A look at Fleetwood
Fleetwood is a business that specializes in building two forms of accommodation – homes with wheels (e.g. caravans), and villages for miners. As such, the company’s share price is highly exposed to the mining cycle – it increased from $2 at the start of 2003 to peak above $10 in 2007. The share price then plunged below $4 in 2008. From this trough it again surged, this time to $14 in 2011, but has since fallen back to $4.
Despite this underlying volatility, we have always considered that the company has been managed well, albeit we haven’t believed that management’s remuneration including options were completely aligned with investors’.
With the share price nearing decade lows again, we were wondering if this presented another opportunity to invest. Unfortunately, we’ve concluded that a light is less likely to be lit under the share price for a third time.
To set the scene, Fleetwood’s profits declined significantly in the first half of 2013 – Earnings before Interest and Tax for December 2012 was $14.9 million, compared to $37.3 million in December 2011. The decline was due to falling demand for accommodation and weak trading conditions for recreational vehicles. Yet management was confident that the business would recover, stating that the balance sheet was strong and the outlook for accommodation demand was positive.
But in May, the company released a further downgrade to full-year earnings, stating that “as a consequence of flat or weaker trading conditions in the group’s principal markets, profitability during the second half of the year has not met expectations. It is anticipated that second half earnings will be marginally below those reported for the first half”. The share price fell considerably as a result, but the market may not have considered the full extent of Fleetwood’s troubles.
Management’s outlook of mining accommodation appears to us to have been consistently optimistic. You can decide whether this was overly so. We believe that the full extent of the slowdown is still not being appreciated by the market.
To explain, Fleetwood’s flagship accommodation village is Searipple, which was constructed in Karratha, Western Australia, for Rio Tinto and Woodside. As a result of the completion and slowdown of projects, the village has been unable to retain high rates of occupancy. Despite management forecasting demand to improve in the second half of 2013, it seems that the occupancy has remained at depressed levels. In addition, it seems that a pricing war is developing in the Pilbara accommodation market. Villages are virtually carbon copies of each other, which means operators can only compete on price. So not only are occupancy rates not improving, but the margin that Fleetwood can earn on rooms is declining.
The situation may also be worse in Gladstone, where it is becoming increasingly apparent to us that there is an oversupply of accommodation. Fleetwood had plans to build a 1,000-room village, which management expected to generate revenues from the first quarter of 2014. If the project is put on “permanent” hold, then write-downs will feature prominently in future reports. Could the project be put on hold indefinitely? We ask why couldn’t it?
The financial impact of disappointing occupancy rates may be exacerbated by the capital expenditure that was required to build the villages. Fleetwood had minimal gearing on their balance sheet in 2009 – this was a critical reason that allowed Fleetwood to recover so quickly from the downturn. Yet this time around Fleetwood has taken on considerable debt to fund construction. So not only is the company at risk, in our estimation, of reporting write-downs if its economics don’t improve, it will also be left with a considerable amount of debt on its balance sheet that will need to be serviced.
At least management’s comments regarding the outlook for the caravan division were more appropriate in the half-year results – “revenues for the recreational vehicles division will continue to be affected by consumer sentiment”. Unlike accommodation villages, demand for recreational vehicles did not improve with the mining boom, and Fleetwood has been forced to consolidate its manufacturing operations in order to contain this cost base.
If the company’s financial position continues to deteriorate, management’s focus will be restructuring the balance sheet rather than maintaining distributions to investors. In recent years, the company has maintained a dividend payout ratio of around 80 per cent – this has been a key attraction for investors searching for yield. If management is forced to restrict dividends, these investors might be rushing for the exits.
It’s reasons like this that we think the chase for yield has been a fad like so many others.
The recent spate of downgrades from mining servicers has not signalled the bottom of the downturn in our view. It could be that the worst is yet to come.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
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Sam
:
Hi Ben,
Is this becoming a textbook Benjamin Graham stock, with equity per share of $3.50 and at a current share price of $2.20? I have always found it hard to understand how Graham distinguishes between businesses deserving to be cheap compared to mood swings in Mr Market.
Be interested to hear your thoughts,
Cheers,
Sam
Roger Montgomery
:
Prospects, Prospects, Prospects? That’s the question. In any ‘asset play’, with Receivables, Inventory and Goodwill the major items on the balance sheet, you really need to be confident in the equity valuation. Then you can determine the level of the discount being presented. WIth return on average equity of no more than 2.3% you do have to ask if a $5m impairment is adequate…
Sam
:
Thanks for the reply,
I would never have bought the stock, however when reading his books, Graham only refers to buying businesses when they are selling for less than the net assets or current assets of the business, he doesn’t rely on qualitative analysis foremost. This led me to look at examples and all I could find was low quality stocks that deservedly were cheap for their dismal prospects.
Cheers
Roger Montgomery
:
If memory serves me correctly, I believe in Security Analysis and The Intelligent Investor there is a discount applied to the asset side of the equation Sam.
Sam
:
Thanks
Sam
:
http://rogermontgomery.com/should-a-value-investor-imitate-ben-graham/
This helped greatly, thanks again Roger and the team.
Luke
:
As someone who lives in Karratha, I can advise that the amount of houses built has rapidly increased and is starting to meet demand, particularly now that the Pluto project has finished construction. The amount of new housing estates going ahead in South Hedland is also massive.
Also the searipple village does have an advantage in that it closer to Town in a nicer area, but the problem is that the employers choose their accommodation for their employees and they choose based on cost.
Hedland Hint
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Fleetwood are currently constructing another camp in Hedland for key service workers, where they are charged rent no more than 40% of their income. This was probably viable when the market was extremely tight however with the recent downturn in Hedland rents and improved availability of accommodation this project could further impact on Fleetwood revenue.
Clown
:
What debt are you talking about?
Roger Montgomery
:
I suspect Ben was referring to the debt on the balance sheet.
xiao fang xu
:
from latest half year report:
cash 9 million
balance sheet 20 million debt
dividend to pay 18 million
all debt 68 million
6 million cash flow
always spending on PPE in excess of 10 mil.
im not sure about 22 million from cash flow statement if it is recognized in balance sheet or no ( Proceeds from borrowings 22 mil.)
receivables 49 mil. –Any bad debt?
Roger Montgomery
:
the key wil be the next half year report and the one after that. Can’t drive by looking in the rearview mirror.
paul wallace
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Take a look at DCG . Gladstone village going very well and the competition wont be building any new villages any time soon . Also no debt and well run .
Roger Montgomery
:
Just need increasing customer base to grow. When you say “going very well”, what measure have you used?
Andrew Legget
:
It goes back to your microeconomics post. When supply outstrips demand than the price being offered needs to drop until the two points meet in equilibrium.prices will keep dropping until they can fill them which is not an attractive scenario for these companies.
As the villages were built for the mining boom times it could be argued that equilbrium where supply meets demand doesn’t exist as it would be unlikely for a while at least that companies will hire enough employees to keep them full going forward with the slowdown in effect.
It is amazing how things can change so quickly, a couple of years ago almost everyone was flocking to anything to do with mining, now it is an area that it would be wise to avoide for now at least.
I think it reinforces the importance of ocmpanies that can control its own environment and create products and services that are desired through all times.