As proof that this stabbing is closer to blind flailing, consider the figures that emerged when I ran through the spreadsheets of data for Carillion (CLLN), the Wolverhampton-based construction services group whose best-known contract in 2016 was building the enormous new stand at Anfield, the home to Liverpool Football Club. Recall that shares in Carillion sit in the Bearbull income portfolio, although rather uncomfortably. I bought them seven years ago at 267p each, since when the price - although it topped £4 in 2011 - has done less than nothing. That London's All-Share index has risen 68 per cent over the same period clearly indicates what the average investor reckons to Carillion's progress and prospects.
So should I soldier on with Carillion, especially as I've resolved to get tough with those holdings about which I'm sceptical (see last week's Bearbull) and, perhaps more important, its share price - now 252p - has dropped below the stop-loss level I set way back in 2010?
Arguably, if a holding has done so little for so long then it's not paying its way and should be axed. Period. A specific limitation of that argument is that it ignores the 6.9 per cent dividend yield on cost that the Carillion shares now generate for the fund. Then there is the wider - and maybe more important - point that such a thought pays zero attention to what might happen. True, the capital tied up in Carillion shares has been comatose for several years. But, actually, that hasn't been a heavy drag on the income portfolio's performance - its value has risen 40 per cent since the Carillion purchase. Meanwhile, the future is where we're heading and there is always the chance that the share price will be shocked back to life.
You might think so if you pondered the value implicit in the average level of notional free cash that Carillion looks capable of generating. Obviously, words such as 'implicit' and 'notional' tell us that such a valuation should be handled with care. Even so, it comes out at 355p per share, 41 per cent above the market price. It's based on extracting the average cash flow over the past five years that's embedded within Carillion's income statement and it assumes that the future will be much like the past except that it will be free of those annoying costs and charges that a company's bosses deem 'exceptional'.
Trouble is, in the real world what's exceptional is depressingly familiar so that the cash flow that Carillion actually generates is less impressive than what it manages in the lab (
True, free cash flow is a notoriously volatile figure. That's why the best estimate is usually to find the average of quite a few years. Yet, in Carillion's case, might the average of the past two years - £82m - be a better guide? It's tempting to think so, but not necessarily. That's because the nature of Carillion's business - signing long-term contracts where payments are often lumpy - can cause wide swings in cash flow as debtors pile up or, in another year, they cough up. For example, in the past five years the net change in Carillion's debtors, creditors and inventories (the main components of working capital) have swung from a £9m inflow to a £165m outflow at the other extreme.
Thus it might be that Carillion is one of those companies where the better assessment comes from studying the income statement, the ledger that can be smoothed by both accountancy fiat and corporate self-interest. Or maybe not, because the impression is of progress slowing. For example, in the past 10 years, on average Carillion's operating profits have risen by 34 per cent a year, pre-tax profits by 14 per cent and earnings per share by 7 per cent. For the past five years, those averages drop to 18 per cent, 1 per cent and minus 2 per cent respectively. It makes dull reading, as does the data for return on underlying equity (where 'underlying' includes reserves for deferred tax and pension-fund deficits). There, the numbers are, on average, 12 per cent for the past 10 years, but 10 per cent for the past five.
The latter figure is just about acceptable, but it's hardly the sort of return by which a company adds much value to the capital it employs. Maybe that's why the market value of Carillion's equity - £1.08bn - is less than its underlying book value (call that £1.4bn, it's always a guesstimate). That might be a bit niggardly since a 10 per cent return on equity is probably higher than Carillion's cost of equity (although that's always a subjective figure). That may mean I needn't be in a hurry to sell the income fund's holding in Carillion. But put it this way, unless something really nice - and unexpected - happens, it's the next out.
