Value Ideas Blog
Hargreaves Services PLC, a diamond in the mud?

Disclaimer: This is not an investment advice, please do your own research and don’t follow anyone blindly. Furthermore, it has to be mentioned that the author don’t have a position in Hargreaves but affiliated parties may have. Thus they participate if the share price increases. Additionally, the author and related parties may sell their shares without further notice.

 

We wrote about Hargreaves two times in the past, since then the stock price tanked another 50%. Here you can find the first and the second writeup about the company. In the meantime, we visited the company in the UK and more recently, Hargreaves published a trading update in which it basically revealed all cash which can potentially be realised within the next 5 years. After this update the share price rose ~20% within a couple of days.

In the UK we learned, that the real estate development will take time and that the company assumes that they can develop 150 plots per year (out of 1.600 total). The good thing is that the Scottish coal restoration trust will get 20% of the proceeds from Edinburgh, but none of the rest. Furthermore, it will cost money to get the land to being valuable, but Hargreaves doesn’t have any obligations to restore anything. 

 

The wind projects are currently worth nothing as subsidiaries were cut and onshore wind is not profitable right now. But it will be worth something one day. The plots are in the top 10% of wind speeds in UK. And the company assumes that it will be worth something in 2020.

 

We also discussed the end of coal, and we came to the conclusion that its is, at the moment, not economically feasible to build gas powerplants. However, as the government wants to stimulate gas power plants, they are very clear about the fact that coal will end by 2025. Hargreaves assumes that coal will decline strongly before 2025 and end completely in 2025. However, other befriended investors doubt this: as the government paper stated: “we will shut down all coal” *”as long as we find alternatives”. At the moment it seems questionable whether the UK wants to have such a strong dependence on Russian gas. Furthermore, we have to think about the fact, that Coal is easily transportable & storable which will also extend its lifetime. Therefore, we think, that the probability is higher than 30% than Coal will survive longer than 2025, in the UK.

 

In April, Hargreaves announced, that they will realize ~66 Mio. GBP from disposal of Current & Non-Current Assets. Which should be generated over the next 5 years. Furthermore, they announced:

 

The Board’s medium term aspiration is that the Group’s core operations, excluding property and energy projects and before Group overheads, should deliver a trend rate of annual operating profit within the range of approximately £10-£15 million, with Services delivering approximately 60% of that figure

 

Additionally, they shed light on the value of real estate where they said:

 

The Board is setting itself the medium term aspiration of generating between £35m and £50m of incremental value over the next five years from this portfolio of property and energy projects. By the nature of the development milestones, this gain is likely to have an uneven profile:

 

If we put these numbers together, you can see, that Hargreaves will generated 100-120 Mio. GBP in FCF from asset disposals within the next fives years for its investors + Hargreaves expects in the medium term to generate 10-15 Mio. GBP EBIT pa. from its underlying businesses. 

 

All in all this are really good news, especially if we consider, that the market cap of Hargreaves is currently ~60 Mio. GBP.

8 Comments

  • Thanks for write up. Quite a few value guys have propositioned this stock. I am unclear as to what the explicit value is in the group.

    The £10-15m EBIT is before overheads which the group have stated to be c.£5.0m a year. So an acceptable assumption would be for £7.5m of EBIT a year. Interest costs of c.£1m, tax rate of 24% and no CAPEX equates to £4.9m of FCF from operations. Assume medium term to be 5 years, no terminal value and a discount rate of 10%, one gets to a value of £18.7m

    As you say the company expect £66m of realisable cash flow from legacy balance sheet items which are expected to be realised before the end of May 2017. Discounted value of £54.5m.

  • (sorry had to post separately as too long to be able to see post comment button below_

    Incremental value of between £35m and £50m over 5 years. Assume total of £42.5m realised equally as cash over next 5 years. Discounted value of £32.2m

    Net debt as at 30 November 2015 of £30.8m,

    This gets us a value of £74.7m compared to market cap of £60m so upside of 25%. Risk return doesn’t seem too attractive on this basis, but perhaps you could critic this analysis for the benefit of myself and other readers.

    Keep up the good work!

    • Hey Daniel,

      sorry for the late response, I’m currently learning for the CFA Level 3 and are switching jobs, so I have a lot on my plate 😉 Thank you very much for your good comment. I think you are right, but I believe that not ascribing a TV to the ongoing business FCF is a little harsh as it is derived from restauration & earth moving business. When we spoke with the company, the potential revenues from restauration projects alone where estimated to be ~200 Mio. I furthermore used a Jockey-stick pattern for the distribution of FCF from the disposal of assets, so my discounted value is a little lower.

      Secondly, Hargreaves has a coal business, which is dying but maybe not as quick as everyone thinks. In this current article from the economist, you can see what is going on in GB: http://www.economist.com/news/britain/21698673-hinkley-point-nuclear-shambles-highlights-flaws-british-energy-policy-power-hungry

      Additionally, I believe that the overheads will be lower than 5 million as they are continuously cutting down costs.
      Furthermore, there will be still a lot of assets left which are not commercialized after 5 years, thus you have some hidden value there as well. Especially the wind projects should be quite valuable after 2020.

      To put it in a nutshell, I believe that Hargreaves offers a good upside potential with some additional optionality for a Graham type of investor, which I personally which I personally don’t am.

  • Why would you place no terminal value on the operating results? Dump trucks for garbage, earthmoving construction, overseas industrial services – all will have life outside of the next 5 years, right? The only piece left associated with coal is the Specialty business. I agree it’s in decline, but a very slow decline and it’s a business that requires little capex or fixed assets and should be highly profitable as it dwindles down.

    • Hey AVI,

      thanks for your comment and sorry for the late response. I totally agree with you and you can find my reasoning in the comment above.

      Cheers,
      Nils

  • why catch a falling knife?

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