Tuesday, December 7, 2010

Begbies Traynor A Counter Cyclical Share that Benefits from Recession

Begbies Traynor is an interesting business to do a bit of equity research on. What makes it an attractive stock, is that it is an insolvency practitioner and should give counter cyclical growth. In other words, it is a nice way to balance your portfolio. Furthermore, over the years they have been making acquisitions and consolidating in order to achieve growth. They gave a trading statement a few days ago..

"As a consequence of this, together with an increase in finance costs resulting from the Group's new banking facilities, we expect adjusted pre-tax profits* in the first half year to be around £0.7m below last year's results of £4.3m. Following some restructuring undertaken in the period, exceptional costs of approximately £0.8m have been incurred in the half year."

Frankly, this sort of thing no longer surprises me about Begbies Traynor. Whilst, they were a great counter cyclical stock to buy in 2008, their management has-in my humble opinion- a bit of a patchy record. I'm not trying to do a 'hatchet job' here but rather analyse how best to view this company and trade it. I've held this stock before (in 2005) and was amazed to look at it again and, see that it is back to the price that I had paid for it in 2005.

In 2005, Begbies Traynor was a recently listed stock that was acquiring private practitioners and consolidating them. The investment proposition was compelling because you got growth through earnings accretion plus upside potential from a slowdown in the economy. It is easy to see how this would balance the portfolio. It worked. The share price went on to tough the dizzy heights of 200p although I was long since out by then.

However, since 2006, BEG seemed to lose their way.  During 2006 the UK economy progressively got better and as a consequence liquidations fell. As liquidations fall, so the pipeline of insolvency practitioners will fall too. Perhaps as a consequence, they expanded their corporate finance activities, in order to balance the future slowdown in insolvencies. However, the commentary in their trading statement of Oct 2006

"The directors are, therefore, unaware of any reason which would explain the recent downward trend in the market price of shares in the company."
suggests the management are a bit 'out of touch' with what moves share prices. If insolvencies are falling, so should the prospects for listed insolvency practitioners. It's not rocket science. See the downward move in 06-07 here

                                                               Compulsory            Creditors
Liquidations            Voluntary
                                Total                                                     Liquidations                           
2000                14,317            4,925                 9,392
2001                14,972            4,675               10,297
2002                16,306            6,231               10,075
2003                14,184            5,234                8,950
2004                12,192            4,584                7,608
2005                12,893            5,233                7,660
2006                13,137            5,418                7,719
2007                12,507            5,165                7,342
2008                15,535            5,494              10,041
2009                19,077            5,643              13,434

 source: http://www.insolvency.gov.uk/otherinformation/statistics/201011/table1.pdf, figures are not seasonally adjusted

Begbies reacted to this by increasing their corporate finance arm. It wasn't enough and the inevitable profit warning came in Dec 07

"Despite an anticipated stronger second half, we cannot be confident that the profit shortfall from the first half will be recovered. Consequently, the board currently considers that the Group's operating profit for the full year to 30 April 2008 may be 20% below that reported for the prior year."
bundled with the confirmation of a slowdown in the once booming IVA market for them. The share price got back down to 87p. Of course, this then proved an opportune time to buy as the credit crunch hit and the recession provided them with good opportunities. See table above.

The share price recovered to nearly 200p at the time of the height of the credit crunch in Autumn of 2008. Since then, it has been downhill all the way, as the economy recovered...

Table I. Company Liquidations in England and Wales (seasonally adjusted)

                                                                                                                                             %Q3 2010               
                                                      2009 Q3    2009 Q4    2010 Q1    2010Q2 r     2010 Q3 p       Q3 2009     Q2 2010 
Company Liquidations                     4,615           4,457        4,060         4,063           3,974                 -13.9           -2.2
of which: Compulsory                       1,289           1,331       1,298          1,164           1,126                 -12.6           -3.2
               Creditors’ Voluntary2         3,326           3,126       2,762          2,899           2,847                 -14.4           -1.8

source: insolvency.gov.uk

All of which leads us to the recent warning. So is this a good time to buy and, what can we learn from this?

I think it is better to focus on the overlying economic fundamentals and the insolvency data, rather than the managements statements. They do try and mitigate the macro drivers but it has proved to be a mistake to rely to much on their commentary. Similarly, I wouldn't take their 'Red Flag Alert' monitor too seriously, when making an investment decision over Begbies Traynor.

 History shows us that insolvencies were in an uptrend in 2008 and you would have made good returns by waiting for an uptick in this metric before buying the stock. This is a stick to monitor, and this may prove an opportune time to buy, but I think it should be on monitor for now.