AIM Shares: And Nichols PLC

Introduction to the AIM market at the London Stock Exchange

AIM (formerly the Alternative Investment Market) was founded in 1995 to allow investors access to young companies that could not qualify or would not pay the cost for a listing on the main market of the London Stock Exchange (LSE).

According to the LSE, "AIM is the most successful growth market in the world." At the last count there were 1,094 companies listed on AIM compared to a peak of 1,399 eight years ago. Companies have raised 86 billion pounds since 1995, yet the total value of all AIM shares today is only 78 billion pounds. It has been a wonderful source of fees and commissions for underwriters, brokers, accountants, lawyers and market makers. But what about the humble investor?

The results of the AIM ALL Share Index (blue) compared to the FTSE All Share (red) for the past 10 years, shows just how rotten AIM shares have been, on average, for the investor:

Graph courtesy Google Finance, click to enlarge

 

Over 3,000 companies have listed on AIM since 1995 and yet only one-third remain. Some have moved to the main market and some have been acquired. But many have gone into administration or delisted, leaving the shareholder with nothing or next to nothing.

 

Yet there are excellent companies listed on AIM. And AIM shares have one feature that marks them out from the main list: given certain requirements they are exempt from Inheritance Tax. This tax feature has attracted good, UK based family-run businesses that can pass on their shares to the next generation without the 40% tax burden. It is here that one finds the best companies.

As the tax concession is an important incentive to investing in AIM shares, it is important to know what companies will qualify for "business relief" for Inheritance Tax.

Ø  The company may not also be quoted on a "recognized overseas exchange" (HMRC).

Ø  The company may not be engaged "wholly or mainly in dealing in securities, stocks or shares, land or buildings, or in making or holding investments" (HMRC).

Ø  If the company is acquired (or the investor sells his shares) before 2 years are up, provided the funds are reinvested in another AIM company that complies with 1 and 2 above and together they are held for at least 2 years, the investment will be free of Inheritance Tax.

There are other considerations that are peculiar to investing in AIM companies.

As they are usually small cap, the touch - the bid to offer spread - can be very high. Invest in Venn Life Sciences (market capitalization of 6 million pounds), and the stock must appreciate by 14% before you break even before stamp duty and commissions.

A second consideration is that, unlike the main market, AIM’s listing rules do not require companies to have a minimum free float. "Free float" is the proportion of shares that are freely traded in the market compared to the number held by all parties. Free float is important because companies can be taken private by their owners at the price they choose if they control 75% of outstanding shares.

BlueStar Secutech, a Chinese manufacturer of digital video equipment registered in the British Virgin Islands, was listed on AIM in 2007 at 48p a share. Six years later, after reporting a 60% increase in earnings per share and a net cash position, it made a tender offer of 2.5p a share. BlueStar's net asset value per share was reported at 40p at that time. So shareholders were offered just 6% of the net asset value of a profitable, cash rich trading company. As the free float was only 23%, outside shareholders could not contest the price. All AIM companies are obliged to inform the public of their free float on their websites.

A third consideration is that AIM stocks can easily run out of money. Small and high risk companies often find it impossible to get bank financing and they do not have the option of issuing debt instruments. If in need, they must dilute shareholders via a public offering or shut up shop.

The wise investor will approach an AIM-quoted company with the circumspection a bear approaches  a honey trap:

1. Stick to companies with no or little debt, a profitable trading record in a niche market and that are cash generative.

2. Be sure management can be trusted to do the best for the company and not just look after themselves.

3. Check whether the company is quoted on an overseas market and is eligible for business relief for Inheritance Tax.

4. Ensure that the free float is well in excess of 25%; look for well regarded institutional investors who are invested in the company.

5. Take into consideration the share price's bid to offer spread.

6. Have a clear exit strategy. You might need it.

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Nichols PLC

 

Vimto can and pre-war advertisement, courtesy Nichols website 

 

  

Nichols is a soft drinks company based on Merseyside. In 2004, the company transferred its listing from the Main market to AIM, explaining that, after selling its foods business, the size of the company did not warrant the costs associated with a Main listing. However, the family held about one-third of the company's shares at that time, so Inheritance Tax considerations may have paid a role in the decision to join AIM. The family now hold about one-fifth of its shares.

The company has a good trading history, a high return on equity and holds net cash of 34 million pounds, 9% of its market value.

Nichols is currently eligible for 100% business relief for inheritance tax, it has a 'free float' of 79%, a market capitalization of 366 million pounds and it trades on a bid to offer spread of just over 2%.

Although Nichols's brands, either owned or under license, cover all main segments of the soft drinks market, except for water, its share of the UK market is only about 1%. And the total market has grown by a compound average of 3% since 2006 (British Soft Drinks Association):

Drink sales UK	Nichols's brands	Total UK Sales in Pounds Million	% Total growth 2006 to 2012
Carbonates	Vimto, Panda, Sunkist, Levi Roots	8,707	30% value
Still & Juice drinks	Vimto,	1,820	14% value
Dilutables	Vimto, Weight Watchers	955	20% value
Fruit Juices & Smoothies	Weight Watchers	1,860	2% value
Total		13,147	20% value
Sports & Energy drinks (Included in carbonates and still drinks)	Extreme Energy and Sport	1,665	82% volume

From 2013 Refreshing the Nation, British Soft Drinks Association.

While the total drinks market (excluding bottled water) has grown by 20% in value, Nichols's sales have more than doubled in this seven year period. Nichols does not give sales figures by brands, but it is reasonable to assume that this is largely the result of acquisitions and license agreements:

·      2005 - Nichols purchased Panda (including Panda Cola, the 3rd cola drink after Coca-Cola and Pepsi in the UK) for 5.5 million pounds.

·         2010 - it licensed Levi Roots (Caribbean flavoured carbonates) worldwide rights.

·         2011 - it licensed Weight Watchers cordials and fruit juices for the UK and Ireland.

·         2012 - it licensed Extreme Sport and Energy for the UK.

Nichols' core brand in the UK is Vimto, which it launched in 1908. And Vimto exports, mainly to the Middle East and Africa, account for 21% of Nichols's sales, where it relies on third party distributors. The company sees its main growth coming from the convenience and online outlets both in the UK and international markets. Sensitive to the anti-sugar campaign, the company reduced the sugar content of its drinks by 20% in 2013.

Nichols Dispense is the third largest supplier of dispensed soft drinks, to pubs etc., in the UK, after Britvic and Coca-Cola Enterprises.

Shares in Nichols (in red) have outperformed the FTSE All Share (in blue) by a wide margin.

Courtesy Investors Chronicle, click to enlarge

 

Nichols runs a very lean organization. It bills 640,000 pounds per employee. The company relies on contracting out production, which keeps capital expenditure and inventory low while avoiding any temptation, as its CEO remarks, "to feed the factory."

 

Financial results are excellent:

 

Ø  Earnings per share have increased by a compound 16% per annum since 2004, and equity per share has increased by a compound 12% per annum in the same period.

 

Ø  Net margins are a comfortable 15% of sales.

 

Ø  Return on equity, both historically and on retained earnings, averages over 30%, and this is without any financial leverage.

 

Ø  Net operating cash flow, after small amounts of capital expenditure, covers the dividend 2.2 times. The company held 34 million pounds in net cash at the 2013 year end.

 

At 1,008p, Nichols trades on an historical PE ratio of 22 and yields 2%. The chairman's outlook is positive (2013 Annual Report):

"Although economic indicators suggest signs of optimism, there is evidence that consumer spending in the UK remains cautious and we expect the UK retail market to remain challenging in 2014. Despite this environment we are confident that the Group can maintain its strong performance into 2014. We will continue to invest in our brands and grow distribution in both our UK and international markets. January saw the launch of the “Vimto Squeezy” product which takes the brand into the new ‘water enhancer’ category and in April consumers will see the new Vimto TV campaign."

 

My valuation model values Nichols' shares at between 1,000p and 1200p, depending on the assumption used for future return on equity.* Nichols' present price of 1,008p is 19% off its recent all-time high, reflecting the recent decline in small cap shares.

 *Assumptions: earnings per share growth 10% p.a.; equity per share growth 10% p.a.; return on equity 25% or 30%; dividend payout 43% of earnings; average PE ratio of 21.5, all discounted at 10.8% (3.8% SLXX + 2% operating risk + 5% margin of safety) for the years 2014-19.

 

The cautious investor will note that:

 

1. The soft drinks business is fiercely competitive. Nichols is dwarfed by Coca-Cola, Pepsi, Snapple, Suntory, Britvic and A G Barr (see http://thejoyfulinvestor.blogspot.co.uk/2013_09_01_archive.html). This makes it very difficult for Nichols to get shelf space in the supermarket chains.

 

2. The underlying soft drinks business is not growing in volume terms in the UK. Nichols management has proven to be wily. It has improved margins and licensed new products. But, can it match its past performance?

 

3. The adjusted earnings for 2013, which showed an increase of 10% on 2012, excludes 1.7 million pounds for management restructuring and a 2 million pounds provision for a claim from its former Pakistan distributor. As a result, reported earnings declined slightly on 2012.

 

4. Cash generation is consistently good, with a year-on-year increase of 10 million pounds in the cash account. Cash conversion exceeded 100% of after tax earnings in 2013. The company has no debt and a cash balance of 34 million.

 

5. It is reassuring that the Chairman, grandson of the founder, owns 6% of the company and that the Nichols family hold one-fifth of its shares. The company's successful formula is unlikely to be changed by an over enthusiastic CEO.