Happily, Mitie's operations look healthier than when I previously crunched the numbers in January (see Bearbull, 16 January 2015). Its brighter prospects are chiefly based on the hope that - after two years' worth of exceptional charges totalling £118m - future 'basic' (ie, unaltered) profits will be much the same as the 'headline' (for which read 'flattered') profits. That would mean profits including nasty one-off items will be the same as profits where those nasty items are popped into a separate column in the income statement with a view to pretending they are best ignored chiefly because henceforth they have not the slightest chance of being significant. For company bosses and the City's sellside analysts alike, adopting this tack usually proves to be a triumph of hope over experience. Nevertheless - and despite the track record - in the ante-post betting, hope is almost always the favourite.
Still, if for a moment we think like sellside analysts, then valuations for Mitie driven from accounting profits would use operating profits of around £130m as the numerator (2014-15's headline operating profit was actually £128.6m). What value one puts on an 'annuity' of £130m depends on umpteen factors - most importantly, the prospective costs of equity and debt and the rate at which the company under scrutiny is likely to pay corporation tax. That means one is deriving an estimated value using some estimates (of profit, for instance) in relation to other estimates (of the cost of capital, say). The resultant figure, therefore, is extremely tenuous, although that's how it always is with investment analysis.
But using the optimistic scenario, £130m of operating profits can translate into a value approaching £1.3bn, or 355p per share or so, compared with Mitie's market price of 295p. Whether that gap between value and price is wide enough to justify buying the shares is debatable. It becomes even more debatable if you think like an investor rather than a broker and base value on, say, the average of the past five years' operating profits. Do that and the numerator shrinks to £81m, generating per-share value of barely more than 200p.
Nor do estimates of Mitie's value improve by focusing on cash flow. In fact, they worsen. On average in the past five years Mitie has generated 12.5p per share of free cash. For someone seeking a sensible equity-style return of 8.5 per cent a year, that cash flow could only justify value of about 150p. The required rate of return would have to shrink to a silly 4 per cent to warrant the current 295p share price. Put another way - free cash flow would have to be 25p or more to make 295p acceptable. That's not imminent. So it's all very well for chief executive Ruby McGregor-Smith to insist that Mitie is in a "really, really fantastic place", but it's hard to share her enthusiasm.
All of which means I can stick with Mitie for now, but I tightened the stop-loss level some time ago so that just a 10 per cent drop from the reference price will trigger a sale - that works out at a selling price of 265p.
Meanwhile, the nice performance of Zytronic's shares since I bought them in October 2013 also means that - following two upward shifts in the stop-loss levels - I have tightened the parameters. Here, a 15 per cent fall from the reference price will prompt the sale at 248p.
The shares were close to that level in April, but decent first-half results this week have pushed the price back to 290p. It was at around the higher figure, early in the year, that I reckoned the price looked overcooked. Even now it's 'up with events'. True, sales, profits and cash flow all moved in the right direction in the six months to end-March on the back of a 16 per cent rise in the sales volume of touchscreen units, to 72,000.
But a good set of results for 2014-15 won't have much impact on valuations. Depending on fine-tuning, Zytronic's shares seem to have intrinsic value somewhere between 270p and 290p. That's the sort of figure it's possible to derive from the group's 'earnings power' - ie, the level of profits or cash flow that's likely to come through in an average year. It also means the shares look fairly priced.
That assessment would look too cautious if lots of growth looked set to emerge. Sure, Zytronic serves growing markets. There is scope for more, bigger, better and costlier touch screens, as the company's latest giant curved screens for casino games indicate. Even so, Zytronic has been around for sufficiently long and its record is sufficiently chequered to deter any inclination to get carried away.
That said, there is an important positive from these two sets of results. They allow me to switch the focus to other, maybe more troublesome, areas of the income portfolio - what to do with GlaxoSmithKline (GSK) or Carillion (CLLN), for example. In a world of finite resources, that's not to be scoffed at.
