MS International (MSI)

 

Chasing MS International down

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Somewhat diversified, with experienced management and a strong balance sheet, investors may be wrong-to sell off MS International despite the lull in defence spending.

What it does

MS International (MSI) manufactures naval gun systems and other narval hardware, forges fork arms for forklift trucks, and makes petrol station canopies and car washes.

The defence division earned just over 50% of revenue in year ending March 2013, with the remainder split between forgings and superstructures.

How it plans to win

The company targets niche markets, where it claims market leadership and stresses its “unending commitment” to invest wisely in future profitability:

Our strategy is based upon the belief that maintaining reasonable and acceptable levels of profitability across the three Divisions emanates from an unending commitment to invest wisely in support of ‘in-house’ product development programmes, the upgrading of production equipment to ensure efficiency and striving for the relentless and constant improvement in everything we do. Our commitment to this policy is absolute

The company has a hundred-year history manufacturing and supplying defence equipment, currently the SEAHAWK gun system, plotting tables, and compression chambers for navies, and shelters, containers and vehicle bodies for armies. MSI-Forks promises any configuration, section size, blade length and back height for every conceivable application. About sixty per-cent of revenue comes from abroad, suggesting, along with ample profitability, MSI has a good reputation in its niches.

The Petrol station superstructures business perhaps has the best immediate prospects as supermarkets build new locations and demand for petrol stations increases in Eastern Europe thanks to road building programmes.

Executive chairman Michael Bell has a 26% stake in the company and has run it since 1980. Fellow directors David Pyle and Michael O’Connell also own substantial holdings. They’ve been good stewards so far, diversifying into petrol station superstructures and maintaining MSI’s financial strength. Their long-term focus may be a source of competitive advantage.

Risks

All three business are dependent on investment by governments or other companies, although defence spending and the business cycle do not necessarily coincide, so diversification may reduce some of the extremes of profit and risk.

Currently defence spending is constrained but in November’s interim results the company claimed it has a “solid base load” of contracted business through to 2020:

Clearly, our objective is to build on this excellent foundation and ensure that we win sufficient additional business to convert into revenue in each of those future years. Management confidence is such as to firmly believe this should be achievable, in the knowledge that the potential order pipeline remains intact, our product offerings are highly respected internationally, our development programmes are bearing fruit and underutilised production capacity is available.

Between them three directors, who control the company, paid themselves nearly £2.4m in 2013 (including pension contributions), which seems high for a company of this size and opens the them to the charge they are syphoning off a disproportionate amount of profit to themselves.

Contrarian add

What is proportionate is a matter of judgement, and mine is that remuneration looks high. But the current undervaluation of the remaining earnings looks even more excessive and on an earnings yield of 21% MSI looks like an utter bargain.

Although MSI does not expect 2014 to be any easier than 2013 due to continuing reluctance by governments to engage in conflict and a general imperative to save money, the most likely interpretation of events is the company is experiencing a lull that does not reflect on the quality of its business. It should eventually reverse.

I have added MSI shares to the Share Sleuth portfolio twice before at higher prices, and I added more on Wednesday 8 January 2014, making MSI one of the portfolio’s bigger constituents.

It remains in the portfolio sheet on the Watchlist page, in the good companies at attractive prices category. To see the live spreadsheet, click on the MSI tab.

Comments

Hey Richard,

I read a post you've published named "Five stocks to watch in January".
One of the stocks was Finsbury Food (FIF), and there you wrote that FIF's ROC is 5%.

If my calculations are correct, FIF's average ROC for the last 8 years is either 22% or 28%, depends whether we base the ROC calculation on 'assets' or on 'liabilities'.

I think the dramatic difference between your 5% and my above 20% is the fact that you didn't deduct "Intangible assets" from the "liabilities base" in your calculation.

As intangible assets equals about a half of FIF's total assets, it is quite essential to ask ourselves whether we should take it into consideration while we calculate ROC.

In my view, we should not consider the intangible assets as part of FIF's capital in regard to the ROC calculation. That's because almost all of the intangible assets' value derives from Goodwill, which is a remnant of past acquisitions, and doesn't indicate necessarily that growth of the business requires growth of the goodwill account. FIF may, and do, grow organically (e.g. buying a new production line in an existing factory); Even if FIF would decide to grow inorganically (e.g. acquisitions), we cannot know for sure what premium it will pay for the acquired businesses.

Disclosure: I'm long FIF.

Kind regards,

Michael

Hi Michael, thanks for your comment. I agree with you about intangibles and believe it or not I exclude them in the return on capital calculation. I expect the discrepancy is due to another factor, I add the capitalised value of operating leases, which few other investors do, treating them as a kind of debt. That might be the factor. If you're interested in my calculation of 'operating capital', the denominator in the return on capital calculation, you can see it in FIF spreadsheet: https://docs.google.com/spreadsheet/pub?key=0AhmpDEM3b-R6dEhEX1pnNlM1Y05...

All the best,

Richard.

Hey Richard,

I did capitalized the operating leases, so it can't be the reason for the difference between our calculations.

If I've understood your calculation correctly, your calculation is:
(After-tax adj. OP 5,989) divided by (Operating capital 106,452) = ROC of 5.6%

In this case, I think you may have an honest mistake in your calculation of the 'Operating capital'.

The value of the "+ current assets" in the 'Operating capital' calculation is wrong, as it appears to be the exact value of 'Total assets' (£107,079 thousand), instead of the value of only the Current assets, which is £31,047 thousand (p.27 in 2013 annual report).

Putting the right number on current assets, would have given you an ROC of 20%.

Kind regards,

Michael

Hi Michael, thanks for persevering with it. You're absolutely right. I've updated the spreadsheet, and have amended the article. I will probably update my view of the company next week (it's Friday night!) in which case I'll republish.

I now get 17%, which is a lot closer to your 20%. Apologies for taking so long to get around to it.

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