Buying things people hate has already proven very rewarding for me and I have a lot to learn, plenty of scope to improve.
My interest in PRG started with its acquisition of Skilled in early 2015. At the time I was going through the complete ASX200 list in a search for attractive stocks and at $1 per share SKE seemed to fit the bill. I was too slow PRG pounced before I could get a handle on what the business was worth and wasn't interested in PRG at the time for the price.
Looking at their 10 year earning histories, SKE was the larger business at around $1.8bn revenues PRG was $1.2bn but they both earned around $30m per annum NPAT.
PRG was the smaller company but it's financial position was more prudent than SKE and it's earnings history more consistent - reflecting in my view the differing management.
After the acquisition the markets' pessimism around SKE was vindicated by a decline in oil and gas offshore, I certainly didn't see that coming and exposure was a key selling point of the acquisition. http://m.offshoreenergytoday.com/#newsitem-174077
Recent comments from management are that they believe the decline in oil and gas has stopped, I agree and think there's already been a lot of pain from the mining bust. Revenues were only $1.3bn in the first half a significant decline and the company has sold broadsword - based on historical margin and 1st half run rate continuing (average of the two companies that would be a $52m NPAT). However the company justified the acquisition on the basis of $20m reduction in overheads.
In the first half to 30 Sep '16 the company reported only a $3m NPAT with $14m of costs related to the SKE aquisition. The first half EBITDA was $46m with $54m forecast of the second half. I see that as a $17 + $27m NPAT for the year or $44m before restructuring.
At the present price of 1.835 it has a $472m market capitalisation. It's net debt is $249m it's propriertorship ratio only 46% and it's EBIT covered interest only 2x.
The working capital ratio was 1.3x which is prudent.
A reduction in receivables was offset by an increase in inventory but there's no warning bell there like at SGH and BAL. The companies major asset is $500m of goodwill arising as the cost of acquisition, $300m of which is attributed to SKE it seems.
That's interesting as theymainly paid in scrip for SKE and also in that management value the goodwill on expected long term earnings as a % of revenue as I did. However they don't state what that assumption is, only the effect of changing it which is disappointing.
These are poor results but not in my view terminal unless you expect revenues to continue to decline. It's very hard to make a call either way but I reckon we are close to the bottom.
The company has stated that they target debt of < 1x EBITDA by 2020 which is a prudent aim and I don't think they should be punished for investing countercyclically. That's around $50m of debt per annum and given they are maintaining a 3.5c dividend an expression of some confidence.
How to account for debt when valuing the company? Having only 5th form accounting I would assume the business is a going concern and will over the course of business return the full value of its receivables and inventories from which I subtract all liabilities. This leaves me with $85m in debt.
Therefore based on the $44m NPAT it is earning now and assuming this is the bottom of the cycle I think the business is worth somethimg more than 15x earnings $665m -$85m or $580m. That compares to the shareholders equity of $610m of the balance sheet so seems sane. It is entirely goodwill I am buying with this business, nothing to liquidate or a lot of cash. All depends on future earnings.
I would be very interested in what people think about the business and it's prospects. As $580m is $2.27 per share I still have a reasonable margin of safety in the event conditions continue to deteriorate based on the $1.85 it is selling for today. Of course for the $1.45 I paid the margin was greater and it was an easier decision.
What little I can tell of management is that they are shrewd and countecyclical, I won't punish them for a cloudy crystal ball as I have given up on mine altogether. They will also be corrupt and self serving by definition and laying lots of people off turns you into a nasty person.
More importantly over the long term from these earnings and $2.27 per share valuation I think the business will have a supportive or at least a stable macro environment with the potential for significant growth from these levels. If historical margins can be restored and improved by combining overheads as originally proposed then perhaps it's worth $4 in say 3-5 years - assuming only stable revenues.
The proven situation of now I am getting at a decent discount with the probability of a brighter future for free. I think this is going to turn out well for me but I won't be surprised if more bad news sends the share price back to $1. Unless something changes or I missed something (very possible) that's a buying opportunity for long term investors.
I am no investment advisor so do your own research. I only post on HC for Mr Market to tell me why I am wrong.
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