Ann: Half Year Accounts - Press Release, page-5

"Does anybody know how much of EC&M write off was included in June trade receivables?"

@Klutch,

Does this help?




While customers being unable to pay are unwelcome, writing off bad and doubtful debts are somewhat of an inevitable part of a business of this nature.

And, for context, for KOV the amounts have been quite modest (averaging around 0.3% of Revenue and 3.8% of Profit Before Tax over the past 18.5 years, which is as far back as my data set extends).

As credit control metrics go, while 0% is always best, KOV's - given the nature of its business and customer base - are not at all too bad.

As can be seen, the most recent bad debt hit is an order of magnitude larger than normal:



I'd therefore argue that a large part of the $905k write-off is non-recurring (it jolly well better be, or else the company's credit manager will be looking for work).

So if we say that $300k pa bad debt is "normal" (still conservative given the average for the past decade was a little over $200k), then the DH2019 result is understated by some $600k, Pre-Tax. It follows that "normalised" DH2019 PBT is closer to $3.7m (some 20% higher than the $3.063m reported figure.)

This goes some way to being able to form a judgement on the full-year guidance which is for "2H to be lower than 1H although FY20 is expected to meet or exceed FY19 in total".

Given PBT in FY2019 was $4.1m, for FY2020 to meet that guidance at the bottom-end requires JH2020 to be around a mere $1.1m.

That's 64% lower than DH2019's $3.06m Reported PBT and 70% lower than the "normalised" figure of $3.7m .

Now we know that a large project that was being supplied came to an end in DH2019, which is what made that such a strong financial result (the fifth-highest half-yearly profit ever, and the highest figure for five-and-a-half years).

But to expect that JH2020's number will be around $1.1m, seems to be way out of kilter with the prevailing generally-healthy market conditions, and with recent results during the current cyclical upswing:



I strongly suspect that when the company reports its full-year number, JH2020 PBT will be closer to $2m than $1.1m, and FY2020 PBT .

But using the mid-point between $1.1m and $2.0m, so say $1.6m, gives normalised PBT of FY2020 PBT of $5.3m (DH2019 =$3.7m + JH202o forecast of $1.6m) , or normalised NPAT of $3.7m.

That has the stock trading on a P/E of 12.7x, after the strong share price moves in recent weeks.

At first glance that might be a fair multiple for a business such as this (certainly not a premium-to-market business); however, the raw P/E multiple ignores the all-time high current net cash holdings of $8.3m [*], following the record Operating and Free Cash Flows of $7.6m and $67m, respectively, generated in DH2019.

And $8m of net cash is meaningful in the context of a $47m market value (18% meaningful).

So if you adjust the P/E multiple for the net cash, it comes to just 10.4x.

If this year represented the cyclical high in KOV's, then I'd say that 10x P/E might represent an appropriate valuation multiple.

But my sense is that the cyclical peak in KOV's earnings will be after this year, in which case the post FY2020 prospective cash-adjusted P/E multiple is decidedly less than 10x.

This is a business that, when operating at full capacity in the past, generated EBIT of $8m (FY2009) and even as high as $9.m (FY2012).

I am certain that, at some stage over the next two or three years, KOV will report EBIT between $6.5m and $7.5m, which will translate into NPAT between $4.5m and $5.4m.

At the mid-point, say $5.0m for easy maths, that would place the stock on a prospective P/E multiple of ~9.5x... ~8.5x, adjusting for $5m assumed net cash.

Still not at all overvalued, I don't think, despite the strong performance of the share price in recent months.

Some months ago I expressed view of a $5.00 probabilistically-based price expectation, with a 40% probability of $5.75 and a 10% chance of the share price reaching $7.50.


"The way I view KOV as an investment proposition is on the following probabilistic terms:

Base Case Scenario = $3.90/share (50% probability outcome)
Boom Earnings, Mid-Cycle EV/EBITDA multiple (6x) = $5.75/share (40% probability)
Boom Earnings, Peak-Cycle EV/EBITDA multiple (8x) = $7.50/share (10% probability)

So, when I derive a crude price objective by weighting each individual price by the probability of such a scenario eventuating I get - quite conveniently - a nice round number of $5.00/share"


Reading between the lines of some of management's articulation about how the business is being positioned for the next few years (notably comments about investment in automation and capacity growth, as well as "engineering solutions for infrastructure projects"), my current leaning is towards a share price outcome closer to the $5.75 outcome, rather than $5.00.

The stock is unlikely to double again over the next two years, after having done so over the past two; but I think that a further 50% share price appreciation is well within the realms of possibility, without too many hairy-chested assumptions about earnings levels or valuation multiples.



[*] That net cash figure is artificially high, I feel, being the result of significant working capital liberation in the past 6 months (~$4m worth), which is unlikely to be repeated in future financial periods. In fact, the company finished the half with Working Capital equal to 20% of half-year Revenue (annualised), a near-15 year low, and compared to its long-term average of ~27%. So I fully expect a further investment in Working Capital in coming periods. I think that $5m is more like the sustainable net cash figure, assuming continuation of the long-standing policy whereby most of KOV's profits are distributed to shareholders.