Flybe is the next candidate for my small-cap value fund, which is based on a variation of the net-net investment strategy.
Overview
Flybe is Europe’s largest regional airline. In 2002 it had a name change from British European to Flybe and moved to a super-low cost business model, which it had to do to stay alive. Later in 2007, it took over the BA subsidiary BA Connect and finally went public in 2010.
Share price history
The share price since the IPO hasn’t been pretty. It started off somewhere over 340p and has basically gone down all the way to 63p, which is a loss of something like 80%.
However, now that the shares are so much lower, they’re starting to look interesting from a low debt and low price-to-book point of view.
Valuation
The shares are now less than half book value and tangible book value. Both of those are classic signs of potential value, on the assumption that the company is at least a going concern.
The price-to-sales ratio is almost a joke. With a market cap of less than £50m and a sales figure from last year of over £500m, the company is priced at less than one-tenth of sales which is insanely low.
Of course, if it can’t produce any significant earnings from those sales, then the current price is fair, but I’m really not in the prognostication business. When I’m investing in small-caps, I just buy a ton of relatively debt-free assets as cheaply as possible and let management get on and try to generate some economic value from them.
Risk management
Talking of being relatively debt-free, after the IPO handily raised over £60m, the company has £80m in the bank, which is just about enough to give it a net cash balance. Hopefully, this means that banking covenants and other debt-related woes won’t be high on the agenda any time soon.
The second step to reducing risk with these out-of-favour small-cap stocks is to be widely diversified, which in my case means having 60 holdings in the portfolio so it can take advantage of underpriced stocks while remaining robust in the face of poor judgement and bad luck.
Always be testing
Investment commentary is worth nothing if it isn’t testable, which is why all of the ideas I like end up in one of several model portfolios. In this case, Flybe is taking a 1.7% part in the 21st-century net-net portfolio of small-cap value stocks. The buy price is 64p.
Hi John
another great write up on a company. I like the way you hoover up net nets without the more detailed research that so many books/gurus advocate ie checking the last set of results etc. I lean towards tangable book value, discounting everything at 100%. Keep up the good work.
Regards
David
Hi David. I like the term ‘hoover’! I must admit it’s a pretty basic analysis, but that’s how Ben Graham did it so that’s how I’m doing it too. Frankly, beyond a quick check to see that they are still currently operating I don’t see that I can add much value to these kind of small and highly unpredictable stocks.
As you can see from the table of current holdings, Home Retail is up something like 20% in a month. There’s just so much randomness to these things in the short-term that any additional research is likely to just increase the illusion of understanding.
Don’t let the management generate economic value, try to change the management as it is incompetent. This is a cut throat cyclical business in which the price of oil can change valuations in minutes. I would stay away.
I like the idea in which you build your portfolio. I am more of growth investor and I like to take bold bets based on valuation and macroeconomics. By creating a portfolio of 60+ pure value stocks you are guaranteed success. In itself FlyBe is a risky bet but within a portfolio of 60+ value stocks it can help you get a winning portfolio. In your portfolio there would be plenty of stocks which are negative corelated with oil price, PV Cristalox Solar is one of them, which can benefit.
Hi Eugen. Not sure how I’d change the management! Personally I don’t like airline businesses because they’re really tough and I don’t think they make good investments most of the time, so Flybe is a bit of a surprise.
Regarding the portfolio structure, you’re exactly right. The portfolio is widely diversified because in each individual case the stocks are gambles rather than investments (which I just wrote about here http://bit.ly/wKYfpk). But, if the risks are asymmetric to the upside then with enough rolls of the proverbial dice the portfolio should come out ahead with little chance of losses over longer time periods.
And by being widely diversified the portfolio has more chance of picking up natural hedges like you said with solar panels and airlines. Thanks for pointing that out.
Hi John,
Nice blog. I found your site whilst looking into what looks like good value at M&S. Flybe looked interesting, had a quick look at their figures for last year. Looked even better! £20M profit, thats half the market cap and 5% of revenue. Looking a bit closer, they seem to have included £18M for lost business due to volcanic ash and weather? This seemed a bit optimistic, and unless I’m missing something, leaves profits of £5M at 1% of revenue which doesn’t sound like much of a cushion. Unless I’m missing something with regards to how companies can account for things like volcanic ash?
Nice website.
Rob
Hi there Rob, thanks for the compliment. I wish I could say something sensible about the profits and volcanic ash, but I can’t. With Flybe there is only a single year’s data to go on, which I think is pretty meaningless anyway – yearly results can go all over the place.
My premise for buying Flybe is based on assets rather than earnings, so I’m not even pretending to have a clue as to how earnings will pan out. Instead the assumption is that the share price is currently ‘low’ relative to the earnings potential of the assets and that, given enough time, the share price has a fair chance of moving substantially higher.
This is all rather vague and non-committal (which is why Flybe makes up only 1/60th of the portfolio), but it’s honest and I think reflects reality better than if I said:
“oh yes, Flybe have quick turns, an efficient capacity ratio and leading market share, so therefore the earnings will probably be up by 28% within 2 years giving a target share price of 150p”
That might sound convincing and authoritative, but would actually be utter baloney.
I would say that if you’re interested in earnings then look at companies that have a long history of stable earnings. Those kinds of companies are much easier to work with (in my opinion).
And good luck with your investing.