It was my intention to write up my usual open and honest blog covering the purchase of Telit Communications and indeed I was in the process of doing that yesterday evening albeit belatedly for a purchase made only 9 trading days ago. The declared figures for Telit, results and those top level numbers available on various financial sites, did attract me along with a couple of encouraging RNSs on 23/5/16. The income for the business has been rising very nicely over recent years as have the apparent profits even taken into account the occupational hazard of a minor profits warning back in October 2015. The stock did not pass my routine screens which are weighted to free cash-flow but nevertheless, I was swayed by the increasing profits year on year and decided to make an initial purchase.
Last night, 2nd June, I started to dig around a little further and did not like what I saw on the cash flow statement which suggests that costs that should possibly have been taken into account against income when calculating profits were actually capitalised. Looking further at the figures over recent years and I see that the capital expenditure is starting to open a big gap over the quoted depreciation & amortisation; starting to not feel comfortable now! Of course, it’s not illegal to do that but it does greatly detract from my original reasoning to make the purchase just a few days earlier. It may well be that things will turn out well and the apparent need to follow this practice will diminish. As I see it the profits year on year are shown far more favourably than they may have been and I am left with the feeling that real profits as I would see them, are actually considerably less than the top line figures suggest. We already have a business on a current PE within the 20’s and whilst this falls to something like a PE of 11 in the future, these PE figures are generated on profits calculated following capitalisation of a lot of costs; had this not been the case then just how high would the PE be? Ok, I am not the greatest fan of the PE and much prefer free cash-flow measures but taking the quoted figures we have a P/FCF of over 75.
Please Note: I am not saying that Telit are cheating in any way, I am not saying that they are a bad business; what I am saying is that based on the criteria I apply that Telit carries a far greater risk than I allow my portfolio to live with: I simply don’t like large amount of costs being capitalised in this way. Accordingly I sold the shares today and booked a fortuitous 11% profit; this was purely down to Lady Luck and not skill as the price ticked up over the last few days. On the same theme, I would not wish to slate Telit and say they are an unworthy business; they simply don’t on reflection tick all of the boxes for me.
As ever with this blog, the above is just a walk through my thought process and should not be seen in any way as investment advice or condemnation of Telit; it’s simply what fits or does not fit with me comfort.
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