AGL - Accordant Group. was previously AWF Madison, Allied...

[Snoopy]

There were further problems redeploying workers from Christchurch (interim report p6).

"We had expected to resolve issues with the Labour Inspectorate relating to an investigation which commenced in May of 2018, following an exaggerated and sensationalised report by the media on 9 May 2018. This investigation stalled our renewal process for Accredited Employer status with Immigration New Zealand and resulted in us having little flexibility to redeploy many workers based in Christchurch, who were surplus to requirements, with large construction projects drawing to a close. We expect to announce a long overdue pathway forward in the coming weeks."

One issue resolved at least. From:

https://www.awf.co.nz/blog/2020/03/a...erseas-workers

"The Labour Inspectorate undertook an investigation of AWF regarding employment agreements for its Filipino workers that had an unlawful addendum which was added at the request of a Philippines agency. The agreements also contained room for confusion around hours of work, in particular, in respect of minimum and maximum hours."

The unlawful addendum was added by a partner recruiting agency, HAPI (Human Aggregates Philippines Inc), in the Phillipines, not by AWF.

"a former AWF Manager had acted without authority in complying with the HAPI request."

So the miscreant manager at AWF has been sacked.

"In terms of ongoing best practice, AWF will make space available at its Auckland, Wellington and Christchurch branches for union meetings at agreed times. It will communicate to staff about such meetings and will pay any migrant worker to attend a union meeting.”

So AWF all hunky dory with the unions now. that has to be good.

"Fleur Board, AWF’s General Manager, said that having reached resolution, AWF intends to renew its accreditation for the recruitment and employment of overseas workers."

Sounds promising except NZ's borders are largely closed to overseas workers. Could be an issue for FY2021?

SNOOPY

[Snoopy]

In the absence of 'new news', my instinct is to keep my powder dry and wait for the full year result. Half year result was cashflow positive, buoyed by more diligent collection of debts, the capital injection from the DRP and non cash goodwill write offs that reduced profit but not cashflow. Having said that, not as much cash was generated as the previous pcp half year. Historically cashflows have consistently exceeded profits by a significant margin for the full year. Yet I have noticed a pattern of reduced cashflows in the second half. Reduced to the extent that on occasion the full year cashflow is less than the half year cashflow! I don't really understand why this is. A 'cleansing of the books', as more construction company client troubles are quietly shuffled off the books to make a better platform from which to spring from for the coming year perhaps? But I do feel that the upcoming full year result will be a turning point, one way or the other, for the company.

The above comments are from 05-02-2019, before the Full Year 2019 (or Second Half Year 2019) dividend payment. It is interesting to look at the half yearly operational cashflows since.

Finance Period	Operational Cashflows	'Dividend Declared' minus 'DRP Reinvestment' (1)
HY2015	$8.330m	($1.986m)
2HY2015	($2.145m)	($1.916m)
HY2016	$6.495m	($2.660m)
2HY2016	($4.437m)	($2.392m)
HY2017	$11.399m	($2.636m)
2HY2017	($3.773m)	($2.602m)
HY2018	$11.879m	($2.476m)
2HY2018	($0.370m)	($2.645m)
HY2019	$6.143m	($1.931m)
2HY2019	$3.334m	($1.906m)
HY2020	$6.875m	($1.959m)
2HY2020	$3.014m	Nil

(1) From the HY2018 dividend, the 'capital preserving' dividend reinvestment plan was introduced.

I have used operational cashflows because I believe that best reflects the picture of the ongoing business as a going concern. You can see from the above table that the old formula of 'borrowing to pay the second half dividend' has gone after 2HY2019. Dividends are now paid out of profits, (except in the case of 2HY2020 where the dividend has been withheld because of Covid-19 uncertainty). There was certainly money there to pay it to previous years levels had macro-economic conditions been different. The problem with tables like this is that all the information is historical. No-one, not even the Bennster, really knows how AWF will trade over FY2021. Sensibly he has pushed out the AGM from July to September. By then the Bennster should at least have an initial feel as to how things are going. My gut feeling is that there will be a capital raising. I think that the 'EBITDA'/I banking covenant is in danger of being breached. And that means buying in today at what in historical terms looks to be a good price, might not be the wisest thing to do.

SNOOPY

[jg8512]

thanks for your reply Snoopy at #807. Even if one takes net debt as $29.8m, that dwarfs the NPAT of $2.7m. Buffett has sometimes used the debt no more than 3x NPAT as an upper limit on acceptable debt levels (and it is one I use too), but on that measure AWF's debt is at 11x NPAT.

I consider that the contingent consideration (a total of $3.3m at March 2020) is really debt too. Yes, performance of the acquired business may be worse and not trigger the consideration (in which case AWF's NPAT may be lower), but if the business does trigger the maximum consideration, then AWF will need to spend cash/raise debt to do so, so its net debt will be higher. Including contingent consideration as debt, the debt/NPAT ratio is even worse. (I agree with you about not including the lease liabilities in net debt).

I too am not sure how the interest on lease liabilities should be treated for assessing compliance with the banking covenants (depends on the loan agreement I guess). While interest rates are very low, the interest charge looks manageable vs EBITDA. That said, circa $30m of debt will take many years to repay, so AWF does look very exposed to higher interest rates should that happen (which seems unlikely to be happening any time soon, I agree). If one sees oneself as a long term holder, the high level of debt, and the risk of a materially higher interest expense, seems very worrying. I'd much prefer a firm like this to have no net debt (or much, much lower debt)

GLAH

[Snoopy]

Even if one takes net debt as $29.8m, that dwarfs the NPAT of $2.7m. Buffett has sometimes used the debt no more than 3x NPAT as an upper limit on acceptable debt levels (and it is one I use too), but on that measure AWF's debt is at 11x NPAT.

That is the concept I have called MDRT (Minimum Debt Repayment Time). I wouldn't be quite as 'exclusive' in eliminating potential investment candidates as Buffett. Especially in his time of ultra low interest rates.

'MDRT' is the answer to the question:

"If all profits for the year were put towards paying off the company's debts, how long would that take?"

My rule of thumb for the answer in years is:

years < 2: Company has low debt
2< years <5: Company has medium debt
5< years <10: Company has high debt
years >10: Company debt is cause for concern

	FY2015	FY2016	FY2017	FY2018	FY2019	FY2020
Significant Event	First full year owning Madison			First full year owning AbsoluteIT		JacksonStone Acquired
Cash & Cash Equivalents: {A}	$3.151m	$0.0m	$1.225m	$6.269m	$6.357m	$6.178m
Non Current Borrowings:	$0.0m	$18.500m	$18.500m	$36.000m	$33.000m	$36.000m
add Current Borrowings:	$21.759m	$2.500m	$0.0m	$0.0m	$0.0m	$0.0m
add Overdraft:	$0.0m	$0.870m	$0.108m	$0.0m	$0.0m	$0.0m
equals Total Borrowings: {B}	$21.759m	$21.870m	$18.608m	$36.000m	$33.000m	$36.000m
Total Net Borrowings: {B} - {A}	$18.608m	$21.870m	$17.323m	$29.731m	$26.643m	$29.822m
Net profit declared {C}	$5.416m	$5.202m	$5.867m	$5.048m	$2.013m	$2.677m
MDRT ({B} - {A}) / (C}	3.4 years	4.2 years	3.0 years	5.8 years	13.2 years	11.1 years

Laid out in this way it is a sad tale. AWF may be the largest recruitment company in NZ and it may now have four divisional cylinders to fire on. But every time a cylinder is added to the cylinder bank the spark plug that fires it appears to no longer run cleanly. Madison is in decline. AbsoluteIT is in decline and the former single cylinder stand alone power plant, AWF, definitely has a sooty plug. JacksonStone is the 'saviour' this year to complete the 'firing on all four cylinders' divisional quartet. But when you look at the additive result, the obvious question is:

"Where's the fire?"

I am probably being a bit unfair here because the principal reason behind what is now 'new normal ' profitability is AWF. The construction industry problems appear to have taken the wind out of what was this company's main driving sail. But the end result of going from a strong performing one cylinder motorbike five years ago to a 'flaccid four' today is more weight (overheads) and less performance (profit). It is enough for shareholders to think nostalgically about Simon Hull standing on the side of an Auckland Street loading the workers into a bus with a megaphone. But 'the Hullsters' approach is now history.

Today , under 'the Bennster', profitability has halved. So net debt should really be no more than half of what it was in 2015. That means we are looking at a cash issue of around $10m to fix the debt problem. Current market capitalisation is $50m, with the share price at $1.45. A 1:1 cash issue at $1 would raise approximately $30m. A 1:1 cash issue at $1.30 would raise approximately $40m. A 1:4 cash issue at $1.30 would raise approximately $10m. That's my pick on the way out.

SNOOPY

[jg8512]

thanks Snoopy, very good post (but an awful story for AWF holders).

[Snoopy]

Time for my FY2019 update!

	eps	dps (imputed)
FY2015	16.7	14.8
FY2016	16.0	15.2
FY2017	19.6	16.0
FY2018	15.8	16.2
FY2019	12.8 (e)	16.2
Total	80.9	78.4
5 year Average		15.7

(e) = estimated profit based on doubling the half year result.

Implied Acceptable Share Price = (Gross Dividend) / (Acceptable Yield)

= (15.7c / 0.72) / 0.08 = $2.73

However, there is a plot in the planning to increase company capital by increasing the number of shares to reduce debt.

The main long term 'problem' with AWF is their 'shortage of capital' and how many new shares will need to be issued to overcome it. The more new shares that are issued, the lower the earnings per share. All other things being equal this means a lower share price.

Estimated Capital Shortage: $27.331m - $20.608m = $6.729m

New capital is being raised twice a year via the dividend reinvestment scheme. Further cash is injected into the business, over and above the declared profit, as 'Customer Relationships' and 'Restraint of Trade' intangible assets are amortized. This effect of these two phenomena over the last two dividend payments are tabled below:

	Dividend Paid	Dividend Money Reinvested {A}	Customer Relationship Amortization {B}	Restraint of Trade Amortisation {C}	Money Available for Debt Repayment {A}+{B}+{C}
1HY2019	($2.704m)	$0.773m	$0.969m	$0.109m	$1.851m
2HY2019	($2.637m)	$0.797m	$0.969m	$0.109m	$1.875m
FY2019	($5.431m)	$1.552m	$1.937m	$0.217m	$3.706m

Over a couple of years the likely cashflow available for debt repayment is therefore poised to extinguish the excess debt that the board wants retired. The 'dividend money reinvested' part of this equation is $1.552m. If these shares are bought at $1.71, then this will require $1.552m/ $1.71 = 907,600 new shares to be issued. Adding that number to the number of shares on issue today makes the total shares on issue:

33,423,399 + 907,600 = 34,330,999

at the end of the debt reduction process.

At EOFY2018 the number of shares on issue was 32,555,193

This means that the incremental number of new shares that need to be issued to retire debt is: 34,330,999 / 32,555,193 = 5.5%

This expected increased number of shares will reduce our fair value target price as follows:

$2.73 / 1.055 = $2.59

At a share price of $1.71 (the price that the last DRP shares were issued), I therefore think that AWF is trading at a price 34% below its fair value. This is why I have been scooping up shares via the DRP and buying on market!

I am not going to pretend that the likes of Warren Buffett would find AWF a suitable investment at this time. So we need to use an alternative method for valuation. I choose the 'capitalised dividend valuation' method as appropriate here.

Time for my FY2021 (estimate) update! I am assuming a cash issue in FY2021 and because of the need to preserve capital no dividend over FY2021 either.

	eps	dps (imputed)
FY2017	19.6	16.0
FY2018	15.8	16.2
FY2019	6.2	16.2
FY2020	9.4	16.2
FY2021(e)	?	0.0
Total	51.0	64.6
5 year Average		12.9

Implied Acceptable Share Price = (Gross Dividend) / (Acceptable Yield)

= (12.9c / 0.72) / 0.08 = $2.23

However as a result of the expected cash issue, I foresee the number of AWF shares on issue to increase by one share for every four in existence right now, or 25%. This will reduce my share price valuation accordingly.

$2.23 / 1.25 = $1.78

This is based on a net dividend per share (dividend declared) of 12.9c/1.25 = = 10.3c

Whether you believe that valuation or not depends on how well you think that AWF Madison will recover compared to pre-Covid-19 earning and dividend levels.

SNOOPY

[Snoopy]

Interest Bill

The net interest rate paid on last years (FY2019) shrinking average net loan balance can be estimated as follows:

Interest Rate = $1.380m / 0.5x($29.731m + $26.643m) = 4.9%

If we assume the average loan balance will be $3m lower over FY2020, and interest rates remain unchanged, then we can expect the FY2020 interest bill to be:

0.049 x 0.5 x($26.643 + $23.643) = $1.232m

One way to assess how vulnerable a company is , is to look at the interest bill that the bank charges them.

The net interest rate paid on last years (FY2020) average net loan balance can be estimated as follows:

Interest Rate = $1.401m / 0.5x($26.643m + $29.822m) = 5.0%

So ASB doesn't seem too worried about the situation. Or are they just fulfilling their contractual obligations?

From AR2020 Note C7 pg54

"The Group has complied with all covenant requirements during the year. Interest is calculated on a floating rate and the annual weighted average rate is 3.13% (2019: 3.90%). The rate is reset every three months. The loan is an interest only loan and is repayable on 1 October 2021"

SNOOPY

[Snoopy]

AWF may be the largest recruitment company in NZ and it may now have four divisional cylinders to fire on. But every time a cylinder is added to the cylinder bank the spark plug that fires it appears to no longer run cleanly. Madison is in decline. AbsoluteIT is in decline and the former single cylinder stand alone power plant, AWF, definitely has a sooty plug. JacksonStone is the 'saviour' this year to complete the 'firing on all four cylinders' divisional quartet. But when you look at the additive result, the obvious question is:

"Where's the fire?"

I don't wish to alarm shareholders (well O.K. maybe I do), but the substantial amount of 'enduring' intangible assets on the AWF Madison books requires shareholder vigilance.

	Madison	AbsoluteIT	AWF	JacksonStone	Total
Brand value	$7.465m	$1.980m	$0m	$1.029m	$10.474m
Goodwill	$20.223m	$7.836m	$11.212m	$5.797m	$45.068m
Grand Total					$55.452m

When assessing the value of these intangible assets, and I am aware that the auditors have already given these figures the big tick for FY2020, I think it is interesting to line up these intangible values against turnover and profit. This isn't easy to do. Once a new division is acquired it becomes absorbed into the 'white collar division' fold. Nevertheless,when a division is acquired, the historical earnings and revenue are made available, so useful insights may be gleaned.

	FY2014	FY2015	FY2016	FY2017	FY2018	FY2019	FY2020	FY2021
Significant Event		First full year owning Madison			First full year owning AbsoluteIT		JacksonStone Acquired
Combined Madison/AbsoluteIT/JacksonStone Turnover		$69.770m	$68.786m	$98.714m	$149.455m	$151.946m	$166.079m
Madison only Turnover (assuming owned whole year)	$61.065m	$69.770m	$68.786m	$71.1m	$76.7m (e1)	n/a	n/a
AbsoluteIT only Turnover		$0.0m	$0.0m	$27.7m	$72.8m (e1)	n/a	n/a
AbsoluteIT only Turnover (assuming owned whole year)				$72.772m
JacksonStone only Turnover		n/a	n/a	n/a	n/a	n/a	$27.510m	$33.325m (e2)
Combined Madison/AbsoluteIT Turnover		n/a	n/a	$98.714m	$149.455m	$151.946m	$138.569m
Combined Madison/AbsoluteIT/JacksonStone EBIT		$4.264m	$4.004m	$3.387m	$5.963m	$5.597m	$7.156m
Madison Only Net profit	$2.513m
AbsoluteIT Only Net profit (assuming owned whole year)				$2.442m
JacksonStone Only Net profit (assuming owned whole year)							$2.405m
Whole Group Net profit declared		$5.416m	$5.202m	$5.867m	$5.048m	$2.013m	$2.677m
NPAT Margin (Madison Only)	4.1%
NPAT Margin (AbsoluteIT Only)				3.4%
NPAT Margin (JacksonStone Only)							7.2%

Notes

(e1) or estimate 1 is the full year turnover from (or derived from) the previous year of AbsoluteIT operations, assuming it had been part of the AWF group for the whole year.

(e2) Under Section G1, on page 49 of AR2020, there is this statement.

"Had this business combination been effected at 1 April 2019, the revenue of the Group from continuing operations would have been approximately $33.325m, and the net profit after tax for the year ended 31 March 2020 from continuing operations would have been approximately $2.405m."

Considering the revenue for the whole group was listed as $263.527m (AR2020 p22) it is inconceivable that the above quote is correct. I am picking that what the quote actually refers to is the revenue and earnings for JacksonStone as a stand alone entity over FY2020. I am using the quoted figure of $33.325m as an estimate of JacksonStone revenue for FY2021.

From p49 of AR2020:

"For the period 1 June 2019 to 31 March 2020, included in Group profit after tax is $1.943m and in Group revenue $27.510m attributable to JacksonStone & Partners."

This implies an actual net profit margin for JacksonStone during the part year of initial ownership of:

$1.943m / $27.510m = 7.1%

That is consistent with the surprisingly high full year figure listed in the table.





What conclusions can we draw from the revenue and earnings table? Despite the headline turnover going up, the existing combined business unit of Madison and AbslouteIT is actually declining.

On page 2 of AR2020, Chairman Ross Keenan noted:

"In Madison and Absolute IT, in addition to the increase in boutique agencies, the growing trend, by clients, to establish in-house recruitment teams contributed substantially to the businesses’ reduced performance."

So all is not well. I can't be absolutely sure, but it looks like Madison and AbsoluteIT are approximately the same size in terms of turnover today. Similarly it looks like historically AbsoluteIT makes more profit. So I do raise an eyebrow at the goodwill and brand value on the books for Madison being substantially higher than the equivalent figures for AbsoluteIT. This doesn't mean the goodwill for Madison on the books is necessarily too high. It has just been signed off by the auditors after all! But it does mean that in the event of an earnings downturn in FY2021 it is more likely to be vulnerable to a downgrade. How much of a downgrade might shareholder expect? That could be a $20m dollar question!

SNOOPY

[percy]

I think if I were a shareholder in AWF, I would be more than worried that their Brand value and Goodwill [$55.452 mil], exceeded their market cap [$46.34 mil] by nearly 20%.
Certainly very questionable when NPAT is taken into account.
Well according to their latest balance sheet Intangible assets – goodwill come to $61,262,000 compared with shareholders equity of just $33,734,000.
So taking out these we end up with negative equity of over $27.5 mil.

[Snoopy]

I think if I were a shareholder in AWF, I would be more than worried that their Brand value and Goodwill [$55.452 mil], exceeded their market cap [$46.34 mil] by nearly 20%.
Certainly very questionable when NPAT is taken into account.
Well according to their latest balance sheet Intangible assets – goodwill come to $61,262,000 compared with shareholders equity of just $33,734,000.
So taking out these we end up with negative equity of over $27.5 mil.

You aren't the first person to rail against the high amount of goodwill on the balance sheet Percy, and neither will you be the last. The historical reason for all that goodwill is that AWF Madison operate a 'capital light' business model. It is the people who make this business work and these 'people assets' do not appear on the balance sheet. The goodwill was created relatively recently, in the case of JacksonStone just a few months ago. AWF paid $10.530m for JacksonStone and of the full business year that company made $2.450m. The net assets purchased in this arrangement amounted to $4.723m. Or if we remove the 'JacksonStone' brand name asset, the 'Customer Relationship Asset' and the 'Restraint of Trade' asset, then we can work out the net tangible assets purchased (Figures taken from AR2020 p47).

$4.723m - ( $1.209m + $2.185m +$1.406) = -$0.077m

So just a few months ago, AWF purchased some net 'negative assets'. Yet AWF were obviously earning a very good return on the $10.530m that they laid down to purchase 'JacksonStone'.

$2.450m / $10.530m = 23.2% return before holding costs.

I can't see how anyone can argue that the purchase of 'JacksonStone' was a bad move, particularly as the founders, the people who are driving the earnings, are remaining on board. Reference the 29th May 2019 acquisition press release.

"The transaction is structured with an initial payment of $6.7 million on closing and an estimated $3.8 million payable in three instalments over the next couple of years, subject to JacksonStone achieving defined performance targets. This aligns the vendors with AWF Madison’s goals over the coming years and provides an incentive for the vendors to continue to drive performance."

The same could have been said for 'AbsoluteIT' and 'Madison' as well, at the time. But what is interesting is to compare the 'on the books' goodwill with the revenue each division is estimated to generate

	Madison	AbsoluteIT	AWF	JacksonStone	Total
Brand value	$7.465m	$1.980m	$0m	$1.029m	$10.474m
Goodwill	$20.223m	$7.836m	$11.212m	$5.797m	$45.068m
Grand Total					$55.452m
Revenue	$71.1m (1)	$67.5m (2)	$97.448m	$33.025m

Calculation Notes

(1) Estimated Apportioned revenue for Madison $138.569m x 51.3% = $71.1m ($76.7m/$149.455m = 51.3% - my post 818)
(2) Estimated Apportioned revenue for AbsoluteIT $138.569m x 48.7% = $67.5m ($72.8m/149.455m = 48.7% -my posy 818)

What becomes obvious now is that the 'Goodwill' and 'Brand Value' attributed to Madison looks way out of proportion to the revenue generated (In comparison with 'AbsoluteIT' and 'JacksonStone') . And all of these goodwill and brand value figures are pre-Covid!

Now let me lay my cards on the table. I have been an investor in AWF Madison for five years. I like the capital light business model. I think the business model will have future in the post Covid-19 world. With so many job applicants to sort through I think more and more companies will use the services of the likes of AWF Madison. But any business is a bad investment if you pay too much for it, no matter how good the business model. I fear that in another era, without the benefit of hindsight, AWF might have done just that when they acquired Madison in FY2014. And I fear that shareholders may soon have to face up to that fact. It won't stop AWF Madison being a good investment longer term if the book value of that base investment is reduced. But in the short term at least that could mean pain for shareholders.

SNOOPY