When the Scalextric-to-Corgi models maker announced in February that it was likely to be in breach of its banking agreements, Mr May earnestly tweeted: "We must save Hornby. Buy a train set today. Every home should have one." True, the difficulty might have been finding the right Hornby set to buy, such is the state of the company's stock control. Besides, the former Top Gear co-presenter may not exactly be unbiased. Back in 2009, he wrote and presented a BBC TV series - James May’s Toy Stories - that revolved around doing anoraky things with Hornby's stable of brands.
Despite product placement of such dream-like proportions, Hornby continued to go off the rails. Yet there is little doubting the presence of those brands, which prompts the question: now that its bank has waived testing the borrowing covenants (at least, this time around), are the shares a bargain-basement play?
It's a possibility since - breach of the borrowing terms or not - the group carries little debt. At the end of September, the net figure stood at £5.7m compared with £42m of shareholders' funds. That healthy picture, which will have deteriorated a bit by the end of the financial year, owes everything to the £15m that Hornby raised via a two-for-five share placing last summer. Meanwhile, those who coughed up 95p each for the new shares may be spitting blood since the share price is now down to 35p. That's another way of saying Hornby's entire equity is only valued at 28 per cent more than those new shares issued in August, which equates to value destruction on an industrial scale.
The market may have overdone it. After all, the shares now trade far below the net asset value - 35p versus 77p book value at the end of September. The book figure will have shrunk by the end of the 2015-16 financial year and Hornby's bosses may make further write-downs. Against that, Hornby's accounts are full of good tangible stuff such as property and plant (£9.2m), inventories (£16.8m) and debtors (£14m), so it's feasible to see the shares as an archetypal value play. Strengthening that view, net current assets minus long-term debt came to £16.9m in the September balance sheet, almost as much as the £19.2m current market value of the equity. Granted, the current assets figure was swollen by £1.2m of properties held for sale. Yet there could be substantial hidden value in Hornby's fixed assets. In particular, the tools and moulds that it uses to churn out models year after year are in the books at a heavily depreciated £7m against an original cost of £55m.
Analysis of Hornby's cash flow also lends weight to the notion that the savagery meted out to its share price has been overdone. Yes, 2015-16 will mark the fourth year running that Hornby has made a pre-tax loss, a record exacerbated by dollops of restructuring charges and write-downs. But underlying cash generation has not been so poor.
Using the valuation model to which I introduced readers three weeks ago (Bearbull, 18 March 2016), on average in the past five years Hornby has generated £3.3m of free cash each year. While the trend over that period has clearly been downwards, in only one year - 2012-13 - was there a cash outflow.
So is £3.3m an acceptable figure to use as a proxy annuity in a valuation; in other words, is Hornby likely to be capable of maintaining that average in future? Given the loyalty of all those anoraks - the ones who keep 20 years' back issues of Railway Modeller magazine in their garden shed - you would hope so. Put another way, over the long haul Hornby averages annual sales of about £60m; assuming its relationship between depreciation and capital spending stays the same - ie, the two are about equal - then an operating profit margin of just 5 per cent would be enough to generate that £3.3m annuity. Raising that figure by a weighted cost of capital of 7.8 per cent - that's 8.5 per cent for the equity and 4.2 per cent for Hornby's slither of debt - brings a capitalised value for Hornby as it stands at £37m or 67p per share, almost twice the current share price.
That's a pretty wide margin of safety. Yet it's only right to have doubts about Hornby. After all, in the imagery of a top-selling line, Thomas the Tank Engine, here is a company whose Fat Controllers, in the 10 years or so that I've followed it, have managed to mess up almost every aspect of its operations. Instead of being Gordon the Big Engine, Hornby has been Henry the Green Engine, which, after a series of mishaps, went into a tunnel and refused to come out.
Whether Hornby emerges from the tunnel largely of its own making remains to be seen. If there were a recovery fund in the Bearbull portfolios, I would be strongly inclined to take a small holding. That said, it's interesting to note that when I used an adaption of the Black-Scholes option-pricing model to estimate the shares' value, the model gave me a figure close to the current market price. That's largely because Hornby's survival isn't in question yet - even if its recovery is.
