Ann: Becoming a substantial holder, page-9

"After a more than 50% rise from just the announcement of a new CEO how much of this rise is based on fundamentals?"

I always think that taking one's investment cues from what a share price has done in the past is fraught with emotional distortions that are at odds with fundamental analysis.

The way I view this company as an investment opportunity is as follows:

1. Starting with the Earnings:

This year, I expect EBITDA, before non-recurring items (of which there are likely to be a few, I suspect, as a result of a the on-boarding of a new crop of executives who will take the opportunity to do some financial spring-cleaning and and probably create some hollow logs) to be between $20m and $25m (that compares with FY2019 EBITDA of $18m).

[Viewed on a half-yearly basis, I'm expecting 100% of FY2019's EBITDA to be booked in DH2019, followed by break-even in JH2020. (For context, DH2018 EBITDA was $25m and JH2019 EBITDA was a $7m loss, but June halves pre-2019 have averaged EBITDA of ~+$7m pa.)]

So I think DH2019 EBITDA of $22m/$23m (down 10% on pcp), and break-even EBITDA in JH2020 (compared to a $7m EBITDA loss).

So, FY2020 EBITDA of $22m, I reckon, compared to FY2019's $18.2m, and the average EBITDA of the preceding 10 years in excess of $40m, so no great leap of faith being incorporated into my FY2020 forecasts, I don't feel:

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2. Now, calculating the prospective EV:

The company finished the FY2019 year with Net Cash of ~$7m (the low point in the company's cash cycle).

Assuming zero working capital liberation in FY2020 (a most conservative position, given Working Cap-to-Sales ended FY2019 at a 5-year high), that means Net Receipts will be around $20m - $23m (pre-any restructuring charges).

Interest Payments will be around $1m (FY2019: $0.74m), and Tax Payments will be around $5m (FY2019: $4.75m).

Now, what is less easy to predict is the extent that the business will incur one-off payments in the current year for restructuring exercises. (And, for certain, there is likely to be restructuring activity... at least, as a shareholder wanting and expecting the business to be turned around, there should be some restructuring activity.)

In the absence of knowing better, I've assumed $3m in restructuring payments (a not-insignificant amount, being equivalent to almost one-quarter of this year's projected EBITDA and more than half of EBIT).

Adding all those items together yields Operating Cash Flow of around $13m

In terms of investing cash flow, on the basis that the roll-out of new stores has paused (if not ceased altogether) I expect the level of expenditure on PP&E of the past half-year ($3.7m) to continue this year, so FY 2020 spend on PP&E to be around $8m to $9m.

So that's Free Cash Flow of around $5m in FY2020. [*]

Which would see Net Cash of ~$12m at the June 2020 balance date.

Combined with the current Market Cap of $92m, that translates to an Enterprise Value of $80m

So here's a company with an Enterprise Value that is equal to just one-tenth of its Revenue base and a mere 25% of its Gross Profit.

That is most uncommon.

And when you do have that kind of situation, it doesn't require much in the way of reduction in the Cost of Doing Business (just a few % points), for annual operating profit to become a very meaningful proportion of the EV of the company.

And when that happens, the market value of the company rises very substantially.


(PS. I'm not so naive to think this is a slam dunk investment opportunity; there are numerous risks, not just the potential for sluggish Christmas trading, but corporate turnarounds are not easy; they invariably take longer and require more resources than are initially expected.)



[*] I'm ambivalent as to whether or not a dividend will be declared in relation to the DH2019 result; if one is declared it will be a modest one, perhaps 10cps (same as FY2019's interim dividend), which would equate to around $2.9m in nominal terms.]