SIF Folio: A second slice of Finsbury Food?

Opinions seem to vary on the outlook for the market at the moment. I’ve seen some commentators suggesting a crash is overdue, with others saying that shares are now looking more reasonably priced to buy.

Personally, I expect to be a net buyer personally over the next few weeks. But one of the beauties of my SIF strategy is that I don’t have to make such difficult decisions. Instead, I simply follow the rules.

After several weeks of rather limited results, my main SIF buying screen is starting to offer a more diverse choice of stocks. The company I’m going to consider this week is Finsbury Food (LON:FIF). I held this cake and bread maker in SIF in 2020, but sold in October with woeful timing:

No one likes to see a chart like this, but it happens sometimes. What I think is important at this point is to neutralise the psychological bias that’s trying to tell me it’s too late to buy. This may be true, but there’s no reason why it must be true. The market has no memory. If a company’s performance is improving, it may still offer value at a higher share price.

Solid trading

In this case, I can see some reason for optimism. Finsbury shares are still below pre-pandemic levels, but the business seems to be performing pretty well. 

The group – which supplies baked goods to supermarkets and the foodservice clients – said that revenue rose by 2.3% to £313m during the year to 26 June. Adjusted earnings for the year rose by 15% to 9.1p per share. 

Net debt halved to £13.1m, while dividends were resumed at 2.4p per share for the full year. That’s 30% down on pre-Covid levels, but a useful payout all the same.

These results reflect strong demand from retailers over the last year and highlight Finsbury’s limited exposure to foodservice. This has proved fortunate.

Another positive is that the company was able to continue delivering new growth initiatives last year, despite disruption caused by Covid-19. Additions to the group’s manufacturing footprint included a new frozen dough ball facility in Manchester and a 50% capacity increase to artisan bread production.

Management say that ongoing innovations are “in line with consumer trends”, such as vegan and gluten-free cakes and breads.

I covered Finsbury’s results in more detail in the SCVR in September, so I won’t repeat too much here. 

Instead, I’ll just conclude this section by noting that despite being a small cap, Finsbury has strong institutional backing. The group’s shareholder register includes several well-respected small cap fund managers:

Stockopedia’s algorithms rate this business highly too, awarding it a StockRank of 99 and Super Stock status:

Finsbury also passes all of my screening tests, qualifying it as a potential buy for SIF.

On that note, let’s take a look at Finsbury’s QVM metrics in more detail. Should I add this stock to SIF for the second time?

Value: reasonable

When I look at a stock’s value metrics, I’m looking at valuation, but also at the company’s balance sheet. What does it own and what does it owe?

Finsbury’s ValueRank of 86 suggests few problems in this department, but there are a couple of things I’d like to highlight.

Valuation: The stock looks affordably valued to me on several key metrics:

I’m encouraged by the low price to free cash flow ratio, but Finsbury benefited from a reduction in working capital last year which generated a £2.9m cash inflow. Now that trading has normalised, I don’t expect that to be repeated this year. Indeed, I suspect we could see cash performance worsen, due to cost pressures and supply chain disruption.

Other valuation measures also look favourable to me. Earnings yield is well above my 8% minimum:

Finsbury’s trailing P/E of 11 and 2.6% dividend yield also look quite reasonable. 

Balance sheet: Finsbury’s net debt halved to £13m last year, or £25.4m if you include IFRS 16 lease obligations. In either case, I think this level of debt should be quite comfortable for a business generating net profits of c.£12m per year.

My only caveat is that Finsbury appears to benefit from very generous credit terms with its suppliers. I discussed this in my SCVR report in September. My sums suggest the company takes more than 100 days to pay its bills, on average. This seems slow to me. It shouldn’t be a problem as long as the company doesn’t need to bring forward payments for any reason. Doing so could trigger substantial cash outflows.

Summary: Finsbury Food looks reasonably valued to me at the moment.

Quality: Improving?

Although Finsbury Food is a substantial producer in its market segments, it’s a small business compared to its supermarket clients. I can’t imagine that they’d allow the company to become too profitable. 

Finsbury’s operating margins have certainly been fairly low historically, averaging 3.7% in the years before the pandemic.

Last year’s operating margin of 5.8% represented a significant advance. I guess this was partly due to strong retail demand, but broker forecasts I’ve seen for the current year suggest this figure could remain above 5%.

If so, this could help to support the group’s return on capital employed. This rose to 11% last year, a level that’s been reached in the past too. I think this is quite respectable for a business of this kind.

Similarly, Finsbury’s operating cash flow also appears to be fairly healthy. In recent years much of this cash has been used to support elevated levels of capex. Spending now seems to be moderating, supporting stronger free cash flow:

The stock’s Piotroski F-Score of 7/9 supports my view that Finsbury’s financial performance is generally improving. 

Summary: I don’t have any serious concerns about the quality of this business.

Momentum: Strong – for now

Finsbury’s MomentumRank of 92 is the stock’s highest factor score. Splitting the score into its two constituent elements does not seem to suggest any immediate problems.

Price momentum: The stock’s Momentum graphic suggests that Finsbury shares could be trading in a well-established uptrend:

Similarly, broker earnings estimates are still showing positive momentum. Forecasts for FY22 and FY23 have been upgraded since September’s results were published:

This is one of a series of upgrades we’ve seen since the start of this year:

In his outlook statement, chief executive John Duffy admitted that Finsbury was “likely to face persistent challenges” around inflation and labour shortages. These problems are well known. What’s not yet clear to me is how widely they will affect corporate results as we head into 2022.

Finsbury shares are currently trading on nine times forecast earnings, with a forecast yield of 2.9%. This seems like a reasonable valuation to me, but earnings growth is expected to flatten out in 2022/23. I think it’s worth remembering that Finsbury is a low-margin business that’s been through lacklustre periods before:

Summary: Based on the facts available today, I think Finsbury has positive momentum and could be attractively valued.

My decision

CEO Duffy seems to have managed the business well through a difficult period, while maintaining a longer-term focus on growth.

In addition, Finsbury Food passes all of my screening tests and does not seem too expensive to me. The group’s valuation is supported by decent cash generation and comfortable levels of debt.

I’m comfortable with the idea of owning this stock. I’ll be adding Finsbury Food to SIF this week and to my own portfolio. As always, I’ll make these trades after this article has been published.

Please let me know what you think about Finsbury. Will defensive companies like this trade well through the current inflationary environment? Or are the risks not yet priced in? I’d love to hear your thoughts.

Stockopedia