Churchill China’s shares have plunged to below book value as the struggling hospitality industry cuts back on new cups and plates. Maynard Paton weighs up whether the crockery manufacturer is a value bargain or a value trap.
I am once again looking for ‘value bargains’ and revisiting a screen that identifies companies trading at less than book value.
Importantly, this screen attempts to avoid ‘value traps’ by demanding the shares offer net cash, dividend payments and a history of trading above book value.
The exact filter criteria I redeployed were:
- A price to net tangible assets of no more than 1;
- A dividend being paid during the most recent year;
- A 10-year average price to net tangible assets of at least 1;
- Net borrowings less total leases of no more than 0 (i.e. a net cash position excluding IFRS 16 lease obligations), and;
- A share price denominated in pounds sterling.
This time ShareScope returned 14 companies, including Castings and Wynnstay:
(You can run this screen for yourself by selecting the “Maynard Paton 19/10/22: Redrow” filter within ShareScope’s comprehensive Filter Library. My instructions show you how.)
I selected Churchill China because, among the 14 shortlisted companies, its shares had previously traded at the highest average multiple of net tangible assets.
Sure enough, Churchill’s 430p shares are priced at 21% less than the 545p per share net tangible asset value:
And yet the shares have in the past traded at beyond 5x net tangible value.
Let’s take a closer look.
Introducing Churchill China
Churchill China’s timeline extends all the way back to 1795, when Sampson Bridgwood began manufacturing earthenware on Market Street in Longton, Stoke-on-Trent.
The archives are somewhat hazy, but Sampson Bridgwood appeared to be acquired by James Broadhurst & Sons that was in turn acquired by Edward Roper during 1922.
Then followed decades of manufacturing a wide variety of cups, plates, bowls, dishes, jugs and other ‘tableware’ for the general public, which since 1980 has been complemented by manufacturing ‘hotelware’ — crockery enhanced by vitrification to increase its durability:
The group renamed itself Churchill during the 1980s to reflect its lead ‘hotelware’ brand.
Supplying cups and plates for hotels, restaurants, pubs and other hospitality venues provides what Churchill describes as a “high level of replacement business“, whereby customers “continue using Churchill products to replace breakages“:
Companies House shows sales of ‘hotelware’ at less than £11 million during 1993 versus sales of ‘tableware’ at more than £25 million. Fast forward to 2018, and ‘hospitality’ revenue had reached £52 million while ‘retail’ revenue had slumped to only £5 million:
Churchill no longer differentiates between hospitality and retail sales, as the latter has presumably become an immaterial part of the group. Alongside hospitality revenue, the top line now includes sales of raw materials to the “majority” of other UK potteries.
After suffering badly during the pandemic, total annual revenue has since reached approximately £80 million:
Churchill says its “technical manufacturing advantages” can deliver “superb value in use and value for money to its end users”, while the group’s “innovative product and design” can provide a “differentiated, competitive advantage” to customers:
Supporting the group’s product quality and designs is first-class service, whereby Churchill claims to fulfil the vast majority of orders “in under 48 hours” — a timescale that apparently provides a “significant competitive advantage“:
Products are manufactured mostly within two sites in Stoke-on-Trent, which Churchill says remains a “leading centre for ceramic excellence worldwide“. Last year 42% of revenue was earned from UK customers, with a further 39% from Europe, 9% from the United States and 10% from elsewhere.
Aside from the pandemic, Churchill’s last major profit setback occurred during the late Nineties when the group undertook a reorganisation to counter difficult retail sales:
The next major profit setback is unfortunately happening right now.
Interim results published the other week reported first-half profit collapsing 38% after “global hospitality markets” were “depressed by weak consumer sentiment and rising employment costs”. The outlook for 2025 generally consists of very large negative percentages:
At least Churchill continues to declare dividends, although the latest first-half payout was slashed 39%. The group’s dividend record up until last year had been very reasonable, aside of course from the profit setbacks during the pandemic and late Nineties:
Churchill joined the stock market during 1994 at 280p per share and transferred to AIM during 2003. The shares have twice reached £20 before crashing to the recent 430p to support a £47 million market cap:
Balance sheet
Any potential book-value investment must start with the balance sheet. And I cannot say Churchill’s asset quality scores extraordinarily well.
This month’s interims showed net assets close to £61 million, of which intangibles represented less than £1 million to give a net tangible asset value of almost exactly £60 million:
I would immediately dismiss Churchill’s £8 million ‘retirement benefit assets’ from any valuation sums.
Churchill’s ‘retirement benefit assets’ reflect the amount predicted to be left over for shareholders when the group’s pension scheme finally winds up…
…although nobody knows exactly how much (if anything!) will be left over until the scheme makes its final pension payment a few decades from now.
Churchill’s 2024 results revealed annual pension contributions of £1.75 million resuming from 2026, which does not suggest the scheme is presently brimming with excess funds.
Alongside the pension asset is property, plant and equipment with a £24 million carrying value, which supports approximately 50% of the market cap:
Freehold land and buildings sport a £12 million book value and, as perhaps befits a 230-year-old organisation, the properties are accounted for at less than their market value:
“The current value of land and buildings is, in the opinion of the Directors, in excess of the value included in these financial statements.”
Whether the other tangible assets are really worth £12 million is difficult to say. But very minor gains reported through the disposal of surplus fixed assets suggest book values are similar to real-life market values:
Elsewhere within the latest balance sheet, working capital consisted of stock of £22 million, debtors of £13 million and creditors of £14 million.
With debtors and creditors nearly balancing each other out, arguably the £22 million stock supports more than 40% of the market cap,
Using ShareScope to delve deeper into Churchill’s working capital, we can see stock levels as a percentage of revenue (red line below) have recently ballooned back towards pandemic levels:
The obvious worry then is stock is simply piling up in the warehouse because nobody is buying cups and plates…
…and perhaps at some point those cups and plates will have to be sold at clearance prices just to recoup a return.
The last annual report indicated minimal stock write-offs for “slow-moving and obsolete items“:
“The movement in impairment provisions against the value of inventory in relation to slow moving and obsolete items during the year was an increase for the Group of £54,000 (2023: decrease of £156,000).”
But stock has definitely become slower moving. Stock ended last year at £23 million versus a £49 million stock expense charge:
“The cost of inventories recognised as an expense and included in the income statements amounted to £49,479,000 (2023: £50,094,000).”
Stock last year therefore arguably took 172 days to shift (i.e. £23m/£49m*365) versus less than 120 days for both 2021 and 2022.
The investment in additional stock is partly responsible for cash in the bank sliding lower:
The latest interim results in fact showed cash slipping further to less than £6 million. At least Churchill’s balance sheet has been commendably free of conventional bank debt for 20 years.
Employees and margin
Probably Churchill’s most impressive ShareScope chart shows the upward trend of revenue per employee:
The headcount has reduced by 50% since the 1994 flotation as new product machinery replaced factory staff. But Churchill remains quite a labour-intensive business.
Last year some 723 workers generated average revenue of only £108k each — not a huge amount to cover salaries and other expenses. The average annual salary is £36k, which again is not huge and seemingly indicative of modest value being created by the wider workforce:
This month’s interims reflected how higher staff costs had hit Churchill twice over. Not only did increases to National Insurance and the minimum wage add an extra £1.5 million to the group’s employment costs, but the group’s hospitality customers cut back on crockery orders to fund their own higher wages.
Fans of the BBC series Troubleshooter may well remember Sir John Harvey-Jones visiting Churchill during 1989. I would recommend watching the entire 39m33s programme, especially from 8m34s when Sir John inspects the factory floor:
Sir John’s comments made clear Churchill required greater automation:
- “My first impression is that there are quite a lot of machines, but there are far, far more people doing rather ordinary jobs“;
- “I would have thought that job would be an absolute natural to be mechanised“;
- “The cost of these machines is so small, and the payback period is under a year… I just can’t understand why there are only two of them“, and;
- “There’s not much visible skill in this, is there?“
Given the long-term reduction to employee numbers, Churchill certainly followed Sir John’s advice.
Although Churchill has done well to keep the total wage bill between 30% and 35% of revenue…
…I do wonder whether the group requires further automation to help extricate itself from the current profit setback.
The other expense hampering progress during recent years concerns energy. Churchill discloses its significant energy usage…
…and I am quite confident the majority of ‘other external charges’ relate to energy expenditure:
For years ‘other external charges’ were kept below 30% of revenue, but reached 40% the other year:
I am pretty sure greater energy costs have helped suppress margins since the worthwhile 16% was achieved before the pandemic:
Given the diminished level of customer orders, I am pleased energy pricing is under good control:
“The Company has further expanded its risk reduction strategy with regards to energy and now has a level of forward purchasing out to 2028 with each year’s pricing at a level lower than the preceding year, meaning that we are well placed to deliver cost control.”
Boardroom
The aforementioned Edward Roper acquiring the forerunner of Churchill during 1922 commenced a 72-year stint as a private, family-run business before the 1994 flotation.
The 1989 invite for Sir John Harvey-Jones to ‘troubleshoot’ the business was sent by three grandsons of Edward Roper — brothers Michael, Steven and Andrew Roper:
Michael, Steven and Andrew joined Churchill during the 1960s and 1970s, and the trio’s boardroom presence ended during 2020 when Andrew retired as a non-exec.
Continuing the Roper family involvement today is James Roper, son of Andrew, who joined Churchill in 2001 and became an executive during 2015. James Roper is 48 years old and, if his father is any guide, has another 20 years of boardroom service to undertake.
James Roper retains a worthwhile 9%/£4 million stake while his father last reported a 2%/£1 million position. Another Roper family member enjoys a further 7%/£3 million holding. I would trust the Roper family still has every reason to want Churchill to one day recover and thrive.
Both James Roper and the chief executive boast MBAs and are (probably not coincidentally) alumni of the Harvard Business School Advanced Management Program. But whether their qualifications will counteract the disappearing orders from the struggling hospitality sector remains to be seen. The chief exec has encouragingly served as boss since 2014, so appears a reliable pair of hands.
An awkward boardroom feature last year was paying executive bonuses when profit dropped 22%:
But a redeeming boardroom feature is the desire to limit dilution. The share count has barely moved for 20 years:
Value bargain or value trap?
I am little sad to say Churchill is not quite a compelling value bargain.
I’m sad because the Roper family has over time established a credible competitive position and offered commendable long-term stewardship…
…but the UK pottery industry may now be a sector beset by structurally higher energy costs and customers struggling with structurally higher wage costs.
Despite lots of repeat ‘breakages’ orders, manufacturing cups and plates in the UK does not seem an inherently lucrative undertaking. Indeed, Sir John Harvey-Jones spotlighted Churchill’s labour-intensive practices 36 years ago and today’s employee productivity continues to suggest a lack of tremendous IP.
I now wonder whether that 16% pre-pandemic margin — leading to the shares reaching £20 and 5x book value — was created mostly through temporarily favourable circumstances.
In terms of value, I would certainly exclude the pension surplus from the net asset calculation to cut the stated 545p per share tangible value to 469p per share — which is not enormously higher than the recent 430p share price.
I am also wary a good chunk of the market cap is effectively supported by slower-moving stock. Cash levels are relatively small, too.
And I am particularly perturbed by the latest results implying a recovery being dependent entirely on revived customer spending:
“Despite the drop in sales we are confident that this is driven by market contraction rather than loss of market share. We continue to strengthen both our product proposition and manufacturing capability, further improving our brand and market position in preparation for the recovery in investment levels in the hospitality industry.”
But just how long will hospitality crockery orders take to rebound?
Identifying a genuine ‘value bargain’ is always difficult, but becomes even more difficult if you must first determine when the customers are going to recover!
Until next time, I wish you safe and healthy investing with ShareScope.
Maynard Paton
Maynard writes about his portfolio at maynardpaton.com. He does not own shares in Churchill China.
This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.
