Why You Should Be Bearish On GYG plc (LON:GYG)

GYG plc (AIM:GYG) 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. Whether a company has a good future, in terms of its business operation and financial health, is an important question to address.

Firstly, a quick intro on the company - GYG plc operates as a superyacht painting, supply, and maintenance company worldwide. Started in 1977, it operates in United Kingdom and is recently valued at UK£53.40M.

The first thing that struck me was the pessimistic outlook for GYG. A consensus of GB commercial services and supplies analysts covering the stock indicates that its revenue level is expected to decline by -3.88% in the upcoming year, however, future earnings are expected to grow. On average, GYG's bottom-line should see an annual growth rate of 61.28% going forward, leading to an unsustainable margin expansion driven by a mix of falling sales from core activities and possibly cost-cutting. In addition to this, at its existing earnings level, GYG produces worse returns to shareholders (2.81%) compared to its industry peers (11.26%), which isn't a good sign. If a company were going through a reinvestment period, it may produce lower returns during that time period, and gains will be factored into the future outlook. Though this is not the case for GYG, which makes me wonder about the sustainability of its business.

GYG's financial status is a key element to determine whether or not it is a risky investment - a key aspect most investors overlook when they focus too much on growth. Alarm bells rang in my head when I saw GYG's high level of debt exceeding its total level of equity. However, cash generated from its core operating activities makes up a decent portion of debt (0.22x), and it generates enough earnings to cover its annual interest payments. There's room for improvement on the debt level front, but its overall cash coverage somewhat increases my conviction of the sustainability of the business going forward. GYG has poor near-term liquidity, with short term assets (cash and other liquid assets) unable to cover its upcoming liabilities in the next year, let alone longer term liabilities. One reason I do like GYG as a business is its low level of fixed assets on its balance sheet (19.14% 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. GYG has virtually no fixed assets, which minimizes its downside risk.

GYG currently trades at UK£1.06 per share. With 46.64 million shares, that's a UK£53.40M market cap - quite low for a business that has a 5-year free cash flow cumulative average growth rate (CAGR) of 14.59% (source: analyst consensus). Given the consensus 2018 FCF level of €6.30M, the target price for GYG is €2.66. Therefore, the stock is trading at a discount. However, comparing GYG's current share price to its peers based on its industry and earnings level, it's overvalued by 337.20%, with a PE ratio of 86.98x vs. the industry average of 19.89x.

GYG 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, GYG 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.

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.