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Uncovering the secrets of company analysis
As our First Time Investor series draws to a close we put into practice everything we have learned so far and apply the principles and techniques to a FTSE 250 company. We have selected a business at random for illustration purposes only.
However, readers may be curious about how to go about finding investment ideas.
Professional managers often adopt a systematic approach by creating fundamentally based screens which sift through data like return on equity and earnings growth to identify suitable candidates for further research.
Valuation criteria like price to cash flow or price to earnings might also be used to zero on the most promising candidates.
Some fund managers even find ideas by following the top holdings of their peers.
In short, there are many ways to find your next investment idea but what you do with it is more important so let’s get started.
We have chosen to look at Cranswick (CWK), one of the UK’s largest food producers.
The company’s website provides a good overview of the business as well as presentations, reports and accounts, and regulated news announcements.
QUALITATIVE FACTORS TO CONSIDER
As we have highlighted in prior articles, investing is a long-term endeavour and its rewards are closely linked to the growth and stability of a company’s cash flows and profits.
With that in mind, our primary goal is to find out if Cranswick has a viable business with durable long-term growth prospects.
If the business doesn’t make enough profit to maintain its competitiveness, then long-term viability becomes questionable and it fails to satisfy our investment needs.
Successfully fending off competitors is essential in maintaining healthy profitability and returns on capital over long periods. This characteristic is a key factor in compounding shareholder returns.
WHAT DOES CRANSWICK DO?
The report and accounts say that Cranswick is an innovative British supplier of premium, fresh, and added value food products. The UK is the core market, but the company has been also been growing its export business over the last few years.
Feeding the nation should provide a durable business to companies that make good quality food that consumers desire, at the right price.
The biggest risk is that other companies do a better job and steal market share away from Cranswick.
The company operates from 15 well invested highly efficient production facilities in the UK. It owns pig breeders and a fully integrated chicken supply chain.
The company started out in 1975 as a group of farmers before moving into food production in the 1980s.
Cranswick provides its products to customers in food retail, food service and other channels.
The historical connection to the farming communities and operating a vertically integrated model has over time created competitive advantages.
These include good provenance, a secure supply chain as well as strong supplier and customer relationships.
Vertical integration means that Cranswick has control over the complete supply chain, from rearing animals to making and distributing the finished products.
WHAT IS CRANSWICK'S STRATEGY?
It’s important to understand management’s long-term vision and how they intend to reach their goals. The company has a three-pronged growth plan.
It aims to consolidate the existing market and thereby grow revenues from core pork products as well as investing in infrastructure to support growth
Expanding the product range and entering new markets and channels in the core UK market forms another leg of the growth plan.
Lastly the company intends to grow outside the UK by continuing to develop its export business.
This all seems to make sense and leverages Cranswick’s core strengths of having well invested, efficient processing facilities.
It is noteworthy that operational excellence and sustainability also feature in the strategic pillars.
Larger scale allows Cranswick to invest more heavily in state-of-the-art equipment which improves quality and efficiency, providing a competitive advantage. The big unknown is the durability of the advantage.
How well the strategy has worked out over the last several years can be seen by the long-term chart that Cranswick provides in its annual report.
Over the last 30 years the company has grown adjusted pre-tax profit from £0.9 million to £102.3 million, equating to a compound annual growth rate of 17% a year, or 114 times the starting value.
The company has an unbroken track record of dividend growth, averaging around 10% a year.
Over the last five years return on equity has averaged around 15% a year, showing that the business makes a healthy economic return.
In other words, the strategy of consolidating the market through bolt-on acquisitions and organic growth seems to be working.
Increased scale has allowed Cranswick to spend more on its facilities to make them more efficient and flexible, creating a positive feedback loop.
As we have highlighted in this series, profit is more reliable when backed by cash flow, so let’s see how Cranswick does on this score.
Over the last 10 years the company has generated £767 million of operating cash compared with reporting cumulative operating profits
of £718 million. This indicates the reported profit is backed by real cash.
What is impressive is the amount of investment that Cranswick ploughs back into the business to meet future growth and maintain asset quality, something which makes it tough for smaller food producers to compete.
Last year net capital expenditures represented nearly 6% of revenue.
The company has cumulatively allocated £457 million to capital expenditure over the last decade.
We can deduct depreciation from capital expenditures, on the basis that this represents ‘maintenance capital expenditures’ which is needed to maintain operations. What is left is the spend related to growth.
We can then compare the additional operating profit that the growth produced in order to calculate the incremental return on investment.
As the table shows Cranswick generated a 30% return on the investments made over the last decade which is very impressive.
Think about it as an owner of the business for a second and you will see that reinvesting back into the business has been an intelligent use of capital.
On this basis, investors should be cheering every time Cranswick identifies new capital investment projects.
CAPITAL ALLOCATION CRUCIAL
As we have pointed out in this series, management’s capital allocation decisions are very important in determining future shareholder returns.
In Cranswick’s case shareholders have also had the good fortune to receive growing dividends over the last 30 years.
In part two we will make a stab at estimating future shareholder returns assuming Cranswick can maintain the same level of growth and returns on capital.
We shall also take a closer look at how the business is financed and the balance sheet strength.