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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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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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A tale of investment in AIM – a disastrous start becomes highly rewarding!

A recent meeting with the management of AIM quoted CVS Group (AIM:CVS) offered a useful reminder of the benefits of patient investing and staying the course. Hopefully the veterinary group will offer plenty more excitement over the coming years as it dominates the UK market and expands overseas.

We first invested in CVS Group at the time of its IPO in October 2007 at a price of 205p. The IPO saw selling shareholders place £92.6m value of shares with the market capitalisation on IPO approx. £105m. It should be remembered that 2007 was the year that AIM saw a flurry of IPOs with AIM reaching a peak of 1694 companies in the year.

There was no new money raised by CVS and the Group arrived on the market carrying £28m of net debt and a shareholders deficit of £1.5m. However cash generative and appealing the business model might appear, negative market sentiment was clearly not going to be good news for a business with a somewhat fragile balance sheet of this type!

When it joined AIM CVS was already one of the leading veterinary service providers in the UK, operating 45 veterinary practices (consisting of 128 individual surgeries) nationwide and three veterinary diagnostic laboratories. It was also the UK’s largest employer of vets with 271 employed, representing 2.2% of all vets estimated to be registered and practising in the UK.

The business was established in 1999 with financial backing from funds managed by Sovereign Capital Partners LLP with the objective of consolidating the fragmented UK veterinary services market. It had already completed acquisitions costing approximately £32.9m.

Turnover for the year ending June 2007 prior to admission was £38.9m and operating profit £2.9m.

Simon Innes had been appointed Chief Executive in 2004 and remains in the role to this day. Prior to CVS he was Chief Executive of Vision Express from 2000 to 2004, over which time he built the business up to £220m turnover and 205 practices. The growth strategy that was successful at Vision Express formed the model of that being implemented by CVS.

Notwithstanding the apparent defensive qualities of the veterinary sector CVS subsequently saw its share price tumble from 242p to a low of 79p, a near 70% sell-off. While we didn’t feel brave enough to whole heartedly commit further client funds we retained a position in the CVS for many of our clients and as things started to look more assured started buying again.

Fast forward 10 years to 2017 and CVS has just reported record results.

Group revenue for the year ending 30 June 2017 leapt 24.6% to £271.8m, with like-for-like sales growth for the Group of +6.3%. Of this The Veterinary Practices Division contributed the lion’s share, growing revenue 25% to £247.9m.

Operating profit rose 46.2% to £17.2m, cash generated from operations increased 10.8% to £37.2m and profit before tax increased 58.4% to £14.5m. Basic Earnings per share increased 59.5% to 18.5p.

CVS acquired 62 surgeries in the financial year and now own 432 surgeries in the UK and the Netherlands. In the UK the equine business has also expanded strongly.

The business is now managed across four divisions: Veterinary Practice, Laboratories, Crematoria and Animed Direct. The Veterinary Practice Division remains the core but all areas are performing well.

The development of their referrals business has been a key priority of late and in October 2015 they opened Lumbry Park in Hampshire, a 13,000 square foot state-of-the-art multi-disciplinary referral centre. This provides a full range of specialisms, using the most modern equipment including both a CT and an MRI scanner. Early teething problems have now been resolved and profitability is now around the corner for Lumbry.

The Group has its MiPet own brand range of products and dual language packaging (English and Dutch) has begun to be introduced so that they can also sell their own brand products in the Netherlands.

The Healthy Pet Club loyalty scheme saw over 53,000 pets added to the scheme increasing membership by 20.9% and bringing the total membership to 306,000. The scheme provides preventative medicine to their customers’ pets as well as a range of discounts and benefits. The Group gains from improved customer loyalty, the encouragement of clinical compliance, protecting revenue generated from drug sales, and bringing more customers into their surgeries. Monthly subscription revenue generated in the year increased to £32.5m (2016: £24.0m) and at the year end, the monthly run rate represented 13.4% (2016: 12.3%) of practice revenue.

CVS also now has 14 emergency out-of-hours sites thereby reducing reliance on third parties for the 24-hour cover that vets are required to provide.

The ten sites in the Netherlands are likely to be joined by others in the short term. This will provide a base from which to establish an integrated business in the Netherlands in a similar way to the UK; the Netherlands is 20% the size of the UK market.

The buying group was enhanced by the acquisition of VetShare and they have now negotiated additional annual rebates for members and sell own brand products to them. We anticipate plenty more gains from improved buying terms over the coming years.

The Group also launched its own MiPet Cover insurance in August 2017 with the initial plan to establish the product in their own practices before considering wider marketing.

A MiNurse Academy was launched in January 2015 and has now helped over 300 nurses learn specialised skills.

A vet graduate training scheme continues to grow and 375 graduates have gone through the scheme in the past three years. The scheme is designed to assist newly qualified vets make the challenging transition from university to day-to-day practice.

Other smaller divisions also performed well as the Group is able to benefit from a broader offering with all divisions serving the practices.

As you can gauge from the above, this business is really starting to dominate all aspects of the veterinary market in the UK.

With plenty more growth to go for in the UK, the Netherlands acquisition strategy in its infancy and ancillary activities such as Laboratories, Crematoria and Animed Direct really now starting to come through, the future looks very bright for CVS.

Those brave enough to have bought shares around the 79p level and held on until now will have enjoyed a 1700% return to date.

Investors in many high flying high growth companies such as ASOS or Amazon and Monster Beverage in the US will have similar stories to tell of multiple share price sell-offs before confidence sets in and the share price and valuation moves to another level. Thankfully CVS’ dip was relatively soon after IPO but no doubt there will be other psychological challenges ahead for investors.

Casting an eye back to the IPO and what went wrong in the early days on AIM, we remain wary that CVS doesn’t overdo the gearing. Net debt at June 2017 year end was £100m and there remained plenty of headroom following an agreed £37.5m increase to its existing credit facility. Thankfully the cost of debt is also considerably cheaper now than 10 years ago. Free cash flow of £23.8m highlights the attraction of the business model and evidently if they stopped acquiring there would be plenty of cash available to pay down debt in quick time.

We anticipate further equity raises to support the likely acquisitions in the UK and Netherlands.

Hopefully investors in CVS will continue to be rewarded for their patience!

If you are interested in investing in high growth companies or AIM shares for Inheritance Tax planning please contact Chris or Stephen at Fundamental Asset Management by visiting the link here.

Our associated research business Investor’s Champion has covered CVS Group since IPO – please visit the link here for their research

 


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April sees AIM surge higher as London’s growth market approaches GBP100 billion value

It was encouraging to see AIM welcome several high growth new arrivals in April 2017 with the market value of AIM creeping ever closer to GBP100bn – good news for those investing in AIM for Inheritance Tax planning purposes

At the end of April 2017 there were 967 companies on AIM with the total market value of London’s growth market GBP92.83bn. This compares with the same number at the end of March 2017 when the market value was GBP88.78bn; there were 5 departures and the same number of new arrivals. It was encouraging again to see newcomers match leavers

A notable departure was Sirius Minerals, the fertilizer development company, which moved onto the Main Market.

AIM’s total market value hit a high of GBP108bn in July 2007 with 1,673 companies on the market. The market value subsequently fell dramatically in 2008 to only GBP37bn, with the AIM Allshare Index tumbling just over 67% over that period. It will therefore be a huge achievement for AIM to breach the GBP100bn level once again, especially with over 700 fewer companies than previously, yet again highlighting the dramatically improved quality of AIM.

From our perspective two of the more interesting AIM news arrivals were as follows:

Alpha FX Group (AIM:AFX) is a corporate foreign exchange specialist with a strategic focus on helping its clients control the impact currency volatility has on their business.

For those faced with the challenge of hedging their cash flow forecasts, they provide hedging programmes that ensure they can price competitively, maintain profit margins and cash flow. For those who don’t need a hedging programme, they still provide a range of execution services designed to reduce the time, cost and cash flow constraints that come from managing FX.

This is a highly profitable and cash generative business.

The Group raised £13m of new money and saw vendors sell down £17m at a share price of 196p. The shares got off to a very strong start on AIM and are currently up over 60% on the IPO price at 321p per share pushing the market capitalisation up to £105m.

The shareholder register includes some well-known institutions including Soros Fund management, who should know a thing or 2 about Foreign Exchange!
K3 Capital Group PLC (AIM:K3C) is a business sales and brokerage business headquartered in Bolton with operations throughout the UK and another highly profitable operation.

K3C helps its clients with the presentation of their businesses for sale to market, sourcing potential acquirers, and project management of transactions to completion. The Group has three trading subsidiaries KBS Corporate, KBS Corporate Finance and Knightsbridge.

The AIM placing raised £15.7m of old money for selling shareholders and £2.1m of new money.

 

Fundamental Asset Management has provided AIM Portfolio Management for Inheritance Tax planning purposes for over 10 years and has an outstanding performance track record.  Further information on our AIM services are available from the link here


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AIM for the end of the tax year

AIM, the London Stock Exchange’s international market for smaller growing companies has delivered terrific performance over the past 12 months, highlighting its growing maturity and the hugely improved quality of its constituent companies. We would strongly encourage investors seeking exposure to growing, profitable, cash generative, dividend paying smaller quoted companies to take a closer look at AIM this ISA season. If one adds the Inheritance Tax benefits, especially in an ISA wrapper, many AIM companies make a compelling investment proposition.

While the FTSE100 has risen an admirable 20% over the past 12 months to date, the AIM All Share Index has eclipsed this with a rise of 29%. Inheritance Tax planning portfolios also continue to outperform and offer greatly improved liquidity compared with many years ago.

At the end of February 2017 there were 973 companies on AIM with the total market value £86.8bn, resulting in an average market capitalisation per AIM company of just over £89m. Looking back 12 months to February 2016 and AIM’s total market capitalisation was only £68.6bn but there were 1,029 companies, resulting in an average market cap per company of only £66.7m.

While there have been a large number of departures from AIM over the past 12 months, including several high quality companies like Fyffes, the importer of tropical produce, which was taken over in February, the vast number of leavers were perennial under-achievers whose time was up! For the first time in many months, February 2017 encouragingly also saw AIM new arrivals match cancellations with 5 departures and 5 genuine new arrivals.

Looking back again 12 months to 2016 and there were 4 AIM companies with market capitalisations over £1bn, with the aggregate market value of these £7.3bn. By comparison, at the end of February 2017 there were 8 AIM companies with market capitalisations of over £1bn with an aggregate value of £14.4bn.

A glance at the lower of end of AIM also supports our view of the improving quality of the market.
Back in February 2016 there were 232 companies (22.5% of the number of companies on AIM) with market capitalisations no greater than £5m. Fast-forward 12 months and this has fallen to 171 companies or 17.5% of the total at the end of February 2017.

However, the statistics don’t tell the true story. It’s the nature of AIM’s larger constituent companies that is really encouraging. Looking back further to 2011 and AIM’s Top 50 companies were dominated by mining and oil and gas companies, many of which were operating in faraway places and consuming vast amounts of cash. The Top 50 of 2017 is now dominated by profitable, cash generative companies that will be familiar to many, notably retailers ASOS and boohoo.com, the soft drinks groups Nichols (Vimto) and Fevertree Drinks and Breedon Group, the largest independent construction materials group in the UK.

While many companies in the Top 50 have significant operations overseas and are therefore currently enjoying a nice currency boost due to the weakness of Sterling, the management and centre of operations are predominantly UK based. This offers confidence to investors who may want to meet with management or carry out company visits – it’s certainly a lot easier assessing the investment merits of a retailer compared with that of an explorer in some far-off land!

The share prices of many of AIM’s largest companies have risen strongly over the past few months suggesting the valuations of some now appear somewhat stretched, however there are also plenty of more compelling opportunities among AIM’s smaller companies that are worthy of greater attention. Substantial AIM businesses like family controlled Watkin Jones Group, one of the UK’s leading construction and development companies or Smart Metering Systems who connects, owns and operates gas and electricity meters on behalf of major energy companies could have a very bright future.

Our AIM for Inheritance Tax planning portfolios can be accessed through our platform with Jarvis Investments or via the Elevate, Transact, Nucleus and Standard Life wrap platforms.

Take a closer look at AIM this ISA season!