Now I’ve confused you. I bet you’re about to look through my Blog Page desperately hunting for Part 1 - but don’t bother - it is not published yet and you know how I love playing little dirty tricks….
I started writing a generic Blog Series about how the Past has gone and although it has its uses with regards to credibility of a Company and Management etc., it is really the likely Future that we as Investors need to focus our minds on. This Blog, Part 2, comes into its own here because I am going to use Utilitywise UTW as an example of precisely what I mean - because it is obvious to anyone that UTW has had a terrible recent History but my contention (and I am backing this with a chunky Long Position) is that the Company is undergoing a significant and profound Transformation that will take it into a serious stage of Growth.
And it looks extremely cheap……
I have been invested in UTW for many years now and by jove it has been a Rollercoaster - but there is one rather pleasant constant that has been part and parcel, and that is a steadily rising Dividend and I expect that to continue. As a result, I know the Company pretty well and it strikes me that in the past UTW was very much run as a Personal Fiefdom by Geoff Thompson who Founded the Company and it grew extremely fast but as a result there was a lack of control in many business areas and I get the impression that the Sales Operation was a bit like watching ‘White Gold’ on BBC2 - in other words it has had the feel of a ‘Double Glazing Salesmen’ place with an added dose of The Wild West……Chuck in some nepotism and you are well away.
However, this is where things get interesting. Some time ago (maybe around a year) a chap called Brendan Flattery (yes, I know, “Flattery will get UTW nowhere” - I beat you to the punch) was brought in as CEO from a Senior Role at Sage and from what I hear on the Grapevine, this guy is a tough cookie and will take no nonsense - which is probably exactly what is needed. As a result, it is clear to me that UTW is taking on a much more ‘corporate’ approach - you could see it as moving from being an Amateur Business to a Professional Business - and with the recent Office move to a much larger building and being the Market Leader, they are well placed to undertake this change.
To illustrate exactly the problem with ‘amateurishness’, UTW has been continually beset with ‘Aggressive Accounting’ accusations (justifiably) and there has clearly been a lack of control in this area in particular. The latest fiasco which has caused the Share Price to get royally spanked has stemmed from such a lack of control by the Finance Function but now UTW has a new CFO who is working alongside Flattery to get a grip on things - this can only be seen as a positive thing.
As part of the Transformation, Flattery has outlined some aggressive Targets for the Business by 2021 and I will talk about those more below. If UTW can rise to the challenge and get anywhere near the aims of this Strategic Plan, then the Share Price could be many multiplies of its currently beat up valuation.
The Accounting Problems
I’ll try not to dwell on this too much and to keep it simple and straightforward for Readers - I am sure many of you who follow me on the Tweet Machine are bored senseless by my constant discussions around this (many thanks to @RanmoorRuffian for his considerable help and patience in getting me to understand what is going on here - there is nothing better than someone sensible and sharp to challenge your thinking when looking at a proper Contrarian Play like wot UTW is).
If I boil it all down to the simple stuff, there are really 2 concerns here. The first one is around Cashflow which has been accused of being light in the past - however, I just don’t get this one. First off, UTW has paid a generous and rising Dividend for many Years now - this is not the sign of a Company with a Cashflow problem. Secondly, look at the Debt situation - for most of the years I have held UTW the Cash Balance kept going up but then it started to drop as they did some Acquisitions (don’t talk about that disastrous T-Mac buy which ended up being massively Written-down - which just goes to show how chaotic and badly run UTW has been in the past) and recently the Debt has risen considerably because of these issues:
- UTW have made the Decision to stop taking Upfront Payments from certain Suppliers - this is a superb Strategic Decision I think because there was a problem that UTW could be accused of not being truly ‘Independent’ - when you are an Energy Consultancy that sets Small Businesses up with Energy Suppliers, you really must be independent or you will lack credibility. This has resulted in a Short Term increase in Debt but that is forecast to go away - indeed, I have had access to a couple of Broker Notes and the Forecasts are for Debt to be £20m this year but then to fall to £15.3m at the end of 2018 (UTW has a Debt Facility of £25m). Note this drop off in Debt allows for payment of the Dividend (at the time of writing this means a Dividend Yield up around 10%) and it also allows for the next Problem what I am about to scribble about - Debt falling is not the sign of a Company with Cashflow problems. The increased Debt comes from Upfront Payments of £5m which UTW has had to pay back to the Supplier and also £11m of expected Cash Inflow that will not now be coming to UTW. Some people have wondered if this will open UTW up to ‘Mis-selling’ Claims, but I would say this is a small Risk because UTW’s Customers are Businesses rather than Retail Punters and because Customer Satisfaction Ratings are very high - in addition, UTW don’t actually charge the End-Customer anything - their Payment comes as Commission from the Energy Suppliers. On top of that, if there were to be Mis-selling Claims, I would anticipate them being pretty small as the Policy of Upfront Payments for certain Suppliers was not in use for very long. Something else to consider with Cashflow for UTW is the very nature of its business - with 40k Customers and new ones constantly being added, UTW is in effect getting huge chunks of Cash every month in a constant stream - this kind of business is by its nature very stable and predictable (unless the Commercial Department are incompetent as per the next Bullet Point !!)
- UTW has just discovered that a chunk of its Customers who are provided with Energy by a particular Supplier have been using a lot less Energy than they had estimated. The normal way it works is that when they sign up a New Customer, they look at the Historical Usage of that Customer and they estimate how much will be used over the period of the Contract with the Supplier. UTW is paid Commission by the Supplier at something like 85% of the Estimated Usage and the remaining 15% is held back by the Supplier until the End of the Supply Contract when the Actual Usage is known and a Balancing Item is paid one way or the other. However, there are some circumstances when this all gets a bit harder because the End Customer might have a new Building or something and then the process of Estimation can lead to mistakes. For one particular Supplier, the Usage was hugely over-estimated for a number of Customers and this has meant that UTW was paid too much Commission which it has now had to pay back - although in terms of the effect on Cashflow and Debt it is paying this over several Years. I do not know for certain, but it seems likely that there might have been some dodgy practices in the Sales Department which deliberately overstated the Estimated Consumption so that the Sales Staff got bigger Bonuses - that is pure conjecture by me. Anyway, it is obvious that any such Estimation should be done in a Conservative Accounting manner and it is farcical that this was being done by the Sales Department and shows exactly the lack of control that was the case in UTW in the past. Now this kind of Estimation is undertaken as a Finance Function (starting from August 2016) as it should be and I suspect this will avoid any future problems. UTW says that typically 90% of Contracts are Estimated with reference to the Historic Usage.
In respect of the recent under-usage problems, UTW said:
“The Board does not anticipate a material risk to the future revenues, profits and cash flow of the group.”
“The Board does not change its expectations in regard of net debt of the company as at 31st July” (note, the Board actually thinks the net debt will be £19m which is a tad less than the Broker Forecast).
The next issue is around a nebulous thing called ‘Accrued Revenue’. This is where Revenue is in effect recognised on the Profit & Loss Account before the Cash is actually received for the ‘work’. As a result, UTW can be seen to be hugely overstating their Profits but from what I can tell this Accrued Revenue only represents just over 20% of ‘Sales’. This Accrued Revenue then gets posted on the Balance Sheet as an ‘Asset’ (which sort of makes sense because if you think about it, if UTW were to cease Trading tomorrow, then the Payments which this Accrued Revenue represents would still be due to the Company so they would be rightly seen as an Asset). Another weird nuance here is that if the Accrued Revenue got Written Down (impaired) then because it has not been Invoiced/Billed yet, it would be a ‘Non-Cash Item’ so it would not impact on Cashflow. God this is complicated !! Anyway, I just don’t see this as a big deal - the worry would be around Impairments but those are unlikely and would be Non-Cash anyway. It is also worth appreciating that Energy Use (when correctly estimated !!) is actually very stable and ‘predictable’ - so there is a high likelihood that these Accrued Revenues will actually become Cash in the fullness of time.
Another twist on this is that the Accrued Revenue on the Balance Sheet could be viewed as a valuable Assets and ‘Cigar Butt’ Investors might start viewing UTW as a true Value play - the current Market Cap must be near the Book Value and you are getting the Business and all its future potential in for free.
Just for completeness, I will throw this paragraph in. With regard to the Accrued Revenue, it is a sort of ever-changing ‘Pool’ - it gets billed (invoiced) by UTW to the Supplier over time - some is up to 1 year, some is 1 to 2 years, some is 2 to 3 years, some is over 3 years and up to 5 years. It is obvious that this means UTW receives a steady Cash Inflow as these Revenues are invoiced.
What is the likely Future that Punters are overlooking?
UTW is a funny old beast but it is typical Psychological Behaviour that I see all the time on Stocks - I am of course suffering from ‘The Endowment Effect’ because I already Hold UTW and am clearly besotted by it, but on the other side, I see the UTW Bears as being psychologically stuck in the past and anchoring on a prior belief (well founded !!) that is preventing them from seeing the Change that is going on here. There is clearly a lot of ‘Group Think’ (I must be the only Bull in the World apart from Woody Woodford) and a certain amount of ‘Halo Effect’ as many well respected Investors have questioned this Company’s Accounting practices. And we can chuck in some ‘Recency Bias’ as Investors are focusing their minds on the continual problems rather than seeing the potential here.
In essence, the Upside I expect comes from the following aspects:
- UTW currently has 40k Customers and the plan is to increase this to 130k by 2021 - that is a huge jump but from a back of fag packet calculation, I think that would take UTW from 2% (that figure comes from OFGEM) of the Market to 7% which could be possible but stretching (bear in mind they are already the Market Leader for Third Party Intermediaries TPI). In addition, they are targeting a 5% Share of the ‘Corporate Energy Controls’ market which is valued at £1.5bn in the same timeframe (that seems a massive Market Share and I really doubt they can achieve that - no harm in trying for it though). This is the Dell/Internet of Things stuff and all about using technology to make Buildings more efficient in terms of Energy Usage - ‘Smart Buildings’ and all that.
- Supplier Independence is a key part of this Growth Strategy along with investments they are making in Technology to enable Customer Self-Service and to make the whole process of signing up Customers a lot more efficient - at the moment they see themselves as too dependent on Headcount increases in Sales Staff and want to become more efficient here. As a side effect this should also lower Staff Attrition (it sounds like a horrible Call Centre type operation) and make it a better place to work - so far they seem to be making progress here but it is still poor. This investment in IT should make much more use of Digital Channels to reach their Customers.
- UTW have recently expanded into Germany - it is very early days but clearly this could bring Growth.
- UTW is not affected by Political blather about ‘Price Caps’ and such stuff - that is for Retail Consumers not Businesses. There is however a risk that a Jeremy Corbyn government could Nationalise Energy Providers - I see that as a low risk because the Tory government should be propped up by the DUP and it would be difficult for Corbyn’s bunch to find the Money to buy Shareholders out - although of course his Marxist approach could easily steal the Companies !! A Corbyn government would not be a reason to avoid UTW - it would be a reason to avoid all Stocks !!
- Inspired Energy INSE seems to be making progress - it is much smaller than UTW but shows what can be done. In a similar vein, perhaps UTW could be a Takeover Target or maybe UTW will bid for INSE.
- No longer taking Upfront Payments as well as providing true ‘Supplier Independence’ is claimed by UTW to also mean that there is a closer connection between reported Profits and Cashflow - with the Accounting concerns that I highlighted earlier, this can be no bad thing although I must admit I am a bit unclear as to how this would improve the situation !!
Valuation and Targets
Broker Consensus Dividend Per Share is 6.8p in 2017 rising to 7.2p in 2018. At a current Share Price of 68p, this is a Forward Dividend Yield of 10% rising to 10.6% in 2018.
Forecasts for Adjusted Earnings Per Share (EPS) are 14.7p in 2017 and 20.2p in 2018 (note these are Adjusted for the recent problems which have been classed as ‘One-offs’ and I see this as reasonable). On the current Share Price of 68p this is a Forward P/E of 4.6 falling to 3.4 - has to be one of the lowest Ratings on the Market.
Obviously as with any Stock there are Risks here but I see it that the Risk/Reward balance is heavily tilted in the direction of Bulls and the ‘Margin of Safety’ is considerable. Of course, those of a nervous disposition could easily deploy a Stoploss if they do fancy having a punt.
In terms of Targets, if the Directors can get a grip and get the Company back under proper control, then I see no reason why this could not be trading on a P/E as high as 15 given time. On that basis we could be looking at a Share Price up around 300p and even then the Dividend would be around 2.5% - there is plenty to shoot at here in other words.
It is also worth considering that if the Management can get anywhere near the kind of Growth Targets they have on the Customers and Energy Controls Market, the Share Price could be significantly higher than this.
I am extremely frustrated by how UTW has played out lately but I think throwing in the towel here now would be silly - as I have extolled in this Blog, the Stock looks extremely cheap and there is clearly a process of Change going on here which will take the Company to its next stage of Growth - I suspect Woody Woodford has been a big influence here as he holds around 29% of the Stock and the constant failures here will not have escaped his (or his team’s) notice I suspect. The appointments of the new CEO and CFO look very good to me and it is precisely this sort of change of Leaders that can instigate a Turnaround in an underperforming Stock as they bring a new professionalism and clean up the mess of the past.
I utterly love these kind of Contrarian Turnaround Plays because you often get the chance to buy a beaten up and hated Stock really cheap just before it performs a strong Recovery - just look at my lovely Molins MLIN to see exactly this kind of thing in action. Yes, it is very difficult to go against the Crowd sometimes but to a large extent if you want to get a true ‘Edge’ then you need to be able to understand a Company in detail and be prepared to take calculated Risks.
Note also that UTW is an incredibly volatile Stock but I think that is due to a tiny Free Float because Woodford holds so much - but of course the upside from this is that when the Tide Turns and UTW gets back into favour, it could move up quite quickly. I note also that Geoff Thompson holds 11% and Hargreave Hale (who are very respected Fund Managers) have 4% in there. It is also worth bearing in mind that Bear Raiders love Volatile Stocks with questionable Accounting because it is easy to spook Holders and get a quick drop in a Share Price. We saw this on Optimal Payments OPAY (now PAYS) and also on Telit TCM many times - both of which have been belters for me.
As I have mentioned plenty of times here, I think the concerns over Accounting are massively overdone but I must point out that if anything Bears perhaps ought to be questioning the Growth Targets that the new Management have set. Thankfully the Revenue and Profit Forecasts from the 3 Brokers that cover UTW look realistic for the next few years but I am struggling to see how they will get from 40k customers now up to 130k in 2021 - but the Valuation and my thoughts on Targets are more based around the current Broker Forecasts.
UTW put out a Trading Update on the 8th August last year and I read in one of the Broker Reports that they were expecting an Update in July. They also said that UTW would be considering the impact of FRS15 (an Accounting Standard around Revenue Recognition) and would let the Market know if there is any impact on UTW. If UTW can put out some decent News for a change, I suspect we could see a very strong and fast rise in the Share Price.
Anyway, that’s my current thinking on UTW and I will be crossing my fingers hard !!
Here is a Blog about UTW which I wrote ages back - a lot is out of date now but it might assist understanding. In particular I recommend that Readers look at the UTW Website and the Customer References - there is a link in this Blog I think and there is also a link to an earlier Blog:
And here is something on Psychology - although the final part has not been published yet:
And another one - note there are links at the bottom to the earlier parts here: