, the lower the Earnings Power per share.)

For this exercise, I have chosen to use three interest rates of 9%, 10% and 11%.
(N.B.: My focused analysis is interest rate at 9% unless stated)

First up Sainsbury’s.

Click the image to open in full size.

On an earnings power value basis, Sainsbury valuation was very expensive ten-year ago, when it had a 75% premium. One reason was Qatar’s sovereign fund wanted to buy the whole supermarket for £12bn.
As that didn’t materialise, the shares took a tumble and trade around £3, cutting the premium by half.
A ten-year trend sees EPV per share averages £2.19 with the current price at £2.06. That is lower than the current share price of £2.45 or a 16% premium, although this is lower than the average premium of 29%.

Using the cash earnings power value, the opposite is true. Even at a higher interest rate of 11%, it trades at a discount of 10% to 20%.
On a 10-year basis, it trades at an average 49% discount, but it currently trades at a premium.

Next up is Morrisons.

Click the image to open in full size.

For Morrisons, it is trading at a premium of 34% but fundamentals are improving.
But, the cash earnings power value suggest value as the current share price gives it an 86% discount, compared with the ten-year average of 33%. Some of that is attributable to Morrisons delaying cash payment to shareholders to boost cash earnings. (Refer back: Cash Cycle)

Finally, we move onto Tesco.

Click the image to open in full size.

Despite seeing a 70% share price collapse, the EPV per share decline is greater and currently stands at 65 pence per share, a 63% premium and higher than their ten-year average of 30%.

Even shocking is if you require an 11% interest rate, due to risk this cuts EPV per share by half to 30 pence and makes the current price even more expensive.

Right now, the earnings power value is telling you to stay away from Tesco’s share price as it is fundamentally weak.

Which supermarket should you invest in?

None of the above.

That’s because all three companies have their separate issues.

You can make the case for and against each company, here is a summary below: -


Solid Earnings;

Normal cash cycle;



Assets are perfectly valued, no revaluation gains;

Growing operating lease;

Higher rental expense as % of sales;

Negative cumulative free cash flow since 2006;

Low fixed interest charges.

The case FOR MORRISONS are: -

Improving earnings; some of this is from increasing use of sales and leaseback;

Growing staff productivity;

Low rental charges;

Low operating lease, but this is growing.


Shareholders’ Equity looks overvalued because of no change in the net book value of fixtures and equipment, despite writing off £1.5bn of original costs;

Average payables period is at their highest of 50 days, whereas Tesco and Sainsbury are below 40 days, helping to boost cash earnings;

The case FOR TESCO are: -

Potential future accounting profits, due to kitchen-sinking their assets;

Some improvements in debt deleveraging;

Operating lease has peaked and is now declining;

The case AGAINST TESCO are: -

Still, highly-leveraged when measuring debt against normalised earnings;

Growing pension deficits;

Loss of reputation following the accounting scandal;

Fixed Interest coverage is the weakest;

Earnings power value per share is 65 pence per share compared to current share price of £1.73 giving it a 63% premium.

The Shrinking Market Share will keep on Shrinking

Earlier in this post, I mentioned both Lidl and Aldi controlling up to 11.9% from 4.6% in 2006. That market share growth is at an annual pace of 10% for Aldi and 8.4% for Lidl.

What if this continues for another 10 years?

How will this affect UK supermarkets?

Achieving the same growth rate looks unlikely, so I will lower the growth rate. Instead, there are three growth rate scenarios.

Here are the results: -

Click the image to open in full size.

If we choose the lowest market share growth rate of 6% for Aldi and 5% for Lidl, then the combined market share at the end of 2027 will come to 20.9% another 9% increase and also higher than the 7.3%!
At the high-end (Aldi grows at 8% and Lidl at 7%), it gives a combined market share of 24.7%, a 12.8% increase.
What does this mean?
Aldi and Lidl will take more of the pie and causes more miserably for the rest of the supermarkets.
It will add further pressure for cost savings.

Amazon Fresh

To add further headaches there is another threat brewing, that is Amazon launching their Amazon Fresh in the UK and selling food online. The one area where supermarkets are seeing double-digit growth is being targeted by a company that has millions of UK customers.
Another thing, the recent purchase of Whole Foods show the company intends to enter the bricks and mortar space too.
If there is one company that would benefit from Amazon it is Morrisons because they have a partnership to supply groceries. With speculation of a takeover from Amazon growing.
However, the rise in Morrisons share price has priced in some of that takeover value.

Final Thoughts

Unless there is a law limiting foreign ownership of the UK grocery market, then this isn’t good for Tesco, Sainsbury, Morrisons and Asda.
If Lidl and Aldi gain a further 9% to 13% in the next decade, you will greater falls in market share from the big four. Cause and Effect!!
So, it is not surprising that both Sainsbury’s and Tesco are moving away from their core business to venture into non-foods and wholesaling. However, this is no means a successful move, especially Sainsbury buying Argos (fierce competition from Amazon).

For those long-term shareholders, it is still an avoid for the big UK supermarket stocks.


The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.
Finally, the writer does not own the company’s stock, unless stated otherwise.
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Old Aug 7, 2017, 12:53pm   #20
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Explaining Carillion PLC £845M impairments

Walbrock Research started this thread To explain why Carillion had to make £845m provisional impairment charge, you must follow 5 sequential FACTORS leading up to this conclusion: -
1. Since last major acquisition in 2011, Carillion EPS fell from 37.2 pence in 2012 to 28.9 pence in 2016.

2. Carillion acquires THREE major acquisitions costing £1.2bn. It has combined sales of £3.5bn or 70% of group sales.
After acquisitions, performance is poor. Here’s why: Cumulative net LOSS = £20m! And Cumulative operating LOSS of over £200m. This begs the question:
“How on earth did they achieve cumulative operating profits (since 2007) of £1.55bn and cumulative net profit of £1.27bn?”

3. One explanation is utilising their Receivables. Their trade receivables numbers are perfectly fine, but the “Other Receivables” is a big concern. (See graph here ) Using total receivables, as % of sales as a measure, it has averaged 30.5% in the past four years (in contrast with trade receivables). Normally comes in at 21%-22%.
The 8%-9% difference is equivalent to £300m-£400m per year for past four years. That boost = GREATER than operating profits!

4. Another sign of manipulating profits is comparing cumulative cash earnings (£166.4m) and accounting earnings (£688.9m) in the last five years. The difference is startling.

5. The BIGGEST FACTOR is that fund managers have noticed High Carillion’s total receivables and high total payables as % of sales have averaged 37.6% (normally at 29.5%). This is a double whammy because rising credit sales will lead to bigger provisions and asset write-downs. (this explains £845m impairments) While delaying payments to suppliers for the future leads cash crunch. (it explains asset disposals and Rights issue rumours)

For detailed analysis, go to
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Old Aug 29, 2017, 10:26am   #21
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A look at Premier Oil

Walbrock Research started this thread Premier Oil is at peak or near all-time highs valuation, depending on your perspective.

If you look at equity alone, then PMO shares at down 90% from 2011 peak.
When you include debt and equity together, minus cash, then PMO is at all-time highs!
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Old Aug 29, 2017, 2:57pm   #22
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Originally Posted by Walbrock Research View Post
Premier Oil is at peak or near all-time highs valuation, depending on your perspective.

If you look at equity alone, then PMO shares at down 90% from 2011 peak.
When you include debt and equity together, minus cash, then PMO is at all-time highs!
Would you say its not going to go any lower?
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Old Sep 19, 2017, 7:11pm   #23
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Greene King, a dividend investment

Walbrock Research started this thread Greene King, the 218-year-old pub operator from the UK has seen their share price fell by 40%. The stock is currently yielding over 5% and has always been a consistent dividend payer.

Here are some good reasons why I think Greene King is a safe business for your portfolio:
1. The pub has solid freehold properties worth £3.2bn that easily cover net borrowings of £2.1bn. In fact, the excess £1.1bn covers 64% of their market capitalisation.
2. EBIT Yield of over 8% is above historical average meaning undervaluation.
3. Using the earnings power value, the stock is 40% undervalued.

However, investing now would risk you losing a further 10%-20% of share price because:
1. The monthly share price is in negative sentiment, which requires time to give definitive direction
2. Due to high inflation, eating out and having a pub is the first to get the cut from households when wages fail to keep up with inflation.

The shares could drift towards £5 or £4.50 in the next three or four months. But, don’t worry this represents a buying opportunity.
So, put Greene King on your bucket list.
Feel free to leave questions.
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Old Sep 20, 2017, 9:34am   #24
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Is Interserve the new Carillion?

Walbrock Research started this thread Since I cover this stock and given the demise of their share price people want to know if the stock is super undervalued.
The update clearly states the company is struggling with disposing of their waste assets and it is likely to cost significantly over £160m. Whatever “significant” means are anyone guess until management clarifies it in further RNS.

Below is the valuation/write down on each Interserve division:


This is Interserve high-value asset, but how much will it fetch in the market?
First, the average operating profits growth comes to 24%, but last year growth slowed to 9.2%.
Second, it has net assets of £226m, comprising of £290.8m in assets and £64.4m in liabilities. So, we can assume the company holds little debt apart from payables, some provisions and pension deficits.
Third, it has a high EBIT margin of 21% and makes 16% return on assets. With £48m in operating profits, deduct 20% for taxes which leaves it with £38.4m in after-tax profits.

Based on the above assessment, I would attach a 13-times multiple on after-tax profits giving it a £500m valuation. That is higher than their current valuation and twice the value of their net assets.
The reasoning behind this is because of the high EBIT margins (20%+) rather than the group average of 2%-3%.

The downside is we don’t know how much operating leases that equipment services are responsible for!

UK Support Services

Their most profitable division and biggest division.
First, the average profits growth is 23.2%, but last year it saw a decline of 12.36% meaning either things have gotten worse or this was a blip. I suspect the former!
Second, it has NEGATIVE net assets of £11.1m, comprising of £372.4m in assets and £383.5m in liabilities. So, you can bet it has a lot of obligations attached.
Third, the EBIT margin saw a gradual improvement to 4.5% and it makes a decent return on segment assets of above 20%.
Fourth, after-tax profits would come to £64m.

Given that it is responsible for a lot more liabilities and requires increasing capital to grow profits, but produces lower EBIT margin, then it is wise to attach a lower multiple.
So, I would give it a 4 to 7 time after-tax profits valuing it between £256m and £448m.

International Support Services

A former shining star.
First, this division average 18% profits growth, Today, it is producing zero profit growth.
Second, it has net assets of £55.2m, comprising of £128.6m in assets and £73.4m in liabilities.
Third, this division was Interserve best division with EBIT margins of 15%, but has fallen from grace. Now, it earns a measly 3%, along with negative returns. With £8.2m in operating profits and deducting 20% tax gives it £6.8m in after-tax profits.

At best, potential bidders would pay no more, then the division’s net assets of £55.2m. The reasoning is lower EBIT margin.

UK Construction Services

First, it has average 33% negative profits growth, which saw their operating profits fell from £24.5m to an operating loss of £3.1m, despite increasing revenues.
Second, it has net liabilities of £179.2m, comprising of £255.4m in assets and £434.6m in liabilities. My suspicion would be that this division carries the bulk of the company’s liabilities.
Third, this division has negative EBIT margins.

If Interserve sells this division, it would be a “write-off” division leading to a provisional impairment. Therefore, expect a writedown of £200m-£300m. Sometimes, these writedowns are not free of charge because the company wants to pay off some debt, therefore they would issue new equity or do a Rights Issue.

International Construction

A turnaround division.

First, despite negative average profits growth of -2.8%, their latest profits growth is around 30%!
Second, it has net assets of £63.6m, comprising of £63.6m in assets and £0m in liabilities.
Third, EBIT margins have recovered to 5.69%. With £16.9m in operating profits and deducting 20% tax gives it £13.6m in after-tax profits.

This is an improving and recovering division with zero liabilities attached. Also, it has a decent EBIT growth and improving returns on segment assets. I would give it a multiple of 11 times after-tax profits valuing it at £149.6m.

Adding it all together

Adding all the sums of its parts gives Interserve a valuation of £806.8m.

However, the group has net debt of £274.4m and pension deficits of £52.4m. After these deductions, Interserve has a valuation of £480m. Current market value has tumbled to under £300m.
But, the above information is based on last year.

Have the 2017’s interim results change Interserve’s valuations?

Support Services

Starting with their UK Support Services, H1’s 2017 operating profit has fallen to £29m from £43.2m. I estimate the full-year number to come in at £55m, down from £80.8m last year. So, it leaves after-tax profits of £45m.
Also, I will lower the multiple ranges from 3.5 to 6.5 times, valuing it between £157.5m and £292.5m.

Their International Support Services saw operating profit (almost) wiped out as it comes in at £0.9m down from £6.5m, though it was an improvement from a loss of £0.3m in H2 16. Management is optimistic due to increased workload, but for prudence, I will knock £5m and value this division at £50m.


Their International Construction saw profits increased to £8.3m from £6m, a 38% increase. This will add more value to the business. However, there is growing political risks as operations are in the Middle-East, so I will leave valuation unchanged at £149.6m. Otherwise, it would increase to £200m!

Meanwhile, the company’s UK Construction saw an operating loss of £2m from a £4.5m profit. With the waste business disposed of, I suspect net liabilities to fall, but I don’t have confirmation of this. But, I will it the benefit of the doubt and improve writedown provisions from £200m-£300m to £140m-£240m.

Equipment Services

This division performance remains relatively unchanged, but operating margin has fallen slightly. Valuation unchanged at £500m.

Overall Results

Here is the table showing sums of its parts on my forecast 2017:
Putting it together, Interserve’s sums of its parts is down to £734.5m. But, with net debt rising to £500m and an estimated pension deficit of £75m, the market equity has fallen to £159.6m from £480m!
Higher debt levels have taken a lot of value in Interserve business making it expensive.

Hope this explains the Interserve business clearly.
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