AGA Rangemaster, owner of a truly iconic kitchen brand, could well turn out to be an incredible bargain. In fact, investors can buy the company today for little more than the cash it holds in the bank.
It may be that – for the moment at least – a price of around 75p is justified as the dividend last year was only 1.7p and is unlikely to be much better this year. Earnings have also fallen during the recession and could stay well below 10p for the foreseeable future.
None of this is exactly surprising. Given that AGA’s products are a big discretionary purchase for consumers, it’s entirely sensible that many of them put their dream AGA purchase into the someday / maybe folder.
A quick look at the company’s 10-year price chart shows why past investors may be less than happy.
As was the case with the review of Marks and Spencer, looking at the past share price can be very misleading. If, instead, we look at the company in terms of its assets rather than its price chart or even its earnings, then things start to look a little different. It turns out that AGA fits the 21st Century Net-Net criteria.
Sign #1 – Plenty of cash
At the last annual report, AGA had around £35m net cash, which just means that if they turned all their liquid assets into cash, they could pay off all their borrowings and have £35m left over.
Any company with net cash is likely to have a relatively small amount of interest-bearing debt, which means that surviving tough economic periods becomes that bit easier.
Partly as a consequence of the £50m cash pile in the bank, the quick ratio is over 1, and the current ratio is over 1.5, both of which are relatively healthy numbers.
I don’t expect excessive debt or cash flow problems to be the downfall of AGA anytime soon, so I think it has a fair chance of weathering the continuing recession.
Sign #2 – Very low price-to-book ratio
P/B is currently 0.29, which is very low by normal standards. The price is also well below the tangible book value, giving a P/TB ratio of 0.59, which means a buyer would be getting a lot of assets for their money.
A low price-to-book ratio is one of the key valuation metrics when valuing companies where profits are uncertain.
Sign #3 – Very low price-to-sales ratio
With a market cap of about £50m and revenue last year of around £260m, AGA is priced well below its single-year sales figure.
This indicates that the assets which can be bought cheaply today (via the low price-to-book ratio) are actually being used to generate a meaningful volume of sales.
This doesn’t mean that sales will automatically turn into profits, but without sales, there is not even the chance of generating a decent profit in the future, so sales are important and could be a better indicator of future earnings potential than current earnings.
Bet the farm, or spread your bets?
Ben Graham was probably the first person to outline an investment approach based purely on balance sheets rather than income statements. His net-net strategy has proven time and again in various back-tested studies to be capable of trouncing the market indices over long periods of time.
What is often forgotten is the extent to which he used diversification as part of the strategy.
Companies that are so far down the price-to-book scale are not great compounding machines. They don’t generate an endless stream of profits that grow year after year as the company profitably reinvests retained earnings.
What you’ll typically find instead are companies that have:
- Fallen on hard times recently
- Been struggling through hard times for many years already
- Cut the dividend to zero or never pay a dividend
- Made a loss this year or perhaps for several of the last few years
- A reputation among investors as a ‘no-go’ area.
- Highly uncertain futures. It’s not obvious how they’ll make a profit in the next few years or if they’ll survive.
To counter that level of uncertainty Ben Graham diversified extensively, holding upwards of 100 positions in his portfolio.
In the same vein, I will be adding AGA to my 21st-century net-net model portfolio, but only with a 1/60th weighting, which is about 1.7% of the total portfolio.
Using time to your advantage
Many active investors are constantly worrying about their holdings, watching the market and the talking heads on TV to look for any news that might affect their hard-earned capital.
In most cases, this is a mistake, and one way to take advantage of the short-termism of other investors is to have a fixed holding period for an investment. Usually, the period used in academic studies is one year, which may be too short for value investors.
Studies (such as Time and the Payoff to Value Investors) have shown that holding periods beyond 12 months can generate higher returns than shorter periods.
For that reason, as well as to minimise the workload of managing 60 positions in this portfolio, my target holding period is five years, during which time each position will be effectively ignored.
In some ways, this is like private equity. The asset is bought; an extended period of time is given for the management team to turn things around, and then it is sold, hopefully for a handsome profit.
This may be an unusual strategy, but as Ben Graham said:
“the investor cannot enter the arena of the stock market with any real hope of success unless he is armed with mental weapons that distinguish him in kind – not in a fancied superior degree – from the trading public”