Investing on a low income.

Author: lewys

Why BHS collapsed + what will rise from the ashes?

After reading countless articles jeering the demise of the ‘iconic’ BHS, I can’t help but think that the company had it coming for a long time. Not to sound too…

After reading countless articles jeering the demise of the ‘iconic’ BHS, I can’t help but think that the company had it coming for a long time.

Not to sound too harsh, I deplore the loss of 11,000 jobs, in which staff worked as hard as they could, going the extra mile to save the ailing business.

Let me be clear, it’s the company’s top brass that got it terribly wrong and I can only hope that most staff can find jobs in the companies that come to replace now vacant BHS stores.

Failure to invest

Sir Phillip Green knew what he was doing when he sold the company for £1 to a group of inexperienced ‘entrepreneurs’. He was abandoning a sinking ship, unwilling  to go down with it or to invest some of his £5.8Bn fortune to revive the BHS brand and offering.

The firm ultimately collapsed after its new owners failed to secure £70m for a turnaround. £70m I’m sure that would have been easily found from Sir Green’s fortune.

In the end, potential investors and lenders knew that BHS was dead in the water and refused to back an ailing brand that lost its significance with customers a long time ago.

What was BHS’s brand in the end?

The artificial changes that the purchasing group made in its final days simply weren’t enough.

Whilst the new branding (1) was a nice touch it was already too late, a cosmetic measure for a company critically burdened by high overheads and an astonishing pensions deficit.

It does raise the question as to the company’s identity in its final few months. The new BHS(1), Bhs (2) or British homestores (3)?

BHS1 BHS2bhs3

 

The failure to establish a consolidated brand that customers could identify with was symptomatic of a complete failure by management to make the retailer relevant again.

As confused as they company’s branding was its in-store offering. Instead of focusing on its core offering the company expanded its offering in a desperate attempt to gain market share. BHS moved into Perfume and food, further confusing consumers and moving into already occupied territory!

Its venture into food was somewhat bizarre as rival M&S already dominated this space. Their confused venture was defined by their stocking of discount Happy Shopper products alongside ‘premium’ brands. A perfect symbolism of the company’s failure to settle on its offering and identify its target market.

Its perfume offering also ventured into a space already dominated by Debenhams and Boots. I’m shocked at what value management thought they could add by stocking perfume alongside homewear.

In the end, instead of focusing resource into branding and customer initiatives the company expanded and was left severely outgunned by rivals Debenhams, M&S and John Lewis.

Just take a look at advertising spend;

 

Screen Shot 2016-08-27 at 16.52.41

 

Source: Marketingweek.com

Not surprisingly the underinvestment in the company’s brand and offering lead to an abysmal YouGov Brand Quality Metric with the company achieving a score of 12.3, way behind rival Debenhams (38.8) and M&S (59.5).

What next for BHS stores?

In the end, BHS ended up like Woolworths, a tired brand that failed to move with the times. The attempts to offer everything ultimately lead to delivering on nothing and now customers can look forward to useful and significant offerings on the highstreet.

As, of the ashes of the old Woolworths, companies such as Poundland, B&M bargains, Iceland and Wilko came to occupy the derelict stores the same will happen again.

With countless online polls showing shops such as H&M, Zara and GAP as prefered occupiers for BHS stores I expect the reality to be harshly in contrast.

It will be retailers such as SportsDirect, Poundland, B&M bargains, Home Bargains and Primark that will rise from the ashes. These are the growing brands of today’s impoverished demographic still scared by 2008.

As we can see from the below table from Satisa which outlines acquisition of stores out of bankruptcy by company between 2009 and 2014, the preferred pics of the public are nowhere to be seen.

Screen Shot 2016-08-27 at 17.22.19

Summary

The demise of BHS gives us no more detailed insight into the state of the UK’s retail sector as Woolworths did.

Being an ‘Iconic british brand’ just doesn’t cut it.

Stores must offer an appealing core offering and value for money.

When faced with troubles, the answer is consolidation of core offering as opposed to expansion into various offerings.

As bitter a pill as it may be to swallow for those with disposable income, Poundland is the future of the empty BHS stores as they were with Woolworths.

 

 

 

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An in depth look at the UK mail sector and Royal Mail

Royal Mail. Since the government put Royal Mail shares on the market in 2013, investors can be quietly happy with their returns. Investors who bought in at day one at…

Royal Mail.

Since the government put Royal Mail shares on the market in 2013, investors can be quietly happy with their returns.

Investors who bought in at day one at a price of 330p a share would have seen a return of just over 35% to date, excluding dividends.

With good dividend stocks at decent prices hard to come by in the FTSE, I thought I’d take a closer look at Royal mail.

With an attractive growing dividend, this may be one for dividend growth investors to look out for.

Background

What makes Royal Mail so interesting is that it’s a former state-owned monopoly which is still in transition from public ownership to private ownership.

The company still holds an effective monopoly in the letters market but are battling heavy competition in the parcel market.

Royal mail operates under two main divisions;

UK Parcels, International & Letters (UKPIL)

UKPIL operates in the United Kingdom collecting and delivering parcels and letters through approximately two main networks, the Royal Mail Core Network and Parcelforce Worldwide

General Logistics Systems (GLS)  .

GLS operates in continental Europe and the Republic of Ireland and has a ground-based deferred parcel delivery network in Europe. GLS provides parcel and express services, as well as logistics solutions.

A brief history;

In 2006 Royal Mail lost its monopoly on the UK parcel market when it became open to competition from companies such as UKMail, DPD and Hermes.

Although Royal Mail also lost its monopoly on letters in 2005, competitors just don’t seem interested in this ever shrinking market. The withdrawal of Dutch competitor Whistl in 2015 left the company effectively unopposed.

In 2013 Royal Mail was offered to investors for 330p a share, thus privatising one of the last surviving state owned companies in the UK.

The overall postal market

Royal mail’s two markets can be defined by the following statements;

Declining letter volumes and increasing parcel volumes.

In 2013, Royal Mail commissioned a review into future volumes from Pwc. The results can be seen below;

Screen Shot 2016-08-25 at 15.10.20 Screen Shot 2016-08-25 at 15.10.15

As the graphs clearly indicate, the UK has an increased demand for parcel services but a decreasing demand for letter services.

These trends are also clear in other developed countries and there are no signs of a reversal.

With a decline in mail volume, Royal mail is rightly positioning itself for the growth in parcels and cutting costs.

The parcel market and Royal Mail’s positioning

As we can see from the chart below, Royal mail continues to enjoy the lion’s share of the UK parcel market

Screen Shot 2016-08-25 at 15.23.40
Source: Royal Mail PLC 2015-2016 results

But, this dominance is declining year on year as is evident above.

The overall parcel market grew 6% growth  in 2015 and Royal Mail estimates a further 4% volume growth moving forward. This growth has allowed Royal mail to grow parcel volumes despite its declining market share.

Whilst focus on the parcel market appears to be a winning strategy significant hurdles exist that I’ll outline below.

Problems

The problem with Royal Mail’s strategy is the intense competition they face in the industry.

This is evident from the meager 1% revenue growth achieved from a 3% increase in parcel volumes. This is a worrying sign of declining margins to come.

If this trend is to continue then clear challenges await for the company;

2016 results show that the 1% increase in parcel revenue was offset by a 2% decline in letters revenue.

With the majority of Royal Mail’s revenue coming from its letters division this continued decline will slowly erode the balance sheet unless growth in other areas (mainly parcels) pick up.

Screen Shot 2016-08-25 at 17.40.15

As we can see from the above table taken from the company’s 2014-15 trading results Total letters accounted for £4,567mn of revenue as opposed to £3,190 for parcels.

Screen Shot 2016-08-25 at 17.43.40

The continued decline in letters revenue (although less than expected) as evidenced in the company’s 2015-16 trading results above creates a pressure on the company to deliver on parcel growth.

Even as the parcel market grows and parcel revenue increases it seems tough for Royal Mail to make a net gain on their overall revenue due to declining letter revenue.

Another revenue worry I have moving forward is the Royal Mails obligation to offer a universal service which means delivering to some very rural areas without the ability to charge more.

This is in stark contrast to competitors who can simply cherry pick the most profitable urban regions and rely on Royal Mail for ‘the last mile’ delivery. Royal Mail has hit back by ramping up the charges for this service but competitors have complained to the regulator Ofcom. With such murky legal waters ahead this certainly casts a shadow over the business.

Profit on the other hand looks promising if we strip transformation costs with profit up 5% in 2015.

Postives

Royal mail has done an outstanding job of turning the company’s finances around.

Debt is down significantly since 2012 and the company continues to make significant efficiency savings;

Screen Shot 2016-08-25 at 15.51.56

(Source: Ft Markets, Royal Mail Plc)

The group has also managed to shed 3,500 jobs since 2015 whilst also increasing productivity by 2.4%. These are promising signs for a company that needs to shed costs fast in order to maintain margins (especially in parcels) in a competitive market.

The company’s cash flow looks worrying at first glance;

Screen Shot 2016-08-25 at 16.09.57

But when you consider the transformation costs the company has occurred the weak cash flow becomes understandable.
Transformation costs in 2015 were £191mn, and the company projects further costs of £160mn in 2016-2017.

Most impressively is the operating profit margin now being achieved by the company as a result of these transformation costs with the profit margin jumping from 4.7% in 2014 to 6.1% in 2015.

Dividend

Royal mail offers a tempting dividend yield of 4.2% and sits comfortably at a payout ratio of 54% from results filed in May.

With room for movement in the payout ratio the company could continue to increase its dividend payments even if earnings disappoint.

The company is also committed to a ‘progressive dividend policy’ meaning that dividend investors can be confident of continued dividend increases in the future.

Value

Due to the scale of transformation costs it’s difficult to efficiently value the shares based on EPS.  Transformation costs in 2016-2017 are expected to come in at around £160mn.

Instead, I decided to use a dividend discount model to value the company’s shares.

As revenue is going to be difficult to expand in such a competitive market (and relative to management’s past performance) I see cost cutting measures as the main source of EPS growth for the company moving forward.

After a big dividend jump from 2014-2015 I expect dividend growth to stabilize at around 5% due to the above mentioned factors.

I factored in a 10% discount rate to account for the risk of our capital

The dividend discount model gives me a fair value of 442p a share. Meaning that this stock appears 15% overvalued by this metric.

Summary

Royal mail management is doing all it can to streamline the business moving forward, yielding impressive results with productivity and margins on the up due to a successful transformation strategy. But, there is only so far that transformation can go before the company is unable to continue to make large savings through efficiency.

The worry from then on would be the poor increase in parcel revenue relative to parcel volume achieved as this metric tends to point towards narrowing margins.

There’s too much uncertainty for me to buy the stock at this price but if the company goes on to continue to dominate the parcel shipping sector, investors should be handsomely rewarded with dividend growth and capital gains.

 

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5 tips to avoid being a skint student

Students love spending money. Students love complaining that they don’t have money. Seems like a paradox? I know I’m generalising but this is my experience after 3years of uni. I…

Students love spending money. Students love complaining that they don’t have money.

Seems like a paradox? I know I’m generalising but this is my experience after 3years of uni.

I get it. The student loan system sucks. But we have to play with the cards we’re dealt.

So here are 5 practical tips on how to have cash left at the end of every month.

                                                                                  Plan your meals

Living in student accommodation for the past three years taught me one thing. We just love fast food and takeaways.

According to data collected from HungryHouse, students spend over £900 a year on takeaway food.

Avoid this pitfall and plan your meals. Try to make the planned meals easy to cook so you don’t get demotivated.

It’s ok to eat takeaways too – But try to only eat takeaway food once every fortnight and give the uni meal deals a miss if you can.

 

Ditch your habits (Coffee and snacks included)

A few weeks back I wrote an article showing how coffee could be costing you £806 a year. This also applies as one of my student money saving tips!

Whilst we all need that late night revision boost once in a while, grabbing a coffee every day into uni isn’t necessary. Not only will it limit the boost you get from drinking coffee but it’ll also burn a hole in your pocket.

I’ll put crisps, pop and sweets in the same category. You’ll be surprised at how much buying the odd snack here and there will damage your wallet and maybe even your health.

Try this: For a fortnight, keep a log of your snacks spending. Once you’re done imagine that money in your bank account instead!

Complain

This is my favourite. Complaining can really pay off.

Bad service at a restaurant?

Food not up to scratch?

Or just not happy?

Complain!

I often use resolver to complain for me. It’s quick, easy and rewarding. I’ve gotten anything from a free coffee to £60 straight into my bank account.

BUT Don’t rush straight for your nearest coffee shop! Only spend it when you would have used cash anyway.

 

Don’t get sucked in by discount

Marketing people are geniuses. They can make you think you’re saving money, by making you spend money.

If you’re local takeaway is offering 20% off for one weekend only, and you order a £10 takeaway because of the offer you’re not saving money.

News flash: You didn’t just save £2. You spent £8!

Companies often offer ‘student lock-ins’ and all sorts of initiatives to help you ‘save’ money, when in fact they’re ploys to make you spend money.

Avoid this trap by only buying something that’s on offer if you would have bought it anyway.

 

Don’t rush into any contract

When you get to uni you probably want to rush straight in and buy a gym membership, get a TV licence and get drunk.

Going on a spending spree will leave you skint for the rest of uni. Digging yourself out of that overdraft is harder than you think.

So, PAUSE before you buy anything;

Don’t rush into gym memberships – Just because a company has a stand at the freshers fayre doesn’t make them the cheapest.

Places at freshers fayres are sometimes even reserved exclusively for university services in some sectors. If the uni has a gym, I doubt they’d be letting a competitor pitch a stall!

A TV License costs nearly £150 a year – But if you only use it to watch catch up TV (except BBC iPlayer)  then you don’t need one.

If you do watch live TV or BBC iPlayer content, think if you could go without it for some cash in your pocket.

Insurance – Probably the most important tip. At freshers events you’re always going to have pushy sales people try and sell you contents insurance or mobile phone insurance.
Shop around! They’ll say they’re the cheapest – but they probably aren’t.

Check price comparison websites such as money supermarket before buying.

It’s also worth noting the plethora of exceptions that sometimes make insurance virtually pointless.

Common exceptions include ‘not covered’ ;

 

  • For accidental loss
  • If water damaged
  • If stolen from a home when there are no signs of forced entry

I even had someone try and sell me laptop insurance that didn’t cover laptops that wouldn’t turn on. Chances are, if it doesn’t work it wont turn on!

It’s also common to see agreements that don’t start for 14days after you’ve signed the contract. So, if you smash your phone at a club the week after you bought insurance. Tuff luck!

Remember, if you’re struggling with cash universities often have a money advice service that will help you free of charge. It’s always important to get advice on any debts before things get worse.

Whilst my student money saving tips might help you avoid getting into a hole, it’s always best to get professional advice if things go seriously wrong.

I hope you enjoyed these student money saving tips and end up with extra cash at the end of every month (maybe to invest!)

Have any extra student money saving tips? Comment below.

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Easyjet shares – avoid this investing mistake

Regular readers will know that I’m always skeptical of forward projections whilst buying shares. This is due to a very important lesson I learnt from a previous investing mistake. Whilst it’s…

Regular readers will know that I’m always skeptical of forward projections whilst buying shares. This is due to a very important lesson I learnt from a previous investing mistake.

Whilst it’s important that you view a company’s market going forward, and take clues as to future performance one should never focus too heavily on forward projections.

Let’s take a case study as to why: My purchase of EasyJet shares.

I bought EasyJet shares at around £16 a share in May 2015. My stake today is worth 35% less. Although, I always say that “my shares could drop 50% for all I care”, EasyJet is different because I didn’t do my homework.

This investment turned sour due to an investing mistake on my part.

The peril of forward projections

It’s important to understand the range of projections that exist for a share, and just taking the consensus recommendation isn’t good enough.

As you can see from the graph below, some analysts give a price target of £20 to EasyJet whilst others place it closer to £5. Who know’s who’s right?

The problem with many investors (and myself in May 2015) is that people buy shares expecting analysts to be correct about future earnings. At Least by taking the consensus estimates one could feel fairly comfortable right?

WRONG – these are estimates. Estimates change depending on continually evolving circumstances. Just look at the target price consensus revisions for Easyjet shares.

Consensus

 

It’s so easy to feel secure because the price you’re paying is below the consensus price target.

It’s easy to feel secure because even the lowest target is not far off the price you’re paying.

But, like any projection. Things are subject to change, and Easyjet is a perfect example.

In July this year Easyjet shares tanked after the company issued a profit warning. Nobody, even the mystical analysts and their abundance of tools and resources saw it coming.

With any other share I’d be delighted at a drop in price but with Easyjet I wasn’t. I wasn’t comfortable in owning the shares at that price. Why? Because I was banking on projected earnings to pay lofted projected dividends. Big mistake.

Blinded by dividend.

When I stumbled across dividend growth investing, I got so obsessed with my own skewed version of the theory that I was blinded by dividend.

When buying EasyJet shares, I didn’t do my homework and betrayed most dividend investing principles.

The rationale for buying EasyJet shares pretty much lied solely on the dividend.

I saw this graph, took the forward dividends and EPS as gospel and plunged in head first. Look at that juicy 66p dividend in 2018. I thought, that would give me a yield of 24%. GENIUS…..More like idiot!

 

 

Screen Shot 2016-08-23 at 16.55.29

Projections de-railed

Another problem with projections and estimates, aside from the range of differing estimates is that projections can only be made with information available at the time.

As things change, so do projections.

But one thing that can’t be changed is the fundamentals of the company for the previous year or latest set of quarterly results.

This is why investors should never base their investments on the factual results at hand.

Management blames the following for Easyjet’s journey off course;

  • Terrorism
  • EgyptAir tragedy
  • Increasing market capacity (i.e more supply)
  • An expensive euro due to brexit
  • A very high level of cancellations during 3rd quarter 2016 with 1,221 compared to 726 in the third quarter 2015”

 

What I should’ve looked at – avoid this mistake! 

What I should have looked at before buying EasyJet shares were the company’s fundamentals, and the environment in which it operates.

Doing so would have clearly shown me that an airline stock is not the steady growing, reliable dividend payer that dividend growth investors should buy.

Indeed, any intelligent investor, not blinded by yield and greed would have seen that the airline industry is;

  • fiercely competitive – Increased capacity mean lower fares for all operators
  • Extremely sensitive to external factors – Think terrorism and weather
  • Very unpredictable – Think delayed flights + compensation claims

How on earth could such a stock be a steady, predictable dividend payer?

Just knowing these facts about the airline industry would have been enough to keep a conservative investor (as I now consider myself) far away.

Warren Buffett has notably said the following on airline shares;

“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers”

— Warren Buffett, annual letter to Berkshire Hathaway shareholders, February 2008

 

Who would doubt the oracle of Omaha?

The future

As for the future of Easyjet, who knows.

My interest in the stock has declined rapidly since I awakened as to the perils of the airline industry and continually revised revisions.

One thing EasyJet did teach me was

  1. Never trust forward projections for any metric. Be it dividend, earnings, revenue e.t.c
  2. Always thoroughly check the industry in which a stock operates (duh!), you may have some serious misconceptions
  3. Don’t be greedy. Predictability is far more important than projections of dividend growth.

Warren Buffet famously made a $353mn investing mistake in the airline sector. Thankfully my investing mistake only cost me £500.

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Tesco’s share price – lower for longer

Tesco’s (TSCO) share price has been languishing since the company was embroiled in accounting scandal and made a £6.3bn loss. With a turnaround in progress and the company returning to…

Tesco’s (TSCO) share price has been languishing since the company was embroiled in accounting scandal and made a £6.3bn loss. With a turnaround in progress and the company returning to profit, investors may think that this is an ideal opportunity to buy. It’s not.

The supermarket sector.

Tesco finds itself between a rock and a hard place. Whilst competitors with defined markets steam ahead Tesco is having a bit of an identity crisis.

Whilst Aldi and Lidl dominate on pricing and Waitrose and M&S (MKS) dominate on quality, Tesco is left wondering what it stands for.

You may think that Tesco has inserted itself right in the middle, focusing on price and quality but I’m afraid it’s a case of trying to please everyone, and in turn pleasing no-one.

Sainsbury’s have managed to insert themselves into Tesco’s traditional niche of ‘quality at a reasonable price’, leaving Tesco with no apparent core market.

 

The future – Where is Tesco positioning itself?

Moving forward, Tesco’s strategy is to focus on price and a superior customer shopping experience. The current plan appears to have had limited success.

UK like for like sales are positive again (albeit by a mere 0.3% last quarter), but this comes of negative growth in the previous 3/4 quarters.

Screen Shot 2016-08-20 at 21.25.36

*Tesco Q1 results – investor relations sector on their website.

The company is also “redirecting coupon spend” into ensuring lower shelf prices in a bid to compete with Aldi and Lidl. From what it looks like to me Tesco’s strategy  simply boils down to competing directly with Aldi and Lidl for price-focused consumers. Bad move!

By fighting Aldi and Lidl at their own game, Tesco is spending time and resource to offer what’s already on offer. 

Aldi and Lidl continue to grow their market share and Tesco can do nothing but wait until their customer base bottoms out.

Here’s the current state of affairs, drag the slider in order to compare dates.


Another major concern for Tesco is that Asda which is owned by US giant Walmart (WMT) is also weighing in on the price war. This will surely further pressure Tesco’s market positioning. The sheer scale of Walmart and its dominance of the U.S market would surely mean it would outlast Tesco in any war.

Consumer spending

As if things weren’t bad enough, consumer spending on groceries and non-alcoholic beverages in the UK remains under pressure. Despite glimpses of hope for the sector with increased spending on food in March this year (0.2% increase) – It appears that as the UK’s voted to leave the European Union has de-railed progress and caused families to tightening their belts. The most current Consumer price figures showed that spending on groceries is down 2.6% since the Brexit vote.

Source: http://www.tradingeconomics.com/united-kingdom/inflation-cpi

Financial position

Believe it or not, Tesco grew monstrously to become much more than a supermarket. It owned Garden centres, Coffee shops and even restaurants. Whilst this may be thought of as an advantage, these projects grew to become a burden on the company by distracting it from its main supermarket offering.

Thankfully, new CEO Dave Lewis offloaded these companies, using the proceeds to pay off debt (£6Bn from the sale of Korean assets) leaving Tesco’s balance sheet looking healthier.

He also eliminated the dividend, freeing up much-needed cash flow for the battle against Aldi and Lidl. But, the company’s debt remains stubbornly high with a £2.6bn pension deficit leading to a total debt of £15bn.

Increased competition in the supermarket has slashed Tesco’s margins from 6% in 2012 to only 2% today. As competition continues, so will the pressure on Tesco’s margins leading to lower profits for longer. It’s really hard for me to see any easing in Tesco’s financial position in the near term.

Value.

Just by looking at the share graph, many people assume, wrongly, that Tesco’s share price is appealing. Tesco’s share price has dropped from near 500p in 2007, to half that today, but that doesn’t make the share’s at all appealing.

Whilst there are some positive signs for Tesco such as;

  • A return to a positive FCF
  • An impressive £6.5bn cash pile

I’m afraid that Tesco’s share price offers little value to investors.

Reported EPS for 2016 come in at 3p giving us a p/e ratio of 53. This is much higher than FTSE 100 peer Sainsbury’s (SBRY) that trades at a p/e of 11.

Even if we take the highest analyst earnings estimates for Tesco in 2017 (earnings of 8.25p a share) the shares are still trading hands at a p/e of 18.7.

Summary – lower for longer

It appears that the market has already priced in any 2017, 2018 gains for Tesco. This is despite continued competition which makes achieving analyst estimates challenging.

Tesco has never traded for such a high earnings multiple (over 50) . It would therefore be reasonable to expect that they won’t in the future.

It seems that investors are pricing Tesco as if it was still the dominant force it was in 2012. We must remember that Tesco today is far smaller. It sold £6.5bn of Korean assets, Dunnhumby (owner of its clubcard division), coffee shops Harries and Poole and Giraffe restaurants. It also has a smaller share of the grocery market and lower margins on products (2% in 2016 vs 6% in 2012).

A return to fortune is already priced into the shares at current levels. Even at 159p a share Tesco’s share price remains too high.

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One stock I’d love to own – Just not at this price!

I absolutely love consumer goods stocks! Unilever (ULVR) is one of my core holdings and I just bought into flower foods (NYSE:LFO). I love Consumer good stocks because they are…

I absolutely love consumer goods stocks! Unilever (ULVR) is one of my core holdings and I just bought into flower foods (NYSE:LFO).

I love Consumer good stocks because they are generally very defensive and predictable investments. After all, even in recessions people still need to eat, drink and clean.

Stocks in this sector also boast superior margins, as the value of their brand mean that customers are willing to pay that much more.

What would you pay more for, Unilever’s Ben and Jerry’s or a Tesco copycat?

Consumer goods stocks in today’s market

With low interest rates people have been buying these defensive stocks for their dividends, which trump measly bank account rates.

High demand for these stocks have left them at high p/e ratios. For example;

Proctor and Gamble (PG) sports a p/e of 25

Unilever of 24.1

Colgate Palmolive (CL) of a whopping 48!

Even at these high valuations the stocks continue to climb and even Procter and Gamble whom are struggling with growth are up over 16% year to date.

With such high valuations I often sit back and watch momentum and demand drive these stocks higher, waiting patiently for an opportunity.

One stock that I have my eye on is Reckitt Benckiser (RB), a British consumer goods company that specialises in health and hygiene products.

Its rapid growth and impressive portfolio of products has caught my eye.

The company owns internationally recognisable brands such as Durex, Dettol, Clearasil, Veet, Strepsills and Scholl. With such a great portfolio of products I felt the need to take a closer look at the stock’s fundamentals;

Growth

Reckitt Benckiser’s sales growth has been impressive as of late with year end results for 2015 showing a further 6% growth in like for like sales at the company. What I love most about this company is it portfolio of Health products, which people will buy regardless of pressures on disposable income.

The growth in revenue from its Health division continues to be strong with a 14% like for like growth in2015.

Screen Shot 2016-08-19 at 09.31.26.png

But, as we can see from this tablefrom the company’s 2015 annual results this growth seems to be a tale of two halves.

The company’s Health segment continues to perform strongly but there are certainly signs of weakness in their home division and portfolio brands – investors should be aware of this.

Whilst Home and Portfolio brands make up a minority % of sales, further weakness in these divisions could neutralize (or certainly damage) the impressive growth in the health division.

We can somewhat see this concern play out in the EPS figures – EPS growth has not been strong with an average growth rate of only approx 1.6% since 2012. The company’s turnover has actually declined over the past few years from £9.485m in 2011 to £8,875m in 2015.

Dividend

The company has paid a dividend since 2008 and has managed to increase its payments by 84% since then. The company’s payout ratio for 2015 was also a comfortable 54% meaning that there is room for dividend growth if EPS stay flat. Dividend yield based on 2015 year earnings is an anemic 1.9%

Value

With no major red flags concerning the company thus far, it’s time for me to burst your bubble.

RB is not a buy!

I feel that this company is grossly overvalued, especially compared to its peers such as ULVR.

Looking over the past five years, we can see that the stock has an average 5-year p/e ratio of 20.2. But today we can see that the stock is trading hands for 30.8x earnings.

Even if we take the highest estimate for 2016 earnings of 301p per share the stock is still trading hands for 24.7 times earnings.

The 30.8 p/e ratio means the market is pricing this stock for some serious growth, something it has failed to deliver over the past five years. Yes, the growth in certain divisions is impressive but we must look at the company as a whole.

I was really interested to see what a dividend growth model valuation would give as a fair price for Reckitt Benckiser and I decided to be generous with my estimations too.

I factored in a 8% discount for the risk of our capital (As it’s a pretty steady earning stock in a great sector), and assumed that the company would grow its dividend by 6% annually (above its average 5 year growth rate of 3.85%).

Even with my very generous and optimistic figures the stock came in at a fair value of – 6,950p a share. Meaning that by my estimations the stock is at least 15.3% over-valued at present.

Summary

Reckitt Benckiser is a brilliant company that is powering ahead with the growth of its Health division. In an uncertain world it makes sense to invest in companies that have a great portfolio of essential health products that people will always need to buy. I’m confident that management can continue to deliver growth in this segment but the decline in their portfolio brands puts a question mark on the degree of overall EPS growth moving forward.

At a lower valuation I’d certainly roll the dice a bit and feel confidence that the intrinsic value I’d be getting would make any disappointment acceptable (relative to the price I paid). But, this company is priced for significant growth and that is far from certain.

If the company does indeed grow as projected then I expect the price to continue to climb higher, sustaining its current momentum which makes the stock unappealing in terms of valuation and yield. But, one slip will certainly lead to troubling times for the share price and ,hopefully, a buying opportunity for me!

Advice: Avoid at these prices, but keep an eye out.

Disclosure: I am/we are long ULVR, FLO.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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Why I just sold BP.

A tough enviroment and deteriorating fundementals mean BP is a sell for me.

Recent sell: BP.

I really hope that I don’t need to write too many articles like this. When I buy a stock, I want to hold that stock indefinitely. My hope is that as I only invest in high quality dividend growth stocks that these stocks will continue to perform and pay me an income for life. For me to have to sell one of these companies means that something somewhere went wrong.

Predicatbility

In my portfolio I want predictability, not in terms of share price (frankly my shares could drop 50% for all I care), but in terms of the income that I gain from these shares. I need confidence that a company can meet its dividend obligations without fail. Unfortunately, I no longer feel that BP can continue to do so in the current environment.

EPS for 2015 came in at -0.35 a share whilst reported dividends per share were 0.40. This means that the company has had to take on debt and sell assets to fund its dividend. Judging by the continued weakness in oil price and Q2 results we can expect that BP will once again have to load up on debt to meet its dividend obligations this year. Although there are predictions that oil price will recover and whispers of any output freeze – the simple answer is that we don’t know if these events will happen.

I’m not happy to sit in hope.

Is it really prudent for investors to sit and hope something is going to happen or should they act on the information they currently have to hand?

I don’t like betting on what may happen and hoping that predictions materialise. The truth is, we don’t know when oil prices will rise  and I’m not comfortable in holding a stock that I feel is in a position of squeeze between pleasing shareholders (via dividend) and doing what’s best for the balance sheet and the company in the long-term. ConcoPhillips is a lesson to investors who think that oil majors can continue to take on debt with the company recently slashing its dividend from 74c per share to 25 per share. In my mind (from what I understand from the decision), ConcoPhillips made the correct decision to protect their balance sheet from further damage and to brace themselves for lower prices for long.

When I begin to look at BP’s fundamentals, its debt and continued asset sales I begin to feel like the prudent thing for the company to do would be to cut its dividend.

XOM Better placed.

I’m sure that BP will be just fine over the long-term once oil prices recover but their dividend remains in question.  Remember – dividend growth investors seek to grow their income from dividends over time and shouldn’t look for capital gains as a factor for investing.

I’m not selling out of oil altogether, I’m simply reducing my holdings in this volatile environment and placing my bets on a company that I feel is in much healthier shape. I won’t go into detail, but it’s clear to me that XOM is much better placed to ride out a situation where oil prices remain low for years to come. It’s balance sheet is superior sporting a much lower debt to equity ratio (by circa 60%), and its EPS are still in positive territory. It’s also worth considering that XOM has a AA+ credit rating from S&P as opposed to the A-2 BP holds. This means that any debt XOM does take on will likely have smaller interest repayments. These ratings are also indicators to the overall financial strengths of the companies.

I also feel much more confidence in XOM’s managements committment to its dividend with its 33 year dividend growth streak a testament.

Summary

BP isn’t going to disappear tomorrow, don’t worry. If you’re a share holder and are happy with the risks then by all means hold, who knows, it may pay of handsomely for you if oil prices tick up in the near future. Enjoy the yield! But, for me, the risk just isn’t worth the reward. When a stock’s current fundamentals are pointing towards danger and my holding in that stock is showing a 10% gain, I’m happy to lock in the capital gain (tax-free) and buy a stock that I feel has more solid fundementals.

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Don’t doubt Next Plc. Why I think the Motley Fool is wrong to be so bearish.

Browsing the news section for Next Plc yesterday uncovered a nasty surprise. Yet another Motley Fool article that scratches a few metrics of a stock then deems it a buy…

Browsing the news section for Next Plc yesterday uncovered a nasty surprise. Yet another Motley Fool article that scratches a few metrics of a stock then deems it a buy or sell. This week was the turn of Next, which I find interesting as a shareholder. Royston Wild notes;
“Like Tesco, clothing colossus Next (LSE: NXT) is also being battered by a backcloth of rising competition and the need for savage price cuts.

Competitive pressures have been a particular problem for the retailer’s Next Directory catalogue division, which stole a march on the rest of the high street with the early embrace of e-commerce. But its rivals have invested heavily in this growth channel more recently, giving Next a run for its money.

And I expect revenues at Next — which has already disappointed investors with profit warnings in recent months — to struggle still further as a probable lurch into recession quells British shoppers’ demand for new clothes, and drives footfall at cut-price operators like Primark and H&M.

I reckon Next is an unattractive stock selection at the present time, even in spite of a conventionally-decent forward P/E ratio of 12.4 times”

What Mr Wild isn’t taking into account here is the financial metrics of Next, its superior margins and the ability of management to deal with change.

Sector
There’s no doubting that the retail sector is full of competition, and although Next Plc is noting tough trading conditions their lean approach to operations enables them to operate at an operating margin of 20%. Next also have a history of growing EPS despite tough conditions with a growth from £2.51 per share in 2012 to £4.43 in 2016. Mr Wild notes that a squeeze on the spending of Brits will drive customers to low-cost competitors such Primark and H&M but he fails to note that we’ve been here before!

Think of the biggest recession of recent memory – 2008. How did Next perform? Whilst it’s true that sales suffered with like for like retail sales down 7% the company proved its durability by maintaining its dividend payments and keeping a robust balance sheet. Next is a company that has performed exceptionally well since it flirted with bankruptcy in 1998 and the lessons learnt then still shape the company today.

Next Directory

Mr Wild notes in his article that competitors are finally starting to catch up with Next directory. Many may also be fearful of online competition from online only retailers such as ASOS. Whilst it may be the case that competitors have caught up and it may appear that this has had a negative effect on the performance of Next directory the figures paint a different picture. In fact, Next directory sales increased by 8% between 2015 and 2016, with Next retail also growing by an admittedly anemic 1%. The online retail sector is going to continue to grow and I see no reason why Next can’t compete and continue to grow its Next Directory sales.

Future EPS growth.

This is admittedly a worry for the company as it competes in a tough market and with the company already lean it’s hard to see how growth could be achieved through greater efficiency.

I expect Next’s growth to remain steady over the coming years as they fight to defend their market share. I don’t expect Next to flourish, but I certainly expect it to be solid and sound until consumer spending picks up.

Value

What’s great about Next is that management loves to buy up its own shares when they feel they are undervalued, usually at or under £65 a share. Showing that their confident in their performance and that the company has access to cash if needed. The share price currently sits at £54 a share, sporting a low p/e ratio of 12.2 given that the company was trading at 17.6 times earnings in 2014 and 17.3 times earnings in 2015.

Dividend

This is what really attracts me to Next plc. The dividend payout ratio for the stock in 2016 was only 36%, meaning that the company is comfortably covering its payments and has plenty of room to increase the payout ratio to maintain the dividend over the coming years even with weak EPS growth.

The current dividend yield on offer is a decent 2.9%, nothing to get excited about but better than a bank account in the current environment, one must also consider the company’s habit of paying a special dividend with its spare earnings when it considers it share the price to be overvalued. This year they paid a juicy special dividend of 60p. Whilst investors should never expect special dividends, they’re always a bonus and can help boost your dividend income. For illustrative purposes, if we included the special dividend it would give Next a yield of 3.8%.

Summary

Whilst admittedly Next wasn’t my wisest buy ever, I certainly wouldn’t tell investors to ‘avoid at all costs’. Next has a great management team that came through 2008 and I have full confidence in their ability to come through any coming recession, we might even see a few less lean competitors suffer! Yes, competitors have significantly improved their online offering but that doesn’t mean that Next directory can’t continue to grow in a growing market.

Next deserves its place in my portfolio and I will only sell if managements attitude towards the dividend changes or if its fundamentals deteriorate significantly.

Disclosure: Long NXT

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Weekly share tip: Why I bought Greggs, even though I don’t see much value

Usually, I don’t dip into the FTSE250 looking for purchase opportunities but with the usual dividend growth stocks trading at high valuations (See MCD and JNJ for just two examples)…

Usually, I don’t dip into the FTSE250 looking for purchase opportunities but with the usual dividend growth stocks trading at high valuations (See MCD and JNJ for just two examples) I felt the need to search elsewhere for some value.

Last week, I analysed Britvic PLC, and my dividend discount model showed that the company was potentially 10% undervalued, well today it’s time to take a look at another FTSE250 stock – Greggs Plc.

One thing that really stuck with me from reading Jason Feiber blog in my early investing days was the need to understand what a business does. Well, with Greggs it really doesn’t come much easier to understand. Greggs sells pastries, and Brits love pasties. In recent years Greggs has also diversified its business from a traditional bakery to a food-on-the-go retailer that offers anything from a pasty to pasta, there is even talk about the company branching out into stocking Sushi! Greggs has also moved swiftly with consumer trends by introducing ‘Balanced choice’ products which contain around 400 calories.

Greggs is present on most UK high-streets and has also been successfully expanding into motorway service stations. Overall Greggs now has around 1,700 stores with plans to expand to 2,000.

With it’s share price down 13% year to date, and nearly 20% since January, is now the time to buy?

Value

At nearly 19 times earnings the stock appears expensive, and taking look at its historical p/e ratio we can immediately see that the stock has traded at far lower multiples in the past. It traded for 12.5 p/e in 2010 and 11.4 p/e in 2011. but by 2014 the stock has skyrocketed to multiples of 19.9 and in 2015 the stock was trading hands for a ridiculous 23.5 times earnings, namely due to lower EPS.

I absolutely hate paying above fair valuation for any stock, so why on earth is Greggs in my portfolio?

Why buy at a relatively high multiple?

In 2013 Greggs appointed a new CEO who embarked on an ambitious shift in strategy in order to aggressively target a growing food-on-the-go market. The company quickly shifted the format of their stores by focusing on a new bakery food-on-the-go format that has proven to be very popular with consumers.  The company also quickly re-launched its improved blend coffee range in 2014. That coffee ended up being its fastest growing product.

Greggs is now uniquely placed in the food-on-the-go market with its ability to offer hot or cold products and fresh coffee for a competitive price. This really sets the company apart from competitors such as supermarket chains due to the freshness of the offering and from high-end competitors such as coffee shops by its pricing. The shift in strategy has evidently paid off with EPS growth of 42% between 2013-2014 and further EPS growth of 29% from 2014-2015. Whilst we don’t have a mystic ball to predict future growth we can be confident in the company’s plan moving forward in an industry that’s growing 9% annually.

Minimum wage advantage

In addition to this, Greggs has a step up on its competition in relation to costs. With chains such as Costa announcing that they will have to raise prices in order to pay staff the new £7.20 minimum wage, Greggs already paid staff £7.11 an hour meaning that they can maintain prices.

Dividend

Greggs currently has a dividend yield of 2.72% which isn’t bad, but nothing to get excited about. But what really does excite me is the company’s commitment to grow the dividend. The company managed to grow its dividend by 30% from 2014 to 2015 with a juicy special dividend of 20p per share.

There’s no doubt that Greggs struggled before its turnaround but it was still committed to annual dividend increases and even increased its dividend during the financial crisis of 2008. It has now increased is dividend every year since 1999, bar a freeze between 2013-2014 where it maintained its payout in order to fund the turnaround.

 With a payout ratio of 52% there is also still room for maneuver to increase the ratio should sales somehow disappoint.

What about fair value?

It’s really hard to find a fair value for Greggs simply because we don’t know if the turnaround will continue to deliver such outstanding EPS growth. It’s currently 2 years into its 5-year turnaround plan and I don’t know a psychic in order to help me predict the future. But, what I do know is that the first two years have been successful and management seem worth their wages from what I’ve seen so far.

I’m not going to put a figure on this stock but am happy in owning its dividend factory at an ok yield with a steady dividend growth history.

Summary

Dividend growth investors look at companies that have a history of annually increasing their dividend and Greggs has certainly proven its ability to do so. With a successful turnaround in full flow and an enviable position in a growing market I can see no reason why Greggs can’t continue to pay me dividends. This stock won’t be a core holding in my portfolio and I’ll be closely monitoring its turnaround progress. Should its success continue and EPS continue to grow I’m looking forward to some nice dividend paydays!

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A dangerous mistake that even experienced investors make.

No-one is perfect and even the most experienced of investors make mistakes, and one mistake that I see time and time again is buying into hype and forward valuations.  …

No-one is perfect and even the most experienced of investors make mistakes, and one mistake that I see time and time again is buying into hype and forward valuations.

 

I’m not going to name names – but I have seen countless articles and countless analysts deem stocks ‘obvious’ and ‘stunning’ buys based purely on projection.

Only today I saw an analyst call Cineworld Group plc a stock that “fully merits a slightly-elevated forward P/E rating of 18.1 times”.

 

But how do we know that in one year Cineworld will indeed achieve its forecast earnings? Maybe it’ll be higher, maybe it’ll be lower, who knows? But we must remember that tens of analysts that evaluate stocks. Some place Cineworld’s estimated EPS for 2016 at 34.2p a share giving you a forward p/e of 17.5. Some place Cineworld’s estimated EPS for 2016 at 30.68 giving you a forward p/e of 19.5. Who knows which analyst is correct?

 

One thing we do know and that is that the stock currently trades at a s p/e of 19.62. Definitely overvalued for a cinema chain!

 

But Analysts are professionals, surely they get things right?

 

You would think so but this couldn’t be further from the truth. Analysts use a range of different methods and take a range of different views on stocks in order to estimate anything from price targets to earnings. If analysts really had the market figured out, why do their valuations vary and why did many close due to wrong predictions during the 2008 market crash?

 

If we take an extreme example of how wrong analysts, predictions and hype can be we don’t  need to travel further back than 1999 and the dotcom bubble for some perfect examples.

 

During this period the US stock market’s p/e rose to 32 and many tech stocks with negative EPS were trading at p/e of over 100 simply because they sounded cool. We’re only now seeing tech companies like Microsoft and Verizon return to their 1999 levels – 17 years later, after trading hands at ridiculous valuations at the bubble’s peak.

 

In 1999, Wall street was buying with both hands and analysts predicted never-ending EPS growth of 100’s% yearly until the bubble burst in early 2000. But, those looking at the facts during this period could see that such valuations were ludicrous and the EPS projections farcical and were spared the losses that bankrupted many investors.

How about an example of these valuations?

Let’s take Yahoo – on January 3rd 2000, Yahoo shares closed at an all time high of $118.75 per share, doubling in price since December 1999. Their earnings per share for that year came out at $0.05 putting the company’s valuation at 162x earnings. On September 26 2001 their shares were worth just $8.11.

 

Current examples of irrationality

I often get criticized by friends and colleges for not buying in to ‘stocks of the future’ a few names that instantly come to mind are – Amazon, Netflix and Tesla.

Well let’s look at the facts,

Amazon trades at a p/e of 192 (ttm). It’s EPS were negative for 2012 and 2014. Even if I took the highest analyst estimates for EPS in 2017 of $15.55, purchasing the stock today for $770 would give me a p/e of 50. There’s absolutely no value in the stock at this level.

Tesla hasn’t recorded a year of positive EPS figures yet, has a net loss of $886m worldwide yet astoundingly trades at a valuation of $226 per share!

Netflix on the other hand has a p/e ratio of near 300 (ttm). But I’m sure it’ll all be ok because the company is expected to earn 0.89c a share in 2017 up from the 0.25c per share the company recorded in 2015. Even if we took the highest estimate for EPS in 2017 which is $1.38 this would give us a p/e of 69 in 1.5 years time.

Conversely, I could buy Walmart today, for 16.33 times earnings and receive a 2.71% yield and annual dividend increases for the foreseeable future. There’s no mystic ball needed here. These are facts.

 

Lesson

 When you’re buying a stock, you’re buying a part of a company. You can sell your part of that company to Mr Market whenever you like – for the price he offers. But, one thing you should learn is that Mr Market is sometimes (often) irrational and can offer you ridiculous valuations for your part of a company be it to little or too large a valuation.

For example, If you went to a car dealership and bought a car you knew was worth £1,000 for £1,000 and parked it outside your drive, you would be content in knowing you have a £1,000 asset sitting outside your house. So, what would you do if Mr Market knocked on your door and offered you £500? You wouldn’t sell it of course, knowing full well your car is worth £1,000.

But, what if when you went to the car dealership and the salesperson said to you;

“I know this car is only worth £1,000 today, BUT our dealership, and other dealerships estimate that this car will be worth £5,000  in three years. I tell you what, I’ll give it to you today for just £2,500.”

If you bought that car and parked it outside your drive, how do you know that Mr Market will knock on your door in three years and pay you £5,000 for it? How do you know that that car will indeed appreciate in value at all?

The mistake would be to buy the car for £2,500. The mistake investors often make is to buy a stock for well over the market/sector’s average p/e in the hope that the analysts were correct when they projected forward earnings.

I must admit that I have indeed done this and it didn’t end well. I’ll be writing an article on my mistake this Monday. Have you ever made this investing mistake? Comment below.

Disclosure: I have no positions in any of the stocks mentioned and no intention on initiating a position within the next 72hours.

All figures taken from ft.com

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