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Twenty Piotroski plays

Cheap stocks showing the early signs of recovery
February 6, 2019

At the turn of the millennium, an accountancy professor named Joseph Piotroski published a paper that outlined a method to find ‘cheap’ stocks that had a greater chance of performing well. Mr Piotroski assigned cheap stocks a point for each one of nine fundamental factors they displayed to create what he called an F-Score. A score of 8 or 9 is considered high. The components of this F-Score are listed below. They are essentially an interplay of factors that suggest a company has successfully been improving its profits and cash flows using only internally generated capital.

 

F-Score criteria

■ Positive profit after tax, excluding exceptional items.

■ Positive cash from operations.

■ Profits after tax, excluding exceptional items, are up on last year, which Professor Piotroski highlights as being of particular importance as a signal that a company may be in recovery mode and in the process of rerating.

■ Cash from operations is higher than profit after tax, excluding exceptional items, which indicates an ability to convert accounting profit into actual cash.

■ Gearing (net debt as a percentage of net assets) is down on the preceding year, which suggests that the company has not had to look for external sources of finance.

■ The current ratio (current assets divided by current liabilities) is up on the preceding year, which suggests that the company's ability to service upcoming financial obligations is improving.

■ No new shares issued over the past year, which again suggests the company has not had to look for external sources of finance.

■ Gross margins have risen in the past year.

■ Improving capital turn (turnover as a proportion of net assets), which suggests greater productivity.

Mr Piotroski found that in the 20 years up to 1996 a long-short approach based on his criteria achieved an average annual return of 23 per cent, almost double that achieved by the S&P 500.

As is very evident from the results from this year’s screen, it tends to certain types of asset-centric businesses and highlights a good few ‘value traps’ – shares that are cheap for a reason. But the screen has enjoyed some real bumper years (it produced a 53 per cent total return in 2013). And while the total return from the screen picks last year was negative, it was comfortably above a combination of the FTSE 350, All Small and Alternative Investment Market (Aim), the indices the screen is conducted on.

 

2018 performance

NameTIDMTotal return (30 Jan 2018 - 4 Feb 2019)
Sylvania PlatinumSLP37%
MS InternationalMSI26%
Anglo AmericanAAL18%
Tritax Big BoxBBOX-1.9%
RotalaROL-4.4%
PetropavlovskPOG-4.4%
MPACMPAC-13%
Babcock InternationalBAB-24%
LamprellLAM-29%
VodafoneVOD-34%
FTSE 350/All Small/Aim--8.1%
Piotroski-

-2.9%

Source: Thomson Datastream

 

Overall, the cumulative total return since the start of 2012 of 96.8 per cent is better than the average total return from the indices of 83.5 per cent. However, this is before factoring in any real-world costs associated with sharedealing. Applying a 2 per cent annual charge reduces the cumulative total return from the screen to 71.2 per cent, which is some way below the return from the indices.

 

 

The FTSE 350, All Small and Aim are screened individually and the table of 20 qualifying shares in the table are ordered from ‘cheapest’ to most expensive (possibly better described as least cheap). I’ve taken a look at a stock that is at the more reassuringly expensive end of the table, which has the potential to recover based on its assets becoming more productive. The short story is that the company, Hunting (HTG), has essentially been a geared play on the oil price for the past few years, but the longer version of the story is set out below.

 

20 Piotroski plays

NameTIDMMkt CapPriceP/BVF ScoreFwd NTM PEDYFwd EPS grth F+1Fwd EPS grth F+23-mth MomentumNet Cash/Debt(-)
Kenmare Resources plcLSE:KMR£217m198p0.495-159%2.0%-7.2%-$9m
Town Centre Securities PLCLSE:TOWN£121m227p0.68175.2%0.1%2.8%-14%-£193m
Northern Bear PLCAIM:NTBR£14m73p0.68-5.5%--0.7%-£1m
Manx Financial Group PLCAIM:MFX£12m9p0.68-----19%£48m
SOCO International plcLSE:SIA£234m71p0.78207.4%---14%$129m
Macau Property Opportunities Fund LimitedLSE:MPO£94m152p0.78-----21%-$66m
Phoenix Group HoldingsLSE:PHNX£4.6bn639p0.7897.9%59%0.3%8.1%£419m
Sylvania Platinum LimitedAIM:SLP£61m22p0.7851.7%35%30%29%$14m
JKX Oil & Gas plcLSE:JKX£72m43p0.78----8.0%-$3m
Highcroft Investments PlcLSE:HCFT£45m870p0.79-5.3%---3.9%-£14m
Real Estate Investors plcAIM:RLE£96m52p0.78146.8%9.8%11%-4.8%-£84m
Elegant Hotels Group PlcAIM:EHG£67m76p0.8885.3%10%5.6%9.6%-$72m
Cardiff Property PlcLSE:CDFF£22m1,750p0.88-0.9%---3.8%£5m
Good Energy Group PLCAIM:GOOD£17m105p0.98153.1%-7.8%17%6.1%-£56m
Highland Gold Mining LimitedAIM:HGM£602m165p0.98106.8%10%-15%14%-$189m
LPA Group PlcAIM:LPA£12m98p0.98113.0%-39%28%-9.6%-£2m
HML Holdings plcAIM:HMLH£14m32p1.08-1.3%--5.0%-£1m
Paragon Banking Group PLCLSE:PAG£1.1bn414p1.0884.7%7.9%6.2%-1.5%-£5.8bn
Hunting plcLSE:HTG£899m547p1.18141.1%573%-30%-17%$39m
Sports Direct International plcLSE:SPD£1.4bn272p1.1820--30%35%-15%-£506m

Source: S&P CapitalIQ

 

Hunting

Oil and gas equipment maker Hunting is showing signs of being in recovery mode following a traumatic few years, although share price gyrations suggest investors are not fully convinced about prospects.

As the price of WTI crude oil plummeted from close to $100 a barrel in mid 2014 to a low point of below $30 in autumn 2016, Hunting’s sales fell off a cliff. The company’s markets are cyclical and its efforts to differentiate itself with investment in product innovation and patents offered limited protection. Indeed, the $456m-worth of sales it recorded in its 2016 financial year represented a third of the $1.39bn reported just two years earlier. And just looking at the group’s sales doesn’t do justice to the pain endured. High fixed costs and high working capital requirements meant big losses were reported and the group’s inventories-to-sales ratio ballooned to 47 per cent, compared with 28 per cent in 2014.

But for fans of recovery plays, it is the potential for these dynamics to work in reverse that holds real allure. The prospect of rising sales, soaring margins and handsome cash conversions represents the sunny uplands Hunting’s shareholders will be dreaming of. The company’s record of investment in patented, cutting-edge product innovation should put it in a good position to benefit. What’s more, there are certainly shards of light breaking through the clouds.

The headline numbers from Hunting’s results for the first half of 2018 made particularly pleasing reading. The company reported a pick-up in its underlying operating margin (this ignores amortisation on acquired goodwill) from -3 per cent to 12 per cent. That’s a level of profitability reminiscent of the good old days prior to the drop-off in the oil price. And while the working capital outlay needed to keep up with rising activity levels ate up a hefty $66m of the $79.7m reported cash profit (Ebitda), cash flows were strong enough to encourage management to reinstate the dividend and declare a 4¢ interim payment. Meanwhile, underlying return on capital employed (ROCE) moved from -5 per cent to 7 per cent.

 

 

There have also been significant earnings upgrades over the past year. Consensus earnings forecasts for the recently completed 2018 financial year have been upgraded by 160 per cent since the height of analyst pessimism just over a year ago. Meanwhile, 2019 earnings forecasts have doubled over the same period.

 

 

That’s all good stuff, but the key question with any recovery is if it has legs. If the recovery story has further to play out, there should be plenty more upside to come given most of Hunting’s geographic business units are still lossmaking – especially Europe, which reported a $5.6m first-half operating loss. However, a recent share price slump points to investors having serious doubts. The paradox here is that while on the one hand struggling units suggest further recovery potential, it is worrying that Hunting’s recovery still seems to be very narrow, especially given the mixed messages from the oil price. Indeed, the company’s return to form is to a large extent based on the strength of its fracking equipment business, Titan, in the US, and particularly activity in the thick rock deposits of the Permian basin in Texas.

Titan’s first-half sales surged by 62 per cent in 2018 to $217m (44 per cent of the total), while operating profits leaped from $19.1m to $57.3m. The strength of the US onshore market was also reflected in a return to profit for the US division, which swung from a $13.4m loss to a $7.1m profit. But the company’s five other divisions, which together accounted for $132m of sales, or 27 per cent of the total, all lost money.

Some encouragement can be taken from management’s comments that pipeline constraints in the Permian basin have increased onshore activity elsewhere in the US. There is also reported to be a slow recovery in offshore activity, particularly in the US, the Middle East and Asia Pacific. However, the fact spending remains relatively muted is reason to remain circumspect about the industry’s strength. Meanwhile, subdued North Sea activity continues to weigh on the European business.

Recent oil price volatility is not aiding the industry’s confidence in making big spending decisions. Indeed, Hunting’s own share price drop since autumn last year reflects the plunge in the oil price.

 

 

For oil bulls, the current share price could certainly be regarded as a second bite at the cherry. While the Piotroski screen uses book value to measure the recovery potential of shares, sales is arguably often a better alternative, especially with highly operationally geared companies such as Hunting that can see dramatic swings in margins. Based on an enterprise value (EV) multiple of forecast sales of 1.2, the valuation is in the bottom fifth of the five-year range. In other words, investors look about as sceptical now as they did before any operational progress had been made. But following the recent pick-up in performance, there is more ground to lose should the recovery prove as flimsy as recent share price gyrations indicate some fear.

On a more speculative note, another consideration is the growing attention being paid to the threat posed by renewables given the plummeting cost of producing energy this way – although it seems a stretch to think the dominance of hydrocarbons in the energy mix could be eradicated all that quickly.