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An assessment of FK

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#1

I¿ve written a 3,576-word report on Fletcher King (for my Newsletter subscribers). Obviously I cannot post the whole thing here, but I would like to make a contribution to the debate on this bulletin board and so have put some points below (I¿m sorry it is still so long). Please let me know your thoughts.
Issues:

  1. Whether the profits downturn is permanent.
  2. Whether the 18 people working for FK will suck out the value due to shareholders through their bonus packages. Linked to that, are questions over the rewards to shareholders through dividends.
  3. Whether the NCAV (mostly cash) is greater than MCap. Linked to that is the question of excessive amounts of shareholder¿s cash stuck earning 0.4% pa.
    The headline profits fall gave such a jolt in large measure because of the great results in the 1st half: revenue was up 36% and PBT up 99%, and interim dividend doubled to 1.5p.
    But, David Fletcher warned: ¿as I pointed out in my Chairman¿s statement last year, those results would be a difficult act to follow, but we will use all our efforts to do so.¿
    There was a black mark against these half year results: Revenue was up by £486,000 but the staff increased employee benefit expense by £232,000, so the advantage of high operational gearing was blunted by the staff being first at the trough.
    The company clearly had a rotten second half in 2015 with revenue at £1,562,000 compared with the last year¿s second half of £2,311,000. Profits fell even more from £431,000 in the second half of 2014 to £128,000 in the second half of 2015.
    A longer term perspective
    I¿ll look at five years of numbers to gain an impression of the earnings power of this business.
    Profit and loss account
    £¿000s 2015 2014 2013 2012 2011
    Revenue 3,380 3,653 3,031 3,105 3,175
    Less Employee benefit expense (1,843) (2,017) (1,641) (1,673) (1,595)
    Less Depreciation (36) (44) (43) (46) (59)
    Less Other operating expense (1,057) (1,083) (1,085) (1,012) (1,130)
    Produces operating profit 444 509 262 374 391
    Add profit on disposal of ¿available for sale investment¿ - 174 - -
    Income from investment 4 13 11 11 13
    Finance income 13 15 19 10 10
    Totals to Profit before tax 461 711 292 395 414
    Tax (102) (169) (65) (115) (83)
    Profit to equity shareholders 359 542 227 280 331
    Earnings per share 3.9p 5.89p 2.46p 3.04p 3.59p
    Observations:
    ¿ Revenue has been fairly flat at a little over £3m, with a boost in 2014 because of some one-off events.
    ¿ Employee benefit rose and then fell.
    ¿ Operating profit rose over the five years from £391,000 to £444,000, with a blip up in 2014.
    ¿ Headline PAT and eps strongly influenced by the one-off profit in 2014 due to the selling of FK¿s stake in SHIPS06 and SHIPS11. Thus it appeared to many observers that the managers lost the plot, with eps falling by 34%. However, look at operating profit - fall of 15% - perhaps this can be accepted as a normal bump in the road of unpredictable business life.
    ¿ We clearly cannot attribute future growth to this firm¿s profits and still claim we are building a margin of safety into our analysis. Thus something like £359,000 after tax is a reasonable estimate, with eps at 3.9p. Unless, of course, there is additional value in the two recently established SHIPS.
    ¿ The strangeness of the decision to hold nearly £3m cash is highlighted by the return it generated - £13,000 i.e. 0.4%. A service-type of business such as this does not need this cash pile.
    ROCE
    A very important factor in judging a good business with good management is the ROCE. FK scores surprisingly well on this:
    With NTA of £3.3m in 2014 and OP of £509,000, a bumper year, it achieved a ROCE of 15.3%:
    £509,000/£3,325,000 = 15.3%
    With NTA of £3.7m in 2015 and OP of £444,000 it achieved a ROCE of 11.9%:
    £444,000/£3,729,000 = 11.9%
    But, look at the transformation in ROCE if £2m is returned to shareholders, so that this service business operates with only £1,729,000 of NTA:
    £444,000/£1,729,000 = 25.7%
    This would make it one of the best run companies on the stock market.
    A serious charge levelled at David Fletcher and the rest of the staff is that this company is being run in their interests only and shareholders are tossed a morsel every now and again.
    So, we have charges of selfishness (lack of integrity regarding shareholder interests), incompetence and contempt to deal with.
    Let¿s start by looking at the facts.
    £¿000s 2015 2014 2013 2012 2011
    Revenue 3,380 3,653 3,031 3,105 3,175
    Employee benefit expense (1,843) (2,017) (1,641) (1,673) (1,595)
    Less Other operating expense (1,057) (1,083) (1,085) (1,012) (1,130)
    Produces operating profit 444 509 262 374 391
    Earnings per share 3.9p 5.89p 2.46p 3.04p 3.59p
    Dividend for first half 1.50p 0.75p 0.75p 0.75p 0.75p
    Dividend for second half 0.75p 2.25p 0.75p 0.75p 0.75p
    Total dividend 2.25p 3p 1.5p 1.5p 1.5p
    Fletcher¿s salary and benefits unknown 131 129 128 127
    Fletcher¿s Bonus 240 86 123 130
    Goode¿s salary and benefits 112 112 110 110
    Goode¿s bonus 240 86 123 130
    Dickman¿s salary and benefits 105 105 102 98
    Dickman¿s Bonus 25 119 67 105
    Total Board remuneration 875 657 688 740
    Staff wages (includes directors¿) 1102 1113 1,150 1,024
    Staff performance related income (includes directors¿) 642 307 309 365
    Staff social security etc. 273 221 214 206
    Observations:
    ¿ Over 5 years dividends amounted to 9.25p. For an investor who paid 30p per share this is a 31% return. To an investor who paid 43p the return would be 22.7%. Attractive.
    ¿ ¿Other operating expense¿ declined over the five years. Commendable.
    ¿ As a multiple of operating profit the total ¿employee benefit expense¿ was 4.08 in 2011, 4.47 in 2012, 6.26 in 2013, 3.96 in 2014, 4.15 in 2015. Thus in the really bad profit year of 2013 the employee expense did not fall in proportion to the profit decline (Board remuneration fell by only 5%). Despite this downward stickiness, employee expense does, over the half decade, remain in the region of slightly over four times operating profit. This co-movement evidence does not add weight to the argument that the firm is being run only for the managers.
    ¿ However, we might be entitled to be upset at the high absolute amount of director¿s pay. For a company with an earning power of around £360,000 to pay two directors more than the annual profits is unjustified.
    ¿ Another interesting benchmark is directors¿ remuneration relative to market capitalisation: annual Boardroom pay is almost double the market capitalisation.
    ¿ Given the great quantity of cash, and a need for a more efficient BS, the decision not to maintain the final dividend is very odd indeed. Perhaps they neither understand the logic of capital structure theory and good practice nor the logic of dividend policy considerations, especially the signalling effect.
    Clearly the two leading directors are taking excessive amounts from the company. Their conscience is such that they feel no shame about taking so much from shareholders year after year.
    So the questions facing investors is:
    If we crack down on pay and bonuses will we be shooting ourselves in the foot?
    Will the talent within the company leak away to rival firms, and/or they will stop putting in so much effort?
    Will we lose those people who hold the best reputations and contacts, and therefore lose a great deal of contracts?
    Possibly we will lose talent and thus ruin the company.
    But you have to acknowledge that the loss of one of these overpaid people would lower costs by over one-third of a million pounds. Would FK really lose so much business as a result of removing one person?
    Is it so badly managed that there is not a team in place to maintain the transition to a new line up of senior managers? If succession planning is so badly thought-through then the current senior managers are not worth backing anyway.
    So I¿m going to vote against the pay of the Board members. If they carry on regarding shareholders as patsies, next year I¿ll be voting against the re-election of the two senior directors.
    I think there is plenty of shareholder value in this business. Here is one idea: It pays out £3m of cash to shareholders now and then continues with the staff remaining after the retirement of one or two of the senior directors. I expect there is plenty of talent below Board level - incentivise them right and we could have a business producing profits of £0.5m or more each year, thus the MCap increases. And this is after the receipt of £3m of cash. Board room pay should drop to around £400,000 providing a further boost.
    I hope some of the major shareholders join me. Such a shake-up is a risky undertaking but so is sticking with the current set up.
    Turning to net current asset value we ask: Does FK have so many current assets that even after we deduct all the liabilities we are left with a number greater than the current market price of the company? Answer: no the NCAV is 37p per share.
    Earnings power: I will not go beyond a future earnings power estimate of around £360,000. I accept that it showed more promise in 2014 but that was due, in large measure, to some one-off events, e.g. fees from arranging ¿the largest sale in the history of the firm of an office block for £110m¿, and the realisation of a capital gain on SHIPS.
    What might lead to greater optimism in the short- to medium-term is the potential to make some one-off gains from SHIP14 and SHIP15 ¿ plus the fees and carried interest from managing the SHIPS. But the capital gains will only occur if they get the timing right on the sale of the properties.
    SHIPS14
    Helped by the good impression given by the returns made for investors in SHIPS06, which owned a property in Basinghall Street generating 11% pa until it was liquidated in 2014, and the returns of 20% pa made for investors in its SHIPS11 fund (property in St Swithin¿s Lane) which liquidated after three years in 2014, FK was able to raise funds for SHIPS14.
    As well as outside money, £750,000 was invested by FK in SHIPS14.
    In December 2013 SHIPS14 bought its only property at Leadenhall Street.
    There was good news in the 2015 Prelims: the property in Leadenhall Street ¿has been letting up at rents in excess of forecast and the last phase of the current refurbishment program is nearing completion.¿
    After the 2015 year-end another fund was raised, SHIPS15, and ¿A new property just off Clerkenwell Green was acquired¿¿ circa £8m ¿… it was oversubscribed.¿ FK only put up £125,000 of cash to co-invest. It will benefit from the ongoing fees and carried interest.
    Fees from SHIPS
    £¿000s 2014 2013 2012
    SHIPS04 101 217 237
    SHIPS06 217 60 56
    SHIPS11 261 16 27
    SHIPS14 95
    (4 months only)
    Thus there is the possibility of £400,000 or more pa in fees from the two SHIPS. On top of that the company might produce capital gains on its £875,000 investment.
    There are other indicators of good prospects in London: FK says that the volume of valuation work has increased as the banks return to the lending market ¿with a vengeance and there is no sign of it abating¿ (Fletcher 2015). And FK has increased the individual deal fee level.
    However, there is a danger of staying too long at the party of the upward march of London property ¿ everyone thinks they will get out before midnight, before everything turns to pumpkins and mice. I hope that FKs directors know when it is 5 minutes before midnight.

#2

Thank you for this Profdoc. A very astute assessment. The yield, lack of debt and ROCE attracted me to this. i will continue to hold and hope for the divis.

Could you tell me how to subscribe to your newsletter please?


#3

Hi Blanketstacker,

Thank you for your interest. ADVFN host the Newsletter, Try http://newsletters.advfn.com/deepvalueshares/ (It’s £6 per month - I write 4 per week - currently posting about Warren’s 1960s investments following my lecture tour in Malaysia talking about Warren. I’m also looking at the entire market for net current asset value investments for my NCAV 2015 portfolio - FK was bought for the 2013 NCAV portfolio)
Regards
Glen


#4

Many thanks. On it now.


#5

Blanketstacker
I think I’ve found a new NCAV share - I’ll post about it next week and invite ideas and comments from fellow enthusiasts