14 shares that (nearly) Have It All

My Have-It-All stock screen is a greedy beast. It wants stocks to display many classic indicators of growth, quality and value. It’s perhaps surprising that such a hodge-podge approach has done as well as it has over the past nine years. However, 2020 illustrated some of the frailties of the approach.

Asking for so much can mean finding stocks with hidden problems. The two stocks that did the damage to last year’s result were a case in point. Indeed, the reasons to be concerned about these two particular picks were glaring enough for me to highlight them both as displaying the screen’s shortcomings at the time. Sadly, in terms of overall performance numbers, I was right. But on the plus side, these calamities do help illustrate why the screens run in this column are best regarded as a source of ideas for further research rather than off-the-shelf portfolios. The calamities in question were NMC Health (NMC), where fraud was exposed, and Photo-me International (PHTM).

Fortunately, the screen’s dud choices do not always make quite such an impression as they did last year. Since coming up with the approach at the end of 2011, cumulative total returns from the screen stand at 186 per cent compared with 87 per cent from the FTSE All-Share. If I add in a notional annual dealing charger of 1 per cent the return drops to 167 per cent. 

This year, I’m adding an extra screening test into the mix. This doesn’t necessarily mean the screen is that much more demanding, because no shares satisfy more than seven of its nine tests anyway. Indeed, of the 14 Have It All stocks for 2021 in the table below, only five get a screen score of seven out of nine, with the others only scoring six.

The added test in this year’s screen involves looking for 'value' based on shares’ forecast free cash flow yield for the coming 12 months (FCF yld +12mth). This measure of value expresses the FCF a company is forecast to generate as a percentage of enterprise value (EV). 

EV attempts to measure the value of all the claims on a company’s cash flows. It does this by adding to market capitalisation other company liabilities that have higher ranking claims on cash and assets; chiefly net debt and lease liabilities. FCF represents the cash left over once all essential cash outflows have been accounted for. In the case of this screen, that includes all capital expenditure. Because FCF is being compared with EV, the measure of FCF used does not subtract interest paid on debt or lease payments. 

The concept of EV and FCF are much easier to understand than they are to calculate with any accuracy. Also, the right calculation for valuing one company does not always represent the best method for another. So, as is often the case with valuation ratios, it is best to regard standardised data of the type used by this screen as useful but blunt. 

Another issue to keep in mind with FCF is that businesses’ cash needs can fluctuate substantially from one year to the next. So a single year’s FCF yield may not be representative of the long term.

One other change I’ve made to the screening criteria this year is to screen based on forecast dividend yield (DY) rather than historical yield. I’m doing this chiefly because a change of data supplier last year means this has become possible. However, the ructions from lockdown also mean it is more important to try to avoid companies cutting future payouts.

The full screen criteria are:

■ Forecast next-12-month price/earnings (PE) ratio among the lowest third of all stocks screened.

■ Forecast next-12-month FCF yield in the highest third of all stocks screened.

■ Forecast next-12-month DY in the highest third of all stocks screened.

■ Average forecast earnings per share (EPS) growth in the next two financial years of 5 per cent or more.

■ Three-year EPS compound annual growth rate (CAGR) of 10 per cent or more.

■ Three-year free cash flow CAGR of 10 per cent or more.

■ Three-year dividend CAGR of 5 per cent or more.

■ Return on equity (RoE) of 10 per cent or more.

■ Three-year average RoE of 15 per cent or more.

Of the five shares passing seven out of the nine tests, I’ve taken a look at the one boasting the highest FCF yld, B&M European Value Retail (BME). Some fundamental data relating to it and the other 13 stocks highlighted by the screen can be found in the table below. A more detailed version of the table with a glossary of terms is available to download as an excel document.

B&M European Value Retail

Discount homewares and groceries retailer B&M (BME) has been a lockdown winner. Unlike many companies selling general merchandise, it has enjoyed the status of an essential retailer, which means it has been allowed to trade through lockdown in the UK. It was not so lucky in Europe, where in the year to the end of March 2020 generated 7.5 per cent of sales and reported a £12m loss. The location of B&M stores in retail parks has helped attract nervous shoppers who want to travel by car and avoid crowded high streets. The extremely competitive prices in B&M’s shops have also helped attract people worried about their financial future as falling gross domestic product (GDP) causes purse strings to tighten.

At the start of lockdown it was hard to see who would prosper in the Covid carnage. But as B&M’s strengths have shone through, brokers have been scrambling to keep up with progress, delivering a persistent stream of forecast upgrades that have sent the shares soaring.

As with all Covid winners, a key question is whether the gains made over the past year are fleeting or whether the group can hang on to them. Consensus forecasts are for some of the current year’s profit hike to be reversed, but for much to stick. Indeed, a relatively fixed cost base means heightened sales per square foot boosts profitability and the past 12 months is likely to prove an exceptional period for getting shoppers through the door.

That said, there are reasons for optimism about long-term benefits from lockdown. One key factor is that many people have been using B&M’s stores for the first time and the company has a good record of creating loyal shoppers. At the half-year stage the company said 23 per cent of shoppers in the six months to the end of June had not been to their stores in the past five months. The company has also seen a broadening out of the demographic that uses its shops. Meanwhile, like-for-like growth has been strong across almost all its product ranges. The company also continues to successfully self-finance new store openings which achieve a rapid payback on investment.

The fact B&M has fared so much better than many rivals in the general merchandise sector also means it could find itself in a strong competitive position when life gets back to a more normal footing. And the vaccine roll-out will not necessarily bring a particularly abrupt end to all restrictions, which means the shopping habits formed over the past year may continue to bed in for some time.

B&M’s key selling point to its customers is convenience and price. In a recent sample of 40 key items, broker Liberum found B&M to on average be 12 to 27 per cent cheaper than leading supermarkets. The company achieves bargain prices hand in hand with robust margins thanks to a strategy of focusing on limited product ranges, which are sourced directly from suppliers. Its ability to shift volume fast has helped it develop strong relationships with suppliers. 

It also has a very lean operating model, focused on low rents, and tightly controlled overheads and stock levels. It’s worth noting that about 12 per cent of the rent roll goes to the founding Arora family, which owns 11 per cent of the shares through its SSA Investment holding company. This looks somewhat uncomfortable at a time when many retailers are playing hardball with landlords. The family also recently reduced the stake in B&M from 15 per cent having cashed in £218m of shares at 545p a pop.

B&M also has a strong record of converting profits into cash. Partly this is down to the fact that the company leases shops, which means it requires less upfront investment to fund its growth. Indeed, as well as funding significant expansion both in the UK and in its fledgling European markets, cash generation has been strong enough to support £600m of special dividends in 2020 (three lots of 20p). Meanwhile, net debt is comfortably in the group’s ceiling level of 2.25 times cash profits. Liberum forecasts that the company will generate about £1bn of free cash over the next three years. 

The company does have plenty of scope to expand the core UK business, with plans to take the 645 stores it had at the end of September to 950. It is also keen to expand in Europe where, following previous hiccups, it is now showing signs of success in exporting its discount model. Acquisitions have also been used to grow the group, such as the purchase of Badou in France in October 2018 and convenience food chain Heron in the UK. 

B&M is a slick operator with a strong business model and growth opportunities. There are always risks in retailing, but the company looks attractively priced based on the free cash flow yield this screen has highlighted it for. There is no universally accepted measure of FCF and the numbers in the accompanying table – pulled straight from a database – look to me like they err on the generous side. However, even based on Liberum’s less favourable forecast, the forecast free cash flow yield of over 6 per cent looks appealing.