Seven companies that will prosper in the recession
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Associate Editor
David Stevenson Feb 13, 2009
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As cash flow dries up and the boom years become a fading memory, David Stevenson looks at seven companies that will do well out of the credit crunch.
"A banker is a fellow who lends you his umbrella when the sun is shining and wants it back the minute it begins to rain," said Mark Twain. It's a classic quote, but for many borrowers, it's just not funny any more. The deluge has arrived, and unless you've enough collateral to convince your bank that your credit's copper-bottomed, your bank won't lend you the money you want to borrow. So companies and individuals in dire need of extra cash to stay afloat just can't get their hands on the stuff. Yet the darkening economic skies do have a silver lining. Some companies are prospering by helping out when the banks won't – or can't. We'll look at some credit crunch winners in a moment. But first of all, just how bad are things out there?
Cashpoint closure
Bank lending growth has been slashed across the board over the past year, the latest Bank of England figures show. Lending to private non-financial corporations (PNFCs) – ie, businesses that make or sell things – grew at an annual rate of 3.7% in December, some 75% down on last year's growth rate. It's the same for consumers. By the end of 2008, lending growth to UK households had dropped to 5.4%, the slowest annual rate since Bank records began in 1998.
There's also been a savage squeeze on cash flow. Businesses are finding that customers are taking longer to pay their bills. For example, Tesco announced at the end of last year that it was extending its payment terms with suppliers from 30 days to 60. And weak consumer spending has forced hefty price cuts, particularly by retailers, hitting profits hard. So corporate coffers have got a lot lighter. A key part of the Bank's monetary data, 'adjusted M4', which looks at company cash balances, has been flagging growing liquidity problems for at least nine months now. Over the year to December 2008, the amount of money held by PNFCs fell by almost 5%. And the pace of decline is accelerating. Last week's Bank quarterly data showed corporate deposits falling almost 2% in the final three months of 2008 alone. "Companies are being forced to dig deep into their savings," says the FT's Daniel Pimlott. "The sharpening rundown of cash reserves at non-financial companies serves as advance warning of rising insolvencies, steep declines in investment and widespread job cuts this year."
The strain is showing. The number of corporate insolvencies in England and Wales rose by 24% during 2008 to 15,535, said the Insolvency Service last week. That translates into one in every 150 actively traded companies going bust last year. And sadly, we've almost certainly seen nothing yet. The 1992 recession saw liquidations peak at almost 25,000, and history could more than repeat itself. As banks won't lend even to sound companies, says Begbies Group's Graham McInnes, "businesses that in the last two recessions would have been able to get the bank to tide them over are being starved of working capital. So quite a number of viable firms are at risk."
For consumers, it's equally unrelenting. Although energy costs and interest rates are coming down, the dearth of credit is posing fresh problems. Mortgage equity withdrawal, where homeowners borrowed against the equity in their properties, has come to a halt as house prices have plunged. And credit card spending has slowed to a walk as plastic has been maxed out. More than 4.5 million credit card users are still clearing debts from Christmas 2007, says MoneyExpert.com, while five million financial product applications have been rejected within the last six months.
Having built up a debt mountain bigger than the UK's entire GDP, many Britons are now finding that the sheer weight of their borrowing is simply proving far too heavy. The number of people becoming insolvent in the UK has held steady, at just over 100,000, for the last three years, but the final three months of 2008 saw a sharp rise to a highest-ever quarterly total of 29,444, up 18.5% from the fourth quarter of 2007. And again, it can only get worse. As the dole queues lengthen in 2009 – some estimates reckon that Britain's jobless total could rise by 1.5 million – the parlous state of consumers' finances will mean yet more people going bust.
All in all, it's rather a tale of woe. But while no one wants to be making money out of misery or distress, there'll always be firms that prosper in a credit crunch, either by serving up lower-priced options for those whose cash has run low, or providing loans to people who wouldn't otherwise be able to get them. And as more and more companies or individuals are compelled to opt for insolvency, there are firms that will benefit from providing much-needed professional advice. Here are six British companies – plus one US stock – which look well placed to ride out the storm.
The grocer
Whatever else we can't afford, we still have to eat – but we can always eat more cheaply. And the cocktail of squashed disposable incomes, battered plastic and jumping job losses means that food shoppers have been trading down the price chain. Unfortunately for investors, most of the low-cost supermarkets are privately owned, so you can't profit from the success of the likes of Aldi and Lidl, while Asda is owned by US giant Wal-Mart. But the broad slump in UK shares has cut the price of Britain's biggest retailer Tesco (LSE:TSCO) to 358p from its high of nearly 492p in November 2007. While Tesco's dominance of the country's food sales – its market share stood at 30.7% in the 12 weeks to 25 January, according to the latest TNS Worldpanel figures – means it will always be vulnerable to a prolonged consumer spending downswing, much of that fear is now factored into the price.
City analysts reckon earnings will come in at 30p a share for the next financial year, with a 10% hike the following year. On that basis, Tesco currently sells on a forward p/e of 12 times falling to 10.8 times for the year to end of February 2011, when the yield is forecast to climb to almost 4%. Historically that's cheap, well below half the company's valuation at the beginning of the decade, and crucially the group's strong position means it should survive the recession no matter how tough it gets – not something that can be said with confidence for every FTSE 100 stock.
The fast-food chain
For Britons who still don't want to cook for themselves, whatever the economic climate, there's always the takeaway. Top-of-the-range restaurants may be feeling the pinch, but one fast-food chain has been doing very well indeed. Domino's Pizza (LSE:DOM) floated on Aim in 1999 and now has a market worth of £350m. With 553 franchised stores, it now accounts for one in six home delivery meals in the UK and one in three pizzas. And the British appetite for pizza seems a long way from being satisfied. This is one of the few consumer-facing companies in the country reporting solid sales growth. For the year ended 28 December, turnover excluding new branches grew 10%, following a near-15% surge the previous year.
Can Domino's keep delivering the goods? "In this type of downturn we never say we're immune," says CEO Chris Moore, "but one of the key differences between the last recession and this one is that we have the advertising know-how, money and very good knowledge of our customers and their purchasing habits. When they start ordering, or order less frequently, we know and we can do something about it." Analysts reckon this year will see another 10% rise in sales, which translates into a 12.5% climb in earnings per share, with a further 12% pencilled in for the following 12 months. At 215p, that puts the stock on a prospective p/e of 18.4 times for 2009, falling to 16.5 times for 2010, by when the yield is forecast to nudge up to 3.5%. That's not cheap, but then this is a hugely cash-generative company with no net debt. And cash flow per share is expected to rise by more than 50% over the next two years – so there should be no need to worry what mood the bank manager's in. But for a cheaper, arguably lower-risk option you could plump for burger giant McDonald's (US:MCD), which trades on a current year forecast p/e of nearly 15 times, dropping to 13.6 times for 2010.
The doorstep lender
In December 2007, The Guardian reported that "customers who are being turned away by high-street banks for loans are banging down the door of Provident Financial (LSE:PFG), the doorstep lender, which is reporting a big increase in business in the midst of the credit crunch". More than a year later, it's the same story. FTSE 250 member Provident has two divisions: customer credit, where agents meet all applicants and collect weekly installments on loans (typically less than £500); and Vanquis Bank, a low-limit credit-card business. Both are high-margin operations – the triple-digit APRs Provident's customers pay would make your eyes water – but the business model assumes "high impairment levels", ie, plenty of bad debts.
As Provident has been treading the same streets for 125 years, it's seen a fair few downturns and knows what to expect this time. So it's no surprise that, mindful of rising bad debt losses, the specialist lender has tightened lending criteria on its card products, rejecting a far higher proportion of applicants. Yet the bank's customer base still grew almost 30% in the first half of last year. At 806p, the stock trades on a prospective p/e of 10.7, dropping to 9.5 in 2010. While there must be a degree of risk attached to any credit business at the moment, such concerns are partly assuaged by the tasty 8% forward yield.
The pawnbroker
One group definitely doing well out of the downturn is pawnbroking. There are two listed pawnbrokers in the UK, H&T (LSE:HAT) and Albemarle & Bond (LSE:ABM), both of which we've tipped several times in recent years. When the bank's not playing ball, these companies offer a quick way of raising cash. You go to the pawnbroker with, say, a valuable watch, and he'll lend you a sum worth about half of its estimated value, charging 7-8% interest a month. Loans can vary from as little as £5 to as much as £1m. You don't pay anything until the term of the loan expires (typically six months tops) – just when you turn up to redeem your watch. If you don't make the payment, the pawnbroker can sell your watch on.
Last month, H&T said that over the last year it had grown its number of stores by 18%, and forecast that 2008 profits would beat forecasts. Of the two brokers, it's slightly smaller – the market cap is just £67m – but at 187p it's also the cheaper on a prospective p/e ratio of 8.3 times for this year, dropping to 7.8 times for 2010. With the forward yield nearing 4%, this one looks a solid bet in the current climate.
The insolvency practitioner
"Like the undertaker for Tombstone when Wyatt Earp and Doc Holliday were in town, Begbies Traynor (LSE:BEG) is one of those companies where a recession is actively good for business", says Management Today, although the firm "is usually brought in only when things have come to a pretty desperate pass". As a specialist insolvency practitioner (IP), Begbies is used to getting a call when firms can't pay the wages bill, and has to make fast decisions on whether the troubled firm can still trade or should shut up shop straightaway, and who is owed what money and in what order.
Unsurprisingly, first-half revenues are up 37%, with SME (small and medium enterprise) insolvency work currently accounting for some 80% of annual turnover of £70m – double the level of five years ago. After a decade in which the market was "flat as a pancake", says Begbies' Graham McInnes, the firm began to expect an insolvency boom in 2007. "All the indicators were telling us to expect rising insolvencies – like over-leveraged balance sheets, supply outstripping demand – so we geared up for it in 2008." They "were nine months too early", but the call was still right. For the financial year from May 2009, analysts expect a 20% rise in earnings per share, with a further 16% for the year beginning May 2010. The shares have pulled back from 200p six months ago to 122p today, giving a prospective p/e of 12.7 times for next year, dropping to below 11 for the following year.
The corporate recovery specialist
Prevention may be better than cure, but a cure's better than a complete collapse. And one firm clearly in the curing category is Tenon (LSE:TNO). Last month's trading update confirmed that the Aim-listed financial consultant is "performing in line with expectations" while "prospects remain encouraging", says CEO Andy Raynor. And while the financial services unit is only treading water right now amid the current market carnage, Corporate Recovery – 25% of Tenon's business – is growing strongly on the back of rising insolvencies, says Jeremy Browne at Fairfax, while Outsourcing is benefiting from "the increasing desire of clients to focus on their core business in times of trouble". At 42.5p, the stock sells on a p/e ratio of 7.1 times for the 12 months to June 2009. Fairfax expects that multiple to fall to 6.5 times for the year after, while the forward yield is 4%. "With the potential for corporate recovery to surprise on the upside during the recession", says Browne, "Tenon appears at this level a compelling bear market investment."
Vulture funds – get a meal from a carcass
For those with strong nerves and deep pockets, there are so-called 'vulture' funds, which try to take advantage of companies in trouble. Many buy up the debt of distressed firms at big discounts in behind-the-scenes deals. They then look to turn this debt into equity in a restructuring, thus gaining a sizeable stake or even full control of the company. The vultures can then push firms into administration and make a profit from selling the assets, even when other investors may reckon such companies are worth saving. "When debt has been acquired at a substantial discount to par, the fund may still make a profit notwithstanding the liquidation of a company", says Mark Hyde at Clifford Chance. "If you buy at 20 and recover at 30, you've made a good profit".
Of course, "meetings between all the stakeholders can get quite heated. People get very angry, which isn't surprising – if they're having to accept that they're going to lose all their investment, they're likely to get emotional". Manchester tea-bag maker JR Crompton was a recent case in point. "The staff and owners of Crompton thought a sympathetic bank manager would rescue them in times of trouble; after all, the company had been around since 1856," says Elena Moya in The Guardian. But instead, traders had bought parts of the company's debt, gaining enough control to block a proposed restructuring. The company was pushed into administration and its assets sold – and Crompton ceased to exist.
Yet not all distressed funds are run by aggressive players who put companies into insolvency deliberately. "Debt-holders are entitled to get as much as they can but you want to save jobs as well", says distressed-debt investor Jon Moulton. "If somebody deliberately blocks a restructuring, or does nothing about a problem, that's being an asset stripper. All we're trying to do is to find value and help a company. Sometimes a hopeless business needs to close down, but more often than not, we preserve jobs." So if you still reckon that vulture funds could be for you, investment manager Unigestion is now launching its Secondary Opportunity Fund II, which will try, by "focusing on small and mid-sized transactions", to "take advantage of the sharp down-valuation in private equity assets and an increasing number of distressed sellers". Full details are on Unigestion.com – though it's important to point out that it's hardly cheap buying in. The minimum investment is €5m.
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