Connect Group – threats to the dividend?

PUBLISHED: Jan 25 2018 @ 10:03 | Comments (0) |

Connect Group (LSE:CNCT) offers a 13% dividend yield. What might cause the dividend to cease or be lowered? I’ll discuss some possibilities.

Summary of the businesses

The Smiths News part of the company focuses on distribution of newspapers and magazines on early morning routes to 27,000 newsagents. It has a 55% market share nationwide, but within particular regions it has 100% market share once it has secured deals with publishers on five year contracts. Turnover is about £1,380m, operating profit around £40m.

Connect also has a small business supplying newspapers and electronic items (e.g. computer games) to 80 airlines in 50 countries called Dawson Media Direct. Turnover: £29m, operating profit: £2.3m.

Alongside delivering newspapers to newsagents it is developing a distribution business for online businesses such as Amazon and Asos, called Pass My Parcel. Goods are taken to newsagents all over the country at short notice for customers to collect, “Click and Collect”.

This business was launched in 2014 and has made a stream of losses: £2.1m in 2015, £4m in 2016 (transported 0.5m parcels) and £6.3m in 2017 (1.5m parcels delivered).

My expectation (after discussing with the directors) is for the year to August 2018 turnover to be £7 – £8m, with costs of £13m and therefore losses of £5 – £6m. Not exactly an attractive pattern.

But the directors are “very excited by click and collect” (Chairman Gary Kennedy, at Tuesday’s AGM)

Tuffnells, a business bought in 2014 for £139m, distributes mixed and irregular sized or weight freight, serving 5,000 SMEs. It shifts around 70,000 items per day. Revenue: £183m, operating profit £12m.

There is also the Books division. An agreement to sell this to a private equity firm for £11.6m fell through earlier this week. Other buyers are being sought.

There is a lot of potential synergy between Smiths News, Tuffnells and Pass My Parcel.

Dividends interrupted

I’ll list what I consider to be the greatest threats to the dividend and then examine each of the issues in light of the company’s past performance, Monday’s profit warning and the comments made by the directors at the AGM.

The balance sheet is not strong enough to support the current dividend.
The newspaper and magazine distribution business declines in turnover and operating profit at a much faster rate than in the past due to (a) readers switching to online news rapidly, and (b) a cessation of the ability to find £5m of cost savings year after year.
The Pass My Parcel business never goes into profit and becomes a drain on the rest of the Group as they keep spending more than revenue.
Tuffnells continues to operate in a very tough pricing environment with cut-throat pricing for work, and it still suffers from the poisonous legacy of being owned by private equity companies who stripped out long-term investment.
The potential synergies between the businesses do not materialise.
Directors go on a spending spree, buying up other companies.

Will the balance sheet support the dividend level?

Connect’s balance sheet is unusual in being heavily dependent on very large amounts of credit granted by its suppliers – mostly publishers. Connect does not pay for newspapers and magazines until sometime after its customers have paid them. Newsagents pay via weekly regular direct debits (on a Wednesday, apparently), but across the Group the average credit period taken by customers is 24 days. However, the average credit period taken by Connect from its suppliers is 32 days. When turnover averages £4.4m per day the excellent cash-conversion cycle produces about £35m of useful cash.

£m	August 2017	February 2017	August 2016
Non-current intangible assets	107	133	165
Other non-current assets	51	55	62
Trade and other receivables	98	154	139
Other current assets	84	108	52
TOTAL ASSETS	340	450	418
Trade and other payables	-136	-213	-199
Other current liabilities	-91	-122	-83
Non-current liabilities	-88	-104	-123
NET ASSETS	25	12	13

At Tuesday’s AGM I asked: Is there a danger of suppliers tightened up on credit terms such that the balance sheet has to move to one with fewer outstanding trade payables and therefore more bank debt?

Answer: Newspapers and magazines contracts last for five years. A key part of those contracts are the credit terms. Already Connect has signed contracts for 93% of its News distribution capacity for the….

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