I always like reading Nate Tobik’s blog Oddball Stocks.
Recently Nate talked about Titon Holdings, a London listed stock, and its cash flow.
Follow this link to see the post:
http://www.oddballstocks.com/2012/08/rethinking-titon-holdings.html
First of all I agree with Nate’s rule of only investing in cash flow positive companies. I would even say that a better rule would be to only invest in companies with positive free cash flow as opposed to positive operating cash flow.
The problem with investing in companies like Seahawk Drilling is that cash burn is very high and dilution from fund raising efforts is likely to occur. Such investments are very speculative and are not worthy of investment by the conservative net-net investor.
Pharmaceutical companies also fall into the cash burning category as those companies have high R&D spend. Conservative net-net investors are better of investing in companies trading at a low multiple of free cash flow however hard they may be to find.
The best way to find a strong cash flow positive company is to look back over the last 10 annual reports. Obviously what you want to find is a company that has been cash flow positive for every one of those ten years.
Sometimes a blip occurs and the odd year might show negative cash flow. This is all part of doing business.
Consider Titon’s operating and free cash flow history:
| Year | Op C/F (£ ‘000s) | Free C/F (£ ‘000s) |
| 2011 | 640 | 170 |
| 2010 | 703 | 371 |
| 2009 | 977 | 771 |
| 2008 | 1,791 | 1,386 |
| 2007 | 566 | 203 |
| 2006 | 833 | (652)* |
| 2005 | 1,183 | 614* |
| 2004 | 1,545 | 605 |
| 2003 | 1,667 | 358 |
| 2002 | 2,114 | 1,685 |
| 2001 | 2,061 | 1,473 |
- These FCF figures include expenditure on intangibles which weren’t separated from tangibles in the accounts
We can see that the figures vary a lot and that they have decreased over the last decade. The figures don’t include movements and adjustments in working capital which of course is a key element of any cash flow statement.
From the above figures Titon seems to be strong on the cash flow front however I too share Nate’s concern about the recent declining cash balance. The above figures should provide a certain comfort that the company will continue to be FCF positive and that the cash balances will improve.
However my personal view is that the dividend is likely to be cut (which isn’t the end of the world) or eliminated (nearly the end of the world).
This situation conveys the biggest investment risk exactly. That risk is the operating development of the business. Whilst the investor initially purchases shares with a large margin of safety this margin may not be enough to offset a loss caused by a deterioration of operations.
In conclusion it is worth looking at the history of Titon’s year-end cash balance over the last decade:
| Year | Year-End Cash Balance (£ ‘000s) |
| 2011 | 2,864 |
| 2010 | 3,110 |
| 2009 | 3,096 |
| 2008 | 2,546 |
| 2007 | 1,678 |
| 2006 | 2,078 |
| 2005 | 3,380 |
| 2004 | 4,017 |
| 2003 | 3,897 |
| 2002 | 5,004 |
| 2001 | 4,462 |
The table shows that the cash balance fell to a low of £1.68m in 2007 before nearly doubling in 2010. With tight working capital management there is no reason why cash balances can’t grow from the current level of £1.7m (end of June, 2012).
Titon Holdings also have large freehold properties on the books which they could sell on a lease-back basis if so required (though such action would be a long shot).
I feel that Nate might have paid too much for the share when he initially bought them but the best course of action to take, based on the above information, could be to stick the shares back in the bottom drawer and see how they are doing in a year or two.
Obviously many more considerations should be taken into account when deciding whether to keep a stock. Personally I think that Titon Holdings shares are trading in that grey area where they are neither a buy or sell.
As an aside I mentioned CPEH in my last article and the stock is up 45% today on light volume.
Happy Investing!!