Buy Two Great Companies In One

Published in Company Comment on 6 March 2012

These two very different businesses have combined to give us a 13-bagger.

A lot of firms operate different divisions that work in different, though usually related, areas. But there's one that has intrigued me for some time -- John Menzies (LSE: MNZS), known to most as the ex-operator of the newsagent chain that was sold to WH Smith in 1998.

Today, John Menzies runs two divisions, Menzies Distribution and Menzies Aviation, and they are very different beasts.

Distribution, headquartered in Edinburgh (where the eponymous John started up his first newsagent shop in 1833), is involved in the wholesale distribution of newspapers and magazines, and controls approximately 43% of the UK market.

Meanwhile, the Aviation division, which has its HQ in Hounslow, provides aviation support services, including ticketing, baggage handling and cargo -- the full bundle needed to get an aircraft turned around and heading back for takeoff, in fact. It operates at 116 locations in 27 countries, and handled 700,000 flights and 71 million passengers in 2010.

Buy them both?

How much sense does it make to have two such disparate business under the same company umbrella? Usually, I'd say not much, and I generally favour companies that stick to doing one thing well. But Menzies looks like an exception.

Back in 2008, Menzies aviation was hit by the double whammy of recession-led consumer slowdown and soaring oil prices, which could have done a lot of damage. But although group earnings per share did fall quite badly, it was ameliorated by a decent performance in the Distribution division. The share price collapsed to 43.5p after the results were out, and a rapid cost-cutting strategy was necessary. But, without Distribution, things would have been considerably worse.

Latest results

Today, with full-year results for 2011 out, things are the other way around. Menzies Distribution is treading water and has maintained reported profits at £28.8m, which is actually pretty reasonable in the current tough economy.

And this time Aviation has brought home the bacon, with a 31% rise in profits to £32.3m, and it is continuing to win new contracts, apparently due to its reputation for efficient service. Chairman Ian Napier said:

"I am particularly pleased that Menzies Aviation, after delivering profit growth of 31%, is now the larger profit contributor. Menzies Distribution, as planned, maintained profits by driving efficiencies through the business.

Growth opportunities exist and we will continue to invest in new projects that meet our investment criteria and produce sustainable returns. Financially, the Group is in a very strong position allowing a continued focus on shareholder value."

Overall underlying pre-tax profit was up 25% to £56.4m, with underlying earnings per share putting on 26% to 73.2p. And a final dividend of 17p was announced, bringing the full-year payout up to 24p, which was about 1p ahead of City forecasts.

Debt falling, too

But what of debt and cashflow, which are especially important in these hard times? Year-end net debt has been falling steadily since 2008 and, at the end of 2011, was further reduced to £80.1m from £95.7m the year before. That's less than current EBITDA, and is really no problem for this £350m company.

Free cash flow is down a bit, from £43.8m to £39.4m, which I possibly wouldn't describe as "strong" as the company does, but it's healthy enough.

On the day of the results, the share price was pretty much unmoved at 590p, largely because the last interim statement and recent pre-close update made sure there were no surprises on the day. But it's been a very nice 13-bagger since that low point of 2008, and has put on nearly 40% in the past 12 months alone.

Are they still a bargain?

On the latest results, the shares are now on a trailing price-to-earnings ratio of 8 with a dividend yield of 4%, even after all that great share price appreciation. And with dividends being more than thrice covered, they're looking pretty reliable.

The outlook for 2012 seems positive, with Aviation already having won new contracts and Distribution implementing more efficiency improvements. And though profit growth is unlikely to reach 2011's heights, I think there'll still be plenty of room for a reasonable dividend rise.

So what about buying the two companies in one now? I reckon it only makes sense if you'd buy each of them individually -- if you wouldn't want to own either on its own, don't buy the two together. But I think there is a strong case to hold them as separate companies, too, with each among the best in its class.

The combined company is still looking cheap to me.

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