Shares in speciality bank note maker De La Rue (LON:DLAR) shed 20% in early trade today as a new era of management decided to get the bad news out of the way. The share price chart looks pretty ugly for long-term holders. The fall seems to have stabilised at 20% after the latest De La Rue profit warning:
This share price is well off the 440p region seen just six months ago in May. Since then, it has been a sorry state, with profit warnings (the first one was missed out by this blog), and also an investigation by the Serious Fraud Office surrounding allegations of corruptions in Africa.
De La Rue is a company that many people may not know of, but nevertheless use their products extensively. They provide and manufacture banknotes for many countries around the world, as well as the associated processing, counting and identification systems. This is no easy task considering the security that must go into such production. No surprise that in the past this has proven to be a durable, profitable business with high margins and a rated at a decent multiple of earnings.
What’s gone wrong at De La Rue?
We won’t get much insight out of today’s announcement, which is short and to the point.
De La Rue expects H1 2019/20 adjusted operating profits for the half year ended 28th September 2019 to be low-to-mid single digit millions. Full year 2019/20 adjusted operating profit will be significantly lower than market expectations.
It is not stated but this is a big miss. This is also given in adjusted terms and no doubt there will be many adjusting items now and in the near future given the nature of the upheaval.
The remaining lines simply read:
Management, led by the new CEO, is conducting a detailed review of the business and will update the market further when it reports its H1 2019/20 results on 26 November 2019.
De La Rue: A business on the slide?
To get some more context we need to look at slightly older events. There have been plenty of them, including:
- 30th May: Annual results show that FY20 results would be ‘somewhat’ below current year
- 12th June: Sells International Identity segment for £42m
- 16th July: Activist investor Crystal Amber puts pressure on company to ditch chairman Philip Rogerson. The company recommended to investors to re-elect.
- 23rd July: SFO open an investigation into suspected corruption in South Sudan.
- 25th July: Rogerson is re-elected, but only 51% of shareholders approve the remuneration policy.
- 2nd Sept: Kevin Loosemore is appointed new chairman.
- 7th October: CEO Martin Sutherland steps down and is replaced by Clive Vacher.
- 30th October: Profit warning as only a ‘low to mid’ single figure is promised for this year.
This is quite a lot to go on, and this comes on a backdrop where maintaining security is getting more complex as technology improves, and yet technology is actually reducing the use of physical banknotes as electronic cash becomes more and more popular.
What we can say is that this used to be a very good business. Profits were extremely healthy, which also supported a decent dividend. Perhaps an indication was the slipping of margins:
De La Rue: A Cash Crisis?
The last dividend of 25p seems likely to be cut to nothing at this current rate. The last few years accounts have been skewed heavily by exceptional items: first a credit provision for business in South America, the year before a valuation gain in the pension scheme. It seems that there will be plenty of restructuring costs in future, and potentially a liability to the SFO.
Despite dealing in cash, there is not much to be said about the level of cash at the company. Borrowings on the last accounts were £119m, and there is a large pension deficit of £77m. Debt is funded by bank overdrafts, which have a decent rate of 2.25%. Total borrowing facilities are £275m, which means there is some headroom, but these are renewable in 2021 and the terms may not be as advantageous.
In terms of the balance sheet, this is not great and may put off some investors altogether. Total liabilities are greater than total assets, and that is before considering that intangibles make up around £30m of the asset pile.
This doesn’t seem to be a great situation to me, especially if the SFO case is adverse. That would quickly lead to another De La Rue profit warning. It may be the case that even at this low share price a discounted equity placing could take place to shore up the balance sheet which would not be beneficial to investors. In retrospect paying out such a high level of dividend looks quite a poor decision. The level has been held at 25p for a few years, but with just north of 100m shares in issue, we can see that this is costing over £25m a year. Since 2014 over £200m has been returned to shareholders in this fashion.
Is the De La Rue profit warning a buying opportunity?
As ever the question with these warnings is are the problems permanent or temporary? It is certainly the case that De La Rue used to be a very good business, looking at past figures. But the past is no guarantee of the future. There are quite a few companies who have been made slowly obsolete by technology.
There are also quite a few moving parts to consider now. The potential liability regarding the SFO case, a potential shift in strategy with the new management team. Most likely further degradation of cash as business reorganisation is paid for out of exceptionals, and a refinance ahead. It is fairly certain that while banknote usage is reduced, real money will not be going anywhere soon. However, for me it is too difficult to call. There are no updated notes on Research Tree just yet, but the last Stockopedia updates were predicting net profits of £36.9m for this year. Even with this out of the window, the current valuation could be perceived as a little cheap, but not cheap enough to be tempted. 3/5.