UK Edition
Questor: Low & Bonar could be skating on thin ice, so we’ll have to sell despite 50pc fall
Questor share tip: a profit warning last week and thin safety margins on debt – holding on in the hope of recovery at Low & Bonar is just too risky
In April last year we advised readers to buy shares in Low & Bonar, the diversified fabrics business, on the basis that it was “misunderstood and undervalued”.
But in light of a profits warning last week that sent the shares tumbling by 21pc in one day, we must now admit it was Questor that had misunderstood and overvalued it.
The company’s announced sales had risen in line with expectations but there had also been increases in the prices of key raw materials. “Our ability to pass on these cost increases continues to be held back by high levels of competition in most markets,” Low & Bonar said.
In other words, the business lacks pricing power – which, as this column has pointed out before, has the capacity to scupper many an investment case. There were further problems, such as inflation in US freight costs and “production issues” in its coated technical textiles arm.
The consequence, the company said, is that “while further price increases and cost reductions are being implemented, full-year profitability is now expected to be significantly lower than previously anticipated”.
The group also said its finance chief was leaving for “personal reasons”, while a day of presentations to investors and City analysts planned for later this year was delayed until 2019.
In Questor’s view the most ominous words in the trading update concerned the firm’s debts. It said the combination of higher raw material costs and trading conditions was “constraining the group’s ability to reduce net debt by the level previously anticipated”.
According to analysts at Peel Hunt, the firm’s house broker, this meant that debt would be £133.5m by the end of the financial year, £10m more than it had previously forecast. The City often decides whether debt levels are reasonable by comparing them with profits on the “Ebitda” measure. If Peel Hunt’s estimates are accurate, the debt-to-Ebitda ratio at the year end will be 3.
Under its agreements with lenders, Law & Bonar’s debts must be kept below 3.5 times Ebitda. However, this limit was increased from 3 only temporarily under the terms of a refinancing in the spring and it will return to 3 on May 31 next year.
The impression left is that the group’s safety margin on debt is thin and that it has only a matter of months in which to get matters under control.
A combination of profit margins at the mercy of outside forces and debt levels close to their limit does not sound healthy and Questor advises readers to sell, even at the price of a 50.9pc loss.
Our original tip was based on the actions of fund managers at Unicorn Asset Management, who held the shares in several of their portfolios. Following the profits warning Unicorn said it had cut its overall holding from 5pc to 1.3pc of Low & Bonar’s shares.
Simon Moon, manager of the Unicorn UK Smaller Companies fund, told Questor: "Exiting our position in Low & Bonar is not a decision we have taken lightly. Having held it across a number of funds for almost seven years we clearly believed in the quality of its product offering.
"However, a combination of factors has led to us fundamentally reappraise the investment case: weaker trading, exacerbated by challenges in passing on rising polymer costs, has left the business with a lot to do in the final quarter of the year."
He added: "This hasn't helped an already elevated net debt position, which could in turn could put pressure on the payment of meaningful dividends. The high level of management turnover over the past 12 months also caused us to look at the company with increased scrutiny."
Questor says: sell
Ticker: LWB
Share price at close: 39p
Update: Gama Aviation
Shares in Gama, the aviation services group, are also below where we first tipped them in November last year, albeit by a more palatable 5.4pc. But this time we will hold.
The company announced interim results last week. Reported profits plummeted from £9.6m to £2.9m, although “underlying” figures were much better. The shares lost about 5pc.
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Nick Hawthorn of Downing, which holds a large stake, said there was little new in the statement. “There were a lot of exceptional costs, which muddy the numbers, and it takes some time to understand all the moving parts,” he said. “But things are better than they seemed from a first reading of the numbers.
“We are holding on for the real reward, which will come from delivering the long-term strategic plan. We think it has great merit and the right operational management to execute.”
He added: “There will be bumps along the road and it is frustrating when earnings don’t go in a straight line but it’s a solid business and a market leader. It has 70pc contracted revenues, no debt and $21m of cash.” He said the forecast price-to-earnings ratio was just 6.8 for next year, disregarding earnings from acquisitions.
Questor says: hold
Ticker: GMAA
Share price at close: 182.5p
- Questor archive: telegraph.co.uk/questor