Valuhunteruk

I haven’t updated the progress on the VH portfolio for quite some time however, nothing of any great interest has happened. Unsurprisingly, performance has lagged the market as I decided to take out what I perceived to be stocks that were heavily leveraged on economic growth late last year. In retrospect, I wouldn’t have made a different decision however, I believe that I was not careful enough in looking over certain stocks. Most notable is Pendragon, they have a far better business than I or the market gives them credit for. I am not planning on trying to rectify this mistake by making an overly hasty purchase but I think it is a company investors should follow.

It should also be clear that there has been a substantial reduction in positions from the already sparse number of the last review. I have discarded Bellway and Daiwa Industries. The former has been discarded because although it is cheap I don’t really think housing is a good risk anymore, especially after the recent rally. The latter is still unbelievably cheap but I as with the old Europe positions it was becoming a burden to track. The only addition, unsurprisingly, is Tesco. Although there are still serious problems I think the non-UK retail side of the business allows considerable downside protection. I also have increased FCCN, I think the restructuring story is good, and decreased DTG, I worry about the macro environment. It is worth mentioning Clarkson, the general view last year was that it would suffer from lower shipping rates. Unsurprisingly, given the nature of the business, this was unfounded and the company has gained market share as marginal players fail and CKN sees more and more flow. Despite the favourable economics of the industry and the dominant market position, the company trades on an ex-cash LFY P/E of 5x. Dairy Crest is undertaking a review of its French operations, which is great news on top of its successful cost cutting program. It was also good to see Robert Wiseman match the 2ppl drop in payments to farmers that Dairy Crest led. Dewhurst is edging closer towards my target however, due to some particularly hopeless trading the gain on this position will not be substantial.

There are a wide range of opportunities out there but I have not had time to research any in any depth. The most interesting situation looks to be BSkyB, the company has a dominant position in the industry, is making significant cuts in costs, and looks to be generally cheap given both its industry position and growth potential. Another one is Devro, this is one that I actually passed over when it was significantly cheaper however, this was an obvious mistake. The key factor is that Devro offers a compelling cost cutting opportunity to its customers and operates in an industry with very little competition. Finally, Hilton Foods has an underlying business registering 45% annual returns, operates in an industry with high fixed costs, high safety requirements, and one that requires a high level of integration with customers. Risks are that it has only two customers and may have trouble growing in the future.

Finally, the VH portfolio has opened its first short position. At this stage, I do not think it is a good idea to publish what this position is but the P/L will be netted against the total value. This figure is shown next to the old total value figure in italics and so this is the new total value of the portfolio. I will say though that this is a company that has featured on the blog before and it should be fairly easy to guess what it is given what I have said above. I will publish short ideas in the future and the aim of doing this is both to hedge the long positions and hopefully develop a greater understanding of how to value companies hopefully leading to fewer mistakes on the long side as well.

One of the biggest problems I have in searching for new investment ideas is in getting to grips with the business and really understanding how it operates beyond the numbers. Why is it successful? Why isn’t it successful? What challenges does it face? With businesses like Robert Wiseman and Dairy Crest there was and is a lot of useful data. With Tesco I remembered reading two excellent posts (here and here) by Steven Dresser, as well as following his tweets, about Tesco and UK retail generally.  I decided to e-mail Steven to see if he could educate an ignorant spreadsheet enthusiast about what was happening with Tesco and UK retail more broadly. I have decided to leave his replies unedited as I fear I would edit out something important that I may not understand.

My original questions to Steven focused on trying to understand where Tesco was relative to the competition. How will the proposed spending close the gap? Is it even possible for Tesco to close the gap? How has Morrisons achieved such impressive sales per sq foot figures and what does this mean for Tesco?

I’d say Tesco are significantly behind the competition now in all areas. They showed an internal metric on their presentation to show how far they’d slumped in 10 years on things like availability, service and what not.

For me they’re behind Morrisons on fresh (as all retailers are) but tellingly behind Asda on quality which is a surprise. Asda was a byword for poor quality cheapo food at one time but they’ve shifted perception succesfully.

Availability, they’re ahead of Asda but behind M and Sainsbury’s on that score. Their systems aren’t broken (although slow) so as such the fix is people rather than systems which means the capex is lower to resolve this.

Tesco have cut too severely for too long, for example they may implement a labour saving idea such as sending in Pop on pre filled trolleys which are wheeled into the display, rather than being handballed bottle by bottle onto a shelf. Someone will calculate the saving and the hours are then removed from the budgets. That transpires into people not being replaced…

However in reality, the bean counter will not calculate the time taken to consolidate half pallets of pop, or late deliveries or x,y,z which then adds into the situation. Stores fall behind and they just don’t have the people to recover a full warehouse of delivery stock. It just can’t be done.

Service is atrocious, colleagues are rightly pissed off at their workloads so absence levels are higher and you don’t deliver good service if you’re worried, annoyed, anxious about the workload.. Morale is key.

They’ve not allocated massive amounts to the refits which indicates that they’re largely rebadging exercises to refresh the signage, similar to the job done by Marc Bolland at Morrisons, however Dalton Philips allocated £1.7m per store for his fresh formats with the new signage, department etc.

So that’s what they’re up against and from what I’ve seen, their concepts really don’t cut it. Tony Hoggett (stores director) can stand there on a video and tell me it’s not ‘rocket science’ what they’ve done, and no it’s not. They’re 5 years behind Morrisons by lowering displays, Dalton is now removing walls and really opening everything up.

It’s not just stores, the former Safeway FD Simon Laffin made a point that I made yesterday on Twitter, it’s in the product range and quality of that, not just refits. That’ll take 2 years to revamp and relabel 8k products, do they have 2 years to sort it out? Phil said a year but the city will expect lfl improvements straight away, I know I do..

Sales per sq ft is a tricky one, Morrisons have utilised extra sales space for years with bins, stacks and other trading ideas to drive money. Their new stores don’t have the plethora of clutter on the aisles but still feature the extra sales space and strong promotional package. Morrisons managers generally have more freedom about setting up displays due to manual ordering, so building a stack of coffee requires 40 cases. M simply order that and it arrives the same day / next day. Tesco can’t do that, they can’t influence the volumes for standard offers on the gondola ends anymore!

Their ideas are broad but is it too broad a remit? There is a £1bn pot (ish) but it’s taken up with revamps, more staff and the like – consider the M capex for fresh format stores is broadly £600m ish and they’re doing a hell of a lot more in the background, and still have the capability to remove cost out of the business, their upside is amazing.

Tesco have a lot more to develop and then the staff input is also costly, it’s needed but I’m not convinced it goes far enough. Consider that Justin King hired 10,000 staff in 2004 to resolve the JS availability issues and they were more system based than people based. Tesco have only hired 8,000 and are only looking at a few departments, all stores need more staff across the board. Is it enough?

Sales per sq ft gap is down to the trading ability of the Morrisons business in my opinion, they’ve always focussed on that as their metric. Make the product be enticing, put it in the customers way, there are far more display units and the like within Morrisons. Tesco just don’t give that freedom to their managers anymore, plus their sales have been falling in the UK, so it could be that people are buying less with them, or indeed not even bothering. People hate queuing and you have to queue at Tesco!

More compelling promotions help to pull people in but they damage margins (already on the wane) unless suppliers pick up the tab. For me, their recent -1.6% Q4 performance was brushed under the carpet but it’s shocking when you consider they’ve had £5 off £40 consistently since January.

I think they’ve underinvested in the UK for a number of years to grow their international division, it was interesting that Phil noted yesterday that he’s no interest in planting any more flags around the world for Tesco. It’s come home to roost and it’s a combination of them taking their eye off the ball but also remarkable progress from the other three, Asda have taken their EDLP [every day low pricing] customers away with Sainsbury’s catering very nicely for those customers who liked a bit of FInest with their shopping whereas Morrisons are unbeaten on fresh.

It’s a nightmare for Tesco as progress from the other 3 has left them needing to do everything all at once, stores have come a long way, JS have done great work with the XL formats and as you know, I’m a massive fan of the fresh formats from Morrisons which strengthen the margin again with the focus on fresh foods.

A signage update would have been a-ok 3-4 years back but now? They need to do so much more and do it quickly, Phil Clarke is a man who having spent £600m on big price drop has actually worsened the UK trading performance.

In my follow up questions I focused on Morrisons. How are their systems better than Tesco or Asda? Are Tesco’s systems poor due to the cutback in investment/staff? What does “lowering displays” mean? How do Morrisons give managers more freedom? How are Tesco managers treated? What is wrong with Tesco’s product range?

Are the systems better? They’re overhauling them certainly M back office systems are dated and the fresh ordering system (controlled by guys at HQ) was designed for 5 years progress in 1987! It’s still running now! Their grocery system is manual so it’s ordered on the pad – this has all the products for an aisle on paper where the colleague can order cases of crisps / biscuits, whatever it may be manually. Their Grocery is all ordered this way, the slow moving lines (sales of less than a case per week (6-8 units) is done via the system. Their lead time is significantly shorter with some stores on a 12 hour lead time (night shift order at 6am – arriving 6pm the same day).

It’s a toss up, Asda / JS / Tesco operate an ‘inventory’ system where the computer knows the stock levels based on sales, deliveries etc and orders when inventory reaches a minimum threshold. The problem comes in where the inventory is corrupted for whatever reason, incorrect opening stock, missed deliveries, theft etc.

It takes less staff and expertise to operate the system within Asda / Tesco / JS, scanning gaps and correcting the system manually. More exceptions rather than checking everything 20% driving the 80%, whereas Morrisons focus on the 80% and leave the 20%… They can benefit from sales uplifts and manually order all but the very popular promotions (allocated) themselves which guarantees the availability is down to the store.

Tesco systems are very good but slow, it was originally built to serve x stores, not all the countries, express stores, metro stores, 24 hour stores and whatever else. They bolt on upgrades to speed tasks up or make them better and it destabilises the system over time. It’s really slow and Clarke pledged an upgrade £40m worth to speed things up. The speed of the system means legal tasks like changing prices on shelf edge labels are delayed.

Asda have the WalMart system which is really slow, lead time from depot to store is 48 hours and it is just too slow to react to the uptake in demand. (if it’s warm, M can manually order pop, juice, sauces etc to take advantage) whereas the Asda system is too slow.

The system broadly works like this, stores scan any off sales and in theory, the night shift is adequate and works all the stock, gaps are filled and any gaps left mean the stock isn’t within the building. Stock control scan those gaps out and any ‘inventory’ on the system is removed and added to shrinkage (theft, misscan at tills etc etc).

The out of stock lines then appear on the next delivery and it’s happy days. However if you don’t have enough staff and the stock isn’t worked, stock control who are under pressure to resolve gaps, zero the inventory (even if it’s in store as the stock isn’t fully worked, warehouse is full) which drives in the delivery.

However that delivers stock on top of stock, the case in the back is replenished in that day when someone gets around to re-working it. The stock intended for the gap then goes into the warehouse adding to high levels… On Fresh where dates are short, this can lead to wastage concerns.

http://ukretailers.blogspot.co.uk/2012/02/tes-go-big-price-flop-forget-cliches.html – the first blog explains the in store ops in more detail!!

Lowering displays means on the counters, bakery racks for the bread are lowered to allow customers to see into the Bakery and the preparation ongoing, Morrisons did this around 5 years ago as I mentioned and the future stores are removing walls and expanding the counter offering. Tesco are doing the same, but is this miles behind the rest?

Morrisons managers have a plan to follow promotions but are free to build up stacks to drive further sales and also have the manual orders to drive sales. They’re clever and if managed correctly stores can really grow sales, it does come with a risk as overstocks can build which ties up working capital.

Tesco managers are dumbed down as a job role, from what I understand it used to be a job with a bit more freedom but now it’s just follow process from HQ. I think stores have lost confidence in HQ and can’t necessarily trust what they’re filtering down. More price changes, promotional changes, merchandising changes (where products move around shelves and bays – re-merchandised) despite them knowing that hours are so tight in stores.

The big problem from a management viewpoint was the removal of the ability for managers to control  their stock levels for promotions, if warehouses fill up, it’s usually with poor promotions (saving not much on a 2 for £3) so despite there being an expected level of sales… It doesn’t happen so the stock is moved to the warehouse once the promotion ends… Then it sits there as the rate of sale at full price is even slower, lines such as Finish dishwasher tables are a prime example..

Historically, Tesco mgrs could see a promotion wasn’t performing well and reduce their future deliveries, typically promotions are hard to forecast and as a result, the system will use a standard week of sales and apply a factor of 50 – 300% uplift (buy one get on free – double the forecasts as each customer is taking one more)… That functionality is gone now, it’s managed centrally and the ability to manage the promotions both to prevent slow moving stock and also to drive more stock in for popular promotions.

Then there’s the impossibility of the job, how can they deliver targets when they’re not getting enough hours to do the basics? How can you achieve a waste target when your person doing reductions is on a checkout? How can you drive sales when 80% of out of stocks are in the warehouse..

Product range is dated, it’s not had anything done to it for a while and it no longer resonates with customers, what does it stand for? Asda – relaunched chosen by you – clear leaders on price and have ramped up quality with relaunches across all labels (Smartprice, CBY and Extra Special), Morrisons – clear leaders on fresh food and counters – working through their relaunch category by category. Doing things differently with sub brands rather than a basics / own label / premium tiering.

Sainsbury’s are massive leaders on quality, it resonates with customers and they have the trust element as customers believe what they are told. JS have led the line on quality for years, they too relaunched their own labels and Taste the difference is easily the most well known sub brand.

Tesco all looks a bit tired, Finest doesn’t really resonate, there was no focus on ‘wow’ foods at Christmas and it all went horribly wrong. Their range is tired, add in discount brands (like Aldi generic ‘brands’) then the Venture brands like Choka Blok where they own the trademark and expand that within Tesco stores – that one is for Ice Cream and now is Chocolate bars and Easter Eggs too. Owned by Tesco. Customers don’t know, thinking it’s a brand…

Confusing for customers? You bet.

I will try to summarize my main takeaways from this analysis and what it means for Tesco investors. I think the most important point is that competition, unsurprisingly, is intense. MRW have a strong fresh/counter offering, Asda have dropped the low quality image, and SBRY continue to dominate high quality. There appears to have been failure to defend the service against any of these attacks whilst making mistakes that have led Tesco to fall behind. The two main problems appear to be: underinvestment and general staffing problems.

On the first point, I think the signs so far are not good. As Steven mentions, £1bn doesn’t sound like a lot of money compared to the examples of what MRW spent. If the £1bn amounts to “rebadging excercises” I think it is real possibility that Tesco ends up pumping more and more money into this black hole. This is not to say that turning around the UK is pointless more that there may not have been any clear analysis of what, how, and why. Problems with the product range could be included here too, the confusion between what is a brand and what is a Tesco product seem clumsy.

The ultimate question when it comes to reinvestment is execution and cost. Can Tesco turn it around and how much will it cost? Tesco are clearly lagging but I think they can catch up although it will probably take a long time. What worries me is the potential for management to continue low-balling the cost of this turnaround. For one, it won’t be clear what kind of return shareholders will get if the cost estimate keeps changing and investor trust is fickle. I think the big price drop has damaged faith in the current management.

The second point is clearly more complicated. Tesco have clearly damaged their service by not hiring enough people to do the job right, simple. The Morrisons systems seem more responsive to customer demand through a combination of short lead times and giving managers freedom to make decisions through manual ordering. I wonder how important short lead times are, after all SBRY and Asda have the same systems as Tesco? Well, Inditex have dominated the retail apparel industry through short lead times alone and I would imagine that, especially as the preference for fresh grows, that this will be an important advantage.Management autonomy is a broader question than this, warehouses filling up with poor promotions direct from HQ is clearly a waste. Is it the case that only store managers can deal with the unpredictability of promotions?

Answering these questions seems more difficult. Perhaps Tesco just needs to hire more people and this problem will go away. Perhaps it requires a fundamental overhaul of the Tesco system. Unfortunately, the comparison with SBRY and the staff they required to solve similar problems isn’t favourable. The question then seems to be: have management grasped the problems they face? This analysis suggests probably not.

My conclusion from this is that Tesco faces some real challenges and clearly lags its competitors. I think the slowdown on international investment makes sense but what will it cost to revamp the UK operations? At the moment, my feeling is that £1bn may not be enough. This is worrying as catching up with MRW’s level of sales per sq foot may only bring £250m down to the bottom line. Considering the fact that the whole MRW operation appears to be focused on maximizing this number it seems that Tesco will require broader and deeper changes. A £250m increase is nothing to be sniffed at if it costs £1bn but the failure of the big price drop should make investors wonder.

I would like to thank Steven Dresser for his invaluable contribution to this piece and would suggest that all readers bookmark his blog http://ukretailers.blogspot.co.uk/ and follow him on Twitter https://twitter.com/#!/dresserman for more insights into the industry.

UPDATE: Steven thought adding a bit more about SBRY’s systems would be useful.

Sainsbury’s systems are stellar, similar in terms of operation to Tesco / Asda but have spent a great deal of cash on them in recent years. They’re very lean and the system is well honed for demand. They are efficient too with in store operations vastly reduced in terms of stockholding and replenishment hours, they refined their operating model before cutting any hours.

Interestingly, the in store procedure is one honed and developed within Safeway, who despite being bought out by Morrison in 2004 were well known for having industry leading availability and system processes.

With the strategy presentation upcoming on Wednesday I thought it might be interesting to try and get to grips with Tesco. I am not sure what I can add here as it is a huge, well-covered company but given the current valuation, it is difficult to ignore.

My usual starting point is looking at valuation in comparison to historical performance. The current market cap is £25.8bn, an LFY earnings multiple of 9.7x, and an LFY book multiple of 1.56x. RNOA is a good measure of core operating performance and as shown below Tesco seems to have been slipping over the past ten years.

RNOA measures the return on core operations, the table highlights that whilst margins have been fairly steady asset turns have fallen rather dramatically. The fall in asset turns explains the fall in returns on core operations. Asset turns essentially measures the sales per unit of assets (in this case, net operating assets) and whilst sales have increased by £18bn over the past five years, total assets have increased £22.4bn. 67% of this increase in total assets is from long-term assets and the majority of this is PPE. The increase in current assets is obviously less concerning as it is met by an increase in current liabilities. Either way, whilst the company has achieved impressive top-line growth, this has required more and more assets leading to lower and lower returns.

However, with Tesco I don’t think it is that simple. First, the book value of PPE clearly understates the actual market value of the assets. The Director’s Report in the last annual report recognizes this, the company has been booking significant gains on sale of property (some £400m in the LFY), and the recent IPO of Thai property all highlight that something else is going on. Second, I am not sure how representative my operating profit calculation is of the underlying business and I am even less sure how to improve on it. My operating profit calculation uses D&A but whilst D&A costs have averaged 2.2% of revenue over the past five years, actual capex has been 6.48%. In other words, operating profit appears to overstate profit by a fairly significant amount. Given the fact that Tesco appears to be selling a lot of property each year as well is net capex more appropriate? Given the Tesco is now a bank as well, how clean is the cash flow statement? It is difficult to get a grip on either of these points but investors should not forget the former point as this has become responsible for a few extra points of ROE for the last few years.

The other difficultly is that being a retailer, a significant amount of operating assets don’t appear on the balance sheet. So a better way to look at this problem might be to look store numbers and sq footage. First, we need to find out how important the UK operations are? The answer to this, as with everything about Tesco, isn’t straightforward. UK operations  are in one sense tremendously important making up 66% of total group sales and 74% of the total retail group (so not including Tesco Bank) “trading profit”, as defined by Tesco. However, the UK counts for only 50% of total stores and 35% of total square footage. What this clearly highlights is that whilst Tesco has made significant investments in new stores and square footage in Asia and Europe this hasn’t translated into better sales.

To understand the scale of this gap between the UK and everywhere else, we can imagine what total sales would be like if all the non-UK stores and square footage was running at UK levels. If the non-UK stores caught up to the UK sales per store, total group sales (inc. the original UK sales) would be £80bn and the two parts would be roughly equal in terms of sales. If the non-UK stores caught up to the UK sales per sq foot total group sales would be £115bn. The point is that to understand Tesco involves understanding that the UK and non-UK operations are running at massively different levels.

Getting back to the issue of asset turns, we see the same trend at the store and sq footage level. Group sales increased at a CAGR of 7.3% over the past five years but stores increased at 10.52% and sq footage at 8.73%. Was this driven by investment in the UK or non-UK business? Non-UK stores increased at 15.89% and UK stores increased at 6.43%. Non-UK square footage increased at 10.61% and UK square footage increased at 5.74%. Unsurprisingly, non-UK sales increased at 15.26% against 4.20% for the UK business. The main data is reproduced below as well as some comparisons with SBRY and MRW.

Clearly, this should all be taken cautiously. For example, a comparison between Non-UK Tesco and Sainsbury’s doesn’t make sense. Even the store comparison between Sainsbury’s and Tesco may not make sense if they have different store sizes. Either way, the point is that the non-UK side of the business is running at a totally different level of efficiency. The company has been growing stores and square footage faster in the non-UK side but this hasn’t led to growth at the sales per store level and growth at the sales per sq foot has been a lot slower than the increase in sq footage.  The UK situation isn’t much better, although it isn’t worse, with mid-single digit annual growth over the past five years leading to declining per store and per sq foot figures. The non-UK side of the business is getting bigger and bigger requiring more and more money but the returns aren’t there, the recent declines in the share price really reflect this situation that has been building for a while.

The question then is: are these investments outside of the UK going to pay off? Clearly, the US operations are troubled but the Europe and Asia operations aren’t so bad. Finding out the answer to this question requires more detailed research but generally it is difficult to understand the pessimism. Most of the countries that Tesco is operating in are growing and presumably the per store and per sq foot figures will develop with the broader economies. For example, in South Korea, a developed economy, the per store figures are at the same level as the UK operations. What is more there is clearly significant value in the property, I am not sure how much but the company has clearly recognized this and shareholders will benefit over the near term. I also haven’t been able to get a clear impression of the various gripes of shareholders but I notice there is a fair amount of concern about the UK operations and the need for reinvestment. Clearly, this makes sense at some level but if UK Tesco moved to Morrisons level of sales per sq foot (and margins stayed constant) that would mean an extra £500m in annual operating profit. It depends on how much it would cost to get to this figure but I would argue the non-UK business would have just as much potential.

Overall, my initial feeling is that the stock is somewhat undervalued. The investments in the non-UK business haven’t paid off…yet but I think they are fairly valuable given the potential for growth in these regions. What is more you seem to get the upside from property, Tesco Bank and all the other assorted operations thrown in for free. It is also interesting that people examining Tesco appear to have a totally different view of the business from those examining suppliers or competitors. For example, there seems to be a lot of pessimism about the non-food offering, I remember when I looked at M&S there was considerable concern about the fact that the supermarkets had just managed to grab something like 8% of the clothes market in a few years. Another example is Halfords, again there is concern that Tesco is taking market share in car accessories. My experience with Robert Wiseman tells me that Tesco drives a very hard bargain. It seems therefore that, to some extent, that investors are overly concerned about the short-term and are ignoring the massive potential of Tesco.

For the first post back I am going to look at a company that has probably been on the radar of most value investors for a while but is one that seems to be instinctively unattractive. Being honest, I feel a sense of repulsion whenever I think about it. I am not quite sure why this is but the fact that it is retail and doesn’t have a particularly identifiable/strong brand is possibly something to do with it.

I changed my mind because I felt the same thing about Topps Tiles and, although I decided not to get involved, I was pleasantly surprised by what I saw. Topps is a company operating in something of a niche, a good portion of competitors are fragmented, and the market share is pretty decent too. Working out Halfords’ market share is more challenging but, in very broad terms, the situation is similar.

I was therefore somewhat unsurprised to find that Halfords’ historicals are pretty strong. In the fiscal year ended April 2011, its RNOA was at an all time high of 10.40% and the average ROE since it IPO’ed in 2005 is just under 27%. In particular, the company increased ROE 16% between 2009 and 2011 whilst decreasing leverage (as measured by net debt inc. OLs/equity) 37%. Another small positive is that the company is producing more free cash flow than net income due largely to gaps between depreciation and capex (as well as, to a lesser extent, gaps in taxes which isn’t so good). Given that the company is trading around 2x book (this is off IR12 equity), offering a healthy dividend (the LFY total pay out is 7.8% of the current market cap), and has started a share repurchase program (has already bought £62m shares at an average price of 345p) so , quantitatively,there seems a lot to be positive about.

However, Mr. Market is rarely this generous. To briefly summarize, Halfords is made up of two core divisions. The main one are the stores that everyone is familiar with which operates in Car Maintenance, Car Enhancement, and Leisure. In Feb 2010, the company bought into the Car Servicing with the £70m takeover of Nationwide Autocentres. The retail operations have about 470 locations and Autocentres have around 250 locations.

Interim results for the current fiscal year were pretty terrible especially on margins and the company certainly won’t be advancing to new highs of RNOA. The more recent Q4 trading statement gave 52 week sales figures and showed a significant drop in Maintenance and Enhancement offset by an a small improvement in Leisure. Sat-navs are a big part of Enhancement, which put in the worst performance, and I would imagine that smart phones are a big part of this threat. The performance for Autocentres was better but it is much smaller.

The projection for FY12 results is for sales of £861m and profit before tax of £93m. Sales would be down 100bps but margins would be down 278bps (their measure of profit isn’t defined but I am taking to mean after D&A and after interest expense). It is difficult to work out what this for RNOA but I think the drop will be at least 50 bps. This is significant but, in my opinion, not a total disaster. It should be a bit higher than the 9% RNOA of 2009.

Halfords made a good acquisition by moving into Autocentres. The market is huge, highly fragmented, and provides essential services. However, this is still a small part of the business and is projected to provide only £7m of operating profit. The Retail section is far more questionable. The company is highlighting the increasing demand for “Do It For Me” services which provide better margins but it is still projecting flat FY13 margins and notes the increasing pressure of input cost inflation and the problems in Enhancement. There are two core questions with Halfords: to what extent is the Retail side in secular decline and what is the growth potential in Autocentres and does this offset the decline in Retail?

At the moment, I don’t really know the answer to any of this. As said already, the Autocentres move seems smart but my instinct is that Halfords is being buffeted by the general tides of the economy as lot of the products are quite discretionary. For example, buying a new radio or audio system for your car is somewhat superfluous if your car already has one. I think it has a problem with sat-navs but the general picture is okay. Having said that, it may be that the case that with 460-odd stores there is really nowhere left to go. If that was the case, I wouldn’t feel too positive about growth off the existing store base. Finally, the Leisure department seems to rely on having access to low-mid quality products sourced from the Far East, I wonder how high inflation in these countries will hinder Halfords’ ability to offer low prices.

Either way, I don’t see any reason to rush into a decision. The guidance for FY12 has been given and it will probably be largely accurate. I can’t see investors rushing out to buy Halfords on the back of it and I think, given the past few days, a drop below 290 may even be on the cards. So Halfords is definitely cheap but, as usual, its carrying a lot of baggage.

The VH portfolio was up 52bps over the past four weeks against 117bps for the FTSE 250. It is unsuprising that the VH portfolio has lagged as it has been running with around 30% cash since mid-January (as well as small Euro index short). Much of the performance is due to Dart Group which began rising as I began to reorder my positions based on the level of undervaluation. The only changes are an increase in the French Connection position and the sale of Exor Spa which returned roughly 30% over the four months I held it for. Exor Spa has some more upside however, the risks of its holdings in Fiat and Juventus mean the risk involved isn’t worth it compared to other opportunities.

In terms of new opportunities, I have recently begun screening for new companies again after a break of about two months and I must admit that, despite coming up with new/better screens, I still haven’t found anything too interesting. Looking back over the past few months, I have noticed that I haven’t really come up with many new ideas (apart from Dreamworks and French Connection) and I have just been running down a list of companies I made roughly four months ago.

Value is still stuck roughly in the same place as it was back then and there isn’t much opportunity to gain anything by doing analysis amongst these companies as these are largely bets on economic recovery. Each portfolio has a certain capacity for these ideas and once you have one or two names there is no point putting anymore in. For example, I think Debenhams has a lot of potential and there is room for a great deal of operating improvements however, it doesn’t make sense to hold DEB if you have Bellway or Dart Group, for example, as the risk is probablly going to turn out to be quite similar (also both of these offer better risk:reward). As a result, I have been continuing to focus my analysis on companies that are priced for cheap growth however, given my past mishaps in this area, I have been more cautious however, in my view, this is where a significant amount of returns are going to be made.

As always, I will give a rough outline of what companies I have been pulling up or plan to in the near future to hopefully give some ideas. UK companies that seem to be around the right kind of price are: Stagecoach, Hilton Food, SSE, and Halfords. In the US: DirecTv, Mohawk Industries, Staples, Autozone and Dell seem interesting. Staples is worth a particular mention as I have done a pretty near full analysis on it and, considering, its growth potential, it looks quite (but not extremely) cheap. I should also mention that I am continuing to look at general media stocks with ITV being an interesting UK company added to the list of primarily US companies. Again, unless specificially mentioned, I have not had an in-depth look at these companies but these are just what has turned up recently.

Over the next month or two, I won’t be adding many new ideas to the website as I have other work to do. If I do add ideas it will only be US stocks to keep up with syndication obligations. I will continue to post the monthly reviews and any new positions that I do take will be registered there. When I do begin posting again I also intend to broaden the remit of the website by writing about short ideas. I have already constructed the screens and so a few companies are on my radar already. Hopefully, this will make the website more interesting and should be an interesting learning experience.