Private equity firms have become good at bin diving, picking up companies discarded by other investors. A £1.36 billion approach for the waste collection group Biffa by the US private equity house Energy Capital Partners (ECP) is another tight-fisted swoop.
Cheap valuations make the London stock market prime hunting ground, one now more appealing due to the sell-off that has ensued from the war in Ukraine and rising inflation. ECP has proffered 445p a share after some back and forth with the company which, if made formal, the board would be minded to recommend. But investors should want them to hold out for more.
The mooted price represents a 37 per cent premium to the undisturbed share price, but that looks less meaty when you consider the shares had been trading just 7 per cent below the potential takeover price as recently as last September.
Biffa’s strategy forks towards expanding its core industrial and commercial and municipal collections business, and building out waste management infrastructure including plastics recycling and energy-from-waste incinerators. For the former, buying up smaller rivals is a quicker means to nabbing more contracts with businesses and local authorities. Last year’s £126 million acquisition of Viridor’s collections and recycling assets has been the biggest example thus far.
The closure of businesses led to a dramatic fall in waste and recycling volumes during the pandemic, but those have rebounded markedly. Over the first half of the financial year, revenues were 2.5 per cent higher than the same period prior to the pandemic, after excluding the impact of acquisitions. Including some one-off accounting items, such as charges relating to the slower recovery of its members-only discount food retailer Company Shop, means analysts have forecast a £2 million loss for the 12 months to March this year. But that switches to a £56 million profit for the current financial year, in line with pre-Covid levels and more than double 2019.
ECP’s approach ignores more recovery potential. Based upon profit forecasts from the brokerage Peel Hunt for this year, which would better take into account the full integration of recent acquisitions like Viridor and a return to more normal trading, the price tag implied by ECP’s approach would be more like 8.8 times adjusted profits before tax and other charges. There is also the value of two energy-from-waste facilities that are under construction to think about, Peel Hunt points out, which if included put the takeout multiple at more like 8.2 times 2023 forecast adjusted profits. That doesn’t look that impressive against an average multiple of seven since IPO. Analysts there think Biffa is more deserving of a price tag of 500p.
A more sustained recovery in trading could justify an even higher asking price. Analysts at Canaccord Genuity reckon that a more normal cash return on assets over the next five years, which it puts at 10 per cent, is just one reason for ECP to cough up more. It says the 445p on the table implies that Biffa will only be able to manage a return of that magnitude for the next two years, before competition erodes sales and margins and causes that metric to more dramatically slip. The Canaccord target? 530p.
What might have weakened the board’s hand? A landfill tax inquiry into the potential misclassification of waste is casting a pall over the industry, The presence of an inquiry is not news, but the gulf between the best and worst case scenarios is more sweat-inducing. EY’s estimate on behalf of Biffa is roughly £170,000, but the potential liability? Up to £153 million. No formal claim has yet been brought by HMRC, but investors often balk at uncertainty.
Still, investors shouldn’t feel grateful for the ECP offer as it currently stands.
ADVICE Hold
WHY A sweetened formal bid for the company might emerge and post-pandemic recovery gains are still on offer
DFS Furniture
Like other big ticket retailers, DFS Furniture is being pulled in two directions: shielding itself from the impact of inflationary cost pressures while also making pricing and promotions tempting enough for customers to part with their cash. A dive in demand over the past two months makes the balancing act an even finer one.
Profit expectations for the 12 months to the end of June have been slashed to between £57 million and £62 million, still a way ahead of the 2019 level but a cut of around a fifth at the midpoint of the range previously guided towards. Sales volumes that were ahead of the pre-pandemic comparison over the three months to March have slipped to being behind in single-digit percentage terms just weeks later.
The question over a recovery in profits for the next financial year is twofold. Will the slide in spending continue at such a dramatic pace? And does DFS have the wherewithal to mitigate higher freight, raw material and wage costs?
DFS has form in taking market share in times of economic strife, but in the short term, that’s a bigger slice of a smaller pie. Putting up prices helped mitigate inflationary pressures earlier this year but those will be tougher to stomach for cash-strapped customers. DFS may have to get more creative on the cost-cutting front, with property and delivery budgets on the block. There are no plans to cut back on opening more Sofology stores or spending on existing DFS shops — yet.
The prospect of a generous dividend, imbued by a highly cash-generative business model, may convince investors to stick around. Special returns, which total 10p a share so far this year, could take a knock over the next 12 months but analysts still reckon an ordinary dividend of 10.94p a share will be possible for the next financial year. After yesterday’s sell-off, that would equate to a potential dividend yield of around 6.6 per cent.
A forward price/earnings ratio of just seven is preparation enough for more pain in the short term.
ADVICE Hold
WHY Inflationary risks are accounted for in the depressed share price
