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My last newsletter explained that McCarthy and Stone (LSE:MCS) was valued by Mr Market at less than net current asset value (I bought at 72p last week). The main reason for the plunging share price is fear among investors that MCS will, for months or years, not be able to sell its apartments. At any one time it has finished or currently in construction 1,500 – 2,500 apartments. It relies on retired customers being able to sell their old family homes in an property market. For a while Covid-19 restriction meant people had difficulty selling to finance the purchase of a MCS place. Perhaps the property market will freeze again and MCS will run out of money before recovery comes.
It has to be acknowledged that it won’t be easy to shift apartments over the next year or so, but the question for today is whether that difficulty is likely to be terminal for the business. We can start the analysis by looking at profits and cash flow
Profit and loss, 2016 – 2020
| £m | 2016 | 2017 | 2018 | 14 months 2019 | H1 to end April 2020 | |||||
| Turnover | 636 | 661 | 672 | 725 | 101 | |||||
| Cost of sales | –500 | -530 | -567 | –620 | -109 | |||||
| Gross profit | 136 | 131 | 105 | 105 | -8 | |||||
| Other income | 9 | 9 | 11 | 21 | ? | |||||
| Administration expenses | -45 | -39 | -44 | -64 | -85 | |||||
| Other operating expenses | -5 | -7 | -8 | -14 | ? | |||||
| Operating profit | 95 | 94 | 64 | 48 | -89 | |||||
| JVs and interest | -2 | -2 | -5 | -5 | -2 | |||||
| Profit before tax | 93 | 92 | 58 | 43 | -91 | |||||
| Tax | -19 | -18 | -12 | -9 | 17 | |||||
| Profit after tax | 74 | 74 | 47 | 35 | -75 | |||||
| Earnings per share | 13.9p | 13.8p | 8.6p | 6.5p | -4.1p | |||||
| Dividends per share | 4.5p | 5.4p | 5.4p | 5.4p | 0 | |||||
| Apartment average sales price £000s | 259 | 273 | 300 | 308 | 297 |
(rounding to the nearest million causes some inconsistencies in additions. H1 2020 EPS is underlying – ignoring brand write-off)
Observations
Turnover is generally around £650m to £700m over 12-month periods, which represents sales of around 2,200 apartments. However, during the six months to 30th April sales more than halved due to lockdown. And the impact of the crisis on the second half is expected to be much greater. But the current mini-boom in the housing market might help with that.
Even before Covid-19, gross profit margin fell from 21% in 2016 to 14% in 2019. This was mainly due to a poor strategy of rapid expansion exacerbated by the economic malaise after the EU referendum. The strategy was changed in 2018 to concentrate on return on capital employed rather than revenue growth.
As well as the “cost of sales” increases the administration expense line shows the penalty paid for trying to greatly raise the rate of apartment construction and sales – admin rose from £45m to £64m. Operating profit margin fell from 20% in 2015 to 7% in 2019.
In the six months to end-April true total administrative expenses amounted to £20.2m which was only slight up on the same period in 2019 (£19.5m). The rest is exceptional items and amortisation of brand. Leaving that aside, because revenue is down so much administration expenses (underlying) as a proportion of revenue grew to 20% compared with 7% in 2019.
Operating profit, prior to Covid-19, declined from over £90m to £48m for full years. The Covid-19 freeze in sales and a large write-off of brand value caused an operating loss in the H1 2020. Ignoring exceptionals the operating loss would be £25m at the interim stage.
Dividends have been stopped as one of managers cash conservation measures – see later for other measures.
Profit after tax and earnings per share halved before Covid-19. But the 2018’s strategic change should address that – see below.
The average sold price for an apartment fell in the six months to the end of April 2020 by about 3%. Most of that period was unaffected by Covid-19, so I deduce that the price falls were pretty large in the spring.
Overall impression: This company had a £387m market capitalisation when I bought in last week. It has demonstrated an ability to produce annual earnings of over £70m after-tax, but profits were headed in the wrong direction even before Covid.
Now that Covid is here managers have rejigged so that cash burn is down to about £7m per month.
Strategic change
When MCS floated on the stock market in 2015 the prospectus stated that managers intended to raise the number of apartments constructed and sold from around 1,500 per year to 3,000 per year. And they were going to do this within a four-year timeframe.
It turned out they were wildly ambitious. They increased costs, strained the organisation and cut corners. And even then, found they could only raise annual sales to 2,302 (the best year was 2017). The chairman and CEO leading that strategy have now gone.
The new team announced in 2018 that their emphasis would be to “shift away from volume towards buying quality land with margin enhancing potential as opposed to being focused on quantity of sites [and] to actively manage our land bank to less than 4 years supply to meet our new steady state volume targets of c.2,100 units per annum…a shift in business mindset … to increasing ROCE and margins…rightsizing the operational cost base…Focus on build cost reduction and developing a more efficient sales and marketing model.” (2018 Report)
The cost reduction and cash saving programme began two years ago has proved helpful in providing some protection in the 2020 downturn.
Cash flow….………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
