This week LogiCamms released half year numbers as of December 2015 (H1 2016). Afterwards the share price tumbled by 25%.
In my recent LogiCamms write up, I provided my reasoning for the company being cheap. In the following paragraphs, I will compare the points I made in my original analysis to the company’s announcement as of February 23, 2016:
1) Threat of future cost and volume pressure
In my write up I pointed out the following: “From my perspective there is no doubt that the company will be more and more affected by the ongoing spending reductions of Australian commodity businesses with contracts running out and not being renewed leading to lower profits for LogiCamms.”
I also explained a number of reasons why I believe that the company’s business might be relatively resilient in the current market downturn due to a diversified client base, focus on brownfield operations, a likely increase in Australian LNG capacity and low capex needs.
In their recent H1 2016 update, management cut the full year 2016 forecast from an 8% to 10% EBITDA margin to a 5% EBITDA margin (before impairments and losses on onerous leases) and kept the revenue forecast stable at AUD 120 m. Roughly 200 bps in margin compression or AUD 2.5 m stem from expenses for an ongoing programme of restructure targeting AUD 6.0 m in annual recurring overhead and operational costs savings.
Although this profit warning comes earlier than I expected, it was clear to me from the beginning that we will most likely see a deterioration in business activity. Hence, no changes here.
2) Acquisition spree over the last years might lead to imminent impairments
I wrote: “I believe it is likely that management will make impairments in the future given that acquisitions were made under assumptions which were based on a different market environment than what LogiCamms is facing today.”
And here we go: LogiCamms recognised an impairment charge of AUD 22.1 for H1 2016. According to management, the impairment has arisen as a result of continued pressures in LogiCamms’ core markets, predominately commodity linked oil and gas markets as well as minerals, such as iron ore and was not due to a singular event.
From an accounting perspective, they treat LogiCamms as one cash generating unit. Consequently, they do not specify which former acquisitions in particular were affected. Still, the write down is substantial representing 41% of H2 2015 goodwill.
It is unpleasant that they overpaid for acquisitions and did not see the headwinds coming (like many others). However, at the time of my investment an impairment charge on goodwill was foreseeable. Hence, no changes here as well.
3) Uncertainty about capital allocation
This brings us to the dividend, an important return component for many market players. And even more so in Australia where franked dividends provide tax advantages to local shareholders. Based on the company’s financials, LogiCamms dividends were franked between 50% and 100% in the past.
Concerning dividend payments I wrote: “The company currently expects to maintain its previously stated dividend payout ratio of 40% to 60% of net profit after tax, but is also saying that it might target a lower payout ratio in case of other capital requirement. Overall, we can expect the dividend to be cut from last year’s AUD 0.08 (12% yield) which will might put short term pressure on the share price.”
However, the company’s board went even one step further and declared no dividend at all for H1 2016 giving the following reason in the recent press release:
“Although the Company maintains a strong balance sheet and cash position, no dividend has been declared for H1FY16. It is the view of the Board that the Company’s cash position be preserved to ensure that there is ample working capital headroom without drawing on unused debt facilities. This will allow the continued pursuit of larger projects, including EPC (Engineering, Procurement and Construction) contracts, such as the current contracts being performed for EPIC Energy, Samsung C&T and Roy Hill.”
I welcome the board’s decision. Paying out a dividend given the extremely difficult market environment and the company’s depressed market value makes no sense (by the way another share repurchase might be more appropriate). Hence, from my perspective this is a positive development.
(On the other hand, the mentioning of increasing working capital requirements during a market downturn worries me somehow. However, according to management, LogiCamms so far continues to operate with negligible write downs on projects or bad debts)
4) Recent increase in provisions on onerous leases
I wrote that “Since 2014, the company has been booking provisions for onerous leases where sub-lease inflows will fall below contractual outflows. The provision on onerous leases increased from AUD 0 in 2013 to AUD 1.9 m in 2014 and AUD 2.4 m in 2015. So, that is something I will keep in mind.”
Provisions for onerous leases were increased by another AUD 4.2 m at the end of H1 2016. Management provides more detail in its press release saying:
“Separately an analysis of the Company’s lease positions has determined that the leases in Perth and Brisbane are onerous. In addition to the decline in market property lease rates, the Company’s space requirements have reduced as a result of increasing numbers of staff working on client sites, establishment of dedicated Competency Training facilities in Perth and Brisbane, as well as overhead and operational efficiencies through the restructure process.”
According to the notes in the latest annual report, LogiCamms leases properties in Brisbane, Perth, Melbourne and Adelaide as well as in several regional locations and New Zealand. The leases typically run for a period of 2 to 10 years. Total outstanding non-cancellable lease payments as of H2 2015 were roughly AUD 12.0 m. Consequently, a large portion of outstanding lease payments has already been booked as provision and will therefore not negatively affect the income statement in the future. However, earnings quality will be affected leading to a lower cash conversion ratio in the future. So clearly a deterioriation in this regard.
From a market timing perspective I bought the company’s shares too early. However, I believe that most of the news coming out with the recent H1 2016 release were foreseeable and should have already been reflected in the market price at the time of my investment. Of course, there are definitely things I do not know or which I might have overlooked, but I think the odds are good that LogiCamms will survive the depression in the Australian commodities sector. At the same time, the current valuation implies a high probability that the company fails.
The suspension of the dividend payments is good news to me. With net cash of AUD 12 m the company should have ample financial flexibility to manoeuvre through this difficult period of time.
With a current share price of around AUD 0.4 the company has an enterprise value of AUD 16 m left. Valuing the business with a mid-cycle 8 times multiple implies an EBITDA of AUD 2.0 m or 21% / 33% of last five year EBITDA / 2016 projected EBITDA (before impairments and provisions).
I decided to increase my position to 3% of the portfolio with a limit of AUD 0.45 per share from today on.
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