This well-established business offers recovery and takeover potential, but debt could be a sticking point, says our companies analyst.
The £270 million Menzies group is nowadays in logistics and support services for air freight and passenger ground handling. Not surprisingly, it was clobbered by Covid-19, so key to the investment rationale is the extent and timing of recovery in air travel.
Green-conscious investors may also wonder how far commercial and passenger flights will reduce to curb (fossil fuel) energy consumption.
A roller-coaster ride over the last 20 years
The stock’s performance has been sideways and highly volatile. At 295p, it is back where it traded nearly 20 years ago after the newsagents were divested. Along the way, highs close to 700p in 2013 and 2018 were achieved, but also lows of 60p in March 2009 and 99p in March 2020.
Yet some of the valuation criteria are modest, should the business meet recovery targets. The price/sales ratio is just 0.3 times – justifiably, you might say, given low single-digit operating margins pre-Covid. The first half of 2021 did, however, show a turnaround in the normalised margin to over 5%, which is a good start.
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If the company meets expectations for near £13 million net profit this year, and a record £31 million in 2022, then the price/earnings (PE) ratio is around 12x, falling to near 7x. The table of summary financials also shows a robust cash flow profile, although also some significant capital expenditure absorbing this.
That suggests the stock could be at an inflection point, which combined with frustrated long-term shareholders makes Menzies a potential target for buyout financiers. Metro Bank (LSE:MTRO) is the latest in this current trend.
If Menzies is able at some point in future to restore a dividend of around 20p a share, that implies a prospective yield near 7%. In that case the stock should mean-revert upwards, especially if management reduces its business mix risk profile by successfully diversifying.
However, I am concerned by a weak balance sheet, where slightly negative net assets support total net debt near £350 million, or £183 million on a pre-IFRS 16 basis, subtracting leases.
Buyout artists typically gear up companies to leverage return on equity, cutting costs along the way, then sell the business on. Menzies looks compromised for such financial manoeuvring, and existing management may also have picked the low-hanging fruit on costs.
The debt also means investors have to be confident in a steadily improving, multi-year scenario for international air travel that will not be compromised by virus, recession or terrorism.
Mixed variables in the first-half 2021 results
Revenue eased nearly 4% to £416 million, but more respectably a £39 million like-for-like operating loss became a £22 million underlying operating profit. This eased to £11 million at the pre-tax level as a near £11 million interest charge bit.
It is concerning that the overview headlines in the half-year report cite: “Turnaround driven by restructuring, cost actions and new business wins, together with continued support from government schemes” (my italics). The results do not explain the extent of government support until notes 8 and 9, where the benefit – at least as presented – appears to be wholly from the US and Covid-related.
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Over £88 million in US federal funding was received during six months alone: £73 million of grant funding to support the US payroll and near £16 million in the form of a loan note. The grant funding element is accounted for via trade (and other) payables.
Is there a cut-off date for this funding, as there has been for the UK furlough scheme, or might the US government take a pragmatic and piecemeal approach? The latter seems apparent from the way the “movement in US government support” entry on the interim cash flow statement was greater in 2020 than 2021.
It is debatable whether Covid support should be subtracted from operating profit, but it is a cash reality – the interim statement shows a 37% like-for-like drop to £75 million generated from operations, the chief element being US funding then depreciation written back.
Given the optimistic 2022 profit forecast, greater clarity is needed on this US grant funding element.
A genuinely international business, expanding reach
In the first half of 2021, the US accounted for 32% of revenue, the UK for 18% and Australia for 15%; however, the remaining 35%, the largest element, was rest-of-world. This makes the stock thematically a good play on the global economy steadily recovering from Covid.
Initiatives have continued since a January 2021 acquisition in Pakistan. Last June, a £3.4 million minority equity stake was declared in a Chinese aviation logistics company in Guangzhou province, and August saw a 51% interest in a Central American cargo handling and security services provider. This joint venture was said to offer Menzies a strong foothold to develop other service lines in the region. New business has also been secured in Australia with Virgin.
John Menzies - financial summary
Year-end 31 Dec
|Turnover (£ million)||1,899||1,982||1,274||1,291||1,326||824.0|
|Operating margin (%)||1.3||1.3||1.6||2.5||3.0||-12.1|
|Operating profit (£m)||24.9||25.3||20.7||32.6||39.4||-100|
|Net profit (£m)||10.1||8.5||12.6||-5.7||10.8||-127|
|EPS - reported (p)||14.5||11.8||2.6||14.6||10.8||-151|
|EPS - normalised (p)||35.7||46.2||36.9||34.4||16.0||-154|
|Operating cashflow/share (p)||33.2||33.0||48.6||34.4||85.3||104.0|
|Capital expenditure/share (p)||35.7||37.7||38.9||38.5||41.6||29.9|
|Free cashflow/share (p)||-2.5||-4.7||9.7||-4.1||43.7||74.1|
|Dividends per share (p)||14.8||17.9||20.5||20.5||6.0||0.0|
|Covered by earnings (x)||1.0||0.7||0.1||0.7||1.8||0.0|
|Return on capital (%)||9.1||9.3||4.3||9.0||8.0||-24.4|
|Net debt (£m)||122||64.8||216||201||392||353|
|Net assets (£m)||70||124||136||105||87.4||-43.9|
|Net assets per share (p)||100||149||163||125||104||-52.1|
Source: historic company REFS and company accounts.
Aviation market activity is improving
Third-quarter 2021 passenger markets show a rise expected to continue into 2022, albeit taking until 2023 to recover pre-pandemic levels. This will commensurately help Menzies’ ground services and fuelling operations.
Management contends: “Prompt actions at the start of the pandemic have put us in a good position to prosper now the aviation sector has begun to recover.”
2021 would therefore be the time to accumulate shares, before the market starts anticipating better prospects in 2022 and, if over £30 million net profit is realistic, even better numbers from 2023.
Management seeks a wider spread of aviation services, where these can be identified with higher growth and margin prospects, which could improve the group’s risk/reward profile.
Balance sheet assets are wholly offset by liabilities
Net gearing is made acutely high due to negative net assets of £6.3 million, within which there is £180 million of intangibles.
A £22 million equity raise last May at 290p a share (involving 8% dilution) had a prospectus for assisting expansion, although it has effectively sustained cash at a considerable £206 million. That is relative to £424 million total long-term debt and £130 million short-term debt, including leases.
£259 million property helped end-June non-current assets to £480 million, versus £474 million non-current liabilities (predominantly debt). But at the current assets level, liabilities slightly prevailed due to £243 million of trade payables versus trade receivables up 29% to £211 million (helped by those US grants). Current liabilities totalled £438 million.
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In a less-likely worst-case scenario involving another downturn in trading, this could cause bank covenants to be breached. Management says these could be renegotiated or a waiver would apply.
It does however mean this stock is suitable only for more risk-tolerant investors.
A speculation on flight activity and international growth
Despite its risks, I think Menzies stands a decent chance of continuing to recover and hone its service mix in a global context. The debt does seem something of a poison pill for would-be acquisitors, but take-over could still happen. Given steadily improving prospects for travel, I see a scenario where this stock could double on a three-year view and also restore a meaningful yield. Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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