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Mr Market thinks Connect (LSE:CNCT) will be forced to cut its dividend from its current 9.8p (13% yield) because its businesses are in long-term decline. Today I will examine those businesses in light of the information we have been given in the recent annual report, last week’s profit warning and the AGM.
Five potential problems:
First, the newspaper and magazine distribution business turnover falls at a faster rate year-on-year than in the past; so fast that operational cost saving do not keep up, resulting in rapidly falling profits and cash flow.
Figures for News distribution business
| £m | 2017 | 2016 | 2015 | 2014 | 2013 | ||||
| Revenue | 1,384 | 1,444 | 1,479 | 1,525 | 1,529 | ||||
| Adj. operating profit | 40.4 | 40.0 | 41.4 | 42.9 | 40.0 | ||||
| Statutory operating profit | 36.1 | 34.1 | 23.2 | 40.8 | n/a | ||||
| Deprec & amortisation | 7.2 | 6.8 | 6.0 | 5.4 | 5.6 | ||||
| Additions to non-current assets | 6.8 | 5.2 | 8.0 | 7.7 | 6.7 |
The volume of newspapers and magazines being bought has declined, but this is offset by cover price increases and lower costs of doing business, leaving adjusted operating profit flat over this period at around £40m.
Being strict, we could knock off £5m – £10m, allowing for directors’ playing with “adjusted” numbers, to bring us to £30m – £35m. (MCap is £184m).
The stability in revenue (even if on a gentle downward slope), and in profits, suggests a gentlemanly sort of competition when bidding for the five-year contracts from the publishers.
Last week’s profit warning stated, “the overall sales decline of newspapers and magazines remains within our medium term forecasts…the overall profit and cash from newspaper and magazine sales is performing in line with our expectations”. I read this as a steady-as-she-goes message (am I being too optimistic?), in which case we can expect statutory operating profits of around £30m – £35m.
This image of stability is reinforced by the response to the question I asked at the AGM: “For News Distribution previous reports suggested on-going £5m of efficiency savings each year. Are you still making that sort of progress?”
Answer: “Yes, we can’t promise it will go on forever, but we expect it for the next few years”.
Efficiencies include actions such as building the Hemel Hempstead warehouse (now operational) with a capacity to deliver to 7,650 customers, 28% of the total.
News business assets and liabilities
| £m August | 2017 | 2016 | 2015 | 2014 | 2013 | ||||
| Assets | 85 | 89 | 93 | 145 | 142 | ||||
| Liabilities | -221 | -280 | -293 | -261 | -267 |
A significant decline in assets used by this division perhaps indicates a combination of switching to more operating leases, lower overall cost base and less volume.
While the amount of credit taken from publishers (representing a large proportion of the liabilities figure) has also declined, it has done so by a smaller percentage. This division, to a large extent, seems to be self-financing – although much of the liabilities figure is likely to be the £80m of bank debt taken on by the Group.
Will this division threaten the £24.5m dividend payments promised for this year? I don’t see why it should be seen as a high likelihood threat given the facts of the past and the proof that managers can wring out economies in a declining volume environment.
Second, Pass My Parcel never goes into profit and becomes a drain on the rest of the Group.
This 4-year old start-up, which taps into the online-purchase-followed-by-local-delivery trend has lost significant amounts of money, currently around £0.5m per month.
In 2016 the directors set a target of transporting 3m parcels in the year to August 2017. They achieved only 1m, losing £6.3m. There were delays in implementing contracts with the online retailers because these clients are required to “adopt and implement supporting technology”.
They already have ASOS and Amazon as major customers but they are talking with others:
“As the Click & Collect market grows, a range of models are emerging and it is clear that a ‘one size fits all’ approach will not be sufficient to meet the needs of retailers and their online customers. Although progress has been slower than anticipated, we continue to believe that the Group’s distribution footprint has unique capabilities that can secure a significant share of this growing sector. In addition to our network of parcel shops, we now offer a range of propositions that leverage the drop density and speedy distribution capabilities of our depots …… Our contract with UK Mail to handle returns and failed household deliveries is now scheduled to commence in 2018….. we are also responding to a growing demand for pre-10am business to business delivery. ….. a trial direct to store delivery service for clothing retailer H&M, supporting their Click & Collect offering to customers; the trial has since been expanded with a view to rolling out the service across the UK in 2018. A further small scale trial with Hovis, delivering fresh supplies to smaller retail stores early morning, has now been extended to some additional areas.” (2017 Report)
The history of losses has not dampened the enthusiasm of the directors:
“We are pleased with the direction of travel and see many related opportunities for the integrated Group. Customer satisfaction and feedback from clients and consumers remains excellent, and the acceleration of volume increases will substantially increase the scale and efficiency of operations. These developments reinforce our belief that there is significant opportunity to serve a wider range of customers, with a range of propositions in the Early Distribution market. The potential for new revenue growth will be further enhanced by the combining of the Group’s network and operations, providing a seamless UK wide customer offer. Although there remains uncertainty regarding volume projections, we expect a significant reduction in losses as the business builds, and are maintaining a break even target in FY19.” (2017 Report)
Last week’s profit warning said that PMP volumes grew 347% year to date “we are pleased with this aspect of progress, which demonstrates an increasing consumer awareness of PMP”. But delays in contracts mean that “we do not now expect full year losses from PMP to reduce from those incurred in FY2017”.
At the AGM the Chairman, Gary Kennedy said he was “very excited by Click & Collect…a real opportunity”. He followed this up the next day by buying 30,000 shares at 75.99p. The next day David Bauernfeind, CFO, bought 20,000 at 74.93p.
Third, Tuffnells continues to operate in a very tough pricing environment with cut-throat pricing, and it still suffers from the poisonous legacy of being owned by private equity companies who stripped out long-term investment.
There is no getting away from it: this business not doing well. Bought for £139m in 2014 it is still making profits of only………………….To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
