Building Value at MJ Gleeson?

When you go trawling for under-valued companies, you come across lots of property, construction and house-building companies that trade at a discount to published net asset value. This is hardly a surprise given the current economic climate and the recent rise and fall of seemingly anything connected with real estate. MJ Gleeson Group plc (GLE) has interests in land development and house-building, and is currently trading on a 35% discount to reported net assets.

The current share price of 121.5p (as at 25 January 2011) gives the company a market value of £65m. Based upon the 2010 basic EPS of 6p, this represents a not-such-value PER of 20x. The company is listed on the Main Market.

In the past five years, the shares have hit a high of 417p (April 2007) and a low of 58p (December 2008). 

For the record, my average cost per share is 147p and, after dividends equating to 15p per share, my break-even cost is 132p per share.

Background

Potted History

The Company can trace its roots back to the entrepreneurial Irish immigrant, Michael Joseph Gleeson ("MJ"), who took on a growing Sheffield building business in the early part of the 20th Century. 

The Company was listed on the London Stock Exchange in 1960 (a fifty year pedigree is not to be sniffed at), and has adapted through the times with forays in and out of engineering, construction and land. In 2004/5, the Company to decided to focus on development rather than contracting, and gradually exited its construction and engineering businesses over the next 5/6 years. 

The Gleeson family connection remains through Dermot Gleeson, who has acted as Chairman for the past 16 years and holds in excess of 1 million shares.

Business Model

There are three principal business operations: (i) Regeneration & Homes (estate regeneration and housing development on brown-field sites in the North of England); (ii) Strategic Land (options over land with a view to adding value by gaining planning consent), and (iii) Capital Solutions (PFI investments in social housing).  

Regeneration & Homes focuses on the social housing / cheaper-end of private housing, with selling prices typically in the £100-140k range. This operation accounted for about half of 2010 revenues (continuing activities), but the volume of houses sold was 60% lower compared to 2009, resulting in a focus on cost control and cash preservation.

Strategic land accounted for about 20% of 2010 revenue, but these revenues by their very nature are going to be lumpy (ie ten-fold increase on 2009).

Commercial Property Developments accounted for c30% of 2010 revenue, but this is in wind-down mode.

The P&L is subject to wild fluctuations in asset value - note the £34m write-down in asset values in 2010 - and going forwards, will not benefit from Powerminster (construction) which was disposed of in 2010 but contributed up to £1m of operating profit.

Risks & Challenges

• The planning system in the UK lacks any transparency, certainty and, at times, sense! The Coalition Government has reform of the planning system on its agenda, but 'when' and 'how' remain to be seen;
• Social housing has been promised large pots of money for the past ten years to fund development and regeneration, but these pots seem to get constantly 'pushed to the right'; and
• The previous CEO, Chris Holt, stood down in September 2010 following the disposal of Powerminster. He has not been replaced as yet, but the FD has had his role expanded to be de facto Ops Director. The lack of a CEO for too long is not a positive sign. 

The Rules

The Rules are calculated on the results for the year ended 30 June 2010 (FY10) unless otherwise stated

1 - Assets - the net asset position at June 2010 amounted to £98m compared to a market cap of £65m, representing a 35% discount. In simple terms, you can buy an ordinary share in the Company for 121.5p, which has a net asset value of 186p. Better still, net assets includes £18m of cash as at 30 June which equates to 35p per share; if this cash is valued at par value, you can buy 151p of assets for 86.5p - a 42% discount!

The Company qualifies as a Net Net (current assets less current and total liabilities is greater than than the market value). In theory, if you ran off the current assets and paid off the book liabilities, you would generate £78m of value (less costs), which is greater than the market value of the Company.

However, the majority of these current assets (by value) are inventories (£76m), which represent half-built houses and strategic land for sale. I am unclear as to how close the book value of these assets is to market value, particuarly in a falling market, but even so, a 42% discount gives some headroom. More of an issue is how quickly they can turn to profit and cash. A provisional Pass.   

2 - Market Value - £64m. Pass

3 - Cash Flow - the business generated positive Operating cash after working capital of £14m in 2010, which is good. In 2009, there was an outflow of £20m, which is bad. This is a function of a lumpy revenue model. Pass (for 2010).

4 - Debt - none! £18m of cash on the balance sheet as at 30 June 2010. Pass

5 - PER - based upon a 2010 EPS of 6p, the current PER is 20x. Looking at the 12 year average EPS of 4p, the PER is even worse at 30x. This is partly a reflection of an 'asset trading' business rather than looking at it on a multiple of earnings. Fail

6 - Yield - I was first attracted to the Company when it was about to pay out a special dividend (a whopping 15p) in March 2010 as the Board "concluded that the Group had cash in excess of its requirements" (at a cost of £8m). With the cash on the balance sheet at June 2010, they could pay this twice-over, but the Company decided to declare no final dividend for FY10, which was disappointing.

Historically, the Company has been a good dividend payer and increased its dividend year-on-year 1999-2007, with an average DPS of 7p (yield of 5-6% on current price). The world changed at the end of 2007 and regular dividends have disappeared since. Fail

7 - ROE - the 2010 ROE was a miserly 0.6%. This is probably not too bad given that three out of the four previous years showed a negative ROE. Fail

8 - Directors - the directors' remuneration pot seems reasonable as listed companies go and the directors have ownership or interest in 11.6m shares, which equates to 22% of the ordinary share capital. The caveat is that Christopher Mills's holdings are through North Atlantic Value LLP (a JO Hambro fund), which is the largest institutional holder in the Company at 18%, meaning that the other directors control c4% (c£2.5m in value). I am satisfied that the directors' interests are aligned with the ordinary shareholders. Pass

9/10 - Buy or Bye? The 12 year EPS of 4p x the 5 year average PER of 10x (2001-2005; negative EPS thereafter), gives a fair valuation based on earnings of 40p. This obviously takes no account of the asset-based nature of the Company and is, arguably, of reduced relevance. Bye
 Update

The trading update issued in November 2010 stated that volumes and average selling prices had improved, but that the availability of mortgages (lack of) was constricting additional growth.

The interim results are due in February 2011.

Conclusion

Before undertaking the detailed analysis, I had expected to conclude with a strong opinion that I should I buy some more. However, I am arriving at the opposite position. 

Whilst there is a significant discount to net assets, and even a 'Net Net' position, I am concerned about the lack of earnings visibility, ie the need to 'trade' strategic land and get people to buy houses (most of the drivers for value are outside of the direct influence of the Company).

If the Company had always been this shape, then I could look at the 10 year history and get comfortable that the Company will ultimately deliver through thick and thin, but the Company going into 2011 is in a very different shape to its predecessors (and their financial results). In reality, the Company represents some parcels of land and a few semi-built buildings, all valued at a perceived discount, together with a bit of spare cash but no CEO; I am unclear what I think the true Fair Value is and how their strategy is going to deliver my target returns of 15% pa going forwards.

I am tempted to remove the Company from my portfolio immediately, but I am going to resist and see what the interims bring in February. On the up-side, there is room to appoint a CEO, articulate/demonstrate the strategy more clearly and use the cash to re-instate the dividend or pursue strategic acquisitions. The question that I am wrestling with is: "why is this any better than other discounted builder/land holder?" and we'll see if the interims can shed any more light on this.

HOLD for now, but to re-consider following the February interims.