When Dave Sokol took over the management of NetJets at Warren Buffett's request in 2009 he hit the ground running. Within a week he had reshaped the managerial structure, including appointing a new head for NetJets North America and a new Chief Operating Officer. He also announced that NetJets' headquarters would be relocated from Woodbridge, N.J., to Columbus, Ohio, where the company's flight operations were based. (Buffett's deals from 1941 to the 1990s and their lessons for investors today are available to read in previous newsletters - I've yet to write about the twenty-first century deals).
Buffett seems to have accepted journalist Brian Foley’s argument concerning the over supply of fractional aircraft. Buffett wrote in his 2009 letter that NetJets owns “more planes than is required for its present level of operations”.
Aircraft orders were cancelled and by Spring 2010 Sokol had lowered debt to $1.4bn from $1.9bn. Within two years 1,700 employees were laid off (from 7,945). Sokol had plans to dispose of “selected aircraft” but refused to do so in fire-sale way, rather waiting until prices were reasonable. The fleet size went from 629 planes to under 500 over three years.
He said the tough decisions were necessary, “When you have a major economic shift such as in the fall of 2008, you have to reinvent yourself. Five years from now, I’ll wager all of us will look back at 2008 and say it was the best thing that ever happened to the aviation industry because it’s forcing innovation that wasn’t going to happen.” (David Sokol quoted in Iteknowledgies (2011) “Owners, Profit Return to NetJets” Aerospaceblog, February 2)
Stephen Pope’s verdict, writing in The Business Jet Traveler, was “the prognosis for the company is good, I think. The fractional-ownership business model has matured and adapting for the next growth cycle will require fresh thinking…the company's core customer base is still out there. They don't want to go back to charter. They want to be able to pick up the phone, arrive at the airport four hours later and climb aboard a meticulously maintained airplane crewed by well-trained, by-the-book pilots. The trick will be finding the right balance to make the numbers work again.”
The remarkably quick turnaround pleased Buffett greatly and in Spring 2010 he wrote (in his 2009 letter) that the plans already implemented would lead to rightsizing. Furthermore, NetJets was on course to make a profit in 2010.
Unfortunately, David Sokol’s time at NetJets was limited. Indeed, his time at Berkshire Hathaway was cut short by a regrettable incident early in 2011. He bought shares in Lubrizol before proposing to Buffett that Berkshire Hathaway buy the company. He purchased them because he thought the company to be outstanding and an excellent investment, but he was also asking Lubrizol’s CEO if he might be interested in being bought by Berkshire.
Sokol didn’t know for sure that Buffett would buy Lubrizol when he invested his $10m. He had told Buffett that he owned stock in Lubrizol but “It was a passing remark and I did not ask him about the date of his purchase or the extent of his holdings” wrote Buffett in his News Release March 30, 2011.
Carol Loomis of Fortune Magazine wrote, “the facts about Sokol’s buying – combined with the lift in Lubrizol’s stock that accompanied Buffett’s decision to indeed buy – put Sokol into disrepute for what some onlookers thought might be insider trading.” (Carol J. Loomis (2012) Tap Dancing to Work)
Buffett was careful to publicly note that Sokol’s actions were not unlawful, even though he made $3m profit, which was a fraction of his annual remuneration.
Sokol resigned March 28 to, as he put it “utilise the time remaining in my career to invest my family’s resources” (Berkshire Hathaway Press Release March 30, 2011). He had submitted two similarly worded resignations in previous years, but Buffett had persuaded him to stay on. In the March announcement Buffett wrote that he had not asked for his resignation and it came as a surprise to him, but he did not set out to ask him to stay in post this time.
In April a Berkshire’s audit committee report concluded that its policy of precluding share buying by its managers in companies Berkshire was considering acquiring had been violated. Also, its policy of not using confidential information for personal use had not been followed, and Berkshire’s reputation had been damaged.
A few days later, at the annual meeting, Buffett said he regretted that he hadn’t expressed a greater rebuke to Sokol. He corrected that by describing Sokol’s actions as “inexcusable and inexplicable”. Sokol was later told by the Securities and Exchange Commission that he would not face enforcement actions. He continued to maintain his innocence in the matter.
The turnaround within a………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Buffett’s 2009 letter included a mea culpa, “It’s clear that I failed you in letting NetJets descend into this condition”. It lost $711m in 2009 and the aggregate loss over Berkshire's eleven years of ownership was $157m. And the Great Recession was only just getting going. There was plenty of room for regretting this investment decision.
His solution was to call in a Berkshire executive known for taking tough decisions, especially cutting back costs and staffing, David Sokol, who Buffett described as “the enormously talented builder and operator of MidAmerican Energy”.
Sokol became CEO of NetJets in August 2009 when Richard Santulli, the founder, resigned. In Buffett’s 2009 letter Santulli was briefly mentioned as the “previous CEO”, as a stickler for safety and service and the “father” of fractional ownership, but no detailed explanation of Santulli’s resignation was given. Was he pushed after a period of massive losses?
But note, while he had resigned as CEO he had agreed to stay on for a year as a consultant, so that didn’t sound like a “don’t darken the door again” type of resignation.
On the other hand, there were rumours that Santulli had been resistant to downsizing the business and the redundancies that would entail. “Sources tell us he was forced out for failing to move aggressively enough to stem financial losses at the fractional-ownership giant. Others say he fell out of favor after rejecting calls to let go of senior managers who'd worked alongside him for years.” wrote Stephen Pope in Business Jet Traveler.
Aviation International News’ Chad Trautvetter caught a whiff of the gossip “The speculation about whether or not the company founder left of his own volition was rampant in the immediate aftermath of the announcement, and several sources told AIN at the time that NetJets’ finances might have been a factor.”
The speculative fever was not helped by Santulli’s use of the time-honoured phrase used in resignation statements, the one usually received with scepticism, “to spend more time with my young family and pursue other interests”.
But there were plenty of people who were willing to take Santulli at his word. He had a passion for thoroughbred horses, three children and three dogs. So there were plenty of other aspects to his life which he had been sacrificing to some degree while struggling to turn NetJets to profits.
Buffett seemed regretful and friendly in his August 2009 the release. “It is with reluctance that I accept Richard’s decision to step down. Richard Santulli is synonymous with the fractional jet ownership industry and his vision and energy has made NetJets the leader that it is today. All of Richard’s friends at Berkshire Hathaway wish Richard well in this transition.”
In December 2009, Santulli became chairman of Loan Value Group (a mortgage market company) and in August 2010 he launched Milestone Aviation Group, a helicopter and business jet leasing company. He also further developed philanthropic activities, focusing on individuals with developmental disabilities; supporting public education for underserved youth; military personnel suffering the effects of a traumatic brain injury and post-traumatic stress, and the Andre Agassi Foundation for Education. He avowed “everything I have will be given away while I am alive, minus enough for my wife to live.”
Can the business be saved?
There was much comment around the question of whether the fractional business model was broken. Had it become too expensive relative to the alternative facing an executive of simply chartering a plane as needed? Were there too many planes chasing too few clients?
Michael Riegel of AviationIQ, an advisory firm, declared in 2009 the fractional business model to be broken, “there are a lot o………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
With Berkshire Hathaway behind them the managers at Netjets really went for growth after the 1998 merger. Within two years revenue had more than doubled and customers held $2bn worth of planes. As early as 1998 Buffett asked Santulli “Who’s the competition in Europe?” to which he replied “No one.” Then Buffett pointedly said, “What do you need to make it stay that way?” (Aviation International News October 1, 1998)
Money flowed from Berkshire to achieve the ambition of dominating fractional ownership in both the USA and Europe.
The task of building critical mass in Europe was well under way in 1999. Buffett wrote that he intended to support NetJets’ expansion all round the world “Doing that will be expensive — very expensive — but we will spend what it takes. Scale is vital to both us and our customers: The company with the most planes in the air worldwide will be able to offer its customers the best service. ‘Buy a fraction, get a fleet’ has real meaning at EJA.” (Buffett's 1999 letter to shareholders)
The accelerator pedal was pushed even harder in 2000 with $4.2bn new planes on order. NetJets’ managers would have signed up for even more, but they were already taking about 8% of all business jets manufactured in the world and the makers could not keep up.
The fast-talking salesman
Buffett became NetJets’ number one salesman. From the off there was a fully fitted out cabin on display at the May Berkshire annual meeting (in 1998 it was a 737 Boeing Business Jet complete with bedroom, two showers, 14-hour range and 19 passenger seats). The scores of billionaires and hundreds of millionaires enjoying the Berkshire weekend events each year are prime targets for the NetJets sales teams. And Buffett started a tradition of always giving a mention in his annual letter.
In 1999 he persuaded two of Berkshire’s outside directors to buy fractions. Then he announced a breakthrough, “And now, brace yourself. Last year, EJA passed the ultimate test: Charlie signed up. No other endorsement could speak more eloquently to the value of the EJA service.” (1999 letter) Munger, renowned for being careful with money, used to fly coach class, even when wealthy, so jumping to private jet travel was quite something.
Buffett was bold enough to include in his letter a free-phone number “Give us a call at 1-800-848-6436 and ask for our “white paper” on fractional ownership” (1999 letter). The May 1999 meeting had initiated the sale of at least eight fractions. To promote NetJets Buffett would speak at dinners or business forums in places like Hollywood or London. And there was a famous advertisement with Bill Gates and Warren Buffett lounging on a jet enjoying a joke. Priceless publicity.
Go for it
In October 2000 Santulli spoke of Buffett’s attitude to growing the company, “One of the nicest things about being part of Berkshire is that if I said to Warren, ‘I’m going to go buy $1bn worth of planes,’ he would say, ‘Why are you asking me? Go do it.’” (Richard Santulli speaking to Robert P. Miles (2002) The Warren Buffett CEO).
Planes were bought at scale – with large discounts on list prices - and fractions sold; in 2001 customers took delivery of more than 50 new jets, 7% of world output.
But rapid growth was coming at a cost to profitability as the operating costs in the infant European market ran ahead of revenues and chasing after growth in the US raised operating costs there. In 2001 the chickens came home to roost. While revenues rose over 20% the business made a loss, despite an uplift of interest private jet flying after the 9/11 attack on the Twin Towers.
By then NetJets looked after 300 planes in the US alone. But rivals' shares, when added together, accounted for almost half the market, and they were determined to remain price competitive, which left little room for profits. Buffett wrote that he expected “for a few years” only “modest profits” (2001).
Despite this gloomy prospect Buffett insisted that the strategy was correct: “Maintaining a premier level of safety, security and service was always expensive…No matter how much the cost, we will continue to be the industry leader in all three respects. An uncompromising insistence on delivering only the best to his customers is embedded in the DNA of Rich Sa
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his newsletter is instructive in two ways (a) the priorities in business deal-making (b) looking for the qualitative factors making a business attractive even when short term profits are non-existent.
Goldman Sachs in 1998 wanted to realise a return on its 25% stake, or at least obtain a market value and trading for its shares, and so pressed Santulli, CEO and majority shareholder, to float the business on a stock market. Santulli was hesitant because he believed stock market investors would run scared of the volatility and poor profits while NetJets was in its fast-growth phase.
If he could sell it to investors at all, the price was likely to be low, he thought. "I could never take this company public. Shareholders wouldn't be able to stomach the ups and downs of this business" he explained to journalist Stephen Pope (From a 1996 interview with Stephen Pope (2009) “Santulli’s Departure from NetJets”, Business Jet News October. )
And Santulli did not want “a 28-year-old analyst” telling him how to run his business.
But maybe there was someone he knew who recognised the strength of its market position and its potential, and would be willing to pay a decent price while leaving him to grow the business?
Selling Buffett a fraction
In 1995 Frank Rooney at H. H. Brown (a Buffett investment described in Newsletters dated 12th - 19th August 2020)) had been extolling the virtues of his NetJets membership and suggested to Buffett that he meet Richard Santulli to investigate signing up.
Buffett says, “It took Rich about 15 minutes to sell me a quarter (200 hours annually) of a Hawker 1000.” (Buffett's 1998 Letter). Warren and his wife Susan went to look at a plane at Teterboro, New Jersey “and Rich was there in a Hawker 1000, and my wife fell in love on the spot," Buffett recalled in an interview with Warren Berger, who then cheekily asked: “with Santulli or the plane?” Buffett laughed. "Believe me, I don't ever want to give her a choice between me and Rich. She would probably leave me in a minute." (Quoted in Warren Berger (2001) “Hey, You’re Worth It (even now)” Wired June 1)
In the following three years the Buffett family flew 900 hours on 300 trips. They loved the service, finding it friendly, efficient and safe. Buffett liked it so much that he enthusiastically took part in a testimonial advertisement long before he knew there was a possibility of buying the company. But he did say to Santulli that if he ever did want to sell then please give him a call.
A short discussion and then a deal
That call came in May 1998 by which time revenues were close to $1bn, up from $100m in 1995. Santulli wanted Buffett’s advice on him caving-in to Goldman Sachs’ insistence that his company be taken public. Buffett’s response: “Well, what if I buy the company”.
The deal was made in less than three weeks with minimal examination of accounts. More important to Buffett than detailed due diligence is the character of the person selling shares to him. He says the key question he asks on every deal is whether the seller “would take the money and go sit on a beach or stay and run the company”(Forbes (1998) “Flying Buffett” September 20, 1998).
Santulli easily convinced Buffett that he would remain the driving force behind the firm. "I still think of it as my company," Santulli told Forbes shortly after the merger.
Buffett has another question he always asks: Is this service worth the money to people? Regarding NetJets he concluded, “the answer in my book………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
n 1984 Richard Santulli bought a small loss-making private jet hire company called Executive Jet Aviation, EJA. He thought it might be useful as a dumping ground for aircraft coming off leasing deals, his main business. Little did he know that he would soon invent a completely new type of business, one that was so successful that Warren Buffett would pay $725m to buy it only 14 years later.
As the new owner of an airplane company Santulli thought he ought to buy himself a private jet – it seemed only fitting - and EJA could look after it for him.
But being a mathematician he sat down and worked through the numbers on outright ownership. Taking into account the limited hours he’d actually be flying – less than 50 per year – it just didn’t make any sense at all. He’d be better off chartering a plane each time he needed one.
But then he thought of better option: buy a plane with a group of friends. Three friends joined Santulli to discuss the plan. It made good financial sense to share the one plane; they could all see that and were willing.
But then the trouble started. One said that if they got a plane then he would insist on having it every Tuesday and Thursday. Another said he wanted it when he needed it, which might well be a Tuesday or Thursday. Deadlock.
After the failed meeting Santulli pondered the problem: shared ownership combined with guaranteed access when you wanted your airplane. If he could crack that he would have it made.
An intellectual challenge
It was a mathematical puzzle. The key input needed to solve it was to use the extensive database containing every trip EJA had taken over the previous 20 years (the military types that previous ran EJA kept good records). Looking at flying patterns he found a high degree of predictability in terms of origin, destination, day of the week, time of day, mechanical breakdowns, etc.
It took nearly six months to figure it out, but the solution turned out to be for every 20 planes sold in fractions NetJets had to buy for itself five and one-quarter planes to put in its corporate fleet to fill gaps where two or more co-owners wanted to use their plane at the same time. NetJets could then supply a substitute plane of the same or better specification at only a few hours notice. This would allow a 98% availability (There are economies of scale here. So if 800 planes are sold to clients the core fleet need only be 80, i.e. 10%.). NetJets could charter planes for the remaining 2% of occasions.
NetJets would take care of everything from maintenance to pilot training. All the client had to do was tell the customer service people where they wanted to go when.
EJA launched the NetJets programme in 1986. Initially, potential clients were sceptical, thinking there are bound to be numerous occasions when they needed a plane but none were available. Santulli simply told them it was all worked out and NetJets could indeed guarantee availability. If they still didn’t believe it worked then after six months they would be entitled to all their money back.
Santulli says he realised that unless NetJets were “absolutely perfect for the first 10, 15, or 20 customers, the whole deal was going to blow”.
To make sure it didn’t blow he bought eight Cessnas. These were not to be sold on to clients but were the back-up planes for the 25 he expected to sell in fractions of in one-sixteenths (50 hours of flight time), one-eighths, one-quarters, one-halfs (400 hours). Thus, if the selling effort was successful, the fleet would amount to 33 planes.
But it took time. Only four planes were sold in the first year.
It didn’t pick up – only four were sold in the second, and in the third.
Then the 1989 recession struck, and no fractions were sold.
Santulli lost $35m - $40m because he ha
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When asked about the influence of the French Revolution, the late Chinese premier Zhou Enlai is reputed to have said: 'Too early to say.' It’s much the same with Buffett’s August 1998 investment in NetJets, at $725m. For the next 11 years it made an aggregate loss of $157m.
By 2010 the investment was certainly looking like a dud. But then the turnaround began, resulting in annual profits regularly north of $200m. If this pattern continues Berkshire should end up with a decent amount of money from NetJets. But it was an awfully long time coming, and during that time billions of Berkshire’s cash or debt guarantees were taken from other investment prospects to expand NetJets.
It is no great surprise that Buffett declared in his 2011 letter that “A few years ago NetJets was my number one worry: Its costs were far out of line with revenues, and cash was hemorrhaging. Without Berkshire’s support, NetJets would have gone broke.”
The opportunity cost of this investment in the first years of the twentieth century was considerable. Future Buffett historians may conclude that although the money put in has been recovered it was a poor investment choice. But we’ll have to wait and see - maybe it’ll start producing $1bn of cash year after year for Buffett to invest elsewhere. It certainly overwhelmingly dominates its niche market of fractional aircraft ownership so there is potential there - if the niche grows and if price competition is restrained. A couple of big “ifs”.
There are some important lessons for all investors in this case study - not least that even Warren Buffett can make mistakes, hence the need for a portfolio approach - which I'll reveal over a few newsletters. Another point to watch out for is: market dominance - NetJets had 50 - 60% of the market - does not guarantee profits . (Much depends on contestability or direct rivalry. Also much depends on the depth of customer demand - how many people do you know that want to pay for a private jet flight?)
The business model
Before the NetJets model was invented if you were a time-poor executive or wealthy person wanting to fly you had three choices. First, you could book like everybody else on a scheduled airline flight. Even with First-class treatment there are obvious downsides such as being limited in destinations and timing. Also, the hub-and-spoke system can be a trial of endurance, even without flight delays.
Second, you could buy your own private jet. But this becomes expensive especially if the depreciating asset spends most of the time in hanger. And it is a lot of hassle to maintain, insure, staff etc. Also, most private planes cannot fly intercontinental. As a rule of thumb buying your own plane is not worth it unless you are going to be in the air around 400 hours per year.
The third possibility is to charter a private plane trip by trip to take you where you want to go with minimal fuss. The downsides here are the higher cost per mile and the limited availability of planes in the right place.
Richard Santulli, a former mathematics academic and Goldman Sachs alumni, thought of a better way for people who did not need a plane every day, which he called fractional ownership. With this you buy a portion – say one-quarter or one-eighth – of a jet. You are then entitled to 200 or 100 flying hours per year.
In addition to the up-front cost of purchase which could be a million or two, you pay a monthly management fee to cover things like pilot salaries and training, insurance and hanger space ($5,000 - $20,000 per month for a smallish plane (7 seater)). You also pay extra for each hour flown to cover fuel, maintenance, landing fees, cleaning and catering ($1,300 and upwards per hour)).
NetJets makes sure that your plane or one equally as good is available at anyone of thousands of airports when you want it (just give them at least 4-6 hours notice depending on aircraft type). Santulli thought that if Netjets got big enough, with hundreds of planes, then there would be blanket coverage of a continent so customers could rely on the guarantee of plane availability even at busy times such as Thanksgiving without the hassle and expense of owning their own plane. And these planes could fly to smaller more convenient airports than scheduled planes.
The final element of the formula was that after five years the fraction owner can ask NetJets to repurchase it at a fair-market price, usually about 80% of the original list price.
Before Richard Santulli bought the company
Business aviation in the 1960s w………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
It’s important to examine MS International (LSE:MSI) with an income metric better than conventional profits after tax, which fails to properly consider the annual cash flows which end up being spent on fixed assets and in working capital items (inventory and receivables in particular) just to support the current strategic market position, and therefore turnover and profits. I’ll use Warren Buffett “owner earnings” approach.
With owner earnings we are trying to obtain the earnings that, in future, would be left for shareholders after the managers’ use of the cash generated to pay for items of expenditure to maintain the strength of the economic franchise (e.g. additional capital items, additional working capital, marketing spend, R&D and staff training) and to maintain unit volume and to invest in all value-generating projects available.
Depending on circumstances, the owner earnings figure may be the same for every future year or on a steadily rising (or falling) trend.
Naturally, owner earnings are impossible to obtain with any degree of precision because many of the input numbers are merely educated guesses about the future. Despite this imprecision it remains an important method for thinking through valuations.
Owner earnings analysis is about future cash available for shareholders to take out of the business. But the only evidence we have available is past data. We start with that, and then use qualitative analysis to judge whether to simply project forward the past pattern or modify the previous trend for future orientated thinking.
In the following we use what the company actually invested in new working capital items and in new fixed capital items, and what they spent on marketing, R&D and staff training etc. already deducted from the P&L.
What the analysis really requires is the amount necessary to maintain the quality of the economic franchise, unit volume and invest in value generating projects. To start with we make the bold assumption that what was spent by the managers was also the necessary amount.
When we move to forward-looking analysis to value the firm we need to make another bold assumption on the real amount needed to invest in new WC, fixed capital items, etc., in the future. The historical analysis helps us make that judgment.
In the table below I’ve been forced to exclude changes in working capital. This is because, with MSI, changes in WC from one year to the next can be enormous because so much depends on whether a major customer has recently paid its bill or not. Thus if the MoD happens to owe £10m to MSI at yearend the receivables number is very high. In the next year receivables might be down dramatically.
Given that Group revenue between 2015 and 2019 rose from £45.5m to £77.7m (a 71% rise) we would normally – for other companies - need to allow for some additional investment in WC. But in both these years, leaving aside cash, WC for MSI was negative.
It seems that as the firm grows it uses increasing amounts of supplier trade credit. This trade credit then finances inventory, receivables and all other current assets. I’ll assume this pattern will be repeated in the future and so not deduct an amount for WC investment in the owner earnings numbers below.
Owner earnings in the past
£m YEAR 2015 2016 2017 2018 2019 2020
Profit after interest and tax deduction 1,353 1,584 1,498 3,386 5,010 -2,491
Add back non-cash items such as depreciation, goodwill and other amortisation 1,434 1,669 1………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
MS International (LSE:MSI) has a very strong balance sheet and decent profits history. But what about the relationship between the two? Given the large amount of net assets devoted to the operating business, does it generate a good rate of return on the money invested?
With a Warren Buffett-style investment I expect to hold “forever”. In the long run a share will not generate a good rate of return for the shareholder if the rate of return on assets used within the business is poor.
We are looking for double-figure percentage return at the very least. Preferably high teens or twenties.
Over a long period the rate of return on assets determines the rate of return on shares held.
£’000s Year end April 2020 2019 2018 2017 2016
INCOME STATEMENT………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
MS International (LSE:MSI) has such a strong balance sheet - including £14m of cash and no debt - that it qualifies for my net current asset value portfolio as well as the Warren Buffett portfolio. This works if I'm prepared to overlook the fact that its collection of freehold property is allocated not to the current asset part of the balance sheet, but classified as non-current assets. I'm also ignoring the pension deficit, which is probably pushing my luck, but then, I'm not actually buying this share as a NCAV investment but as a Buffett-style value investment. Market capitalisation is currently 16.5m shares x 122p = £20.1m (it has fallen since I bought at 129.2p).
Net current asset value
£m Half year Oct 2020 Yearend April 2020 April 2019 April 2018
Cash 14.0 16.1 22.9 15.9
Inventories 17.6 15.9 12.6 11.7
Receivables 7.0 4.6 7.0 14.6
Other current assets 3.0 2.5 1.8 1.2
Total current assets 41.5 39.1 44.4 43.4
Minus current liabilities -28.2 -25.2 -26.3 -28.7
Minus non-current liabilities (excl pension deficit & leases) -1.6 -1.6 -1.6 -1.6
Current assets minus all liabilities except pension deficit 11.7 12.3 16.5 13.1
Minus one-third of inventories -5.9 -5.3 -4.2 -3.9
Minus one-fifth of receivables -1.4 -0.9 -1.4 -2.9
Ben Graham NCAV (if we can ignore pension deficit) 4.4 6.1 10.9 6.3
Freehold property 17.7 17.7 17.0 17.2
NCAV plus property 22.1 23.8 27.9 23.5Can we ignore the pension deficit? Not really, at £9.1m. But that might be whittled away in a high-bond-yield-greater-inflation environment.
The pension scheme ceased being a defined benefit one in 1997 and is now a defined contribution scheme. The deficit could be wiped out should discount rate rise by two percentage points.
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MS International’s (LSE:MSI) directors have done a very good job of diversifying from guns and forks. In 2010 they paid £3.53m to buy the second half of the Petrol Station Superstructures business they did not own. And in 2015 they paid €3.4m (£2.6m) for a company which was to become their Branding Division. Both divisions have generated strong profits and return on assets confirming that senior managers have demonstrated their ability to both see a strategic opportunity and to manage acquired businesses within the Group.
Petrol Station Superstructures Division
The directors claim this to be “without doubt the leading specialist in the design, manufacture and installation of forecourt structures throughout Europe”.
Petrol station sites are becoming more complex and sophisticated constructions with a range of fuel types (petroleum, electricity or hydrogen), larger shops, sophisticated car valeting services, undercover electric vehicle charging and restaurant and coffee house/snack facilities. “This is all good news for our design and build superstructures business.” say MSI's directors.
In addition, the division undertakes alterations, refurbishments, maintenance and damage repair services (a 24/7 call out service in the event of damage to canopies).
Superstructures is managed from operational bases in the UK (Doncaster), Poland and The Netherlands.
They hold a key asset: “the most comprehensive reference library of original drawings and structural calculations for thousands of petrol stations…..leads to prompt response, instant specification, minimising downtime, disruption and expensive intrusive site surveys and multiple site visits.”
Petrol Station Superstructures figures
£mRevenue Operating profit Capex Assets minus liabilities Operating profit/net assets
20119.0 0.6 0.2 1.8 33%
201210.6 1.1 1.9 1.3 85%
201312.2 1.5 0.7 1.4 107%
201413.6 1.7 0.1 2.6 65%
201513.4 0.7 0.2 3.2 22%
201610.8 0.3 0.5 7.1 4%
201713.8 1.0 0.3 5.7 18%
201812.4 0.02 0.1 6.9 0%
201916.3 2.1 0.2 6.4 33%
202012.3 0 0.3 6.1 0%
Half year to Oct 20 annualised13.4 1.7 0.12 6.8 25%
Average 36%The average figure for operating profit as a percentage of yearend net assets devoted to the division is a very impressive 36%. But returns are volatile.
The lower revenue and profits in 2018 is put down to a hiatus in forecourt construction and refurbishment “owing to a notable change in the market it principally serves. Until relatively recently, many of the division’s major customers had been global oil companies but they have accelerated the divestment of their company owned petrol filling station estates, with ownership passing to both large and small independent dealer/retailers. Accordingly, construction of new sites and the refurbishment and expansion of existing facilities are passing through a state of limbo as numerous sale and purchase transactions continue to dominate the attention of the sector’s active participants.” (2018 Report).
As predicted, once the hiatus period was over, profits bounced back in 2018/19, “driven by the structural transformation of traditional 'petrol filling station' sites, that were once almost exclusively selling fuel, into ones that are distinct, local convenience stores and multiple food outlets with ample car parking - that also serve fuel.” (2019 Report)
But in the year to end April 2020 profits fell to almost zero again. This time the excuse was the pandemic close down. But they pointed to “pent-up demand...starting to be unleashed” in the summer of 2020 as both new construction took place and essential maintenance was required.
Sure enough, the recent interim report showed an impressive profit for the half year of £0.835m (£1.7m annualised). The directors also noted “a recent upturn in the number of new station developments” suggesting that the full year result to end of April 2021 should be good.
Petrol station structures require the supplier to have knowledge beyond that for constructing conventional buildings. For example, the flammable liquids or the presence of overhead cables requires great care in the design and erection. Thus, an incumbent supplier such as MSI with a reputation and long experience has a competitive advantage.
Examples of recently completed projects beyond petrol stations:
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