Caffyns (LSE:CFYN) has been a family-dominated firm for over 150 years, despite it now being a Premium Listed company on the LSE. The family have been accused by a bulletin board writer of running a corporate board of directors which “is grossly self-indulgent”.
I need to start the process of assessing whether this is true to the point of being seriously detrimental to minority shareholder interests, a group to which I now belong.
The family do not control through ownership of more than 50% of the ordinary shares, of which there are 2.695m in issue. They control the firm through their holding of all the 2m 6% Cumulative Second Preference Shares, which each have the same voting rights as the ordinary shares (one vote per share), except in a few special situations related to the Premium Listing provisions, such as voting to leave the LSE (the prefs lose the right to vote).
In addition, Caffyn family members not sitting on the board own around 16% of the ordinary shares. Sarah Caffyn, who is a board member, has 46,232 (1.7%) ordinaries and Simon Caffyn, CEO, has 76,988 (2.9%). Also, the Caffyns’ Pension Fund holds 4.66% of the ordinaries.
(There are some other preference shares held by the family but they do not carry votes and are not relevant to the power dynamics of the firm).
Evidence for the self-indulgence charge
We’ll start with the money paid to shareholders, staff and directors over several years.
£mDividends + cost of buying the company’s shares Staff pay (including directors) Issue of shares for SAYE Directors’ emoluments
20210 13.6 0.003 0.59
20200.61 13.7 0 0.66
20190.61 13.7 0 0.74
20180.61 13.1 0 0.63
20170.61 + 0.9 15.0 0.3 0.81
20160.60 + 0 15.7 0 0.88
20150.56 + 0 14.8 0.005 0.86
20140.36 + 0.39 14.5 0.3 1.153
20130.33 + 0 14.2 0 0.91
20120.34 + 0.1 15.0 0 0.83Clearly, the directors have taken more cash than the shareholders have received, and £590,000 in director’s pay seems a lot for a £12.5m company. But, I suppose, at least director remuneration has fallen from the heights of 2014.
The question we need to ask is whether……………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
In earlier newsletters we established that Caffyns’ (LSE:CFYN) net current asset value is between double or treble the current market capitalisation (assuming properties are current assets and there is no need to write down the value of its stock of cars for sale). We’ve also seen a big improvement on the balance sheet, financial distress risk and potential to pay off almost all bank debt with a single asset sale. Today we turn to its profit history.
Profit after tax and earnings per share 2012 - 2021
Reported profit after tax (including the “non-underlying” negatives and positives) £‘000 Earnings per share
2021 1,424 52.4p
2020 -252 -9.4p
2019 -566 -21p
2018 1,030 38.2p
2017 5,123 186.3p
2016 2,487 90.1p
2015 9,255 335.5p
2014 1,411 51p
2013 1,289 46.6p
2012 1,416 51p
Average earnings per share 82.1pThe cyclically adjusted price earnings ratio at my buying price of £4.65 is 465p/82.1p = 5.7. But we need to scrutinise the components of the earnings.
For example, the 2015 result deserves a special mention: most of that £9.255m profit was a result of pension rules changing (so that future pensions could rise by only the RPI rather than the CPI) – it is a true one-off.
The 2019 earnings number was greatly affected by impairment charges on two properties (£945,000). Also there was a negative £572,000 exceptional charge mostly caused by a one-off expense for equalising pensions (a countrywide imposition on companies).
If I correct for these distortions, remove true exceptional items and take away the profits made on property I arrive at earnings coming solely from the operating business (including rent collected on properties).
Method 2. Stripping out the one-off elements and separating the operating income from the property development capital gains.
Profit from selling cars and rent, £000s Earnings per share from selling cars and rent
2021 1,571 58.3p
2020 -252 -9.4p
2019 952 35.3p
2018 1,030 38.2p
2017 1,284 46.7p
2016 2,525………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
I’ll use Piotroski’s nine variables to get an overview of financial distress risk at March 2021.
2. Does the company produce positive cash flow from operations?
Caffyns generated £4.6m of operating cash flows before movements in working capital, thus a Piotroski point is gained.
3. Has return on assets improved?
A profit in 2021 following a loss in 2020 means an improvement. Third Piotroski point.
4. Is cash flow greater than profits?
Yes. Fourth point scored.
5. Has the ratio of long-term debt to average total assets during the year diminished?
For 2020: £11.8m/£94.7m = 12.46%
For 2021: £12.2m/£95.5m = 12.77%.
No Piotroski point.
6. Has the current ratio improved?
………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Superficially, there is an impressive gap between the company’s market capitalisation, £12.5m, and property assets of £54.7m. But before getting carried away we need to consider whether the company is vulnerable to failure because of its debt levels and covenants on those loans.
Net bank borrowings fell between 31st March 2020 and 31st March 2021 from £16.1m to £10.3m, so that is encouraging. The makeup is £5.7m of cash and £16m of borrowing.
Debt facilities have been agreed with HSBC and VW Bank:
Debt outstanding at March yearends 2021 - 2018
£m 2021 2020 2019 2018
Current 3.9 8.9 4.9 1.4
Non-current 12.2 8.7 12.6 13.1
Total debt 16.1 17.6 17.5 14.5
Less cash -5.7 -1.5 -3.9 -2.2
Net debt 10.3 16.1 13.6 12.3Preliminary results to 31st March 2021: “This substantial reduction [in bank debt over the year] reflected the strengthened controls over working capital and cost savings implemented during the year, as well as the significant covid-19 support received by the Company from the Coronavirus Job Retention Scheme and the business rates holiday.”
The VW term loan and the HSBC debt, are subject to covenants tested with respect to:
I first bought into Caffyns, the car dealer (LSE:CFYN), in 2017 for my Modified price earnings ratio portfolio. But I sold it last summer at the height of the first Covid-19 wave as part of a defensive strategy in fear of a long and deep recession, which would not be good for either car sales or land values.
Of course, we all know now that, thanks to vaccines and economic stimulus, far from a recession the economy is set to boom. This means that a company with property assets worth four times market capitalisation is worth another look. These acres of market towns in south-east England are currently being used to house thousands of vehicles in 13 showrooms and display sites. But as house prices rise and space for warehousing becomes scarce these sites have valuable alternative uses.
As well as the valuable land (valued at £55m in March) the company’s profits have moved ahead during the Covid-19 crisis as the demand for second-hand cars boomed and servicing provided a steady flow while the firm was in receipt of government money. With recovery we should see an increase in new car sales once supply issues are resolved.
Furthermore my previous concern about onerous debt clauses has lessened considerably because the company reduced its debt significantly in the last year: HSBC could, in theory, take a showroom or two in the event of default, but the chances of this happening are reduced because (a) net debt has fallen from over £16m to £10.3m and (b) profits keep flowing further bolstering the balance sheet and cash flow.
I bought at market capitalisation of 2.695m shares x £4.65 = £12.53m.
Previous newsletters about Caffyns: 10th – 16th Aug 2017, 14th – 16th Dec 2017, 27th – 31st July 2018, 5th – 10th Aug 2019, 23rd – 24th July 2020.
Net current asset value
£m March 2021 March 2020
Inventories 36.6 41.5
Receivables 5.1 4.3
Cash 5.7 1.5
CURRENT ASSETS 47.4 47.5
Less Liabilities (ignoring lease liabilities, including pension deficit) -65.9 -68.0
Less one-third inventories -12.2 -13.7
Less one-fifth receivables -1.0 -0.9
Very conservative NCAV -31.7 -35.1
Investment properties 7.8 8.1
Freehold property 34.6 35.2
Property revaluation surplus 12.3 11.8
NCAV + property………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
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
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