There's no one magic formula when it comes to assessing companies and making investment decisions. Hardly a revelation but a concept which accounts for the huge variety of funds on offer, the numerous strategies employed and crucially, the degrees of success (or lack of) achieved. In this article Luke Newman, manager of the F&C Special Situations Fund offers an insight into the potential of focusing on ‘real' assets.
Cash is king
At F&C Investments we have a range of UK equity funds all looking to harness the potential of UK stock market in different ways. One thing we share however is a common way of analysing and assessing companies. In very simple terms we look at cashflow within a business focusing in particular on returns a company can make on cash it reinvests. We believe this approach offers a true insight into the current performance of a company and from there is an effective way of assessing its likely fortunes in the future. This analysis then indicates whether the share is attractive from an investment perspective given its current price. We also look closely at a company’s balance sheet as real investment opportunities can be uncovered.
Our obsession with the balance sheet has proven positive in 2006 not least through the targeting of firms where hidden value is overlooked. Nowhere has this been more identifiable than companies boasting significant property assets and crucially, the potential to realise value through the sale of land and buildings to alternative users.
Increased hunger for property investment and its inherent characteristics means that companies with ‘real’ assets have, in many cases, seen significant appreciation in their value. The opportunity for us as investors lies in the fact that values are often understated on balance sheets – typically property assets are valued irregularly and their stated value often belies their real worth. Identifying such anomalies takes time and effort, but numerous examples of companies disposing of assets at a significant premium to ‘book value’, not to mention the high incidence of M&A driven fundamentally acquiring firms looking for ‘real’ assets signals that there are gains to be had for the canny investor.
Forecourt for sale
Two areas geared into this theme have been the auto distributors and pub operators, and by selectively building exposure to both we’ve been able to benefit from structural changes in the way each industry is structured and firms within them operate.
Many firms in the pubs industry for example have been looking to realise the worth of their property assets, either selling properties for conversion to alternative uses, often residential, or foregoing freehold rights in order to generate cash to reinvest elsewhere in the business. Indeed, in an industry rife with consolidation those with attractive assets often find themselves subject of approaches – Greene King’s acquisition of Hardys & Hanson, was partly triggered by the tempting nature of the latter’s property assets.
The auto distributors are another area typically characterised by ‘real’ attractive assets, and one where fundamental changes mean firms are increasingly keen to unlock their latent value. Recent European Union regulations have improved the position of car distributors relative to the manufacturers, meaning that there is less emphasis on them owning their own property assets. In turn many firms have looked to expand through acquisition and a strategy of identifying those ripe for consolidation has proven to be a profitable strategy in recent months. We held Pendragon who bought Reg Vardy and hold European Motor Holdings (which recently became subject of a bid).
Real long-term potential
Whilst we don’t foresee these trends carrying on indefinitely we do expect an appreciation of ‘real’ assets to remain an important element of successful investing. One area of interest is the roll out of REIT legislation in the UK, particularly if firms with significant property assets are able to organise themselves into distinct operational and property companies – further increasing their strategic options. This will not be a fast process but it is clear from our recent meetings with management within the pub and car retailing industry that a number of companies are monitoring the situation very closely.
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