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’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:
MS International (LSE:MSI) is comprised of four business. Today I’ll look at two of them. Tomorrow’s newsletter will cover Petrol Station Superstructures and Corporate Branding.
The Defence division mostly makes naval guns, selling to 20 countries, with 300 systems already in place. It also services those guns – a source of continuing revenue in times of order drought. The guns have now been adapted for land use, which seems to be a hit with the American army in particular.
Defence division numbers
£mRevenue Operating profit Capex Assets minus liabilities Operating profit/net assets
201132.6 5.4 0.0 16.6 33%
201229.9 6.6 0.1 15.8 42%
201328.0 2.9 0.1 16.7 17%
201419.4 0.9 0.1 14.4 6%
201517.0 -0.2 0.1 14.1 -1%
201621.9 2.0 0.2 14.2 14%
201720.8 1.8 0.2 12.2 15%
201821.9 2.6 0.02 21.5 12%
201926.7 2.8 0.07 10.4 27%
202023.5 -0.3 0.08 10.0 -3%
Half year to Oct 20 annualised17.3 -2.3 0.16 9.3 -25%
Average 12.5%From the table I detect a feast-and-famine type of business. There are years when defence ministries order many new guns and others when they hold back. Having said that the profit numbers in recent years have been far lower than those of the early part of the decade. And now they have fallen into losses; hence a major cause of the share price falls from over £3 in 2011 to under £1.30 now.
Even if the profits to net assets ratio merely remains the same in the next eleven years as it was in the last eleven, i.e. 12.5%, shareholders will benefit from the business by over £1.2m per year on average (market capitalisation of the Group is £21.3m). But things could be better than that given the directors confidence that recent innovations will restore sales. I’ll look at their optimistic statements after an overview of the business.
The defence products and services offered
The Seahawk naval ship gun is at the centre of the Defence Division, based in Norwich. The Seahawk is the primary weapon on smaller ships and a secondary weapon on frigates and bigger ships. Cannon options include 5.56mm, 7.62mm, 12.7mm, 14.5mm, 25mm, 30mm & 40mm.
A key part of modern weapons is the computer and other tech link up. The Seahawk has a day camera, thermal imaging camera, laser rangefinder and a remote fire control system. Computerised motion stabilisation is also crucial.
There is a commando version for unmanned speedboats using remote control settings (trails showed it to be “best in class” for accuracy and dispersion in challenging sea conditions).
In recent years MSI has used its knowledge of guns to move into land-based systems. Its Terrahawk (launched 2019) can be mounted on a Humvee or tracked vehicle with gizmos such as computer tracking of thermal and colour images within the terrain. It also has laser sensors.
The Terrahawk can act as a heavy machine gun with 12.7mm, 7.62mm and grenade launcher weapon options. It has available 400 rounds of ammunition and can swing through 360 degrees. It can be manually or remotely controlled. Retrospective fitting on already-in-use vehicles is possible. It can also be fitted on unmanned platforms for remote operation. (The videos on the MSI Defence Systems website showing the guns in action are fun to watch).
Over 300 Seahawks and Terrahawks (mostly Seahawks) have been delivered to or are on order for over 20 international end users. They have been developed from combat experience, fulfilling multi-role requirements for a variety of naval, military and constabulary services.
MSI’s in-house support services works on over 300 naval gun systems already in use offering
(a) a 24/7 telephone support,
(b) customer in-country depot / maintenance facilities,
(c) on demand field service support, surveys,
(d) repair and replenishment,
(e) ongoing training for operators, maintainers and depot support personnel, and
(f) obsolescence management and performance enhancements to coincide with evolving operational and technological demands.
Progress of this division
The strategy pursued is to keep ahead of the competition through R&D spend, building on its current pre-eminence, and to grow the non-UK market “so that we can effectively counter the varied current constraints on UK MoD decisions regarding future requirements and expenditure.” (2019 Report).
And this approach is bearing fruit: “It is pleasing to report that once a………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
MS International (LSE:MSI), a British engineering company, is selling at a low price relative to its past earnings, its net current asset value and its earnings power. I have bought shares at an average of £1.292 for my Buffett-style portfolio (Market Capitalisation is £1.292 x 16.5m shares = £21.3m).
MS International has two economic franchises:
(a) specialised defence equipment, mostly unique naval guns,
(b) dominant position in building and maintaining petrol station superstructures in Europe.
It also has a business forging forks for fork-lift trucks, but this is not a franchise.
There is a strong business in corporate branding with a particular emphasis on petrol station branding (signage etc.). I’m not sure if this qualifies as a franchise because, although it had two terrific years, already earning back the €3.4m (£2.6m) paid for it in June 2015, I’m not sure if it has sufficient dominance of its industry?
There are three characteristics of a franchise business according to Warren Buffett. The product or service is:
Good in the past, and strong balance sheet
MS International is a family-run firm with very experienced managers, most of whom have been with the company for decades. I have followed MSI for years and so have been witness to many managerial statements and subsequent events - there is no dressing up announcements, or over-promising and underdelivering. They just get on and tell it like it is.
I’ve also met the directors and concluded that they are likely to act with decency regarding the interests of minority shareholders (although they do tend to pay themselves very well).
The four businesses, taken singly, are not especially stable, with falls into losses from time to time. But diversity helps to stabilise overall Group profits, most of the time. Average profits after tax over the last ten years amount to £2.76m.
The balance sheet is exceptionally strong, with no debt and £14m………………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.
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