Thank you for sharing this high-quality article, very interesting company. I do have a question about the dramatic increase in Cost of Sale, for year end Mar 2020, Cost of Sale is 4.3M vs 18.6M Revenue. For H1FY24 cost of sale 6.2M vs 11.2M Revenue. So 23% to 55%. I don't find a lot of details about sale of cost, from FY23 annual reports it mentions "...external legal costs are either capitalized as investments for open cases or recognized as cost of sales on completed cases". So external legal cost per case increases dramatically over past few years?
I asked management this very same question Kevin, thanks for asking. Here is their response: (It’s basically due to accounting standards)
The key point that explains your question is: (a) the very high proportion of unrealised gains in FY20; and (b) the very low level of unrealised gains in FY21.
“Unrealised gains” are the Fair Value estimates of the gross profit Manolete will make once these cases are completed. So the “Unrealised Gain” is a gross profit number (after estimated COGS on those cases). That same number is included in Revenues (very confusing…).
It is only when cases are completed (realised) that we reverse out the Unrealised gain to zero and put in the ACTUAL Realised Revenue, Realised COGS and therefore REALISED GP on the cases. Bizarre but those are the rules….!
So in a year like FY20, which has very high unrealised gains the COGS will be low because there is NO COGS associated with unrealised gains. Unrealised gains is statement AFTER estimated COGS on those ongoing cases.
And in FY21, when those unrealised cases from FY20 all completed they became REALISED Revenues and only then are they stated as: Realised Revenues, COGS and GP.
So as Realised Revenues increase so will COGS.
This is what the CFO explained in the FY21 annual results report:
“The decline in gross profit of 7% to £13.4m in FY21 (FY20: £14.4m) and the decrease in gross margin from 77% to 48% was a result of the increased proportion of realised revenue, for which revenue and related costs of sales are recognised, whereas, unrealised revenue (the Company’s expected profit on each case) is recorded at 100% margin which is illustrated in the analysis of gross profit above. The large case completion in FY21 also impacted the gross margin for FY21.”
Please respond if that´s unclear and I will try to clarify.
Indeed debt collectors are having a bad time. However this doesn´t affect Manolete, their business model relies on insolvencies, not defaulted loans. Firms like Dovalue, Altisource and Intrum are possibly heading into insolvency though. That is if mortgage defaults dont increase a lot more from here.
I dont get to decide the PE ratio of a business, the market does. From the point of view of valuation I think its pointless to set a random PE like 15 (to use your example). I much rather use the historical average of a business as long as its reasonable since that is what the market thinks of a business in the long run. To quote Ben Graham: “In the short run, the market is a voting machine but in the long run it is a weighing machine.” Therefore the PE set by the market by Manolete in the long run (historically) is what makes sense.
On the other hand, Manolete isn’t a cyclical business as you say, in fact I would say its “cycle proof”, which is a logical conclusion from their high double digit historical margins. As long as the government doesn’t interfere, Manolete yields very stable and growing returns. As a result of this, a PE of 21 is more than justified, I would even argue that 21 may be a bit pessimistic given the constant cash flows this firm has generated.
Another good play on UK insolvencies is Begbies Traynor. Less risky than Manolete, as Begbies is an insolvency practitioner firm; ie the firms that are appointed to oversee and administer the insolvency process.
So whatever the outcome of the insolvency, Begbies will take their fees. Whereas Manolete still needs to be finance and win litigation to get a payout.
Thank you for the comment. I considered Begbies as an option to play this thesis, however it is not as attractive as Manolete for the following reasons:
1. Their historical average margins are way lower than Manolete´s as I show below:
Manolete margins: (including the terrible years after the insolvency ban)
Gross margins have averaged 57%
Operating margins have averaged 23%
Net margins have averaged 16%
Begpies margins:
Gross margins have averaged 46%
Operating margins have averaged 12%
Net margins have averaged 5%
2. PE ratio: (LTM)
Manolete: 31
Begpies: 417
Im not interested in a business with much lower margins and a more expensive valuation.
Really like this idea. Thank you for sharing. Have been looking at a basket of UK banks, specifically Barclays. Think this could be a great long pair. How did you come across it ?
See the chart “New cases by quarter”. It took UK firms about a year to start declaring bankruptcy in mass after insolvency laws were reinstated. The business cycle in this sector isn’t short and there is a time lag. Now business is recovering at a fast pace. Hope it helps
Thank you! Im glad you found it useful. Yes, they have paid dividends, I wrote so in the report. They have paid dividends from 2019 until 2022. See the link below for more details.
Hello!I l'm deeply impressed by your Substack articles. I am curious about your thoughts on the recently announced ARRCC number. Compared to the 109K for April to September, the number for October to March seems to have dropped slightly. Doesn’t this seem to contradict management’s claim that the numbers will return to the pre-COVID level of 200K? I would like to hear your opinion. My english skill is not good, I hope you understand.
“Luxury development in heart of Mayfair falls into insolvency”
Even in luxurious London bankruptcies are emerging.
https://www.standard.co.uk/business/luxury-development-mayfair-insolvency-60-curzon-thierry-despont-interpath-b1135560.html
Thank you for sharing this high-quality article, very interesting company. I do have a question about the dramatic increase in Cost of Sale, for year end Mar 2020, Cost of Sale is 4.3M vs 18.6M Revenue. For H1FY24 cost of sale 6.2M vs 11.2M Revenue. So 23% to 55%. I don't find a lot of details about sale of cost, from FY23 annual reports it mentions "...external legal costs are either capitalized as investments for open cases or recognized as cost of sales on completed cases". So external legal cost per case increases dramatically over past few years?
I asked management this very same question Kevin, thanks for asking. Here is their response: (It’s basically due to accounting standards)
The key point that explains your question is: (a) the very high proportion of unrealised gains in FY20; and (b) the very low level of unrealised gains in FY21.
“Unrealised gains” are the Fair Value estimates of the gross profit Manolete will make once these cases are completed. So the “Unrealised Gain” is a gross profit number (after estimated COGS on those cases). That same number is included in Revenues (very confusing…).
It is only when cases are completed (realised) that we reverse out the Unrealised gain to zero and put in the ACTUAL Realised Revenue, Realised COGS and therefore REALISED GP on the cases. Bizarre but those are the rules….!
So in a year like FY20, which has very high unrealised gains the COGS will be low because there is NO COGS associated with unrealised gains. Unrealised gains is statement AFTER estimated COGS on those ongoing cases.
And in FY21, when those unrealised cases from FY20 all completed they became REALISED Revenues and only then are they stated as: Realised Revenues, COGS and GP.
So as Realised Revenues increase so will COGS.
This is what the CFO explained in the FY21 annual results report:
“The decline in gross profit of 7% to £13.4m in FY21 (FY20: £14.4m) and the decrease in gross margin from 77% to 48% was a result of the increased proportion of realised revenue, for which revenue and related costs of sales are recognised, whereas, unrealised revenue (the Company’s expected profit on each case) is recorded at 100% margin which is illustrated in the analysis of gross profit above. The large case completion in FY21 also impacted the gross margin for FY21.”
Please respond if that´s unclear and I will try to clarify.
Hope it helps.
Thanks for the detailed explanation, really appreciate. Make sense now, truly bizarre revenue recognition.
https://www.reuters.com/markets/europe/europes-debt-collectors-face-reckoning-bad-loans-vanish-2024-03-20/
Indeed debt collectors are having a bad time. However this doesn´t affect Manolete, their business model relies on insolvencies, not defaulted loans. Firms like Dovalue, Altisource and Intrum are possibly heading into insolvency though. That is if mortgage defaults dont increase a lot more from here.
Does your thesis still remain the same?
Yes
sorry, but I wouldn't hold a small cyclical firm to reach a 21 PE target! could you also recalculate potential upside at 15 PE or even less?
I dont get to decide the PE ratio of a business, the market does. From the point of view of valuation I think its pointless to set a random PE like 15 (to use your example). I much rather use the historical average of a business as long as its reasonable since that is what the market thinks of a business in the long run. To quote Ben Graham: “In the short run, the market is a voting machine but in the long run it is a weighing machine.” Therefore the PE set by the market by Manolete in the long run (historically) is what makes sense.
On the other hand, Manolete isn’t a cyclical business as you say, in fact I would say its “cycle proof”, which is a logical conclusion from their high double digit historical margins. As long as the government doesn’t interfere, Manolete yields very stable and growing returns. As a result of this, a PE of 21 is more than justified, I would even argue that 21 may be a bit pessimistic given the constant cash flows this firm has generated.
Hope it helps.
Impossible to know
Another good play on UK insolvencies is Begbies Traynor. Less risky than Manolete, as Begbies is an insolvency practitioner firm; ie the firms that are appointed to oversee and administer the insolvency process.
So whatever the outcome of the insolvency, Begbies will take their fees. Whereas Manolete still needs to be finance and win litigation to get a payout.
I've been holding Begbies for a few years now in the Boon Fund: https://boonfund.substack.com/
Hello Boon:
Thank you for the comment. I considered Begbies as an option to play this thesis, however it is not as attractive as Manolete for the following reasons:
1. Their historical average margins are way lower than Manolete´s as I show below:
Manolete margins: (including the terrible years after the insolvency ban)
Gross margins have averaged 57%
Operating margins have averaged 23%
Net margins have averaged 16%
Begpies margins:
Gross margins have averaged 46%
Operating margins have averaged 12%
Net margins have averaged 5%
2. PE ratio: (LTM)
Manolete: 31
Begpies: 417
Im not interested in a business with much lower margins and a more expensive valuation.
Hope it helps
Great article again. Thank you very much.
Really like this idea. Thank you for sharing. Have been looking at a basket of UK banks, specifically Barclays. Think this could be a great long pair. How did you come across it ?
I was looking into countercyclical firms and Manolete appeared in my research. Im glad you like the idea
The government suspended insolvency laws until April 2022. Why do you think the stock has continued to get crushed?
See the chart “New cases by quarter”. It took UK firms about a year to start declaring bankruptcy in mass after insolvency laws were reinstated. The business cycle in this sector isn’t short and there is a time lag. Now business is recovering at a fast pace. Hope it helps
Great post, Alberto. O enjoyed it very much. Congratulations.
One question: have they ever paid out a dividend?
Thank you! Im glad you found it useful. Yes, they have paid dividends, I wrote so in the report. They have paid dividends from 2019 until 2022. See the link below for more details.
https://www.fidelity.co.uk/factsheet-data/factsheet/GB00BYWQCY12-manolete-partners-plc/dividends
Thank you once again for a great article Alberto!
Thanks Jimmy! As always you are the first to comment. Thank you for the continued support.
Hello!I l'm deeply impressed by your Substack articles. I am curious about your thoughts on the recently announced ARRCC number. Compared to the 109K for April to September, the number for October to March seems to have dropped slightly. Doesn’t this seem to contradict management’s claim that the numbers will return to the pre-COVID level of 200K? I would like to hear your opinion. My english skill is not good, I hope you understand.
"Where do the 38M and 12.7M come from? In the image, the "Current assets" total 36.506M?"
"If I add the "current liabilities" 5,547M and "non-current liabilities" 17,773M from the picture, I get 23.32M and not 25M?"
Most likely from a portion of the NCA I took into account. I wrote this a year ago so its hard to remember.