Why I've topped up my stake in LYL

A few weeks ago, I stated that I felt that LYL had current "earnings power" of about $17m. Further, I conjectured that in the future (vaguely defined as "five years from now") it might be earning a sustainable EBIT somewhere in the range $17m to $28m (see here). Or taking the mid point, an EBIT of about $23m. Just quietly, however, I have for a while now felt that cash generation has been running well ahead of reported profits (see here, for instance) (1).

Well it appears that the future has arrived early - because underlying EBIT (purely from normal operations) for FY18 was about $24m. The H2 period was particularly buoyant. I don't wish to place too much weight on any 6 month period, in an industry that can have very lumpy contracts. It's quite likely that the H2 results are ahead of current "earnings power". That said, the H1 result was still on a rebound trajectory from the depths of the trough in FY15. So I'm, guessing the H1 result under cooks current "earnings power". On balance, I'm willing to bet that the annual result of $24m is fairly indicative of what the business is able to currently earn on a sustainable basis.

But my previous sense that cash generation was running well ahead of "earnings" have been doubly confirmed - and then some. In the FY13 current provisions increased by about $12m, largely to allow for warranties and the like. I'm not suggesting we can assume this is all "free cash". Frankly, if this was a run-of-the-mill contractor, I would be concerned. However, LYL management take conservatism to the level of an extreme sport (as seen here, for instance). Even if we assume that 50% of that cash can be expected to be unencumbered - then I hate to even think what that means in terms of the FCF generated in FY18, versus the reported profits.

The truth is that whilst all accounting standards are equal(ish), when you have a management that is the polar opposite of the norm and is hell-bent on down-playing their earnings, then you know its earnings are more equal than most.

The other key plank of my prior valuation (#) was that "surplus" cash was running at about $1.2 per share (after adjusting for working capital levels, and especially unearned revenues). Well my best guess now, after digesting the FY18 accounts, is that this is running at about $1.65. Once again, providing further evidence, if any more were needed, of what a cash fountain this business currently is.

My conclusion at that prior assessment, was that LYL was an attractive buy at prices that prevailed then. Well the prevailing price has barely changed, and so I believe LYL is an even more (substantially more) compelling proposition today. As such, I have boosted my holdings by about 18%.


(1): Something that has been masked by the very large customer prepayments received in FY17.