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Absurdist investing

It points to the trusting side of human nature, which is good in so far as it helps us to co-operate, not so good when it makes us credulous. Somewhere between co-operation and credulity lies persistence, which helps explain why momentum can be such a strong force behind asset prices. Once a pattern is set, it does not take much in the way of confirmatory bias to keep it rolling along since we want to believe.

So persistence is fine when it helps maintain the rising price of shares we own. It’s less good, however, when it locks in the sub-optimal, such as the so-called 90 per cent economy. Yet for many companies that level of performance may be the best on offer while the rituals of social distancing continue to be observed so deferentially.

Thus there are two ways of interpreting this week’s comment from construction group Henry Boot (BOOT), which said that activity on its construction sites is back to 90 per cent of its pre-Covid-19 levels. Accentuating the positive, that represents a healthy recovery from the period when all sites were closed while lockdown was at its tightest. Yet it’s not possible to eliminate the negative that 90 per cent is not really enough for almost any group and not for one such as Boot, whose operating profit margin has been 12 per cent in the past two years.

Take that 90 per cent level literally and, based on 2019’s experience, revenue of £380m would be hacked back to £342m. If all else remained equal – which, of course, it wouldn’t – then group operating profit would be scythed down from £46m to £7m. Something not a million miles from that did happen in the first half of 2020, results for which Boot announced this week. Revenues almost halved from £189m to £109m and – despite lots of costs saved as the group went into suspended animation – operating profit dropped 70 per cent from £24m to £7m.

However, it’s an ill wind and cash flow – for Boot, usually the weaker of the two revenue accounts – benefited hugely from the lockdown. As Boot is normally in growth mode, then cash gets sucked out of the expanding business to fund investment and developments. The reverse happened in the first half. Almost as astounding was the swing in working capital, the cash consumed by funding inventories and trade debtors. From 2019’s first half, when an extra £38m of working capital was needed, there was a £50m swing and, in effect, £12m of cash was raised as working capital needs fell. As a result, Boot finished the half year with more net cash than it started – £42m compared with £27m. This was nice for the Bearbull Income Fund, which holds shares in Boot, since it prompted the directors to recommend a half-decent half-year dividend.

Still, as August’s crop of first-half results has shown, Boot has performed better than the average. Sure, there is the occasional winner, such as Bunzl (BNZL), whose distribution services have been given such a shot in the arm by the response to Covid-19 that its bosses have not just raised the half-year payout but have reinstated 2019’s final dividend.

But for every Bunzl – or even Boot – there are a good few more who will struggle badly with the 90 per cent economy as the results season also demonstrates. Take Marshall Motor (MMH), which scrapped its dividend as revenues dropped 24 per cent and the group swung from underlying pre-tax profit of £15m last first half to a £9m loss.

Similar to Boot, a combination of trading put into deep freeze and financial ingenuity meant that Marshall’s financial position improved. Marshall started the half year with £31m of net debt and finished it with £27m of net cash. For a group running on gross assets of about £900m, almost half of which are cars waiting to be sold, that’s quite an achievement.

And, true enough, cars were flying off the forecourt in June and July as trading resumed in socially-distanced mode. What chances, though, that trading will be anything but rotten come foggy November when every muffled cough strikes fear and alarm and companies engage in mass distancing themselves from employees on a permanent basis? After all, even at the best of times motor retailers, such as Marshall, run on profit margins of less than 2 per cent. What hope for them in the 90 per cent economy?

Thoughts such as these make me less optimistic than I was in late spring (Bearbull, 22 May 2020). While it becomes increasingly likely that Covid-19’s threat is distinctly limited, heavy-handed caution remains the go-to response. Thus, much like Vladimir and Estragon in absurdist theatre’s best-known work, Samuel Beckett’s Waiting for Godot, we wait for something that will only ever arrive tomorrow. Meanwhile, also like those two, we occupy ourselves with pointless rituals. Perhaps they make some people feel secure. They are less likely to have that effect on company profits or – for that matter – on employment.