Magic Hat Portfolio

On 19 December 2013, I reported that I wanted to change my public portfolio on Stockopedia from a defensive style to a Magic Formula style. I just didn’t think I could achieve significantly superior outperformance using the former approach.

So now I am experimenting with the Magic Formula. My aim is to beat both the ASXX (All-Share Index ex. Inv Trusts) and the shares chosen by Stockopedia as part of the Magic Formula screen over the long term. The transition will take a year, as I rotate a share on a monthly basis. Can a monkey that follows Stockopedia’s approach blindly outwit the intellect of a former Mensan? Prepare for Epic Fail.

Since the portfolio is only beginning its transition, I’m making the sell rule simple: eliminate a low-scoring share. You will see that, on Friday, I sold out of SGE (Sage) to clear up some cash for the purchase. The MF score is 75 – which actually isn’t too shabby. Whilst we could argue if the PE of 16.7 is a bit toppy for what it is, I reckon it wouldn’t make a bad hold for those wanting to practise some “strategic indolence”.

In terms of what to buy, my basic plan is to keep it as simple as possible: reject the Chinese stocks, and buy where directors have bought.

However, I noticed that there is currently a lot of BB discussion about one MF candidate: HHR (Helphire). “The Company is engaged in the provision of non-fault accident management assistance and related services. Its main revenue is derived from replacement vehicle hire, the financing of vehicle repairs and the management of personal injury claims for the innocent parties involved in motor accidents.”

On further investigation, I am going to forego the simple selection, and instead discuss the merits of HHR. It has a market cap of £166m, a ROC of 58%, an EY of 22%, and an MF rank of 95%. Their seems to be some “special situation” occurring with HHR. Stockopedia lists its (FCF) Price to Free Cashflow as 5.78, which is very low. The great thing about Stockopedia is that it actually breaks down the cashflows. In the latest set of accounts, it has £31.2m in CFO (Cash from Operating Activities), and net cash inflow of £29.0m from investing activities. The company has had a number of such inflows over the years, and seems to be related to disposal programs. Although revenues have halved from 2008 to 2013, ROCE has actually improved.

Let me ignore these disposals, and strip out what look to be expectional investing inflows. It appears, then, that a reasonable estimate of capex expenditures is about £2.5m. So free cashflow is about £28.7m (=31.2-2.5). Given a market cap of £166m, that means that my adjusted PFCF is 5.78 (=168/28.7). That’s an implied return of 17% (the inverse), which is very good.

But I think the story is even better than that. The company had net cash at the year end. The interest paid last year was £460k, which I am going to take as negligible. What’s more, on 5 December 2013, the company placed £57.5m to grow its business. The shares represent 42.3% of the enlarged share capital. They were also placed at a premium to the market, which shows quite some interest.

The company has a ROC of 58% and a ROCE of 39%, as calculated by Stockopedia. Suppose it can only generate a 10% return on the money placed, though. Maybe it will take time to invest its money, or whatever. I will also assume no gearing. So a 10% return on £57.5m placing, add in £28.7m existing cashflows, gives forward free cashflows of about £35m.

How much will the market pay for these cashflows, given its high ROC and low gearing? I don’t know, but i would certainly hope more than 10. 15? Very feasibly. Let me split the difference and call it 12X.

So we’re looking at a company that may be worth £420m (= 12 multiple x 35m free cashflows). Current market cap: £165m. Seems like a lot of upside there, which is why I want to put it in the portfolio.

About mcturra2000

Computer programmer living in Scotland.
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