Why I've topped up my stake in LYL, page-46

Hi All

I have held LYL for around 5 years initially buying on the last boom and adding at times.

Interesting to read some thoughts so I decided to add a comment after not looking at HC for a long time.

The 1st comment I would make is that this is a very cyclical business. No one really knows what stage of the cycle we are in at any given time in terms of the duration to the next change in business conditions. We have some clarity on the next 12 months from management outlook statements but beyond that it is anyone's guess. If someone asked Mick Carrati to project earnings for 2021 or even 2020 he would likely say he has no idea because to many variables outside of their control are at play, and he has seen conditions change quickly on previous occasions.

Because the business is so cyclical doesn't mean its not a good business but I believe it does mean that any attempt to ascertain value at any given point in time is futile. Looking at returns over one or two financial periods and projecting forward is dangerous. To try and decide value it is better to look over several financial periods that encompass a full business cycle or more.

The 2nd point I would make is that this is in my opinion a very conservative well run business by a team of capable managers who's interests are completely aligned with shareholders. Its also a business that is strengthening its hand over time. This last part is hard to really define but over time they have spread across a large geographical area and across a wide array of commodities, plus more recently an infrastructure component. This provides a wide amount of streams to source work across the high or low cycles. For this reason I believe that earnings per share will be higher in both the low and high part of future cycles.


Turning to what sort of value it offers now I feel its necessary to consider a long period that includes at least 1.5 full business cycles to try and decide if the market offer is reasonable.

Since 2010, LYL has produced around 140m in adjusted OCF (OCF minus lease liabilities). Stay in Business CAPEX (SIB) is low as others have pointed out due to it being a PPE light buisness. SIB of 5% of OCF is conservative enough. Therefore FCF since 2010 is around 140m OCF - 7m SIB + 8m dividends received. So FCF approximately 141m over 8 financial periods since 2010.

This FCF has either been paid out in dividends, been used to grow the business such as the ADP acquisition or has accumulated on the balance sheet. My point is that its real hard cash that represents owners earnings during the period. Also I have no doubt that these earnings will one way or another return to shareholders.

The next step requires an assumption like all valuation. If the business has produced 141m in cash over the last 8 years what will it produce over the next 8? I am comfortable using a metric of 1.5 times which due to factors I touched on above i feel is conservative. This business is growing and strengthening the last FY report gives a view of that position as does the JV with MND and the appointment of a new director and so on.

So at 1.5 times over the next 8 years the business will produce 211.5m in FCF. If I used 1.8 times it would be 253.8m.

I can buy the whole business today for 186m. If I did so I could I believe straight away take 30m in cash out of the company without affecting its ability to function. The surplus cash is an interesting separate topic. Its always hard to know what cash plays in working capital unless you really know the inside of the business. The sizable cash holding could be a strong benefit in tendering for EPC work etc. However I do feel that we aren't that far away from some capital management if it continues to build. Anyway I digress

So outlay to buy the business 186m

In return I get 30m straight away, 211.5m in FCF over 8 years plus I retain the business to sell. Even if I sold the business for the same as the purchase price assuming I was in a low part of the cycle perhaps my total cash return from owning it for 8 years would be 427.5m (30m + 211.5m +186m). This represents a return of 427.5m compared to my initial outlay of 186m or an average annual return of 30.18m a year or 16.2%

The best time to buy this business is on the low cycle if you are smart and composed enough to do so. In 2015 you were largely buying cash on the balance sheet. In lieu of doing this the above offers some attempt at what return you could expect at current prices over the long term.

Again as the managers are also the owners I have no concerns that the return from owning the whole business would also follow through to owning a part of it.