Buffett, in the late 1990s, faced a dilemma common to all investors from time to time (perhaps with smaller sums): he had money to invest, billions in cash or near cash, but “prices were high for both businesses and stocks” (Warren Buffett wrote in his 1997 letter to shareholders).
What to do?
First, he was not interested in selling companies such as See’s Candies or stakes in world-beating companies such as Coca-Cola or Washington Post, saying he was delighted with what Berkshire owned. Beside which he had made commitments to the company leaders that he would not sell them on.
Second, he did not act on the basis of a prediction of a market fall: “we have absolutely no view on that matter” (1997 letter).
That left the great difficulty of a buying at a time when Berkshire would “get relatively little in prospective earnings when we commit fresh money”.
The Dow Jones Industrial Average 1988 - 2001
Let the balls go by
Such times call for extreme discipline. Buffett used a baseball metaphor to explain the level of self-control required: “we try to exert a Ted Williams kind of discipline. In his book The Science of Hitting, Ted explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his "best" cell, he knew, would allow him to bat .400; reaching for balls in his "worst" spot, the low outside corner of the strike zone, would reduce him to .230. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging indiscriminately would mean a ticket to the minors.” (1997 Letter)
In this period Buffett was seeing business “pitches”, but most just weren’t in the strike zone at all. The few that were headed for the “lower outside corner” were not all that attractive. Swinging at these would lead to Berkshire being locked into low returns.
Unlike a baseball player, investors can’t be called out if they resist three pitches that are at the extremes of the strike zone. They can let ball after ball fly by.
For Berkshire this means the cash flowing from its operating businesses, insurance float and dividends from minority stakes in American giants like Disney would just pile up or be put into Treasury bills.
But, as Buffett says, “just standing there, day after day, with my bat on my shoulder is not my idea of fun”, even if it is the right thing to do.
Your time will come
To cheer yourself up at moments like these it is important to bear in mind that the time will come – maybe soon - when there again is a plethora of fat pitches, just as they did for Buffett in the 1970s and 1980s, and then again after the dot-com crash (2000-2002), and the financial crisis of 2009. These are the bonanza periods, because low prices mean the long-term investor can lock in future cash flows cheaply while ignoring short-term market worries and fluctuations.
Don’t go with a cheery consensus
When shares………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
It isn’t jumps in stock market prices of his investments that Buffett measures himself by. He focuses on increases in intrinsic value. A very rough and ready proxy for annual changes in intrinsic value is movements in net worth (book value). For example, in just the twelve months of 1998 Berkshire’s net worth balance sheet gain was $25.9bn, which translates to a per share book value rise of 48.3%.
Over the 34 years since Buffett had taken a substantial stake in that down-at-heel textile maker, Berkshire Hathaway, its per share book value had grown from $19 in 1964 to $37,801 in 1998 (it is now over $300,000), a rate of 24.7% compounded annually.
Even this underestimates the achievement because “intrinsic value still far exceeds book value.” (Buffett’s emphasis on “far”). In other words, the balance sheet net asset figure does not adequately capture the value of the discounted owner earnings expected to accrue to Berkshire from its collection of excellent economic franchises and high-class businesses in future years.
“Gains in book value are, of course, not the bottom line at Berkshire. What truly counts are gains in per-share intrinsic business value. Ordinarily, though, the two measures tend to move roughly in tandem.” (1997 letter to Berkshire shareholders)
While Buffett remained focused on intrinsic value, he found himself in 1998 surrounded by people caught up in the psychology of a stock market mania, later called the dot-com bubble, where shares were pushed up by punters hoping for increasing numbers of eyeballs looking at a particular Silicon Valley company’s website.
Despite the great gains in Berkshire’s share price as it was swept along with the naïve excitement, he never lost sight of the real origins of value, that is, the soberly assessed likely cash to flow to shareholders in the long run.
Don’t preen yourself if a general market rise lifts you up
In his 1997 letter to shareholders Buffett pointed out the error in thinking you, as an investor, had done well when in reality all that had happened was the market was on a tear.
………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
SpaceandPeople (LSE:SAL) has been one of my worst investments. The company works with owners of high footfall spaces such as shopping centres or railway stations to use that space by charging either retailers to set up a stall/unit or promoters to advertise and promote through things like tasting or talking to potential customers.
Naturally, it has been hard hit by the restrictions brought in to combat Covid-19. Its finances were not all that strong at the best of times and so it found itself in the summer with virtually no income, high staff costs, big losses and payables of £3m.
It had drawn down £750,000 of a revolving credit facility (theoretically this could be extended to £1m). It had also drawn down a CBIL loan of £1m.
This is a lot of borrowing for a company making losses of over £260,000 per month and with a market capitalisation of only 4.5p x 19.52m shares = £0.88m
The RCF ends 31 October 2021. I struggle to see how the company might make it through till then without breaching covenants. Even if it made it, I doubt the bank will renew the facility.
They have cut costs, yes, but when they have no income to speak of the challenge is just too great.
I note that the directors were not buying shares in their company even at 4.5p.
A glimmer of light
Last Wednesday (2nd December) the directors announced the company had signed exclusive agreements with the owners of four ………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Dewhurst (LSE:DWHA) reported its annual results to 30th September 2020 this morning. They were very pleasing. Basically, they had to adjust operations considerably during lockdown, but by dint of dedication and teamwork, overall sales were down only 1.5% and adjusted operating profit was up from £7.7m to £8.6m.
If I add back exceptional costs that will not reoccur then underlying profit after tax is £6.35m compared with £5.4m in 2019. That is earnings of 78.5p per share (or 74p if we deduct the non-controlling interests). The A non-voting shares are trading at £6.50 to buy. At that the PER is £6.50/£0.74 = 8.8.
“Owner earnings” for 2020 is even more remarkable. Profit after tax and deduction of non-controlling interests was £5.98m. Adding back depreciation and amortisation we get to £8.99m. Cash was released from working capital (£2.43m) but some money was spent on capital items (which is not disclosed so I’ve estimated at £0.32m). Thus “owner earnings” is roughly £11m or £1.36 per shares. Of course, we should not take just one year’s owner earnings to estimate earnings power. But it is encouraging to see such a large lift in “owner earnings” last year. (Owner earnings for the previous 8 years were provided in yesterday’s newsletter).
Most of the rest of the newsletter was prepared before I knew that annual results will be announced today. I have however updated the data and analysis below.
Return on net tangible assets, RONTA
Today’s newsletter looks at a stab at a valuation of a Dewhurst “A” share through a consideration of its return on net tangible assets.
Profits, assets and liabilities
£’000s Year end September 2020 2019 2………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Dewhurst (LSE:DWHA) has a lot of assets, and no debt, backing its 8.08m shares. When viewing the key numbers below consider that the “A” shares (non-voting) are currently trading at £5.50 - £6.50. Market capitalisation is £66.7m with the 3.31m Ordinary shares at £11.60 and the 4.77m “A” shares at £5.94 (what I paid).
Balance sheet strength (March 2020)
Net asset value in total (excluding non-controlling interests) £40.4m
Net asset value per share: £5
Net tangible asset value in total (also excluding non-controlling interests): £29m
Net tangible asset value per share: £3.59.
Borrowing: zero, and no overdraft facility.
Pension deficit: £10.6m
Conclusion: this is a strong balance sheet, with no suggestion of potential financial distress.
Owner earnings analysis
With owner earnings we are trying to obtain the earnings that, in future, would be left for shareholders after the managers’ use of 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.
£m YEAR2009 2010 2011 2012 2013
Profit after tax (excluding non-controlling interests)3.27 3.50 2.90 3.75 1.30
Add back non-cash items - depreciation, goodwill and amortisation0.58 0.70 1.31 0.88 2.50
Totals to: Amount available for distribution to shareholders before considering the need to spend on fixed capital items and working capital items to maintain the company’s economic franchise, unit volume and invest in value generating projects.3………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Dewhurst (LSE:DWHA) owns a number of niche manufacturing and distribution business with many displaying high market shares, strong reputations and long-standing relationships with customers and the agents of clients (e.g. an architect specifying Dewhurst lift components for new high rise building).
The UK and European businesses
Dewhurst UK Manufacturing
What it makes:
2018 Report: “Sales declined at Dewhurst UK for the second consecutive year mainly due to overseas markets being less buoyant than had been expected. The UK market was also quite stagnant, with a recurring theme of projects being delayed. We have been extremely active on the product design side. We launched our first wholly new rail product for many years. The Train Despatch Equipment Unit has been developed in conjunction with Network Rail and brings together all the components required by a train despatcher, into one module. For the lift industry we have extended our Profile Plus Landing Station range to include three new widths.” (These directors are justly proud of their engineering!)
2019 Report: “Sales improved as our drive to increase fixture sales gained momentum. The UK market was particularly strong with an increase in demand for infrastructure products, especially within the rail sector. We fulfilled our first order for signalisation of a new range of lifts for London Underground (LUL). We expect further orders over the coming years to support LUL’s program to install lifts in all their surface stations. Overseas we started delivery of fixtures for the first of 180 lifts for the new Riyadh Metro. This is a significant order for Dewhurst UK…We have also added to our Lift Indicator range with a number of new offerings based on glass designs.”
Thames Valley Controls
Lift control and remote monitoring of lifts (e.g. gives operational information online such as reports lift performance). Also, CCTV, e.g. in Manchester’s Arndale Centre.
This business was sold 30th September 2019 to a specialist in the field which benefits from economies of scale, particularly R&D.
Dewhurst and TVC will continue to work together on projects.
Traffic Management Products
Mostly the manufacture of road bollards that bounce back when run over. This division was bought over a decade ago and was a perennial disappointment.
However, in 2016 sales grew “significantly”, and in 2017 “slightly”. These bollards are highly customisable regarding style, signs and banding (976 variations available). Far Eastern sales are growing.
In 2018 “business fell slightly… we have taken the decision to move key manufacturing processes in house. Good progress has been made on this project, which has led to some major changes for TMP. We have relocated the business to Birmingham…This should allow us to generate a significant improvement in both the gross and net profit of the business.”
2019: “We had a particularly difficult first half of the year at TMP, when revenues were especially soft. At the same time the team at Wednesbury still had a great deal of work to do at the new factory, ensuring that the plant was running efficiently, refining the manufacturing and assembly processes and establishing new Health & Safety and Quality procedures. There had been a greater turnover of sales staff at TMP than is ideal”
Half year to 31 March 2020: “had a strong first half, continuing the progress made in last year’s second half”
A&A Electrical Distribution – the new UK division
This business was bought June 2018 for £12.25m cash. It has a 55,000 sq ft warehouse in London containing 30,000 lift components, cable and electrical equipment, such as those for escalators. It has stocked Dewhurst’s products for many years alongside those from other manufacturers and can supply anywhere in the UK within the day using its own vehicle fleet.
Leading products include electrical trailing cable, s………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Dewhurst non-voting shares (LSE:DWHA) are in my Buffett-style portfolio. It’s earnings history is not spectacular, just one of steady progression over the years. But earnings are based on firm foundations of strong market positions, which bodes well for future growth.
Sales, earnings and dividends
Sales, £m Earnings per share (p) Dividend per share (p)
2009 36 38.43 6.06
2010 37 40.97 6.36
2011 42 34.35 6.69
2012 52 44.48 7.02 + 5 special
2013 44 15.7 8.0
2014 47 43.87 9.0
2015 46 50.21 10 + 3 special
2016 47 40.75 11.0
2017 53 52.65 12.0
2018 55 47.93 12.50
2019 66 (continuing: £56.5m) 116.23p 13.0p
H1 2020 28 20.78p 3.75p (2019: 3.75p)In the table above the 2019 earnings number is raised due to the inclusion of a capital gain on selling the Thames Valley Controls, TVC subsidiary, In the next table we remove that element as well remove the profit contribution made by operating the TVC business in the financial year.
Underlying earnings of continuing businesses only (in 2019 that means excluding capital gain on sale of TVC and the £1.1m profit after tax TVC made):
2019 £000’s 2018 £000’s (excluding profit from TVC)
Profit from continuing operations after tax 3,095 3,543
Add back exceptional: pension female/male equalisation charge 639 0
Add back exceptional: amortisation of acquired intangibles 1667 555
Less tax on exceptionals -461 -111
Underlying profit after tax before minority interests 4940 3,987………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
I’ve bought Dewhurst “A” non-voting shares (LSE:DWHA) at a price of £5.94. This is after selling all my A shares in March at £7.22. I explained back then why I sold in a 2nd March newsletter “not because I judged it to be over-valued but because I wanted to rebalance my portfolio so as to have more cash available for post-Covid purchases.” This turned out to be very useful – see recent purchases of Capital & Counties Properties and McCarthy & Stone.
In March I added that I didn’t think the Dewhurst A’s were seriously over-valued, but wanted to take a very cautious approach through the pandemic, “The Dewhurst A’s were selected to be turned into cash because they were trading close to intrinsic value, not because Mr Market had pushed them up beyond a reasonable level. Ordinarily I would have held on to the Buffett-style investment when it traded near – or even slightly above - intrinsic value. But we do not live in ordinary times. I judge the supply and demand shock of Covid to the world macroeconomy to be so great that I feel much more comfortable with a large buffer of cash”.
So, I’m relieved to have bought back into this excellent company at a lower price (by 18%) at a time of economic revival on the back of vaccines.
Dewhurst has a strong economic franchise, managers who are both competent and behave with high integrity toward all shareholders, good accounting numbers and the shares are available at a low price relative to past earnings and a reasonable expectation of future earnings (its “earnings power”).
I bought Dewhurst shares at various prices over the last six years: April/June 2014 at £3.11, December 2014 at £3.75, November 2017 at £5.46, February 2019 at £5.54 and April 2019 at £5.64. Newsletters setting out rationales for those purchases can be found at those times: 12th – 22nd Dec 2014, 15th June 2015, 14th – 17th Dec 2015, 25th – 27th July 2017, 21st, 22nd Nov 2017, 3rd – 5th Jan 2018, 20th – 24th July 2018, 25th – 30th April 2019, 19th – 23rd Dec 2019, 2nd March 2020.
Brief description of the firm
Dewhurst is over one hundred years old, started by the grandfather of the current brothers who command both share control and operational control. It manufactures its own components for lifts, ATM’s and other keypads, and for trains. It also sells other manufacturers’ electrical and other components to the trade (such as lift repairers), and supplies handrails for escalators and various traffic products such as large road bollards.
Richard and David Dewhurst have decades of experience in this field: Richard, age 63, joined in 1985 and has been Chairman since 1991; David, aged 58, Group Managing Director joined in 1987. They are supported by a longstanding, loyal, professional team.
Over the last two decades they have grown profits both by organic means with an almost obsessive interest in design prowess and manufacturing efficiency, and by a measured acquisition strategy of companies supplying (generally) complementary products. Often these acquirees have a long association with Dewhurst as suppliers or customers - the managers know each other in this small engineering world, and the Dewhurst brothers know the weaknesses and strengths of the firms they are acquiring from the perspective of suppliers or customers.
Demand for individual product l………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
At the end of this newsletter I set down what I think are the key lessons for modern day investors (speculators need not read - this is about businesses and understanding them not about financial markets and their ups and downs). First I'll finish the story of Al Ueltschi, the founder of FlightSafety, by looking at how he used much of his $2bn.
In the 1970s Juan Trippe asked a favour of Ueltschi, who was more than willing to do what he could to repay all the kindnesses received from his mentor. The favour was simply to have lunch with Trippe’s daughter, Betsy, and a friend of hers, Dr. David Paton. It seemed modest enough, but that meeting was the start of something big.
Dr. Paton was the was head of the Ophthalmology Department at Baylor College of Medicine in Texas. He had a dream to use the technology and knowledge held in the rich world to help the poorest be free of eye disease.
There are hundreds, if not thousands, of eye specialists in western hospitals and clinics eager to help but unable to reach those most in need. Paton had come up with a plan: put the eye specialists in an airplane and fly it to where the patients are and where local medical professional could be mentored by the world’s best.
At the lunch he and Betsy quizzed Ueltschi first on whether it would be possible to put a hospital inside an aeroplane. “I told them I wasn't sure, but if the airplane was big enough, it seemed like it could work.” Ueltsch responded.
That led to the second question: Where do you go to get such an airplane? And they added for good measure, “for a discount of approximately 100 percent”. Ueltschi wasn’t sure, but thought there might be a manufacturer or an airline that would donate one. And there and then, Ueltschi volunteered to get an airplane for free, and to oversee the modifications to make it a Flying Eye Hospital. (He later took on the chairmanship of the continuing effort to keep it airborne).
He called every airline and manufacturer he knew. Eventually, United Air Lines, offered an old DC-8 parked in the Las Vegas desert. It dripped hydraulic fluid and leaked fuel but was fixable. Then the search began for microscopes, fuel, operating room equipment, etc.
The charity established after that lunch is called ORBIS International. Its DC-8 lasted around 10 years, flying to some of the most impoverished places on earth carrying volunteer doctors and other medical staff restoring the eyesight of thousands of children and adults. It was replaced in 1994 with a DC-10, and, in 2008, United Airlines and FedEx donated a replacement for that one. The fourth generation Flying Eye Hospital, a DC-10 donated by FedEx, was unveiled in 2016 complete with back-up generator, water-t......
Warren Buffett prefers to make outstanding rates of return on capital in businesses that do not require much of a capital base, such as See’s Candy or Scott Fetzer. FlightSafety, on the other hand, needs to invest $19m or more in one simulator. When you have over 300 simulators and need to replace them regularly with more advanced models, then you have a large amount of money being ploughed back into the business. For example, in 2000 alone $248m was invested in simulators.
But this does not make it a bad business in which to invest. It may not be sensational, but it can produce high rates of return. Its durable competitive advantage, due to its “best in class” reputation, means that customers will pay high fees for each hour of training.
As Buffett says, “Going to any other flight-training provider than the best is like taking the low bid on a surgical procedure.” (2007 letter). This gives it good business economics, and therefore it is able to factor in high operating profit margins.
Some illustrative numbers
On its purchase date (costing $1.5bn), December 23, 1996, FlightSafety had $570m in fixed assets. With those it generated $111m of pre-tax operating earnings.
Between then and the end of 2007 Buffett says depreciation charges cumulated to $923m (written off profits), but capital expenditure was much larger as simulators capable of imitating a wide range of new airplanes were acquired totalling $1,635m.
In 20………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
I'm a full-time investor running my portfolio. I invest other people's money into the same shares I hold under the Managed Portfolio Service at Henry Spain. Each of my client's individual accounts is invested in roughly the same proportions as my "Model Portfolio" for which we charge 1.2% + VAT per year. If you would like to join us contact Jackie.Tran@henryspain.co.uk
investing is about making the right decisions, not many decisions.