Category Archives: Dart Group

Dart Group – When to sell / Skill & Luck in investing

Today, Dart Group issued preliminary 2012/2013 figures which were excellent.

The stock price jumped another 10%, making Dart my first triple in the 2.5 year history of the blog portfolio:

For me, two questions are now interesting:

1) Should I sell ?
2) Was this skill, luck or both ?

Re 1)

The nice thing about the blog is that you can always go back and look what you have written back then.

Dart was actually the first tangible result of my “Boss Score “model back in June last year. Additionally, at that point in time, the stock was very cheap by any standards.

That’s what i wrote about valuation:

Valuation

A few simple thoughts about valuation:

Dart Group will never be a P/E 15 company, but it could easily be a P/B 1 company. At the moment, you get a company which increases shareholder equity by something close to 20% p.a. at 0.6 times equity. If we assume for instance they manage to generate 15% ROE in the next 3 years and the company would trade at book at that time, we would have a fair value of 1.7 GBP per share or an upside of 150% over 3 years. More than enough for me.

Looking back, under my metrics, Dart increased equity by 8% in 2011/12 and 18% for 2012/13, on average 13%. So slightly below my expectations but still very good. However the share price has shot way beyond my expectations.

Compared to back then, Dart now looks quite expensive as this table shows:

at purchase now Easyjet Ryanair Vueling
P/E: 4.7 11.0 24.6 18.3 11
P/B: 0.6 0.6 1.8 3.33 3.2 1.17
P/S: 0.1 0.1 0.4 1.4 2.1 0.2
Div. Yield 2% 0.87% 1.70% n.a. n.a.
Market Cap 97 mn 348 5558 10290 275
Debt/Assets 2% 1.70% 22.30% 39% 4.50%
EV/EBITDA 0.02 1.8 10.2 8.2

I have included some other discount carriers in the table. Compared to Easyjet and Ryanair, Dart looks rather cheap, but honestly I do not really understand why Ryanair and Easyjet trade so high. Vueling from Spain in comparison does look cheaper than Dart on that basis.

All in all, Dart performed according to my expectations, but the multiple expansion was clearly above expectations.

Personally, I don’t believe that a business like Dart will trade at 2 times book in the long run, nevertheless, momentum and comparable valuations could carry the stock even higher.

As a compromise, I will sell half of my position as of today.

2) Skill or luck

A second question one should always ask oneself: Was this just luck or was some skill involved.

With Dart, I actually try to improve my process compared to the past. I looked quite deeply for instance into fuel hedging as well as into the business model.

That is what i wrote in the first post about the business model:

Business model

There is an interesting discussion about the business model to be found here.

In essence within the airline business, their main competitive advantages seem to be

– regional focus (not fighting on the crowded London market)
– buying cheaper used airplanes for cash instead of leasing new ones (used aircraft buying seems to be one of the special abilities of the CEO..)
– higher flexibility due to ownership and contracts with Royal Mail
– differentiation with slightly better services as a “family budget” airline

I am not able to judge how this holds against Ryanair and Easyjet going forward, but so far the strategy seems to have worked OK and better than many of the smaller competitors.

Actually, part of that competitive advantage, the Royal Mail contract got lost earlier that year and they earn lower margins. What I clearly didn’t see was the fact that Dart could compensate this by growing quite significantly with their packaged tours. This was luck.

Secondly, the stock got a lot of tailwind by the very good performance eof Ryanair and Easyjet. Over the last 12 months, Ryanair gained 84% and Easyjet 147%. Compared to that, Dart’s 192% look good but not totally out of line. That was luck too.

So overall I would say my dart investment was maybe 50% skill and 50% luck. Clearly, my boss model and the research helped to identify a stock which was undervalued. However the timing and the extent of the share price increase and multiple expansion are more luck than anything else.

Behavioural bias: “Averaging down” vs. “averaging up”

Sometimes it makes sense to reflect why one has done something and why not.

Following my “boss Score harvest” project, I invested in two new UK stocks this year, Dart Group beginning of June and Cranswick in Mid June.

In September I increased the Cranswick position to a full position, for Dart however I was hesitant and could not decide to increase .

One doesn’t need to be a genius in order to find out that increasing the Dart position would have been better:

Since mid of September, Dart made 50%, against more or less flat performance for Cranswick. If I look back to September, I think one of the “true” reasons why I didn’t increase Dart was that I would have to “average” up on Dart, as the stock was already 20% up against my purchase price.

For some reason I am much more hesitant to buy at higher prices. So for Cranswick, it was easier to increase the position because I could slightly decrease my average purchase price. Somehow I seem to prefer lowering the percentage loss on a loss position (“averaging down” than to lower the percentage profit of a gain position (“averaging up”).

I am not sure if this fits into the standard behavioural biases, maybe it is a special form of “anchoring”.

This behavioural bias, not increasing the Dart stake cost me around 1% of portfolio performance so far and now I am even more hesitant to buy. It is also in direct contradiction to the fact that “momentum” combined with Value seems to generate strong results in the long run as demonstrated by O’Shaugnessey’s “what works on Wall Street”.

Lessons (hopefully) learned:

In the future I need to have a better formulated plan for scaling into a position in order to avoid this “behavioural bias”. Either a clear timeline or some clear fundamental triggers where I then execute regardless if the position has already increased to a certain extent or not.

Some half year updates – Poujoulat, Total Produce, Dart Group, Installux

Poujoulat:

Quite surprisingly, Poujoulat announced a stock split 1:4,, this is the release from Poujoulat:

En date du 21 juin 2012, l’Assemblée Générale de la société POUJOULAT a décidé la division par 4 de la valeur nominale de l’action POUJOULAT négociée sur le marché ALTERNEXT Paris. Cette mesure permettra de fluidifier les échanges et de rendre le titre POUJOULAT plus accessible (son cours étant actuellement supérieur à 130€) En pratique, l’opération de division par 4 sera réalisée sur les soldes EUROCLEAR du vendredi 7 septembre prochain et sera effective le lundi 10 septembre à l’ouverture du marché. Les détenteurs d’actions POUJOULAT se verront attribuer automatiquement 4 actions nouvelles pour une ancienne.
Les droits antérieurs rattachés aux actions ne seront pas modifiés, notamment le bénéficie du droit de vote double pour toute action gérée au nominatif pur depuis plus de 24 mois. Le nombre d’actions POUJOULAT en circulation sur ALTERNEXT Paris sera ainsi porté de 489 750 à 1 959 000.

Let’s wait and see if this somehow helps the stock or not.

Read more

Dart Group – Follow up on fuel hedging and comprehensive income

As proposed in the last Dart Group post, I wanted to take a better look at the impacts on fuel hedging.

Quick summary (or spoiler): During writing the post, I got less and less sure of what to do with the fuel hedges, so the post got very long without a satisfying end. If you are not interested in the process and accounting details, the result is: I am not sure.

Let us start with a “accounting refresher” first.

Accounting for Cash flow hedges

Dart Group uses “cash flow hedges” for their fuel hedges. What does that mean ? Normally, any derivative financial instrument would be considered a “trading instrument” and would have to be marked-to-market directly through P&L.

If a company however wants to hedge a future cashflow (doesn’t matter if in- or outflow) one can apply a technique called “cash flow hedging” which requires basically two things

1) one is able to predict future cashflows with a reasonable accuracy
2) one uses a heging instrument which is “efficient” i.e. tracks the value of the hedged

If one achieves “cash flow hedging” treatment, then the hedge will treated in the balance sheet (under iFRS) the following way:

A) the value changes in the derivatives can be recorded under “OCI” (other comprehensive income)
b) in the future, when the cashflow actually happens, the corresponding hedging gain or loss will then be added or subtracted from the then realised spot price

This is what Dart Group is doing with its fuel hedging and as Wexboy commented fully aligned with accounting standards.

However my argument was that you shouldn’t ignore those movements in OCI but try to understand them and make adjustments if necessary. In order to understand this better, we have unfortunately step beck a little bit and ask the following question:

What is a hedge anyway and when is a hedge a speculation ?

In the case of Dart and airlines in general, this question is quite difficult to answer. In an ideal world as a company, you would like to pass on all your changes in costs directly to your customers and just earn a fixed fee on your products. As we all know, prices on tickets are relatively volatile, however many clients prefer to fix a price well before they start a trip in order to be able to control their budget.

An airline could also, if they were really really good speculators, create a big competitive advantage if they for example could hedge their fuel at low prices while the competitors have to buy much more expensive fuel on the spot markets if prices are rising. However, this is clearly speculation, not hedging as it could go the other way as well.

accounting wise however, one does not distinguish between “economic” hedging and what I call speculation.

So let’s look at Dart Group.

First step: READ THE ANNUAL REPORT

Before one starts to speculate how and what Dart is hedging, it makes sense to look at the annual report to find out what they are actually saying.

On Page 21 of the 2011 report they give us the following information:

2011 2010
Average hedged Price per ton $ 870 786
Percentage of estimated annual fuel requirement hedged for the next financial year 91% 90%

So we know now, that they have hedged ~90% of ALL fuel requirements according to this and we know the price.-

On page 67 we can look at fuel costs (in GBP):

2011 2010
Fuel Cost 122.8 95.3

On page 57 we can see the fair values of the fuel hedges, both an the asset and liability side:

2011 2010
Fair value Assets Forward jet fuel contracts 55.9 16.4
Fair value Liabilities Forward jet fuel contracts -17.8 -8.7
 
calc net Fair Value 38.1 7.7
Delta yoy 30.4

On page 58 we can see that in 2011, none of the fair value movements have been recorded in equity, we can also look at the total fair value movement of the ALL hedges (including currency) which were

2011 2010
Fair value Assets all hedges 59.4 21.7
Fair value Liabilities Forwardalll hedges -24.7 -9.7
     
calc net Fair Vlaue 34.7 12
Delta yoy 22.7

So basically, fuel hedges increased by ~ 30 mn GBP in vALue, FX hedges lost ~ 8 mn GBP

On page 61 they give us another interesting piece of information:

2011 2010
Impact on Profit and Loss 10% change in jet fuel prices 3.8 0.8
2011 2010
     
Profit for the year 17.3 15.6
Exchange differences on translating foreign operations 0 0
Effective portion of fair value movements in cash flow hedges 23 10.6
Net change in fair value of effective cash flow hedges transferred to profit -1.8 0.1
Taxation on components of other comprehensive income -5.2 -3
Other comprehensive income and expense for the period, net of taxation 16 7.7
Total comprehensive income for the period all attributable to owners of the parent 33.3 23.3

One important final piece of information:

Prepayments or “deferred income” stood a 177 mn GBP against trailing sales of 540 mn GBP.

So how to interpret those numbers ?

A) as the hedges seem to qualify almost completely as “cashflow hedge”, we can assume that they use “traditional hedges” like forwards or (tight) collars to hedge

B) IMPORTANT: Dart Group “hedges” 90% of next years fuel prices, but only 177/540 = 32% of (trailing) sales are prepaid. So one could argue that in order to “truly” hedge, Dart should only hedge a third of next year’s fuel consumption as for the rest, the final sale price of the tickets is still variable.

If the competitors don’t hedge, than Dart would have locked in potentially different fuel prices than the competition for 60% of next years fuel consumption and therefore run the risk of being uncompetitive if fuel prices fall.

So coming back to the initial question: What are we going to do with the change in value in OCI for dart Group ?

I have to say I am not sure anymore. I am oK with “ignoring” the part that is covered by deferred income but I honestly don’t know what to do with the part which is “speculation”.

I have quickly checked Ryanair’s latest statements and Easyjets last annual report.

While Ryanair similar to Dart seems to hedge 90% of next years fuel cost, Easyjet only hedges 65-85% of next years fuel charges and 45-65% of the costs in 2 years time.

Ryanair interestingly said that increasing fuel prices were responsible for a 29% profit decline. That sounds strange as they were supposed to be 90% hedged. Interestingly, fuel prices for Jet fuel decreased strongly in Q2, so the problem for Ryanair seem to have been locking in high fuel costs whereas some competitors were able to buy cheaper fuel in the spot market and compete better on ticket prices.

Bloomberg even compiles hedging ratios across companies:

Jet Fuel Hedging Positions for Europe-Based Airlines (Table)
2012-07-30 07:46:25.103 GMT

(Updates with Ryanair.)

By Rupert Rowling
July 30 (Bloomberg) — The following table shows the amount
of jet fuel consumption hedged by European airlines to guard
against price fluctuations.
Data is compiled mainly from company statements and is
updated as it becomes available. Hedges are for prices per
metric ton of jet fuel, unless otherwise stated.

*T
Company/ Percent Hedging Period Price
Disclosure Date Hedged
————— —— ————– —–

Ryanair Holdings Plc
7/30/12 90% July to Sept. 2012 $840
7/30/12 90% Oct. to Dec. 2012 $990
7/30/12 90% Jan. to March 2013 $998
7/30/12 90% April to June 2013 $985
7/30/12 90% July to Sept. 2013 $1,025
7/30/12 90% Oct. to Dec. 2013 $1,005
7/30/12 90% 2013 $1,000
7/30/12 50% Jan. to June 2014 $940

EasyJet Plc
7/25/12 85% Three Months to Sept. 2012 $983
7/25/12 79% Year to Sept. 2012 $964
7/25/12 77% Year to Sept. 2013 $985

Air Berlin Plc
5/15/12 82% April to June 2012 Not Given
5/15/12 92% July to Sept. 2012 Not Given
5/15/12 61% Oct. to Dec. 2012 Not Given

International Consolidated Airlines Group SA*
5/11/12 80% April to June 2012 Not Given
5/11/12 69% July to Sept. 2012 Not Given
5/11/12 55% Oct. to Dec. 2012 Not Given
5/11/12 55% 12-month forward Not Given

Vueling Airlines SA
5/10/12 76% 2012 $1,023
5/10/12 71% April to June 2012 $1,008
5/10/12 83% July to Sept. 2012 $1,035
5/10/12 74% Oct. to Dec. 2012 $1,042
5/10/12 28% 2013 $1,027

Air France-KLM Group
5/4/12 60% April to June 2012 $1,081
5/4/12 53% July to Sept. 2012 $1,081
5/4/12 50% Oct. to Dec. 2012 $1,078

SAS Group
5/3/12 50% April to June 2012 Not Given
5/3/12 49% July to Sept. 2012 Not Given
5/3/12 48% Oct. to Dec. 2012 Not Given
5/3/12 50% Jan. to March 2013 Not Given

Aer Lingus Group Plc**
3/29/12 62% 2012 $972
3/29/12 7% 2013 $991

Deutsche Lufthansa AG
3/15/12 74% 2012 $107/barrel
(Brent crude)

NOTES:
*Hedging breakeven for 2012 at $1,003 a ton, according to May 11
presentation.
**Aer Lingus figures as of Dec. 31

Summary:

To be honest, I am not sure what to do with the fair value movements in OCI. To simply ignore them and assume mean reversion would be very naive. The extent of the movements is just too large. However the impact of the fuel hedging is difficult to estimate as it depends on the behaviour of the competitors.

In general, a positive movement in fair value should be positive for the company and vice versa. nevertheless, the whole fuel hedging issue exposes Dart to quite substantial business risk, especially for the part which is not covered by deferred income.

However, this exercise made it clear to me that running airlines is a quite difficult business, especially in times of volatile fuel prices.

For the time being, I will stick with my half position and try to learn more about it.

One technical remark with regard to hedging:

In the “good old times”, fuel hedging could be done without cash collateral. A bank would happily “step in between” the airline and the futures market and only require cash at settlement of the contract.

As one of the consequences of the finanical crisis, every bank now requires cash collateral on a short term basis from the airlines for the fuel hedging contracts. For the airlines this means a significant increase in reuqired working capital. Lufthansa et al are lobbying strongly against this, but especially for smaller carriers this is a problem.

As a proxy I would use 25% of the notional as working capital requirement for fuel hedges. For Dart this would mean that 25% of around 150 mn GP or 40 mn GBP of Dart’s liquidity should be considered as “locked” for fuel hedging cash collateral.

Why comprehensive income matters – Dart Group Plc

I have mentioned a couple of times that in my opinion, the so-called “comprehensive income” is a much better indicator for shareholder wealth created than net income or earnings per share.

In my experience, almost no one cares to look at what happens after the net income line. Usually, comprehensive income is stated on a separate page anyway.

A good example to turn this into an interesting practical exercise is the most recent preliminary annual report from Dart Group, one of my Portfolio holdings

The first thought is of course “Yippie yeah”, a really significant earnings increase, P&E of 4 etc etc.

Richard Beddard at the excellent Interactive Investor blog even says the following:

The highest earnings yield ever calculated by the Human Screen is 35%. It’s so high, he’s wondering if air line and road-haulier Dart has bust his value yard-stick.

Highlights

Adjusted operating profit up 9%
Adjusted return on tangible assets: 4%
Net profit of £23m compared to net cash flow of £95m (£48m after net capital expenditure)
Net cash after approximate capitalised lease obligations of £125m is £34m, 5% of tangible assets
Per-share dividend up 7%

Not so fast. I guess that Richard stopped at page 9 of the interim report and didn’t bother to read that strange stuff at page 10 which looks as follows:

So we have additional items which significantly decreased shareholders equity but didn’t need to be recorded in normal earnings but comprehensive income. In this case we are looking at fuel hedges.

Items which can be recorded in comprehensive income are:

– Unrealized holding gains and losses on available for sale securities ( a trick often used by banks and other financials)

– Effective portion of gain or loss on derivative instruments (cash-flow hedge);

– Foreign currency translation adjustments (i.e. change in value of a foreign subsidiaries net asset value)

– Minimum pension liability adjustments.

Normally people would argue that those items are “non operating” and therefore not or less relevant. However, as it affects shareholder value, in my opinion it is very important to look at those item to determine real value creation for the shareholder.

Coming back to Dart Group: The fuel hedging is an essential part of the business model. Fuel costs are around 20% of sales and cannot be passed directly too customers, especially for the prepaid part. I will have a separate post on how to interpret the fuel hedges but for now the important point is:

The result of the fuel hedges should be treated as part of the normal business of Dart Group.

Therefore real 2011/2012 earnings for Dart are rather around 9 pence per share and not the 16 pence recorded in the income statement. Still cheap (PE of 9) but not “busting any value yardstick”.

Summary:

Any value investor interested in the total value creation of a company for shareholders should include all items of the comprehensive income statement into his valuation. Many companies are very good in shifting all unpleasant stuff into this section. Especially for financial companies, recorded earnings are more or less meaningless without the items in comprehensive income. Also fuel hedges for airlines or other fuel cost eexposed companies should be viewed as relevant.

Portfolio updates: AIRE KGaA, April SA, Cranswick, Dart, Installux

AIRE KGaA:

For AIRE KGaA, I decided to accept the tender offer at 18.25 EUR per share. There is not a lot of upside left and I guess the stock will be really illiquid after the offer.

Installux

Whereas the built up of Poujoulat goes really really slow, For some reasons, last Friday almost 2.500 Shares have been traded. That’s almost 1% of the market cap. Interstingly, in Bloomber a new fund called “Agicam” showed up at the end of April with a 0.99% position. Due to those sales, I could now already built up a stake of 1.8% of the portfolio in Installux shares, a lot faster than I thought.

DJE Real Estate

The sell down of this position is quite cumbersome. Up to know, I could only sell half of the position so far. However prices are relatively stable.

Dart Group & Cranswick

Both shares were relatively active over the past few days, so I could establish 2.5% positions fopr both. Dart Group issued their “preliminary annual” statement as of MArch 31st, a very good write up can be found here at ExepctingValue.

For Dart I will wait for the final annual report in order to determine if I increase the position to the full amount (5%).

April SA

Since I ahve increased my buying limit for April to 11,50 EUR, I could establish a small position in the stock (0.6% of the portfolio). Of course I got punished and bought ~2% higher than today’s share price……

Cash is now down to around 16.5% of the portfolio, but taking into account the AIRE Tender Offer, Cash is around 21.5% of the portfolio. So plenty of room for 2-3 new ideas…..

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