Fleetwood: Interim result 2017

To those unfamiliar with our investment case, Fleetwood's half year result didn't sound too impressive. Net profit of just $3.6m on revenues of $153m suggests a low margin business, while abysmal return on capital numbers suggest poor quality to boot.

Yet we have recommended Fleetwood for the business it could be rather than one that it is currently. Adding to its attraction, Fleetwood has been cheap for a long time.

With that said, let's look at the result a little more closely.

Earnings before interest and tax (EBIT) was small but meaningful because it was the second consecutive underlying profit recorded after years of losses.

It is still a small number, though: $5.5m represents an EBIT margin of just 3.6%. Return on capital remains lousy too. However, with capital employed falling and profits rising, the turnaround appears to be on track.

Turnaround in caravans

Crucial to that process have been changes to the recreational vehicles (RV) business, which manufactures and sells caravans.

In Fleetwood starts to turn last May, our visit to a trade show suggested that the RV product range had improved considerably as new manufacturing facilities, new dealers and new designers were all installed. That work has paid off with revenue from the division up almost 90% compared to the same period last year.

Although losses from RV have narrowed to $3m over the period, they haven't been eliminated.

It appears that new staff hired to complete more orders aren't yet generating the productivity of more experienced staff so higher volumes haven't yet been accompanied by higher margins.

Over time we expect manufacturing costs to fall as productivity improves. We should see profits from the RV business – for the first time since 2013 – next year.

Another positive is the expanded dealer network. Encouragingly, management expects that half the network will return to exclusive distribution agreements, a key plank for success during the business's halcyon days. All in all, the injured RV business does appear on the mend.

Sell accessories please

The parts and accessories business was less impressive. We argued in Fleetwood's asset problem that Fleetwood should sell the business as it consumes huge amounts of capital and spits out little cash. That view remains.

The manufactured accommodation business shrugged off the mining decline and now supplies the education and affordable housing segments. Revenue rose 16% but it can be lumpy from period to period. EBIT rose substantially, to $5.9m, as scale benefits and lower costs increased margins. This has been the key driver of better profitability.

Occupancy of Searipple, a managed village at Karratha, returned to low levels of about 30%. At this level, there is little profit but at least it doesn't generate losses or consume much cash. Searipple will need higher occupancy to generate meaningful profit but remains a cheap option within the business.

Changing cash flow

For the second time, we have noticed poor cash generation. This is unusual as the business has historically delivered excellent cash flows. Management claims the usual things such as higher working capital and delayed payment terms and that all will be well next time.

We suspect, however, that the cash dynamics of the business have changed along with the revenue mix.

Fleetwood has historically enjoyed strong cash generation but, as its revenue shifts from village operations to modular accommodation and RVs, the business will need to spend money upfront and collect it at a later stage, increasing working capital requirements. This is likely a permanent change.

This isn't a huge problem but we should recognise that reorientating the business away from mining exposure, while vital for continued profitability, has come at a cost.

Dividends were again not paid but, with the recovery still early, this is prudent. We expect dividends to recommence next year. It didn't look like it from the headline numbers but this was an excellent result and our investment case is well on track. HOLD. 

Note: The Intelligent Investor Growth Portfolio owns shares in Fleetwood. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

Disclosure: The author owns shares in Fleetwood.