Is Spotless Group Holdings Limited (ASX:SPO) Cheap For A Reason?

Spotless Group Holdings Limited (ASX:SPO) may be cheap for a reason. The company has been on my radar for a while, and I’ve been consistently disappointed in its investment thesis. The biggest risks I see are around the sustainability of its future growth, the opportunity cost of investing in the stock accounting for the returns I could have gotten in other peers, and its cash-to-debt management. It’s crucial to understand if a company has a strong future based on its current operations and financial status.

Firstly, a quick intro on the company – Spotless Group Holdings Limited provides outsourced facility, laundry and linen, technical and engineering, and maintenance and asset management services; and refrigeration solutions to various industries in Australia and New Zealand. Started in 1946, it operates in Australia and is recently valued at AU$1.21B.

The top-line decline of -5.35% was the first metric I noticed about SPO. A consensus of AU commercial services and supplies analysts covering the stock illustrates the trend may continue into the foreseeable future. According to their forecast, SPO’s revenue level is estimated to decline by -1.03% by 2020. As SPO is currently loss-making, this revenue headwind is expected to negatively impact its bottom-line, which should see a further decline from -AU$28.90M to AU$46.95M.

ASX:SPO Future Profit Apr 4th 18
ASX:SPO Future Profit Apr 4th 18

Limiting your downside risk is an important part of investing, and financial health is a key determinant on whether SPO is a risky investment or not. Two major red flags for SPO are its debt level exceeds equity on its balance sheet, and its cash from its core activities is only enough to cover a mere 17.86% of this large debt amount. Furthemore, its debt-to-equity ratio has also been increasing from 97.69% five years ago. Although, EBIT is able to amply cover interest payment, cash management is still not optimal and could still be improved. Or the very least, reduce debt to a more prudent level if cash generated from operating activities is insufficient to cushion for potential future headwinds. The current state of SPO’s financial health lowers my conviction around the sustainability of the business going forward. Although SPO has high near term liquidity, with short term assets (cash and other liquid assets) covering upcoming one-year liabilities, it is not enough to cover longer term liabilities. This is not a big concern, though something we should be aware of. One reason I do like SPO as a business is its low level of fixed assets on its balance sheet (16.81% of total assets). When I think about the worst-case scenario in order to assess the downside, such as a downturn or bankruptcy, physical assets and inventory will be hard to liquidate and redistribute back to investors. SPO has virtually no fixed assets, which minimizes its downside risk.

SPO is now trading at AU$1.08 per share. With 1.1 billion shares, that’s a AU$1.21B market cap, which is in-line with its peers based on its industry and adjusted for its asset level. Currently, it’s trading at a fair value, with a PB ratio of 3.07x vs. the industry average of 1.71x.

SPO is a fast-fail research for me. Good companies should have good financials to match, which isn’t the case here. Given investors have limited time to analyze a universe of stocks, SPO doesn’t make the cut for a deeper dive. For all the charts illustrating this analysis, take a look at the Simply Wall St platform, which is where I’ve taken my data from.