Connect Group – a history of earnings

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Connect Group (LSE:CNCT) has one business generating an operating profit north of £34m.  For a £37m market capitalisation company that is a substantial amount. And this operating profit, from the Smith News newspaper and magazine distribution business, has been consistently high (2014: £40.8m, 2015: £23.2m, 2016: £34.1m, 2017: £36.1m, 2018: £25m, 2019: £36.3m, expectation for year to August 2020: £34m).

Smiths News has a 55% market share, and local monopolies all over the country.  Its only opposition is Menzies News, which tends to stick to its own newsagent territories. Entry into this line of business is very hard given the strengths of the two incumbents. Over 80% of publishers have already signed up to contracts with Smiths News for another five years.

If this business was the only one owned by Connect Group then, obviously, it’s a good share to buy.  Mr Market, on the other hand, thinks, because fewer physical newspapers and magazines are being bought year by year, that SN will suffer greatly, and this has helped push down the share price.

I do not see good reasons for such pessimism in the numbers coming out of the company. Even though volumes of papers/magazines sold have gone down by 5-10% per year for a long time now, the managers have largely offset this by finding efficiencies, and cover prices have risen.

The main reasons, however, for Connect’s shares to be trading on a cyclically adjusted price earnings ratio of only 2.1 is not to do with Smiths News but derive from two large risk factors.

The first is that the Tuffnells parcel delivery business, bought for £121m in 2014, might continue to lose money hand over fist for years to come.

The second is that the Group’s high debt levels will become unsustainable should the cash flow of the Group decline substantially.  Bankers – in normal times – may not be understanding if the EBITDA-based ratios used for loan covenants are breached.  The nightmare scenario becomes possible if directors do not get a grip of the………………To read more subscribe to my premium newsletter Deep Value Shares – click here


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