De La Rue is the world’s largest independent printer of banknotes and other security documents, such as passports, travellers’ cheques and government stamps. It also owns a 20% stake in National Lottery firm Camelot.
De La Rue (LSE:DLAR), rated a BUY by ING
It recently sold its cash systems unit to the Carlyle Group for £360m (representing a trailing exit multiple of eight times underlying earnings before interest, tax and amortisation – EBITA) and simultaneously announced a £460m capital return worth a tasty 305p per share to shareholders.
Growth in its core banknote unit is driven primarily by global GDP, with the rest of the industry characterised by limited direct competition and high barriers to entry. So De la Rue is a classic defensive stock, which has helped it outperform the FTSE 100 by 12% over the past month. What then makes it a sell?
It simply boils down to valuation. At 907p, the stock trades on forward 2008/2009 and 2009/2010 p/e multiples of 16.0 and 13.2 respectively, which looks stretched, given the strong headwinds expected for the global economy. Moreover, some City analysts who rate it a buy are calculating their target prices using a weighted average cost capital of 8% (this is basically how much it costs De La Rue to raise money).
This appears far too optimistic, since it equates to a mere 1.75% equity risk premium (the added return that investors demand for taking on the added risk of buying shares). That’s assuming, of course, that firms can still borrow funds at three-month Libor rates (or 6.25%).
As a value-investor, a much wider margin of safety should be used. I would advise a 5% figure in these distressed times. That in turn means I would value the company (post-restructuring) on an adjusted 2008/2009 enterprise value/ EBITA multiple of seven, generating an intrinsic worth of about 760p a share (including the one-off 305p payment).
The other potential curveball is De La Rue’s chunky £541m defined benefit pension scheme, of which around 55% was held in equities as at March. Since then the FTSE All Share index has slipped 13%, which, if extrapolated across the scheme, would blow a 25p-a-share hole in the company’s intrinsic worth. You can find better value elsewhere.
Recommendation: SELL at 907p (market capitalisation £1.4bn)
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.