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Dewhurst’s (LSE:DWHA) conventionally calculated earnings numbers have been fairly flat for a few years, as have their owner earnings numbers – see yesterday’s Newsletter. Today I want to look at some reasons for hope that both might be lifted in the future.
Return on net tangible assets
Warren Buffett and Charlie Munger are very keen on knowing the return on net tangible assets because this indicates:
(a) how effective the managers are at extracting a return on the assets entrusted to them (intangibles such as goodwill on acquisitions are not in the operational managers’ control so we do not include them), and;
(b) how fast owner earnings might grow in the future if we make some assumptions on the rate of reinvestment within the firm and that the retained money will generate rates of return comparable with those obtained on the existing assets.
Here are the historical numbers for Dewhurst:
Return on net tangible assets employed
|
Operating profit, £m |
Net tangible assets, £m |
Return on net tangible assets |
|
| 1st half 2017 (profit annualised) |
3.11 x 2 = 6.22 |
21.6 |
29% |
| 2016 |
5.4 |
21.0 |
26% |
| 2015 |
5.7 |
21.5 |
27% |
| 2014 |
5.2 |
18.9 |
28% |
| 2013 |
4.1 |
17.8 |
23% |
| 2012 |
5.6 |
17.9 |
31% |
| 2011 |
4.9 |
14.3 |
34% |
| 2010 |
4.8 |
14.8 |
32% |
| 2009 |
4.5 |
13.4 |
34% |
With the company displaying a long history of high retention of earnings (low dividend payout ratio) put to use in acquisitions, organic growth and building up a cash balance of £16m (39% of MCap), and generating returns on tangible assets of 23% to 34%, there should be significant future growth in owner earnings to look forward to.
If for every pound in the business you are generating operating profit of, say, 30p, even after taking away tax, you are going to be left with a hefty sum to invest in additional projects or businesses. These will, in the hands of experienced and capable managers produce high returns.
What might stop that process is the absence of additional opportunities to invest in value generating projects/businesses. Then the existing businesses throw off cash (owner earnings) to be available for shareholders (then special dividends and share buy backs beckon).
Of course, we must allow for the doomsday scenario where the existing businesses lose their edge in terms of economic franchise and pricing power, and so return on net tangible assets declines or becomes negative. Then neither will there be value-generating investments nor a rising cash balance.
Note on the use of net tangible assets metric
When using return on net tangible assets a distorted picture can be gained if the company regularly uses its capital to acquire businesses and then place in the accounts large amounts of goodwill or write off large amounts of goodwill. Dewhurst currently has £3.4m of goodwill in the accounts (related to the purchase of three Australian businesses). It has also written off £6.9m of goodwill from previous acquisitions over many years.
If we were to be really strict then we could say the managers had around £21.6m of tangible assets (taken from the table above) and another £10.3m (£3.4m + £6.9m) of money put into goodwill. These two should be added together to gain an idea of how efficient they are in using shareholders’ money. So in rough terms we have £31m of net assets on which the company generates around £5.5m before tax in a year, a return of 17%. This is still very respectable.
Balance sheet strength (based on March 2017)
Net asset value in total £27.5m
Net asset value per ‘A’ non-voting share: £3.24
Net tangible asset value in total: £21.55m
Net tangible asset value per ‘A’ non-voting share: £2.54
Borrowing: zero
Cash: £16m
Property: £7.1m
Pension deficit: £14.9m
Conclusion: this is a very strong balance sheet, with no suggestion of potential financial distress.
Character of the managers
They have stuck to engineering. Any strategic moves are very measured, allowing plenty of time for integration and improvements. They do not make “bet the company” acquisitions.
They tell it like it is with no embellishment.
The family own over 50% of the voting shares and have consis………………………………………..To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
