Flybe is the next candidate for my small-cap value fund, which is based on a variation of the net-net investment strategy.
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.
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.
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.