Stockwatch: Will a new CEO revive this high yielder?

A 12% yield points to a dividend cut, but with a new CEO on board all is not lost for this famous name.

On the face of it, De La Rue (LSE:DLAR) is a classic "Avoid". Its two-year share price chart shows a persistent decline from 680p to 202p; it has public notoriety for losing a Brexit-blue passport printing contract to a European rival; and after two profit warnings there was a soft one in July's AGM statement: performance expected "heavily weighted towards the second half-year" (to 30 March 2020). 

Two-thirds of operating profit is currency-related where revenues grew an impressive 20% overall last year but where competition is increasing. To cap it all, the Serious Fraud Office announced on 23 July it had opened an investigation into De La Rue's conduct in South Sudan.

A new chairman from 2 September lost no time however in the chair's prime role – to replace the CEO. On 7 October it was announced that Clive Vacher had joined with immediate effect: interestingly he has a strong industrial background and successful track record of turnarounds.

It's tempting to think: why would he assume the role unless confident of getting results.

On the other hand if his plans go pear-shaped he could blame his inheritance. There's also a Warren Buffett adage:

"When a manager with a reputation for excellence tackles a business with a reputation for poor fundamentals, it's the reputation of the business that stays intact."

Banknotes aren't necessarily a poor long-term business though, unless you major on "emerging market risk" like the way De La Rue was hit by an £18 million credit loss in Venezuela in its last financial year.

As for technical market risk it’s a concern how US investors Brandes Partners have trimmed their stake from 14% to 12.7%, as if this could become an overhang should De La Rue's newsflow continue disrupted.

UK investor Schroders (LSE:SDR), however, appeared to buy from Brandes, increasing its stake from sub-5% to 5.8%, as if recognising recovery potential. Obviously as an institution Schroders is highly diversified and has to buy when meaningful stock comes available; while as a private investor you want more of a rifle-shot approach.

I'm still intrigued by De La Rue, where at 202p support rests on the reliability of a 25p dividend. This is the world's largest designer and commercial printer of banknotes and also passports, moreover it provides product identifiers and "track and trace" software.

Capable management should be able to hone a value-accretive company.

Re-organisation for better focus and efficiency

Action taken (albeit triggered by the previous CEO/chairman) aims to focus on two divisions - "currency" and "authentication" which is logical anyway. Last year’s results showed 79% of group revenue deriving from currency printing, with identity solutions at 14% and product authentication and traceability at 7%.

A near-term risk would be the new CEO extending this to a root-and-branch review that generates cash demands in the short term, hence compromising the dividend payout; likewise any material fine by the SFO in the longer term.

The table already shows a history of significant capital expenditure needs albeit until last year, well covered by cash generation.

Last May's annual results targeted annual savings of £20 million by the 2022 financial year: time will tell what that will cost to achieve although 2019 restructuring costs were modest - e.g. £1.9 million for site issues, £1.6 million staff compensation payments and £1.3 million miscellaneous.

However, management already makes clear it can only "partially mitigate" the conclusion of De La Rue's UK passport contract in 2020 and growing competition in banknote printing.

On 14 October, there was news of selling an international identity solutions business for £42 million cash, this being significant for cash inflows to help sustain the dividend.

Last year's slump in cashflow can improve   

The annual cashflow statement showed operational cashflow collapsing from £63.4 million generated to £6.6 million absorbed, chiefly due to a slump in after-tax profit.

In such context the dividend cost was £25.7 million so could be viewed as being paid with the help of a £53.5 million increase in borrowings. End-March cash was £12.2 million, down from £15.5 million, i.e. insufficient to buttress the 25p payout policy since 2015.

Much therefore depends on mitigating the likely fall in operating profit "somewhat lower" (as guided) for 2020 versus £31.5 million last year.

At just over 200p a share, however, some extent of dividend cut is already priced in. The chief hurdle I envisage is weak interims in a month’s time when the new CEO might also opt to flag any extra house-keeping costs.

Yet it appears possible the working capital dynamics can improve, which weighed heavily last year. The trade receivables position swung radically (e.g. a £19 million negative impact due to revenue phasing) and £20.5 million was required to be paid into the pension fund given a £78.6 million deficit.

This all helps explain why net debt leapt from £49.9 million to £107.5 million. Last year's results didn't offer forward guidance on working capital but there was such a slew of issues, the company would be very unlucky to see a repeat.

So unless De la Rue faces a fundamental de-rating of profitability, capable management should be able to restore a profile of cash generation versus capex needs that is conducive to payouts.

Patient approach required

Exercising my regular balance sheet tests I am concerned at £175 million trade payables versus £114.4 million receivables (as if profits may be supported by delaying on creditors) which contributes to a ratio of current assets to current liabilities of just 0.6x – entertaining a "distress" ratio, at least historically.

Despite the year-end balance sheet concluding with £29.2 million net liabilities the intangible assets' element was £33.3 million. The balance sheet doesn't offer any comfort for downside protection but it should not thwart a capable turnaround CEO.

I therefore view the long-term risk/reward profile for De La Rue as positive with its shares priced just over 200p; the question is chiefly timing.

Schroders' being a highly diversified institution, it can afford patience although I think averaging in can pay off in the long run.

With a 12.4% prospective yield if the dividend is held, the stock can rise even if the payout is trimmed, so long as the market senses the company is stabilising. For those with patience, who appreciate risks and speculation are involved: Buy.      

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.