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I’ve bought shares in Connect (LSE:CNCT), formerly known as WH Smiths News, at 104.6p each (market capitalisation of £256m). The Group distributes newspapers and magazines to UK retail outlets, and owns Tuffnell, the parcel delivery business, and sells books.
Based on last year’s earnings per share they stand on a PER of 7.6. More importantly, using the average earnings per share over the last ten years the shares also stand on a cyclically adjusted price earnings ratio of 7.6.
The directors are committed to a progressive dividend policy, with dividend per share rising from 6.4p in 2007 to 9.5p last year. With the share on 104.6p dividend yield is 9.1%.
The dividend is consistently easily covered by both earnings and by free cash flow. An indication of further advances in annual dividends was made with the recent interim dividend lifted from 3p to 3.1p.
Seems too good to be true
You have to be suspicious of a company with such good looking statistics. Why on earth would Mr Market push its share so low relative to both earnings and dividends?
One possible avenue of inquiry is to ask whether it is likely to go bust. I’ve checked this out using Piotroski factor analysis, and a general gander at its financial and trading position.
It scores 6 out of 9 Piotroski points based on the annual report to August 2016 and a whopping 8 out of 9 based on the interim results to February 2017, indicating low likelihood of financial distress.
Debt levels have been lowered considerably by the recent sale of a non-core division. Even before that it had no problem servicing its debt.
Mr Market may be on to something with his pessimism concerning the core activity. Around three-quarters of revenue and profits come from the early-morning distribution of newspapers and magazines to corner shops and other retailers.
The volumes of this business have been in decline for many years already; and no one is pretending that the trend will reverse. The directors are very straight about this – people are buying fewer newspapers and magazines.
But, Mr Market may be over-pessimistic. Despite the decline in volume, the increase in cover price has reduced the impact on revenue received by Connect.
This, together with a continuous bearing down on costs through efficiency savings, has meant that the company is today reporting much the same earnings per share numbers it reported five years ago, and ten years ago. The collapse that Mr Market has been anticipating has not happened.
This happy result has been helped by two other factors. One is the purchase and building-up of complementary synergistic businesses.
The second is the oligopolistic nature of the paper media distribution business. Indeed, you could go so far as to say the business is monopolistic in many/most parts of the UK, as Connect and John Menzies bid for territories where they concentrate their delivery vans.
Management
I haven’t found a bad word said about the quality of the managers at Connect; they have been dealt a bad hand, but nevertheless ran the business with a methodical strategy of entrenching market positions where they had competitive advantage, being very cautious in capital expenditure, thus throwing off free cash flow which is then used to pay very high dividends.
I think the odds are in favour of a continuation of that strategy, with the added spice of newly-established business assisting internet merchandisers get their products to customers same-day or next-day (Connect has the vans and the relationship with the corner shops to offer a handy click-and-collect service).
Today I’ll give you the earnings per share and dividends numbers and tomorrow go over the issue of financial distress likelihood. Later Newsletters will look at the businesses and their competitive advantages.
The cyclically adjusted price earnings ratio
| Year to end August |
“Adjusted” earnings per share (p) |
Statutory basic earnings per share (p) |
Dividends (p) |
| 2016 |
19.8 |
13.7 |
9.5 |
| 2015 |
19.7 |
9.3 |
9.2 |
| 2014 |
19.6 |
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