Paul Hill, one of Briain’s most successful private investors, picks the worst tip from the week’s press and brokers’ reports:
It is commonly said that only two things in life are certain – death and taxes. Chancellor Gordon Brown is the chief recipient of the latter, while this week’s turkey is a beneficiary of the former.
Turkey of the week: Dignity (DTY, 593p), tipped as a BUY by The Times
Dignity is the UK’s largest provider of funeral services with around a 12% share of the market. It owns 520 funeral directors and operates 22 crematoriums across the country.
At 593p, the company’s shares are presently trading around their all-time peak, after floating on the London Stock Exchange at 230p back in April 2004. Not surprisingly, this is a classic defensive stock because it operates in a relatively stable environment.
This was demonstrated by last week’s solid if less-than-exciting interim results. Revenues grew 5% on 2005, while operating profits were up 6%. Overall, UK death rates fell by 4% in the year, but this is expected to reverse by 2012 once the effects of World War II run their course (the death rate is currently falling because so many young men were killed prematurely during the war that there are significantly fewer old men dying now).
In the meantime, the management team is trying to spruce up the top line by signing affinity deals with third parties (such as insurer Axa and charity Age Concern), acquiring smaller rivals and buying local authority crematoriums. However, this is a slow, uphill task and, in the short term, the main boost to earnings per share (12% growth in the first half) has been through clever financial re-engineering.
In February 2006, Dignity tapped into the bond markets and raised £86m of debt – secured against the company’s future earnings. This in turn has
allowed a special one-off dividend of £1 to be paid to shareholders. As a
result, net debt has risen from £171m in June 2005 to £248m currently. Although this level of debt is manageable, interest cover has now fallen to roughly 2.3 times, which is probably about the optimum level.
With regard to valuation, I would rate Dignity on a forward p/e of 16, thus generating a fair value for the stock of around 450p. So at 593p, the shares currently trade at a 30% premium. I think this is far too rich for a low-growth business, even if it offers excellent defensive qualities. I believe that the shares are over-valued and best left for the birds.
Recommendation: TAKE PROFITS at 593p
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