@gold1650 , In response to your question (on the OMN thread),...

@gold1650 ,

In response to your question (on the OMN thread), namely:

"Is there any reason (other than gut feel) that you think GAP may be a value trap?
I was thinking that the US business should start getting some traction and Capex spending should reduce seeing a FCF increase incoming periods. "

The most obvious reason that GAP may be a value trap is that it almost always has been.

A large part of the reason for this is that this company has a tarnished reputation and has - until recent years - been being a serial disappoint-er.

In the early 2000's the company almost went to the wall due to a badly-executed strategy of setting up manufacturing capacity in China. It had to raise fresh equity capital in every year between 2003 and 2009, totalling almost $80m... a not-insignificant figure in the context of the company's $100m market value today.

Since then, a series of issues - some company-specific (lack of market traction in US and low organic growth) and some extraneous (raw material price inflation, weather, exchange rate fluctuations) - have conspired to deliver a pretty uninspiring operating earnings profile.



However, its not all bad news:

The good news is that - with a complete overhaul of the board and management, which commenced in around 2010 with the appointment of the current chairman but which really gained steam from around 2014 with the appointment of several key execs, including the current MD, CFO, Supply Chain GM, and China Manufacturing GM - the stewardship of the company's capital has undergone a complete turnaround for the better [*].

For context, during the "bad years" of poor capital allocation (i.e., pre-2010) the company raised a total of $78m, and paid out just $11m in dividends, so net capital flows away from the owners of the business of some $67m.

By contrast, since the discovery of capital stewardship religion under the new management, after the "watershed" moment around 2010, net capital flows to shareholders have totalled an impressive $60m ($52m in dividends and $8m in buybacks):





So, to answer your question about whether this stock is a value trap today:

It could well be.

While it is undeniably cheap, at less than 10x P/E and less than 5x EV/EBITDA, I don't think it is exactly one of the world's greatest businesses. Probably only a little more than an average business, is my opinion.

It does not have much pricing power and demand for its products is somewhat out of the company's control. So I don't see much chance of of sustained share price appreciation due to consistent, year-in, year-out, earnings growth.

Rather, I think earnings will continue to be lumpy and volatile, depending on how all the external factors which impact this company, happen to fall in any given 6-monthly reporting period.

But the difference today, compared to most of the company's history, is that should earnings not meet expectations in any reporting period, at least my capital is merely at-risk in a cyclical manner, and that capital losses are not permanent. Before, if the company's financial performance fell short, it inevitably required fresh equity capital injections and the attendant dilution. In which the capital losses were permanent, not merely cyclical.

So if it does indeed turn out to be a value trap, at least it won't be one that is overly painful, in my view.

And with the favourable trend in Current Assets Less TOTAL Liabilities now clearly intact, I think the scope for permanent loss of capital is limited:



(It warrants noting that that graph is actually more impressive than it appears given that the favourable trend in recent years- since 2012 - has occurred concurrently with the consistent stream of capital returns to shareholders, as discussed above.)


In summary, I'm always wary of investing on the basis of "This Time It's Different" , but in GAP's case there is enough tangible evidence, demonstrated over a period of several years, to suggest that something is different today.

Sure, it is not a pristine-quality business, and will never be, but it is highly cash generative and sensible things are now being done with the surplus capital (as opposed to the past, when it was p*#@ed away).

It's 6 out of 10 business being priced like a 4 out of 10 business, I think.


[*] I'd really like directors and management to have more skin in the game: directors and KMP's own a total of some 8m shares and the CEO has 2m performance rights on top of his shareholding.