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.

RPC plc. A Plastics Packaging Company and Restructuring Story.

RPC is a supplier of rigid plastic packaging.  It is an interesting stock because it gives you the chance to play lower oil prices (margins should improve) not only via lower polymer prices but also via lower energy prices. Conversely, margins would fall should they oil prices go up.

RPC’s end markets tend to be loaded towards the food sector and also towards household consumer products like lipstick cases and coffee capsules etc. As such, they can be seen as a defensive play. They sell primarily into Europe, having expanded into Continental Europe over the years. The three divisions of thermoforming, injection moulding and blowforming are all single digit margin businesses.

Even though they are defensive in their end markets, they are still cyclically exposed because when economies slowdown in industries like plastics manufacturing-capital intensive, operators need to keep capacity utilisation high-they usually get price competitive and try to grab market share.

Before showcasing the numbers, I should point out that these numbers are adjusted to exclude restructuring costs. And there has been a lot of restructuring over the years! In a sense, the story of RPC is a company struggling against rising commodity costs whilst refocusing their activities and making cost efficiency savings.

RPC					Year to March
			2006	2007	2008	2009	2010
Turnover			611.5	645.7	695.2	769.1	719.9
Adjusted Operating Profit			36.8	38.1	40.6	35.5	40.9
Margin			6.02%	5.90%	5.84%	4.62%	5.68%
Inventory			86.37	94.20	110.30	87.90	96.40
Inventory Days			54.85	56.59	61.50	43.73	51.82
Debtors			117.29	128.20	139.90	120.70	125.80
Debtor Days			70.01	72.47	73.45	57.28	63.78
Creditors			135.87	130.80	157.70	164.60	185.60
Creditor Days			86.29	78.57	87.93	81.90	99.77
Op Cash Flow			66.60	65.10	56.20	49.60	55.90
Working Capital			-2.09	-24.20	7.30	65.60	15.50
Tax			-9.67	-7.50	-10.90	-5.10	-2.20
Interest			-7.92	-8.40	-10.60	-10.60	-4.50
Net Op Cash Flow			46.93	25.00	42.00	99.50	64.70
Capex			-50.31	-35.50	-33.40	-33.40	-28.00
FCF			-3.39	-10.50	8.60	66.10	36.70
FCF*			-1.30	13.70	1.30	0.50	21.20
FCFYield			-1.17%	-3.64%	2.98%	22.91%	12.72%
FCF*Yield			-0.45%	4.75%	0.45%	0.17%	7.35%
FCF*Normal			5.44%	5.27%	1.39%	-0.24%	5.13%
Depreciation			-33.31	-34.00	-30.70	-34.60	-34.40
Capex/Dep			1.51	1.04	1.09	0.97	0.81

I should explain that FCF* is simply free cash flow but with working capital neutralised. Similarly, FCFNormal is the free cash flow whereby I have equalised capex with depreciation. It helps to get a clear picture of what is going on.

Again, I should point out that almost every year there have been substantive restructuring. However, RPC know feel that they are beyond the restructuring phase and can now pursue growth. Indeed, free cash flow generation has been very strong recently but I suspect there will be some 'payback' as inventory levels may need to rise. Similarly, I'm not sure if the change in working capital (from a negative to a positive) is sustainable going forward. Their working capital requirements are somewhat dependent on where commodity prices go.

Longer term growth rates look to be around 4% but there is a cyclical element which will be tied to European growth rates. They do try and pass on oil price rises but are susceptible to sharp and volatile upwards movements.

In general, I like the restructuring here and think the current share price gives good value. However, I did not take a position as -short term- there are significant questions over the ability of European consumers to borrow as a result of the Sovereign Debt Crisis. The nightmare scenario for RPC would be surging Oil prices driven by emerging markets and speculation, coupled with European consumer entrenchment over austerity measures.

However, this is definitely one to monitor.