On 20 August 2015 Hornby (LSE: HRN) closed at 109p
Recently Hornby’s share price hit 30p representing a 72% decrease.
There’s been more to it than that.
A lot more.
But after reviewing the issues facing Hornby and after a recent announcement that Hornby’s bank has changed the rules so that it does not break it’s banking covenants one can be forgiven for not making an investment in this business.
“But it has an iconic brand!” I hear you cry.
Yes indeed it does but an iconic brand is no good if a protracted yet necessary (and costly) turnaround is having a detrimental affect on the ability of a business to sell it’s wares:
The Group now expects to report a substantially wider trading loss than previously forecast in this current financial year. The team has also conducted a full stock take at the Group’s consolidated warehouse in Hersden and a balance sheet review following the reorganisation of the European subsidiaries which will result in a £1.0m write off. The disappointing sales performance experienced in the New Year is expected to result in a trading profit deterioration of between £2.5m – £3.0m, with approximately half due to UK performance. In total the Group is now expecting to report an underlying loss before tax in the range of £5.5m – £6.0m, which represents a substantial setback in our recovery plan for the business.
Why Is Horby’s Turnaround Taking So Long?
Hornby is in the middle of modernising it’s product sourcing, improving management of the supply chain, upgrading logistics, upgrading warehousing, upgrading it’s stock control processes and speeding up deliveries to customers.
Hornby is also rolling out a new IT system across it’s UK and European sites which has required major investment and impacted on the trading performance of the business.
Anyone who has been around long enough will know that IT system implementation is a complicated process requiring time and money.
The fact that the new IT system is aimed at targeting not one but three key areas of the business – sales, logistics and finance – means lengthy delays and bug fixing.
I can’t see it being fully implemented for quite some time.
What’s The Easiest Way To Invest In A Turnaround?
The best and easiest way to invest in a turnaround is not to invest in them at all, especially if you’re a newbie.
There are great investors who make it their daily bread to research and invest in turnarounds with success but they are high functioning nerds.
Just stop it. pic.twitter.com/4XDAiPlNtk
— David Thomas (@djthomas) April 10, 2016
Unless you have an advantage like lengthy industry experience then you are better off steering clear and investing into stocks that you can clearly identify as being more likely to create value for shareholders over the long term.
Buffet called them economic moats; those businesses that are able to maintain a sustainable competitive advantage over its peers in order to protect market share.
Examples of economic moats include things such as having low costs, and dare I say it a strong brand name but as Hornby exemplifies having a strong brand name in isolation is not enough when looking for a sound business to invest in.
6 Easy Ways To Help You Identify Economic Moats
Having trouble finding stocks with strong economic moats? Here are a list of ‘indicators’ to look out for when researching your next stock:
- An instantly recognisable brand name: (Volkswagen, Tesco, Barclays) the value of a brand name is found on the balance sheet as an intangible asset which is why when calculating intrinsic value from the balance sheet if I know that a company has a strong brand name then I will not discount intangibles down to zero and normally opt for a two-thirds discount for a conservative valuation
- Customer loyalty: Apple has managed to create a loyal fan base who will purchase their entire suit of products. They have done this because their products are innovative and their customer service/after sales care is awesome (yes I own Apple stuff).
- High returns on capital, equity and assets: look for long periods of high returns and make sure they are higher than 10-12% on average. The usual caveats of careful balance sheet evaluation and making sure debt levels are not out of control apply: returns should not be financed by debt.
- Free cash flow (FCF): (operating cash flow minus capital expenditures) this is the cash a business is able to produce after shelling out for the things that keep the business running in the first place. The business can then use FCF for dividends, stock buybacks or debt reduction. Look for a high and/or rising FCF.
- Network effect: as more and more people use a businesses products or services then the product of service becomes a better experience for both new and existing users. Examples include websites like Amazon and Ebay.
- Cost advantage: Geico can sell car insurance cheaper than it’s competitors by marketing direct to them on the internet and by telephone and not through a network of agents which adds and passes on costs to the consumer
It is possible that Hornby will become a good investment at some point in the future should it’s fundamentals change.
Management would need to publish more upbeat forecasts on revenue.
A successful investment is based on sound research and asking the right questions. if the answers don’t stack up you know it’s time to walk away for now.