I’ll consider Orchard Funding’s (LSE:ORCH) financial stability by firstly looking at its vulnerability to financial distress and secondly it propensity to generate cash year by year.
In 2000 Joseph Piotroski published research looking into the question of whether you could take a bunch of value shares and then separate out the strong from the weak using accounting ratios and measures.
The nine factors, taken as a whole, indicate where a company is along the spectrum, ranging from showing great improvements to its financial position at one end to exhibiting increasing financial distress at the other.
I'll conduct Piotroski analysis on both year on year changes and secondly on changes between the latest half year and that of the previous corresponding HI.
If the firm is profitable and produces positive cash flow it has a capacity to generate funds internally. A positive earnings trend suggests an improvement in the firm’s ability to generate positive future cash flows.
Measuring changes in capital structure (debt:equity ratio) and firm’s ability to meet future debt service obligations.
What about cash flow?
Orchard has demonstrated excellent cash flow generation ……………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Orchard Funding (LSE:ORCH), a company I bought into this week, is a small player in an industry dominated by two giants. Nevertheless, it has been profitable in each of the last ten years. Indeed, it was growing profit steadily until Covid-19, so there must be some degree of protection from the big boys bullying the firm out of its markets.
Ravi Takhar, CEO and 53.3% shareholder, took control of a small company in 2002. A subsidiary, Bexhill, was created that year to target clients of insurance brokers by lending to them for up to 10 months. Monthly repayments meant that the money returned to Bexhill pretty quickly.
By 2014 Bexhill had about 100 broker clients who arranged loans for policyholders so that they could pay their insurance policy premiums upfront (it now has 150 insurance broker partners). Annual advances were about £30m (at any one time only £10m - £15m was outstanding) which generated revenue (interest) of £1.8m. Profit after tax was £0.87m.
Orchard Funding Limited
The second strand to the company’s lending was conducted through Orchard Funding Limited. From a standing start in 2010, by 2014 this subsidiary was lending money to clients of 400 accountancy practices. In early 2015 its loan book stood at £8m having lent about £16m over the previous 12 months. Annual revenues (interest) were £1.17m and profit after tax £0.15m. It had 2,236 borrower agreements, with an average loan value of about £4,000.
Floating on the stock exchange
On joining AIM in 2015, in which it raised £10m gross or £8.7m after financial advisers had taken their cut, the directors were able to proudly state that the business model was so good that there had been “no arrears or losses on the lending book of the Group over the last seven years” (Admission document). We’ll look at the reasons behind this impressive statement by a lender later.
There were then only 11 members of staff so operating costs were low. Even today there are only 22.
A good net interest margin, low operating costs and low/no default meant that the business was cash generative leading the directors to declare a high ambition for dividends: “As the Group is cash generative it is the directors intention to implement a progressive dividend strategy” (Admission document).
Staff numbers could be kept low because it had, for 13 years, been improving its processing platform for loan proposals, with feedback from daily use. By 2015 it was used on 100 insurance brokers’ and 400 accountancy firms’ computers, processing each year transactions for over 3,000 borrowers.
Delivered via the internet it incorporated all the systems, procedures and documentation required by an insurance broker or an accountancy firm to introduce its clients to the Group and conduct a finance business. It also managed all the agreements, calculated funding requirements and performed all day-to-day accounting and administrative tasks of the Group.
On flotation the directors said their aim was to double the size of lending from its annual £46m. They were going to do this by (a) increasing the number of insurance broker and professional firm clients, (b) increasing the volume of business from existing brokers and accountancy firms.
Some of the extra £8.7m raised in the float was useful for handing out to brokers and accountancy firms as commission when they persuaded a client to take credit. Money was also useful for reducing financial risk, i.e. not having to borrow so much from Barclays; until that point about 75% of the money lent was obtained from Barclays, after the float one half came from Orchard’s own cash resources.
Size of market
While the general insurance market is about £50bn per year only a fraction of policyholders choose to by on credit, about £9bm to £12bn.
The potential of the accountancy fee finance market was given a boost at the time of the float by the banks pulling out of market for small-ticket, short-term, unsecured funding. The addressable market was perhaps £300m.
Orchard has multiple layers of credit protection:
About 90% of ins……………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
In the last newsletter I drew attention to Orchard Funding’s (LSE:ORCH) net current asset value, NCAV, per share, at 72p, being appreciably more than its share price of 56.8p. This was a good starting point for including it in my net current value portfolio. Other factors, mostly on the qualitative side, also came into play - to be discussed in future newsletters.
First I’ll show how Orchard might have fitted into my Modified cyclically adjusted price earnings ratio portfolio as well as the NCAV portfolio. As you can see in the table below for the last seven and a half years Orchard has produced impressive earnings per share numbers for a share valued by Mr Market at 56.8p (market capitalisation £12.1m). The average is 6.5p (if I include an annualised EPS for 2021).
Thus the cyclically adjusted price earning ratio is 56.8p/6.5p = 8.7, about one-half of that for the UK market.
My, admittedly thin, reasoning for allocating to the NCAV portfolio is merely that I only have seven and half years of data for earnings rather than the more conventional ten used for a CAPE ratio calculation. It really doesn’t matter which portfolio it goes into; simply that it is deep value investment likely to provide a good return. Having the reinforcement of fulfilling not just one but two strict criterion is comforting.
It’s also comforting to see such a high proportion of earnings flowing to shareholders in the form of dividends. The business is cash generative, growing steadily (until Covid-19) at a rate which doesn’t absorb a high proportion of the money it makes.
The directors, including the 53.3% holder, prefer to reward shareholders regularly – his dividends amount to more than a third of a million each year – rather than splurge on rapid expansion and speculative ventures………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
I’ve bought shares in Orchard Funding (LSE:ORCH) at 56.8p because its net current asset value is 72.1p and it is financially and operational stable with a loyal customer base and low-risk business model as well as a highly experienced and capable managerial team. It also produces a reliable 3p dividend each year supplying an attractive 5.2% dividend yield.
Given the quality of the customer offering and the potential to tap into adjacent markets it is likely that the dividend will grow nicely from here.
Since the company floated on the AIM market in 2015 annual earnings per share have averaged 6p putting the shares on a cyclically adjusted price earnings ratio of less than 10, two-thirds the market average.
Even in the year ending 31st July 2020, one affected by Covid, earnings per share came out at 5.96p. In the most recent half year, 1st August 2020 to 31st January 2021, a period of significantly reduced client activity, Orchard Funding generated 2.19p earnings per share (2019: 3.75p).
The resilience displayed in the Covid slump was the second time the business model was tested by events beyond the firm’s control having sailed through the Global Financial Crisis in good shape.
The company in its modern form was built by former investment banker Ravi Takhar following his acquisition of 100% of the equity in 2002. He now owns 53.66% after the sale of £10m of new shares to other investors when it joined the AIM market in 2015.
The business model is simple: around the country are thousands of insurance brokers whose clients often do not want to pay say a £20,000 annual insurance premium all in one go at the start of the policy.
Orchard Funding, through its Bexhill subsidiary, offers brokers and their clients a deal. It will pay the premium and, in return the client will make say 10 monthly payments to Bexhill. The amount paid each month is slightly more than one-tenth of the premium to allow for an effective interest charge.
Typically, Orchard will fund one half of its outstanding loans to customers with its own money and one half will come from an annually arranged loan facility from Barclays Bank or a couple of other banks it has relationships with.
Even paying around 4.5% on the funding it borrows (which includes bank fees etc.) Orchard can make a good profit because it charges APRs much higher than that (high teens).
The insurance broker is happy because the ultimate customer is provided with an additional service and because it receives commission from Orchard/Bexhill.
The broker will use Orchard’s in-house developed software. This can be set up to allow the broker to either operate their own funding company to provide a high level of personal service to clients. Alternatively, the broker can act as an introducer to Orchard which then takes on the direct lending to the customer.
Orchard insists on recourse to the broker………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
The stock markets, the US ones in particular, at this late stage in a bull market, seem to be increasingly influenced by speculators. Warren Buffett and Charlie Munger have long argued against speculation in shares, saying that share buyers should thoroughly understand what they buy (understand the underlying business, the managers and finances). So the following question about the latest manifestation of the ancient human tendency toward speculation posed little intellectual challenge to Buffett and Munger (speaking 1st May 2021).
Q: What do you think about Robinhood and other trading apps or fintech companies enabling all ages and experience to participate in the stock market.
BUFFETT: “It [Robinhood, the “free” brokers] has become a very significant part of the casino group that has joined into the stock market in the last year, year-and-half. They have attracted 12% or 13% of casino participants.
“You know, I looked up on Apple the number of seven day calls [options], 14 day calls outstanding. And I’m sure a lot of that is coming through Robinhood. They’re gambling on the price of Apple over the next seven days.
“There’s nothing illegal about it; there is nothing immoral. But I don’t think you build a society around people doing it.
“I mean, if a group of us landed on a desert island and we knew that we’d never be rescued, and I said, ‘well, I’ll set up an exchange over here, and I’ll trade our corn futures and everything!’ [Laughing].
“I think the degree to which a very rich society can reward people who know how to take advantage of essentially the gambling instincts of not only the America public, but the worldwide public…it’s not the most admirable part of the accomplishment.
“But I think what Americans have accomplished is pr…………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
“If you’re not a little confused by what’s going on you don’t understand it. We’re in unchartered territory.” (Charlie Munger)
Warren Buffett and Charlie Munger were recently asked whether the current boost to fiscal and monetary stimulus will lead to higher inflation, the consequences of which could be significant for the equity markets.
BUFFETT: “The answer is we don’t know...the best we can do is recognise that we don’t know and proceed in a way where we get a decent result no matter what happens.
“We do not think that we can make money by making macroeconomic predictions."
When asked about the conditions currently being experienced by Berkshire companies he said “We’re seeing very substantial inflation. It’s very interesting; we’re raising prices, people are raising prices to us. And it’s being accepted.
“Take home-building. We’ve got nine home builders in addition to our manufactured housing operation (which is the largest in the country). The costs are just up, up, up. Steel costs…just everyday they’re going up…the wage stuff follows...
“It’s an economy really that’s red-hot. And we weren’t expecting it. I mean, all our companies when they were allowed to go back to work…you know, the furniture stores can’t stop people from buying things, and we can’t deliver ‘em. But they say ‘well, that’s OK because nobody else can deliver them either, and we’ll wait for three months’. But the backlog grows.
“We thought it would end when the $600 payments would end [additional unemployment benefit each week] around August of last year. You know, it just kept going, it keeps going and it keeps going.
“I get the figures every week...and it just won’t stop. ………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
It is important to clearly distinguish between rates of return on capital employed by operating businesses and potential rates of return available to those buying shares at various prices. It’s perfectly possible for a very high return on capital company (small amounts of money used internally relative to profits) to have shares so expensively priced that they offer any new shareholders poor rates of return on their money. This phenomena makes most high rates of return on operating unit companies impossible for value investors to buy.
BUFFETT speaking at Berkshire's AGM 1st May 2021:
“We’ve always known that the great business is one that takes very little capital and grows a lot. Apple and Google and Microsoft and Facebook are terrific examples of that. Apple has $37bn in property, plant and equipment, Berkshire has $170bn or something like that.
“They’re going to make a lot more money that we do…it’s a much better business than we have. And Microsoft’s and Google’s business are way better businesses than we have.
“We’ve known that a long time; we found that out with See’s Candy in 1972. It just doesn’t require that much capital – it has a couple of manufacturing plants – but it doesn’t have big inventories, it doesn’t have a lot of receivables.
“You know, those are the kind of businesses, they’re the best businesses but they command the best prices too.
“We’re looking for them all the time. And we’ve got a few that are pretty darn good, but we don’t have anything as big as the big guys.
“But that is what everybody is looking for, that’s capitalism. It’s about people getting a return on capital and the way you get it having something that doesn’t take too much capital. I mean if you really have to put out tons and tons of capital…
“Take the utility business. It’s not a super-high
………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
At Berkshire Hathaway’s Annual General Meeting (1st May) Warren Buffett warned investors to keep a close eye on managerial quality because it is there that the biggest risk resides.
In the lead up to that statement he talked about how, when you’ve made a mistake and put money into a badly managed firm or in one with poor industry economics it may not be too serious for your overall portfolio result because your good decisions will come to dominate your overall result.
First the basic principles:
BUFFETT: “Any time we’re look at buying a business we look at evaluating the competitive strengths of the business; the price we have to pay; the management we get”
Mistakes will be made, but that’s OK
BUFFETT “And I’ll continue making mistakes. And we’ve got some wonderful deals and some terrible deals.
“The nice thing is when we’re disappointed in a business it usually becomes a smaller and smaller percentage of our business [portfolio]. And when we get a successful business like a GEICO – doing 15 times as much business as when we bought control – they become proportionally a much more important part of our mix.
“So you really get, just through natural forces, more of your money in the things that have developed more favourably than you thought. You actually end up getting a greater concentration in the ones that work out.
“It’s not like having children, where the bad ones cause you more problems. Bu………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Buffett and Munger – we are living in “the most interesting movie, by far, that we have ever seen in terms of economics”, but it could end in “disaster”
Warren Buffett, speaking at the Berkshire Hathaway AGM, said: “The Fed moved with speed and a decisiveness on March 23rd 2020, that changed the situation, where the economy had stopped. Then Congress acted very, very big, so you have fiscal and monetary policy that responded in a way that was incredible, and it did the job...better than anybody expected. I mean, this economy right now, 85% of it, is running in super high-gear and you’re seeing some inflation.
“Interest rates have fallen to very little…If present rates were destined to be appropriate those [hi-tech] companies are bargains. They have the ability to deliver cash at rate that if you discount it back, and you’re discounting at present interest rates, stocks are very very cheap.
“Now the question is what will interest rates do over time? It’s a fascinating time; we’ve never really seen what shovelling money in on the basis that we’re doing it - on a fiscal basis following a monetary policy - with close to zero interest rates. It is enormously pleasant.
“But in economics there is always one thing to remember: you can never do one thing, you always have to say, “And then what?”.
“And we’re sending out huge sums…e.g. $1,400 cheques...and so far we’ve had no unpleasant consequences from it. People feel better – the people lending money feel very good - and it causes stocks to go up, it causes businesses to flourish, it causes an electorate to be happy.
“And we’ll see if it causes anything else. And if it doesn’t cause anything else you can count on it continuing in a very big way.
“But there are consequences to everything in economics…and people feel good and will become numb to numbers, you know, trillions don’t mean anything to anybody, and $1,400 does mean something to ‘em. So we’ll see where it all leads. Charlie and I consider it the most interesting movie, by far, that we’ve ever seen in terms of economics”
MUNGER: “Yes, and the professional economists, of course, are very surprised by what’s happened. It reminds me of what Churchill said about Clement Atlee, he said he was “a very modest man who had a great deal to be modest about”.
“And that’s exactly what happened with the professional economists. They were so calm about everything. It turns out that the world is more complicated than they thought…I don’t think any of us know what’s going to happen with this stuff. I do think there’s a good chance that this extreme conduct is more feasible than everybody thought, but I do know that if you keep on doing it without any limit it will end in disaster.”
BUFFETT: [Many funds such as SPACs] “have to buy within two years or give it back. The managers of these benefit from doing deals but get nothing if there is no deal. It’s an exaggerated version of what we’ve seen in gambling-type markets. In fact, I have a quote from Keynes, it really sums up the problem:
“Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.” (The General Theory, 1939).
“Well, we’ve had a lot of people at the casino in the last year. You have millions of people set up accounts where they day trade, where they’re selling puts and calls. I would say that you’ve had the greatest increase in the number of gamblers essentially.
“They’ve had cash in their pocket, they’ve had action and they’ve had a lot of good results.
“And if they just bought stocks and held them they’d do fine.
“But the gambling impulse is very strong, and people worldwide, - and occasionally it gets an enormous shove – and conditions lead this to the place where more people are entering the casino than are leaving every day.
“And it creates its own reality for a while. And nobody tells you when the clock’s going to strike 12 and it all turns into pumpkins and mice.
“When the competition [to Berkshire loo………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
In the May 1st Annual General Meeting of Berkshire Hathaway Warren Buffett warned investors with little experience or sense of stock market history to be cautious. Investing in a way that allows you to out-perform is not as easy as it looks.
“I would like particularly new entrants to the stock market to ponder just a bit before they try and do 30 or 40 trades a day in order to profit from what looks like an easy game”
Buffett showed a slide of the current largest 20 companies as measured by market capitalisation with Apple, Saudi Aramco, Microsoft, etc., at the top (Berkshire is tenth) he then posed a question:
“How many are going to be in such a list in 30 years from now?” Obviously the question cannot be answered, but to make a point he showed a slide of the largest companies in 1989.
The top companies then were predominantly Japanese (whereas no Japanese were in the 2021 list) headed by Industrial Bank of Japan, Sumitomo and Fuji Bank. The important point is that none of the top 20 in 1989 were still in the top 20 in 2021...zero (out went companies such as Royal Dutch Shell, Toyota, IBM and Philip Morris.
Buffett said in 30 years from now some of the current top 20 will get onto the 2051 list, but the 1989 example “it is reminder that extraordinary things can happen…We were just as sure of ourselves as investors and Wall Street in 1989 as we are today. But the world can change in very dramatic ways”.
Are rising industries sure bets?
He offered another example to ponder: “People get enormously attracted to various industries. They think if the company says it’s in XYZ industry, and it's a popular one, it can sell IPOs, sell SPACs; you as an investor can [therefore] disregard sales numbers, earnings numbers because ‘it’s the place to be’”.
The place to be in 1903 was in the new technology of the internal combustion engine. So Buffett asks us to remember the that investment history when we are contemplating investing in the c
………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Prof. Glen Arnold
I'm a full-time investor running my portfolio from peaceful Leicestershire countryside. I also happen to be UK´s best selling investment book author and a Financial Times Best selling author.
Originally, I wrote all my ideas out in full on this website. Now that ADVFN publish them they are entitled to display the full version for six months – you can see them here. Thus can I only post the first few paragraphs here for anything younger than six months.
I write 2 to 3 newsletters per week - investing is about making the right decisions, not many decisions.