Ashtead (AHT) - The recovery continues

Saturday Oct 22 2005 . All times are London time.

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Nick Louth: Go for discipline
By Nick Louth
Published: October 21 2005 12:42 | Last updated: October 21 2005 12:42

The longer I have invested, the more I have become convinced that investment outperformance is more to do with the way investments are treated once you own them than it is in getting those picks right to begin with.

I firmly believe that an average stockpicker who consistently cuts losses and lets winning shares run is likely to do better than a good stockpicker who lets a few losses balloon out of hand and takes profits quickly on winners. As the years have gone on I have tried to put more emphasis on the psychological disciplines, particularly in regard to cutting losses, and a little less on the detailed research to begin with. As a result my returns have improved. This year so far my UK portfolio is up 26 per cent.

In last month’s column I described the process of weeding out losers. Doing this helps stabilise a portfolio’s value, keeps assets within areas of expanding value, and eliminates the sapping anxiety of sliding prices. Taking these decisive steps won’t, on their own, make you any money. It is running winners that puts money on the table, and I have been fortunate to ride one of the best UK recovery stories of the last two years – plant hire group Ashtead.

At the end of 2003 Ashtead was in a sorry state. It had debts of £622m which dwarfed its £60m market capitalisation, and a string of pre-tax losses which made bankruptcy look possible. This was made worse by the discovery of an alleged accounting fraud at one of its US units, which led to a breach of banking covenants. However, towards the end of the year market conditions improved, and by dropping its prices Ashtead began to see increased rentals. With fixed overheads and improved cashflows, plus an indulgent attitude by its creditors to the covenant breach, there seemed hope by the start of 2004 that Ashtead could trade its way out of trouble.

I bought shares in Ashtead on January 7 2004 for 16.7p. The small initial stake allowed me to monitor what I considered a speculative story before I undertook detailed research. It was only after the good news started and I began to see a profit that I went to the trouble of analysing the company.

I doubled and then quadrupled my investment as a positive newsflow developed and the shares rose. I soon realised that Ashtead’s initial debts actually aided the recovery potential. Better revenues, better cashflow, refinancing at lower interest rates and better profits produced a powerful spiral of operational improvements.

By July 2004 the price had soared to 46p, a gain of 169 per cent in seven months. At this point it would be natural to consider how much further such gains had to run. My usual calculation is to see whether existing earnings are being repriced, a symptom that the rating may be getting ahead of itself, or whether the rising share price was accompanied by only a modest rise in the forward price/earnings ratio. Yet, because Ashtead was still lossmaking and the balance sheet was littered with exceptional items, such a calculation was not possible. I thought hard about the value Ashtead offered, but remained convinced that the shares had further to go.

So it has proved. Most of the company’s progress has been made in the Sunbelt subsidiary in the southern US where higher utilisation rates, prompted by the deluge of hurricanes, a growing market and higher prices have continued to increase revenues. Having now broken through to profits, Ashtead is promising the resumption of dividends for the current year. The operational gearing of the recovery is still impressive. A 12.3 per cent improvement in revenues in the first quarter of 2005 led to an improvement in operating earnings of almost twice this magnitude.

Though debt-equity ratios remain high at 360 per cent, interest cover has been much improved by the debt restructuring. Best of all, the share price at 133p is up almost 700 per cent from my initial investment. The firm has now entered the FTSE 250, and is on the buy list for a tranche of tracker funds. It may spin off its UK-based A-plant division, which will give a chance of some debt repayment.

At this higher price I have to consider whether the company offers further upside. Now at least I can see a positive p/e ratio, 15 times estimates for the 2006 financial year. That is in line with the sector, and with operational momentum still impressive there seems no reason to let go yet.

Nick Louth is an active private investor, writing about his own investments. He may have a financial interest in any of the companies, securities and trading strategies mentioned.