value and opportunity

As promised in the post comparing Colefax and AS Creation, I wanted to have a quick look at Colefax from a valuation point of view.

Mean reversion pricing

One very simple check I am always doing is the following: I look over a period of 10+ years at the following numbers:

– average P/E
– average profit margin

I then multiply current sales times avarage profit margin times average P/E to get a “reversion to the mean” pricing. The same can be done for EBITDA Margins and EV/EBITDA.

For Colefax, this results in the following “mean reversion” price targets (1999-2010):

NI/P/E: 172 pence
EBITDA/EV: 245 pence

So no big upside here compared to the current price of ~220 pence. The main reason is that Colefax was always cheap. Average P/E over those 12 years was 7 and average EV/EBITDA (ex leases) was 3.4. As current margins are also close or slightly above averages, there is no “mean reversion potential” in the stock.

Free Cashflow valuation

If we look at the Cashflows of the last 5 Years (2007-2011) we see the following picture:

	2011	2010	2009	2008	2007	Avg
Oper CF AT	6,200	4793	3596	4647	6209	5,089
Delta WC	-455	306	725	-815	-427	-133
Normalised OCF	6,655	4,487	2,871	5,462	6,636	5,222
Investing cashflow	-2885	-1716	-1729	-1448	-1648	-1,885
Free CF norm	3,770	2,771	1,142	4,014	4,988	3,337
Depreciation	2,044	1,883	1,795	1,690	1,629	1,808
Share buyback	1,840	137	895	465	3,093	1,286
Dividends	486	412	592	604	600	539

On average, Colefax generated around 3.3 mn GBP free cashflow. I think it is clear that we should not assume a lot of growth going forward, apart from some potential cyclical recoveries which might be offset by cyclical down turns.

If we look how the “intrinsic” value developes using different growth rates and discount rates we can use the following table:

	8%	9%	10%	11%	12%
0%	2.97	2.64	2.37	2.16	1.98
1%	3.39	2.97	2.64	2.37	2.16
2%	3.96	3.39	2.97	2.64	2.37
3%	4.75	3.96	3.39	2.97	2.64

We would need to assume a 3% growth rate under my “standard” discount rate of 10% to get a decent margin of safety. On the other hand, the downside seems to be limited to a certain extent as well. For the time being I would hesitate to use a low discount rate because of the difficulty to explain the relatively high operating leases.

So let’s make a quick summary:

– assuming no nominal growth at all, Colefax seems to be fairly valued using the standard discount rate of 10%
– if for some reason one could assume growth or the operating lease issue would be clearer, the intrinsic value could be significantly higher
– very positive is the shareholder friendly use of free cashflwo with significant share buy backs and dividends

For now, I think the stock is no screaming buy but definitely something for the watch list. For a semi-cyclical, housing related stock like Colefax I would like to see more “reversion to the mean” potential than what we see at current levels.