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Sunday, 2 June 2019

New Investment: Howden Joinery at 14.5* forward earnings

New Investment: Howden Joinery

My last post was full of pessimism but owning a piece of Leaf Clean Energy has helped me to recover from a crisis of enthusiasm and confidence. It’s gone up around 600% since I bought it and this has been in my ISA, which is extremely helpful:

The lesson learned has been to slow down, work towards the minimum return I need to achieve the life I want (8%) and try and apply principles which were obvious and what I knew anyway, which is that I shouldn’t invest in anything I don’t understand, that are “safe” and have a high quality and somewhat unique business model.

My problem with the above is that as I have a strange anchoring bias to low P/Es, I have struggled to convince myself to pay the extremely high multiples on offer for high quality businesses.

But I do need to force myself into this world and I’m going to start with what I think is a high quality business, returning bundles of cash, where the P/E is not sky high.  That’s probably because the growth prospects are not proven and stellar but I’m happy to own this low risk stock with no debt.

Howden Joinery – the annual report lays out the business model very well and the investment case is well known to the value investing community:

Howden Joinery screens very well as a Magic Formula stock.  As a believer, I should be happy to buy it “blind”.

But it’s so much more than that.  It’s a wonderful shareholder friendly business with a unique, hard to replicate, business model, where all parties in the eco system benefit.  It’s debt free, ROCE is high, and kitchens aren’t going to become obsolete any time soon.  At 14.5* forward earnings, coming off a decent trading statement, it just needs to keep doing what it’s doing because.

The key risks to the investment are an erosion of competitive advantage – see the performance indicators below.  A UK recession will reduce profits and share price but one should really be prepared to buy into that.

What are the performance indicators I need to watch?

-      Gross Margin as an indicator of pricing power. If margins are falling, it could be an indicator of increased competition.  If they are going up, it could be an indicator that revenue increases are coming via pricing, not volume, which may not be sustainable in the long term.

-      Any change in metrics like working capital to revenue or receivable to revenue.  This is especially interesting because the business extends credit to its customers. Could this have the potential to blow out during a recession?

-      Any information on the roll out into France. It’s good that the group has settled on France as the next country to benefit from its full attention in terms of a growth strategy.  It’s still not at all clear what sort of runway or economics it might benefit from.  

-      Evidence of competitors evolving their business models such that they can erode Howden’s competitive advantage.  Key ones are Benchmarx (owned by Travis Perkins), in particular, and Magnet (owned by Nubia).  Benchmarx appears to be struggling to grow its branch network at the moment.

-      While the new CEO appears to have the right background and qualifications, any sign of a deviation from model or strategy.

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