- The Big Reliables stock screen has produced a cumulative total return of 156 per cent over the last decade compared with 86 per cent from the FTSE 350
- The screen almost kept pace with the market over 12 months despite the turn against large-cap, quality, growth shares
- Seven new shares selected for the coming year
My Big Reliables screen is 10 years old this month. It’s a simple beast. It focuses on identifying companies that are large (by UK standards, at least), are growing earnings, and generate sufficient returns on equity and cash conversion to suggest that growth may be worthwhile.
Simple as the screen is, over the decade it has beaten the FTSE 350 by a decent margin, albeit not a spectacular one. The FTSE 350 is the index the screen is conducted on.
The cumulative return since I began to monitor it in 2011 is 156 per cent compared with 86 per cent from the index. While the principal idea behind the screen is to generate ideas rather than off-the-shelf portfolios, if I factor in a 1 per cent annual charge to account for notional dealing costs the return drops to 132 per cent.
The screen actually ended its first decade with a bit of a damp-squib performance. It returned marginally less than the index over the last 12 months. The result was also significantly buoyed by outsized returns from online gambling firm 888.
|Name||TIDM||Total Return (14 Jul 2020 - 30 Jun 2021)|
|B&M European Val.Ret.||BME||47%|
|Hilton Food Group||HFG||-7.7%|
|Source: Thomson Datastream|
Perhaps the lacklustre period should not be too much of a surprise. The kind of tilt the screen has towards quality-growth large caps has been rather out of favour since November’s vaccine breakthroughs, which triggered strong outperformance by value plays and small caps.
A noteworthy aspect of last year's screen results was that they were the product of some necessary tinkering by me. The impact of lockdown on broker estimates meant very few companies could pass the screen’s test for forecast growth along with all the other criteria.
While the key issues faced by the screen last year was the view of the road ahead, now the issue is what is in the rear view mirror. Namely, fewer companies than usual have an unbroken record of consistent EPS growth over five years, which is one of the screen’s tests. This can be put down to an event that feels one-off so it seems reasonable to make adjustments to allow the screen to come up with a decent number of positive results.
I’ve therefore tinkered with the criteria to accommodate shares that experienced a Covid-blip in growth but appear to be making a strong recovery based on recent forecast upgrades.
The full criteria are:
■ EPS growth in each of the past five years… or a Covid-blip, but also 10 per cent upgrade to forecast next financial year* EPS over the past three months.
(the upgrades in the accompanying table related to the next 12-month periods rather than the next financial year.)
■ Return on equity of 12 per cent or more in each of the past five years.
■ Forecast earnings growth in the current financial year and the year after.
■ Gearing of less than 50 per cent, or net debt of less than two times cash profit.
■ Cash conversion (cash from operations as a proportion of operating profit) of 90 per cent or more.
In total, seven stocks made the grade. Full details can be found in the table below and I’ve taken a closer look at one of the picks.
Hilton Food Group (HFG) appeared as one of the Big Reliables screen’s stock selection last year. Despite liking the characteristics of the business at the time, I was more reticent on what investors were being asked to pay for the shares. The wider market has also struggled with the price tag since and the shares have performed disappointingly compared with the market. That said, the company has continued to make progress on a number of fronts which makes me think it is worth revisiting.
The company’s business chiefly involves building and operating state-of-the-art meat-packaging facilities. It has 18 such facilities with 3 in Australia, 4 in the UK and 7 in other European countries. Most of its operations are fully owned, although a few are joint ventures, and the facilities tend to serve major retailers on a dedicated basis.
The allure of Hilton to big retail partners is that its know-how and buying power provides a security of supply and a scale advantage, all of which is shared with customers. Hilton is also focused on providing supply-chain transparency and more sustainable products, which has further benefits for customers.
It’s customers are in a powerful position, though, with over half of sales coming from just three supermarket groups: Tesco in the UK; Ahold in Europe; and Woolworths in Australia. As a consequence of this, Hilton has a business model that is based on low margins but high volumes.
The relatively defensive nature of food retail, coupled with long-term contracts operated on a cost-plus or volume-dependent basis, provides Hilton assurances about profitability. That’s good, because Hilton’s business is very capital intensive which could make any serious drop off in trading particularly painful.
The company’s high investment requirements has been brought home to shareholders over recent years as the company has pursued growth opportunities both geographically and by moving into new products, such as seafood and vegetarian food. Indeed, capital expenditure over the last three financial years of £294m is about a quarter more than the entire amount spent by the company between 2004 and 2017 of £238m. It also dwarfs the depreciation charge over those three years of £81.6m. The company has also moved from a £34.6m net cash position to £122.2m net debt over the last five years. The company also does not currently hedge against currency fluctuations or movement in interest on its floating rate debt which is a risk to be seen in light of the business’s low margins and high capital intensity.
Sales and profits lag Hilton's investment in new facilities. This has meant the rise in spending over recent years has led to a steep decline in the company's return on capital employed (ROCE), which reflects the operating profit from a company as a percentage of average capital employed by its business in a financial year. But as spending slows, profits should play catch up. The graph below shows the trajectory of ROCE compared with the rapid increase in the amount invested in the company's operations. There was a big accounting change in the period covered by the graph which saw companies start to report leases on their balance sheets. For ease of comparison, the graph ignores leases to provide a clearer picture of the trend, however, based on FactSet data, including leases, the company’s ROCE is currently 10.8 per cent.
An ROCE of 10.8 per cent normally would not be considered very impressive. However, in Hilton’s case there are grounds to think there is now lots of gas in the tank thanks to the mega-spend of the last three years plus an £81m acquisition in 2017. Assuming the group ratchets down investment in coming years, consensus forecasts are for ROCE (including leases) to bottom at 10.2 per cent this year before climbing to 11.3 per cent next year and 12.3 per cent in 2023.
The recent performance of the shares may suggest some there is some caution about the pace of the company’s recent expansion. While trading has been very strong, the shares have de-rated from a high last May of 25.3 times next 12-month forecast earnings to the current valuation of 18.8 times. That rating compared with a mid-way rating over the past five years of 20.8 and a low of 16.1. However, the moderation in the rating is also likely to reflect a temporary boon while people ate at home more during lockdown which should now reverse.
If the company takes a breather on expansion, as brokers forecast, shareholders should see free cash flow bounce back to healthy levels while earnings continue to tick up thanks to past investment. Based on forecast FCF for 2023 and the company’s current enterprise value (market cap plus net debt) the forecast FCF yield stands at 7 per cent. For a company with such a dominant position in its market, that looks attractive.
There are risks associated with periods of heavy investment and contract disappointments could be devastating for a company like Hilton, but its market leadership offers safeguards too.
7 BIG RELIABLE SHARES (and downloadable version of table with extra data)
|Name||TIDM||Mkt Cap||Net cash/debt(-)*||Price||Fwd PE (+12mths)||Fwd DY (+12mths)||FCF yld (+12mths)||Net Debt / Ebitda||Op Cash/ Ebitda||EBIT Margin||ROCE||5yr EPS CAGR||Fwd EPS grth FY+1||Fwd EPS grth FY+2||3-mth Mom||3-mth Fwd EPS change%|
|JD Sports Fashion||JD||£9,481m||-£1,134m||919p||23||0.2%||4.4%||1.2 x||94%||7.4%||13.8%||18.1%||12%||23%||10.1%||7.7%|
|Hilton Food||HFG||£897m||-£367m||1,094p||18||2.6%||6.0%||2.9 x||77%||2.3%||10.0%||12.0%||7%||6%||1.3%||2.7%|
|Source: FactSet. *FX converted to £|