21st Century Net-Net #2 – Home Retail

The doom and gloom that surrounds retailers continues and it’s thrown Argos and Homebase into my sights.  As things currently stand the FTSE 250 listed company has a price to book ratio of 0.27 and price to tangible book of 0.76, so it’s cheap by book value.  For those that like to look at liquidity the headline figures are net cash of £200m (at the last interim report), quick ratio of 0.72 and current ratio of 1.63.

The market cap is over £700m so it’s quite big for a net-net, even a 21st century one.  In terms of the original net-net ratio, it does have a positive number which on its own is a stretch for most companies, but at more than 2 it’s well past Ben Graham’s old limit of 0.66.

However, that’s the whole point of using an updated set of ratios, so that the pool of available stocks is wider in order to allow greater diversification in a smaller market like the UK.

Looking at the most recent reports, it’s obvious and completely expected that times are tough.  You aren’t going to get many net-net type companies that aren’t having lots of trouble, but that’s exactly why the requirement is that they have net cash, i.e. enough ‘cash’ assets to pay off all borrowings.

Home Retail passes my 10-minute sanity check, which just includes a quick glance at the most recent reports and statements and any news about the company.  I didn’t find any obvious signs that the company was about to collapse in the next few weeks or months so I will be adding Home Retail Group PLC to the 21st Century Net-Net model portfolio is due course.

You can see below the top 10 stocks by this screen, sorted by price to book.  All else being equal I’ll be adding AGA next week.

Further reading:

  1. 21st Century Net-Nets
  1. 21st Century Net-Net #1 – PV Crystalox Solar

 

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Comments

  1. Cautious Bull says

    Is HOME still a net-net once all the operating leases commitments (ie. off-balance sheet liabilities) have been capitalised and brought on to the balance sheet?

    • says

      Hi Steve. Yes because off balance sheet liabilities are not on the balance sheet so they’re not part of the analysis! I see what you’re saying but that kind of investigation into the possible effects of lease costs just isn’t part of the net-net strategy.

      What you’re suggesting is the same as deeper analysis into Magic Formula stocks, the benefits of which are highly uncertain. This is a mechanical system like the Magic Formula and much like the original net-net strategy so these kind of insights are just not relevant.

      It’s also why each individual position makes up only 1.7% of the whole and also why the holding period is 5 years. Any deep analysis of the company is just not likely to be relevant with so many positions held over such a long period of time.

      If I were holding say 10 of these things as an anti-diversifier like Buffett might, then yes I’d probably look at it in more detail, but that’s not the spirit of net-nets.

      More importantly, I see from your twitter profile that you now operate from a secret volcano lair… I suppose that keeps the heating costs down!

      • says

        John,

        I disagree with you in terms of Home Retail being a net net on this one. The concept of net net is that if the business was to close that one would be left with a surplus cash value.

        To focus only on the mechanistic nature of the stock screen is to miss the point of what a net net is.

        I doubt very much that that is the case with Home Retail Group. The off balance sheet liabilities cannot in my opnion be ignored.

        Now I can see that you are seeking to reduce risk by running smaller position sizes. However a stock is a net net or it isnt. This isnt one in my book.

        John

        • John Kingham says

          Hi John. These “net-nets” certainly get us value investors animated, that’s for sure.

          I disagree with your point about what a net-net is but I’d rather not argue the toss here (although I would say that liquidation is typically the least frequent route to profit with net-nets).

          My portfolio is based around the net-net study done in the UK, which you can read here (although you’ve very probably read it already):

          http://bit.ly/y10Edx

  2. says

    Thanks for the article. I have not read it but will rectify that. I was aware that liquiditaion was very rare as a release of value.
    I do believe that HOME is deeply undervalued and distressed. I see some huge opportunities that could be released if an appropriate startegy were ever pursued (ie reducing store count, particularly in areas with store overlap) and concentrating on the web. Less stores more trucks so to speak. Also, the receivables book is as far as understnad it unleveraged, so it is a store of value.

    I think that iver the course of your holding period that HOME may well make you a lot of money (and that is all that counts), but they need radical surgery first (and that to my mind could well involve a rights issue). At the very least the company needs an entirely new mgt team with a less hang-ups about store based retailing.
    I concede that none of that is likley to be of any interest in a quantitative approach, where a security meets your criteria or it doesnt. To be fair, many opportunities are missed by investors because of over analysis. A quant based approach dampens much of that.

    • says

      I agree, I think they have a lot of challenges ahead, but hopefully they’ll make it as I like Argos. Very handy for buying something on-line and immediately wandering down the high street to pick it up.