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

[Snoopy]

I have searched through the Annual Report for FY2016. There is no further mention of the $1.3m adjustment referred to in the Chairman's address. I hope he is right and the benefits of this adjustment flow thorough to future years. But in the absence of further information, as an investor, I believe I should treat this as a 'normal business expense' that does not distort the result for this year.

That wasn't very diligent of me.

Further detail of this $1.3m debt does appear on p39 of AR2016, with a note that $0.3m of provisioning has been taken on the books against it. Fast forward one year to AR2017 p41 and the debt has grown to $1.4m (not sure how as the company owing the debt was put into receivership by AWF: Could the difference be receivership fees?). Total provisioning against this debt has jumped to $0.8m, and that means an extra $0.5m in provisioning provided over FY2017.

Now I have this extra information I will have to decide if the debt incurred was part of normal operations or a significant 'one off'. Hmmmm?

SNOOPY

[percy]

Hopefully a significant "one off".
Does seem to be a lot higher debt than I would expect from normal operations.
Maybe lessons learnt.
Selling off 75% of my holding in both AWF and EVO was because both results were well under what I expected.Had I had a high conviction stock I wanted to buy, I would have sold out completely.The result is I have lowered my average price.I was also sitting on more cash than I wanted.Both stocks now have PE ratios higher than their growth rate,however their yields are satisfactory.

[Snoopy]

The Annual Report for FY2014 says that: (AWF Limited) is New Zealand's largest recruitment company. This is a position achieved through 27 years of growth from modest beginnings.

The company mission statement is:
"To be the leading provider of quality recruitment and staffing solutions to NZ business."

Measured by their own standard, AWF have already fulfilled their vision as they are 'number 1' already. The scale requirement for the business is therefore satisfied.

Conclusion: Pass Test

A lot has happened over the last couple of years. So time for an update.

AWF Madison is in the business of recruitment and provision of people. The company operates in both the white collar and blue collar market place. AWF are the largest recruiter and labour provider in New Zealand providing the full spectrum of temporary and permanent recruitment services to industry and commerce.

The prime mission of the AWF (formerly Allied Work Force) sub-brand, founded in 1988, is "the provision of blue collar temporary labour", both semi-skilled and skilled. Industry sectors covered include construction, infrastructure, manufacturing, food processing, timber processing and waste management. AWF have 30 branches nationwide with 124 staff who supply up to 3,500 people per day on deployment.

The Madison sub brand, founded in 1998, acquired by AWF in 2nd December 2013, both recruits outright (5,615 placements last year) and deploys on their own behalf (up to 1,100 people per day) white collar staff through 5 offices and 98 support staff.

Absolute IT, founded in 2000, acquired by AWF on 1st November 2016, is also a 'white collar' recruitment business, but is an Information and Communication Technology (ICT) recruitment specialist (complimentary to Madison). Absolute IT has 4 offices with a total of 48 support staff deploying around 450 people daily.

"Madison" and "Absolute IT" report as one operating segment.

The combined group is New Zealand's largest recruitment company in terms of placements and the only NZX listed company in this market sector.

Conclusion: Pass Test

SNOOPY

[percy]

Divie in my bank.

[Snoopy]

For this exercise I have removed the group's foray into the healthcare sector. I am referring here to the groups purchase of Panacea Healthcare on 04-10-2010, the additional purchase of Nursing NZ on 19th March 2012 and the subsequent sale of the lot on 31-08-2012.

Earnings figures calculated are adjusted net profit after tax.

2010: $2.002m/26.125m= 7.7cps
2011: ($3.212m - $0.003m +0.7x($0.465m) )/26.125m = 13.5cps
2012: ($2.877m +0.72x($0.167m+$1.100m) )/26.125m = 14.5cps
2013: $4.952m/25.805m = 19.2cps
2014: ($3.952m+0.72x(0.095m+0.257m) )/25.804m = 16.3cps
2015(*): $5.416m/ 32.463m =16.7cps

Notes:

1/ Panacea Healthcare NPAT (an non continuing business stream) removed from results for FY2011, not included in FY2012 and FY2013.
2/ Business acquisition costs removed from FY2011, FY2012 and FY2014.
3/ Goodwill impairment removed from FY2012.
4/ Due diligence cost removed from FY2014
(*) FY2015 results based on abbreviated results released. When full result becomes available it may require adjustment.

There was one dip in the underlying earnings trend following FY2013, but apart from that the eps path is steadily upwards.

Conclusion: Pass test

Just to show there is more than one way of doing things, I have slightly changed the way I am calculating underlying profit. I am now removing property plant and equipment sales profits/losses from all of my calculated profit figures.

2013: ($4.952m+$0.124m)/ 25.805m = 19.7cps
2014: ($3.952m-$0.025m+0.72x($0.095m+$0.257m) )/ 25.805m = 16.2cps
2015: ($5.416m+$0.031m)/ 32.463m = 16.8cps
2016: ($5.202m+$0.008m)/ 32.463m = 16.0cps
2017: ($5.867m-$0.050m+0.72x($0.262m+$0.442m) )/ 32.463m = 19.5cps

Notes:

1/ Due diligence cost for "Madison" removed from FY2014. "Madison Business" acquisition costs removed from FY2014.
2/ "Absolute IT" acquisition costs removed from FY2017. Legacy software write down removed from FY2017

Conclusion: Fail Test

[Snoopy]

ROE= (Net Profit)/(EOFY Shareholders Funds)


2010: $2.002m /$18.588m= 10.8%
2011: $3.535m /$19.913m = 17.7%
2012: $3.789m /$19.201m = 19.7%
2013: $4.952m /$21.607m = 22.3%
2014: $4.205m /$20.763m = 20.3%
2015 (*): $5.416m/$35.931m =15.1%

The big improvement from FY2010 has been sustained. A significant drop in the FY2015 is because of the newly enlarged equity base. But even with this, AWF is earning well above its cost of capital.

Conclusion: Pass test

ROE= (Net Profit)/(EOFY Shareholders Funds)

2013: $5.076m / $21.607m = 23.5%
2014: $4.180m / $20.763m = 20.1%
2015: $5.447m/ $35.931m = 15.2%
2016: $5.210m/ $36.274m = 14.4%
2017: $6.324m/ $36.935m = 17.1%

Conclusion: Pass test

SNOOPY

[Snoopy]

Margin = Net Profit/Sales

2010: $2.002m /$70.329m = 2.85%
2011: $3.535m /($95.800m - $7.000m) = 3.98%
2012: $3.789m /($119.264m-$14.349m)= 3.61%
2013: $4.952m /($138.852m - $8.375m)= 3.79%
2014: $4.205m /$148.691m = 2.83%
2015(*): $5.416m/$197.5m = 2.74%

Note: For FY2011, FY2012 and FY2013 I have removed the healthcare unit profit and the associated turnover.

Margins were certainly raised above inflation between the base year FY2010 in comparison with the next subsequent three years. The last two years have seen a decline back to FY2010 margin levels. Is this because Madison is inherently 'lower margin'? AWF have already shown they are prepared to deal with below par margin businesses. That is why they sold their healthcare assets. So I am prepared to back AWF management and let them work some margin magic going forwards, as they have done before.

Conclusion: Pass Test

Net Profit Margin = Net Profit/Sales

2013: $5.076m /($138.852m - $8.375m)= 3.89%
2014: $4.180m /$148.691m = 2.81%
2015: $5.447m/$197.514m = 2.76%
2016: $5.210m/ $214.589m = 2.43%
2017: $6.324m/ $256.428m = 2.47%

Note: For FY2013 I have removed the since sold healthcare unit profit and the associated turnover.

One uptick in the data in FY2017 is so far a welcome blip rather than a trend.

Conclusion: Fail Test

SNOOPY

[Snoopy]

That wasn't very diligent of me.

Further detail of this $1.3m debt does appear on p39 of AR2016, with a note that $0.3m of provisioning has been taken on the books against it. Fast forward one year to AR2017 p41 and the debt has grown to $1.4m (not sure how as the company owing the debt was put into receivership by AWF: Could the difference be receivership fees?). Total provisioning against this debt has jumped to $0.8m, and that means an extra $0.5m in provisioning provided over FY2017.

Now I have this extra information I will have to decide if the debt incurred was part of normal operations or a significant 'one off'. Hmmmm?

The exercise of trying to normalise results is not always easy, as there are always 'judgement issues' to consider. And whatever numerical tools you think you have to assist with your investment decisions, you must still use judgement to assess the validity of those tools.

Management in AR2016 and AR2017 have gone on about this 'one off' bad debt, but haven't adjusted for it in AR2016 (when they still produced their own 'underlying earnings' figure). While a big account going wrong like this is unusual, is it unusual enough to distort the normal earnings of the business? I am forced to conclude that while management have put in extra checks and will no doubt learn from the experience, there is still a good chance it will all happen again. In this instance I have taken my queue from management, and not made any 'underlying adjustments' for this account gone bad. Doing nothing in this instance is also the more conservative thing to do. Conservatism, when valuing an investment, gives you an extra safety factor.

By contrast I have now decided to adjust my 'normalised results' for property, plant and equipment sales under the broader concept of adjusting for asset sales. Once an asset it sold, it cannot be sold again. So it seems right to remove property plant and equipment sales to give a better picture of operating results. However the actual adjustments in relation to profit are quite small (for example in FY2017, $50,000 on a $6.324m normalised profit is less than 1%). So doing this breaks my other rule of 'keeping things as simple as possible' and not being distracted by minutiae. However I decided to do it anyway, because not all asset sales are trivial. And if I am going to include the non-trivial asset sales when they occur, I need to include the trivial ones of today to be consistent.

SNOOPY

[Snoopy]

AWF Limited is showing a strong return on equity profile. One way to do this is to borrow heaps. Unfortunately this method of increasing ROE usually comes back to bite shareholders. So has AWF currently leveraged their balance sheet to help make this important statistic look good?

My preferred method of answering this question is to look at what happens if all profits are redirected to repaying debt. In reality this is unlikely to happen. Shareholders like their dividends, and businesses must invest for the future. Also a debt free company may not be 'capital efficient'. Nevertheless 'MDRP' does provide a gauge of just how quickly a company could eliminate their debt should they (or their bankers decree!) that they do so. A figure over 10 years I regard as suspect. A figure under three years I regard as very good. So how does AWF measure up in 2015?

Bank debt in the FY2015 results announcement is as follows:

Cash & Cash Equivalents: {A}	$3.151m
Non Current Borrowings:	$0
Current Borrowings:	$21.759m
Total Borrowings: {B}	$21.759m
Total Net Borrowings: {B}{A}	$18.608m

Net profit after tax: $5.416m

MDRT = $18.608m/ $5.416m = 3.4 years

This I regard as quite acceptable. AWF are not overleveraged, and considering their cash issue had just been banked on this balance date, probably close to their targeted leverage.

Bank debt in the FY2017 results announcement is as follows:

Cash & Cash Equivalents: {A}	$1.225m
Non Current Borrowings:	$33.500m
Current Borrowings:	$0.0m
Overdraft:	$0.108m
Total Borrowings: {B}	$33.608m
Total Net Borrowings: {B}{A}	$32.383m

Net profit after tax: $6.324m

MDRT = $32.383m/ $6.324m = 5.1 years

Quite a large increase in leverage at AWF in the last couple of years. The acquisition of "Absolute IT" last November funded by bank debt would have something to do with that. However going from and MDRT of 3.4 at EOFY2015 to 5.1 today I would see as a move up, but still within, the medium debt spectrum. Not too much to worry about here, but the debt situation deserves monitoring.

SNOOPY

[Snoopy]

I should add that these four tests are 'indicators'. Passing these four tests means that I can apply my 'growth model' to check the fair value of this share. You will note that none of these tests say anything about fair market value. It is fair market value that determines if AWF is a buy, not passing these four tests!

<snip>

I would say that should margin shrink again in FY2016, then the argument that management is still capable of increasing margins going forwards would be looking shakey.

Fast forward a couple of years and much has changed. What was a clean pass on all tests at EOFY2015, has now morphed into a couple of failed tests. The net profit margin in FY2016 did shrink again and the recovery in FY2017 is still below FY2015 levels.

Next we have the somewhat sorry 'earnings per share story'. Five years on from the first corporate move and two acquisitions ('Madison Recruitment' and 'Absolute IT') have joined the AWF family. So we now have a much bigger company in revenue terms. But what has happened to 'eps' over that time period?

2013: ($4.952m+$0.124m)/ 25.805m = 19.7cps
<snip>
2017: ($5.867m-$0.050m+0.72x($0.262m+$0.442m) )/ 32.463m = 19.5cps

That's right. 'Eps' has gone down! OK the latest acquisition of Absolute IT is still bedding in, and I do expect 'eps' will rise in FY2018. But right at this point, shareholders who have held for five years (I haven't) must be disappointed. Sadly this means the 'Buffett Growth ' model is currently not suitable for checking out the value of this share :-(. Time to bring out the alternative 'Capitalised Dividend Valuation Model', and see what sort of valuation figures I get!

SNOOPY