Airea is trading below liquidation value

CORRECTION: There is an error in this article. Airea is trading at a 4% premium to estimated liquidation value!

Carpet manufacturer at 19% discount

The net-net calculation used by the Bargain screen to find the very cheapest companies is an approximation of an approximation.

Inventing it, Ben Graham reasoned that some current assets, the only assets Graham considered sufficiently liquid and easy to value, would fetch less than the values recorded on the balance sheet in a closing down sale. Using book values as a proxy for liquidation value would overvalue the company somewhat.

On the other hand he ignored fixed assets, property, plant and equipment, which would probably have some value, however uncertain, if the company was no longer a going concern. The over-valuation of current assets would cancel out the undervaluation of fixed assets and, as a crude measure, net current asset value would do.

A potentially more accurate, but still approximate estimation of liquidation value can be achieved by reducing the value of current assets and accounting for the value of fixed assets using the pretty arbitrary multipliers in the worksheet below (% of BV column):

Since Airea has yet to publish it’s annual report and doesn’t break down property, plant and equipment in its preliminary announcement, I’ve assumed a similar split as last year between property, which is valued at 50% of book value in this calculation, and plant and equipment, which is valued at 10% of book value.

The share price is 35% below net current asset value, an approximation of an approximation of liquidation value, and 19% below liquidating value, an approximation!

That’s unusual for a profitable company.

Caveats:

  1. Airea is committed to nearly £5m of rent payable under non-cancellable operating leases on property and vehicles. Arguably I should have added the leases as an asset and a liability in the worksheet (which, arguably, companies should include on their balance sheets). If Airea had to sell the leases, there’s no guarantee it would get full price, so I’d have to apply a multiplier to them as with the other assets, bringing down the value of its assets in a liquidation. On the other hand, I’ve ignored a deferred tax asset of nearly £1m, which, assuming the company remains profitable should increase the company’s profit in future, and its valuation now.
  2. Airea shares are illiquid, the mid price is 11.5p, but an investor buying in today’s market would probably pay closer to 12.5p. That reduces the discount to liquidation value to 12%.
  3. This model ignores some costs that would almost certainly have to be paid in an actual liquidation, redundancies for example, so I’d hesitate to rely on it were a company actually liquidating.

Using liquidation values requires less guesswork than forecasting future profits, but beneath the surface there’s still a fair bit of fudging going on.

Nevertheless, Airea has passed this test. Providing Airea remains a going concern, I can say with some confidence it’s in bargain territory.

Comments

I think its a candidate for sure. I'm yet to do an in depth analysis myself. Thats for saturday :). I have a concern in the calculation. Graham, to memory didnt consider the non-currents in the NCAV in Security Analysis allthough I think your liquidating values are spot on.

Without the Non current assets which i certainly acknowledge in this day and age, I see a Ncav of 8.9p and 5.7p for deductions of Short term and (Short plus long term) liabilitys.

With the price at 11.5p, how do you feel about the margin of safety in this respect. Is the dividend enough to compensate, just my 2p...

Interesting find. Those net-nets seemed to have worked out fine for Geoff Gannon.

Hi Blippy. It's worked out well *so far* for Geoff's Japanese net-nets - he's had them six months I think, and I imagine he's expecting bigger returns in future! I think, particularly with net-nets the timetable is years not months.

Hi Robert, my worksheet is adapted from Security Analysis (1940 edition), and described here: http://blog.iii.co.uk/net-net/

It's based on his worksheet for White Motor Company in 1931 (on page 587).

Not sure how you are calculating net current asset value, but using current assets - total liabilities I make it 17.6p, so there's a considerable margin above the market price of 11.5p.

I used to own these guys back in 2010, but only for a couple of months. It was a 'last of the net-nets' effort until I got fed up owning rubbish companies.

History says these blighters work out in the long run (on average), assuming you're diversified enough and have the nerves for it. It's a 'close your eyes and hold your nose' investment style but one that worked well for Graham and Schloss for decades.

Hi John, I agree with you, up to a point.

The best performing company in the Thrifty 30 at the moment is French Connection (up 85%). It was a net-net when I added it. It's has in the past been a very good company, iconic even, and maybe one day it will be again. Certainly its chief executive and major shareholder has turned it around before. Branding net-nets as 'rubbish companies' is a generalisation, although it's fair to say they're almost certain to be performing poorly at the moment.

Of course one example doesn't prove anything, except perhaps you shouldn't generalise... Investing in net-nets is difficult psychologically, and not just because the companies themselves are doing badly. There's also a paucity of information about them because investors and analysts are disinterested. That explains why they are most likely to have anomalous share prices, and therefore why they often produce outsized returns. But the life of a net-net investor is a lonely one, and the kinds of companies we pick are likely to repel other investors - as you are demonstrating.

As you know, I don't just include net-nets in the portfolio, although I am attracted to them I have to admit.

I think you're both right ;)

Things have to be fairly dire to be a net-net. Maybe you get a situation like Japan where they are abundant - in which case it probably makes sense to invest. For the UK, though, we haven't seen a good net-net era for decades. Maybe we'll get there someday - maybe even within a decade - but you'll almost certainly regret the circumstances which lead us to that type of situation!

I can sympathise well with John. You end up with too much rubbish. If one could be reasonably certain of earning returns in the 20 percents, then sure, lets load up the truck with the smelly stuff. But, like John, I don't think it's that straightforward.

Best of luck with your portfolios, guys.

Hi Blippy, not just Japan. How about the UK in 2008? I picked 13 net-nets for Money Observer magazine in 2008 and they returned 126% in one year, see: http://blog.iii.co.uk/nn/ .

That is of course a freak result, and one I may never repeat (I don't even try over a year). But I just use it to warn against assuming net-nets out of existence.

The only UK study of net-nets I know of is linked in the blog I mention. It's by Glen Arnold and Ying Xiao and they found that £1m invested in a series of net-net portfolios, each held for five years, would have increased to £432m between 1981 and 2005.

The same sum invested in the stockmarket would have have increased to £34m.

To get Xiao and Arnold's returns you'd have had to have, in some years when net-nets were very few, run a concentrated portfolio.

I agree that investing in net-nets is difficult, psychologically you have to buy companies that have done poorly in recent times, and physically you have to do your own research.

However, I think the returns are there, for people prepared to invest in them. And that's been proved many times through history.

Richard, very interesting. I didn't know about 2008. 126% sure is enticing.

Well, as I said, that was 2008! Today is 2011. I have no expectation of returns like that over that time frame. But I do keep my eyes open for net-nets.

"re-sets comment thread to avoid squish"

Sorry Richard, of course, 'rubbish' is a description of the average quality of these companies
;-)

I was going to mention French Connection since I did own them back in the 2008 net-net glory days. Made a reasonable profit too but sold out 'too early' as usual.

However, I'm not sure I'd call them a good company. Perhaps they were back in the last century, but certainly in the last 10 years they've gone nowhere. Revenue flat in over a decade (so that's down quite a bit in real terms) and earnings half what they were back then.

So I'd say that they are a mediocre business with a well known brand and a vast £30m cash pile. In other words, a great net-net. But now at 70-odd pence I think they're overpriced (with a PE10 of about 7 but zero growth and only a 2% yield). But that's off topic.

Back to net-nets - I think it's one of the great strategies and if I could turn off the fear I'd follow it, but when it's my retirement money at risk I just can't take all the bad news these companies generate!

Hi John, I'm afraid I have to disagree. 'Rubbish' isn't a description of the average quality of net-nets. Rubbish is something you throw away. To me rubbish has no value, or very little value. The fact is net-nets as a group are usually very good value as indicated by the Arnold study, and the experience of investors who invest in them. They may not be highly profitable at the moment, they may have been through or be going through years of painful restructuring, some of them may go bust. But because the expectations of investors generally are so low, on average, or if you can pick individual winners, they make very good investments precisely because they are not rubbish and most investors think they are!

Richard,

Thanks for the info on Airea, trash or not stocks like this get me excited. I'm going to dig into the numbers myself, but this is the sort of company I love to own in my portfolio. Thanks for bringing it to my attention!

Nate

Cheers Nate - like minds :-)

I hope you'll blog the outcome!

Hi Richard,
I notice there's a pension liability in your numbers - I'd check out the size of the pension liabilities and consider factoring in an increase in the size of the liability.

Hi Trident, thanks for your comment. You're right of course, the pension liability could increase. It decreased significantly in the latest year, mostly due to a technicality. I will have a closer look at the pension although I'm unlikely to adjust the valuation - mainly because I don't know how to in any way that isn't completely arbitrary. My attitude towards pension funds tends to be either they're big enough to worry about, which blows the case for the whole investment, or they're small enough to ignore the risk of an increase in the deficit.

Hi Richard

I think you're right to fess up that you don't know how to value the pension liability on a company's accounts. I think the real problem is that no-one really does and it will always be out of date and very exposed to general market valuations and interest rates. I'm very conservative in my approach to companies with a defined benefit scheme and just won't take a big position in any company with such an arrangement. Somewhat limits the number of companies I can invest in though.

It's certainly an added complication with Airea. I've had a closer look, and this my thoughts on the pension fund are buried part way down this post: http://blog.iii.co.uk/correction-airea-is-not-trading-below-liquidation-...

You're mentioned!

Thanks for the clarification on Airea. What are your views on the company as a result of the revisions? It doesn't look too attractive on either an earnings basis or an asset-based valuation as far as I can see.

Just to add to the debate on "rubbish companies", I guess it depends what kind of 'value' investing you're doing.

The Thrifty portfolio is closer to the 'enterprising' approach, which is possibly a riskier approach (though this is debatable) investing in secondary companies that appear undervalued. I say debatable because the Thrifty portfolio appears to have displayed less volatility than its FTSE 350 benchmark and generated better returns.

John's approach looks like it based more around the 'defensive' approach, where stocks are added when considered cheap by historical standards, which will tend to focus on buyng leading (or good) companies at cheap or fair prices.

Hi Prof, I'm just forming my views. But in a nutshell I think it's cheap, and management are increasingly committed (increasing their stakes in the business) and doing the right thing. However there are significant uncertainties about the business (tiny profit this year, worse than last, negative cashflow - will post more later) and the valuation (pension obligation is big and unpredictable).

You always have to compromise in investment but I prefer not to compromise too much. Contrary to your 'entrepreneurial' description of the Thrifty 30, I think of it as a safety first approach. So as I bring my research on Airea to a conclusion (one more post). I'm thinking I'd like more certainty, either around the pension fund, which seems unlikely, or its trading performance, which may mean waiting to see how it does in 2011.

Regarding the rubbish debate, I think John used the term emotively. Empirically they're not rubbish - generally net-nets have value. The danger in portraying them as rubbish companies is you ignore that value! I think there's more than one kind of value, and I try and include good companies at cheap prices in the Thrifty 30 too. However, I'm not going to pass up a bargain, if I think I've found one.

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