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Why we invested in Patisserie Holdings

Patisserie Holdings (AIM:CAKE), is a UK branded café and casual dining group offering cakes, pastries, snacks, meals and hot and cold drinks from over 200 stores in the UK.

It currently operates under five different brands – Patisserie Valerie, Druckers – Vienna Patisserie, Philpotts, Baker & Spice and Flour Power City.

The largest and best-known brand, Patisserie Valerie, represented 75% of Group turnover and 80% of Group operating profit in the last reported 6 month period ending 31 March 2018.

For the last full year ending 30 September 2017, the Group had sales of £114m and pre-tax profit of £20.1m, having generated operating cash of a similar of a similar amount. In every practical sense, it therefore looked in great shape.

– Background

Patisserie Valerie was first opened in Frith Street in London’s Soho in 1926 by Belgian born Madam Valerie. During the Second World War the Frith Street premises were bombed by the Luftwaffe and Madam Valerie subsequently set up shop around the corner in Old Compton Street where her legacy continues to this day in the Group’s Soho branch.

But enough of the romantic past!

– AIM admission

Patisserie Holdings PLC, the holding company of the Group, was admitted to AIM on 14 May 2014 at a share price of 170p.

£32m was raised by the company for the purpose of paying down senior debt (£21.9m) and shareholder loans (£10.9m). Total borrowings prior to admission were £33.2m.

£46.5m was also raised by selling shareholders of which Executive Chairman Luke Johnson received £23.6m, Chief Executive Paul May £5m and Finance Director Chris Marsh £1.45m.

These were the only Executive Directors with the Non-Executives:
Lee Ginsberg – former FD of Domino’s Pizza
James Horler – ex Frankie & Benny’s and La Tasca restaurants

The Board has the same composition today and, given the rapid expansion since IPO, seems to have needed bulking up!

At the time of Admission the Group had 138 stores.

The Executive Directors oversaw a period of growth from 8 stores in 2006, suggesting they initially had a fairly hands-on involvement from relatively humble beginnings.

The Group’s main bakery in Birmingham, its only freehold site, is also the head office.

All the stores are leased.

– Why we invested

Unless the valuation looks very compelling, we are generally reluctant IPO investors, preferring to see how new AIM arrivals develop in the public eye. Having had a good look, we first invested in CAKE in December 2016, attracted for the following principal reasons:

Growing sector
A business that is simple to understand, follow and monitor
Retail roll-out self-funded from internally generated cash flow
Attractive operating margins 16%+
Attractive Return on Equity 15%+
Highly cash generative
Growing dividend distribution – interim dividend was raised 20%
Strong net cash position and zero debt
Experienced senior management who had a material stake in the business, despite selling down at IPO
UK domiciled
Clean financial statements with an absence of adjustments

In summary, we invested in what we considered was a relatively simple, well-run, cash rich business, overseen by highly regarded sector specialists, operating in a very vibrant sector, that was easy to understand.

We like investing in companies where senior managers are large shareholders and have grown with the business. Luke Johnson and Paul May both come with excellent reputations in the sector and, despite selling down, retained material equity stakes.

We were slightly wary of Mr Johnson’s multiple directorships, but reassured that, with a 37% stake in a sizeable business he would hopefully be keeping a close eye on things.

– What has happened

On 10 October the Company announced that the board of directors of the had been notified of significant, and potentially fraudulent, accounting irregularities and therefore a potential material mis-statement of the Company’s accounts. This had significantly impacted the Company’s cash position and may lead to a material change in its overall financial position.

On 11 October they announced that, without an immediate injection of capital, there is no scope for the business to continue trading in its current form.
Chris Marsh, the Chief Financial Officer, has been suspended from his role and was subsequently arrested by police, although then released on bail.

– Recent Director option sales

In July 2018, Chief Executive Paul May and Finance Director Chris Marsh exercised options and immediately sold shares for a combined value of £5.26m. While they were both sizeable transactions, Mr May still held 4.54m shares, representing a sizeable stake with a value of approx. £20m.

Option exercises followed by share sales by senior managers are a regular part of the stock market and AIM and we are particularly wary if this results in the said managers having little or no stake afterwards. This was not the case here, although Finance Director Chris Marsh, who is considerably younger than Johnson and May, has only ever held a relatively small stake in this business.


– Cash flow was the real attraction

We aren’t big on earnings numbers or the mythical EBITDA so often quoted by analysts. Cash flow is our focus and the real appeal of CAKE to us.

In the 6-month period to 31 March 2018 claimed operating cash flow of £14.6m in the period, was up £2.9m or 25% (2017: £11.7m). There was nothing untoward on the balance sheet to suggest any unusual movements.

£2.7m of this cash was used to make income tax payments and £5m invested in capital expenditure, leaving free cash flows of £6.8m (2015: £4.9m). Of the £4.4m, £2.9m was invested in new stores and £1.5m in refurbishment of the existing estate or additional bakery or fleet facilities. Normalised Free Cash Flow for the 6 months, excluding new store investment, was therefore £7.7m.

The business is apparently well-funded with zero debt and claimed net cash at the end of the first half of £28.8m.

– Any clues in the cash flow?

Hindsight is a wonderful friend to the investor and, looking at things afresh, cash flow post IPO may have been a little too rosy, however, glorious cash is an attribute of a business such as this.

In the period prior to IPO, when the group was opening 15 sites per annum, capital expenditure represented approximately 58% of operating cash flow and 10% of turnover. For the period ending 30 Sept 2017, when the group opened 20 sites, cash flow represented 36% of operating cash flow and 7.6% of turnover.
Capital expenditure for the year ending September 2017 was in line with the prior year which may be viewed as mildly surprising given the ongoing maintenance requirements of a larger estate. However, allowing for lease expiries the net increase in the store estate was only 15.

Finance expenses of £36,000 in the period suggested the Group was using an overdraft facility on occasions.

– Low level of finance income

The single orange flag which may have suggested that something unusual was going on was the low level of Finance income for a business that claimed such significant cash reserves at its accounting period end.

Finance income for the year ending 30 Sept 2017 was only £44,000 whereas the Group stated period end cash was £21.5m.

However, rapidly growing businesses of this nature, which are collecting small amounts of cash on a daily basis and periodically paying out large sums to contractors can experience wide swings in cash flow, necessitating cash be available at short notice. Furthermore, deposit rates have been extremely low over the past few years.

– Wage inflation

We were concerned about the impact of wage inflation but the Group appeared to be taking this in its stride.

While inflation on food costs was high, management commented how they had benefited from a number of contract renegotiations, and in some cases switched suppliers to mitigate inflationary pressures. This, along with production efficiencies from investment in their bakeries helped them maintain a gross margin of just below 78%.

Management commented that ongoing labour inflation was built into budgets and is being absorbed as the group continues to grow.

– Too many pies….

At the time of AIM admission Luke Johnson was a Director or Partner in more than 50 companies and limited partnerships, including some high profile names. However, he was not a Director of many of Patisserie Holdings’ key operating subsidiaries, notably Stonebeach Limited, through which Patisserie Valerie trades, where Messrs May and Marsh were Directors.

Companies House currently lists him as Director and Partner in 33 companies and Partnerships although the list excludes Elegant Hotels PLC (see below), where he also a Director. Another list indicates he is a Director or Partner of 40 companies or LLPs.

Of significance, since June 2015 Mr Johnson has been Executive Chairman of Brighton Pier Group, which owns and trades Brighton Palace Pier, as well as twelve premium bars and six indoor mini golf sites. This business had a very active period this year.

In May 2017 he was also appointed Non-Executive Director of AIM listed, Elegant Hotels Group. However, the influential advisory firm ISS urged shareholders to oppose his election to the Group, on the grounds he is already on the boards of two other listed companies.

He stepped down from the Board of Arden Partners (AIM: ARDN), the AIM listed institutional stockbroker in May 2018.

He also has a controlled function in Risk Capital Partners LLP an FCA regulated firm.

Mr Johnson also has an interest in Gail’s Bakery (a trading name of Gail’s Ltd) and there was rumour of a combination of this business with CAKE. Gail’s Ltd is ultimately owned by Bread Holdings Ltd in which Luke Johnson’s Risk Capital Partners II LP and RCP Co-Investment LP have a combined controlling stake.
Surprisingly, financial statements have never been filed for either of these 2 LPs whose ultimate ownership seems to be hidden behind an extensive web of Limited Partnerships.

Mr Johnson also writes a regular column for the Sunday Times.

Paul May is involved with FD Chris Marsh in another business called Christian Lewis Performance and Classic cars, a company which appeared to be technically insolvent at 31 May 2017.

With due regard to current events, it now seems clear that Mr Johnson needs to have more focus in his business interests and extract himself from a number of executive and non-excutive roles….for his own financial well-being and that of his fellow shareholders!

 

We are absolutely staggered how a profitable, cash generative business of this nature could have collapsed so dramatically and suddenly. We will issue an update when we know more.  

 


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AIM’s growing stature, £1bn companies and IFA attractions

In this video with IG markets Chris Boxall, co-founder of specialist investment manager Fundamental Asset Management, talks about AIM’s growing stature with 17 companies valued at more than £1bn.

Chris discusses the Inheritance Tax planning attractions of the larger, better-balanced AIM and considers why large companies such as ASOS (AIM:ASOS) and Fevertree Drinks (AIM:FEVR) choose to remain on AIM.

The video covers the attractions and potential pitfalls of ‘Buy and Build’ strategies adopted by the likes of Keywords Studios (AIM:KWS) and Victoria (AIM:VCP) and the growing interest in AIM from Independent Financial Advisers (IFAs) with IFA platforms Nucleus Financial Group (AIM:NUC) and Simplybiz Group (AIM:SBIZ) having joined AIM in the summer.

You can find out more about Fundamental AIM portfolios, including the latest fact sheets, from the link here.


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Fundamental IG AIM portfolios – Sept 2018 video update

In this video with IG markets Chris Boxall, co-founder of specialist investment manager Fundamental Asset Management, comments on the performance of the AIM for Inheritance Tax (‘IHT’) portfolios created for IG.

Chris picks through the portfolio of ‘Standard’ AIM for IHT stocks and also looks at the ‘High Yield’ portfolio of AIM shares, highlighting what investors should be focusing on for reassurance on the big dividend payouts.

Companies discussed include: AB Dynamics (ABDP), SIMEC Atlantis Energy (SAE), Smart Metering Systems (SMS), XLMedia (XLM), K3 Capital (K3C), Manx Telecom (MANX), Property Franchise Group (TPFG) and NAHL Group (NAH).

 

You can find out more about Fundamental AIM portfolios, including the latest fact sheets, from the link here.


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Inheritance Tax bill cut by 12%, or £710m, through investing in unlisted companies including AIM – record high

A new report from national accountancy group UHY Hacker Young highlights the tax saving benefits of investing in AIM quoted companies – there are considerable investment benefits as well!

According to UHY Hacker Young, HMRC forecasts show that the value of “Business Property Relief” is expected to rise 8% in 2017/18, from £655m in 2016/17.

Taxpayers are expected to reduce their Inheritance Tax (IHT) bills by 12% over the next year, or a record £710m in 2017/18, through investments made in unlisted companies and other business assets, says UHY Hacker Young.

Investments in qualifying AIM listed companies, Enterprise Investment Schemes (EIS) and other private companies have become increasingly popular over recent years as these assets are often exempt from IHT.

Investors have also benefited from exceptional investment gains as AIM has materially outperformed the main stock market over the past few years. This is reflected in the outstanding performance of AIM portfolios managed by Fundamental Asset Management and other providers.

– Scope to use BPR further

Latest figures show that taxpayers paid £5.3bn in inheritance tax in the last year to February 28 2018, up from £4.7bn in 2016/17*, suggesting that there is scope to use BPR to further lessen tax bills.

Mark Giddens, Partner at UHY Hacker Young, says: “The Government has reduced the scope of legitimate tax planning opportunities over the years especially for higher earners – so the few that are left are increasingly popular.”

“Encouraging investment in AIM shares and other unlisted companies is good for the broader economy as they create growth and jobs.”

“High inheritance tax bills have become a concern but there are steps that can be taken to cut the tax bill.”

The Publications section of our website contains more information on our high performing AIM portfolio service

 

 


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Fundamental IG AIM portfolios – video update

In this video with IG markets Chris Boxall, co-founder of specialist investment manager Fundamental Asset Management, comments on recent changes to the AIM for Inheritance Tax portfolios created for IG.

Chris discusses first quarter’s performance from the Standard Fundamental IG AIM Portfolio, which was developed for IG in September 2016, and the subsequent Higher Yielding Fundamental IG AIM Portfolio created at the start of 2018.

Chris also comments on changes to the portfolios, including the sale of the position in Restore (financial reporting that borders on the dishonest), review of the new IG portfolio position in Focusrite (a stock held by Fundamental since not long after IPO) and a replacement share for the higher yield portfolio following a dividend cut from one of the previous holdings – as anticipated, the higher yielding AIM portfolio is providing plenty of excitement!

Other companies discussed include Patisserie Holdings (AIM:CAKE), RWS Holdings (AIM:RWS), K3 Capital Group (AIM:K3C), Safestyle UK (AIM:SFE), NAHL Group (AIM:NAH), Epwin Group (AIM:EPWN) and Zytronic (AIM:ZYT).

 

After a challenging first quarter in 2018 for equities, Fundamental Asset Management AIM portfolios have seen strong performances from several portfolio companies over recent weeks, supported by excellent results and updates.


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The key to AIM success

Chris Boxall, co-founder of AIM specialist Fundamental Asset Management, writes in this week’s Investors Chronicle.

The article ‘The key to Aim success’ suggests how the AIM Admission Document should be essential reading for any investor in AIM companies, yet large parts of this vital document are often ignored.

The disastrous performance of Conviviality (CVR) and Accrol Group Holdings (ACRL), suggest many investors – both large and small – missed the warning signs in the admission documents of both these companies that may have prevented a substantial loss of capital.

Subscribers to Investors Chronicle can read the article by visiting the link here

Be wary of Buy and Build!
We are increasingly wary of the so-called ‘Buy and Build’ strategies adopted by some companies on AIM, led by corporate managers with little real equity participation; Conviviality being one such example of this. Many of these businesses seem to address low growth markets and are struggling to make real progress, flattering their reported returns through large ongoing exceptional items and restructuring costs, with signs of trouble often reflected in poor cash flow. To quote Warren Buffett, ‘Only when the tide goes out do you discover who’s been swimming naked.’ On this measure Conviviality could be likened to a nudist colony!


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How to work out if a company is in trouble?

In this video with IG markets Chris Boxall, co-founder of specialist investment manager Fundamental Asset Management, comments on the lessons to be learned on the fall in Conviviality, the wholesaler and distributor of alcohol and impulse whose shares are now suspended as it considers the anticipated impact on its funding position.

Chris suggests the signs were there long before the most recent news and all it took was simple common sense to steer clear of the impending disaster.

More positively, Chris discusses what Fundamental looks for in a growing smaller quoted company.

Fundamental Asset Management has been successfully investing in AIM for more than 14 years and therefore has plenty of experience in sorting the good from the bad! 

 

 

 


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IG AIM for High Yield – January 2018

In this video with IG markets Chris Boxall, co-founder of specialist investment manager Fundamental Asset Management, introduces a new High Yield AIM portfolio created for IG markets.

The average yield for this basket of 14 Inheritance Tax qualifying AIM stocks is nearly 6%, with one company offering a forecast dividend yield of 8%.

Chris considers the ability of the selected companies to continue to pay out hefty dividends and also discusses the merits of focusing on Free Cash Flow when assessing dividend payers. Stocks discussed in this interview include K3 Capital Group, Manx Telecom, Shoe Zone and NAHL Group.


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Will 2018 bring changes to the Inheritance Tax qualifying rules for AIM shares?

In this video with IG markets Chris Boxall, co-founder of specialist investment manager Fundamental Asset Management, comments on the rules governing the Inheritance Tax qualifying status of AIM companies.

Chris considers whether the Business Property rules have become too generous and which companies could be most at risk of losing their Inheritance Tax qualifying status.

Fundamental’s associated business Investor’s Champion provides a research tool to help identify qualifying AIM companies. You can access the research tool from the link here.


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IG AIM portfolio update – December 2017

In this year-end video with IG markets Chris Boxall, co-founder of specialist investment manager Fundamental Asset Management, provides an update on the AIM portfolio created for IG Markets which continues to perform strongly.

Stocks discussed in this interview include Fulcrum Utility Services, Patisserie Holdings, XL Media, Character Group and Atlantis Resources. The portfolio delivered excellent returns in 2017, with a particularly strong performance from one of the companies discussed in the video here. Chris also offers his thoughts for 2018.