Quarto: Illustrating A SuperStock

6th Jul '23 by Mark Simpson

9 comments 1775 reads

Last week, Ed completed the introduction to the Stockopedia Strategy Map by looking at SuperStocks – companies that have high Quality, Value and Momentum Ranks. Over the next couple of weeks, I will be taking a look at some of these SuperStocks in more detail. Starting with illustrated book publisher: Quarto (LON:QRT)

Summary

Quarto has had a turbulent decade with several boardroom bust-ups leading to management changes, ending up with Asian publisher CK Lau becoming an executive director and owning over 50% of the equity.
Since Lau has been an executive director of the company, the EPS has almost trebled, and the company has had a ROCE that has averaged over 20%, indicating that with him at the helm, it is well-run and has maintained a solid competitive advantage.
Despite this strong recent track record, the company trades on a P/E of less than six.
In the past, the company has been heavily indebted. However, the combination of a rights issue in 2020 and good operational cash flow have all but eliminated the debt.
However, there are reasons for investors to be cautious. Lau, together with major Italian book publisher Giunti, own over 70% of the company. While they have no history of mistreating minority holders, investors are very much in their hands.
In addition, there are no forecasts in the market. The outlook is cautious but vaguely positive. My central case is that they will do at least as well this year as last year, but it requires trusting management to deliver.
This is indeed a QVM SuperStock, but one that should not be a significant proportion of an investor's portfolio, given the ownership risks.

Profile

Quarto was formed in 1976 by Columbia professor Laurance Orbach, together with London-based designer Bob Morley and writer Michael Jackson. Originally, Orbach's business partner Sid Mayer was to join, hence the Quarto name, but ultimately decided not to. In the 1970s, illustrated book publishing was too expensive to be economical but very popular with consumers. Quarto understood that there were economies of scale from large print runs, which could be achieved if they sold books in multiple regions.

The company publishes books in almost all categories where a strong visual component is a necessity, such as cooking, art or adult colouring books. Children's books are a very important part of Quarto's catalogue. Series such as little people, BIG DREAMS, which is a series of…

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shipoffrogs

6th Jul '23

Excellent article - thank you.

jimrog64

Great article. Thanks so much. A useful and reassuring analysis. This has been one of my few successful investments in the last two years. High Stocko rank and my own analysis flagged this one up, and it has been interesting that it is hardly discussed. I know that a few people have bailed out because of the ownership and the risks that you highlight. I am sitting tight for now, as I think that the potential further upside is worth the risk at the moment.

thirty fifty twenty

thanks Mark for a very thorough analysis. i thought also you were very balanced of the risks and rewards. i am a long term holder in a profitable position and have decided that the risk reward is still attractive for my strategy - i agree with you that it is higher risk, and higher reward type investment.

a couple of extra points from me...

director and NED salaries are modest which also gives further 'evidence' that mgt are not taking advantage of their controlling power.

secondly, i work on the simple basis that mgt will try to make money for themselves. thus i agree that one scenario is that they try to buy on the cheap - i also see this as low possibility. another scenario is that they start to pay dividend to give them some return - this i think would increase the valuation. my last scenario is that the best way for them to make money is by acquisition, and the best way to make acquisition is to do so with highly rated equity i.e. now that the ship is stabilised.. they have more incentive to tell the recovery story, maybe even give fcsts to the market.. this will increase the rating which will allow them to buy businesses more cheaply because they are using higher valued equity. i.e. if they got the share price 20 per cent higher it would effectively save them 4m on a 20m acquisition. not a prediction from me but one possible scenario.

lastly, the chart trend looks very much like a multi year head and shoulder bottom i.e. despite all the risks you highlight, the underlying trend is net buyers which is particulalry impressive becasue relative to the small cap market that is massive momentum.

fingers crossed, thanks again for the detailed dissection. disc i hold

Martinus 67

7th Jul '23

Mark, have you seen this comment from the company's Auditor Mazars? "The Quarto Group, Inc. filed its Annual on Apr 26, 2023 for the period ending Dec 31, 2022. In this report its auditor, Mazars, gave an unqualified opinion expressing doubt that the company can continue as a going concern." https://www.marketscreener.com...

I can't find any other sources for that news story besides that website.

Is that a comment from Mazars or a comment from that website. Have a look at the actual audit report - where they do not express a going concern concern.

Hi Shipoffrogs, just had a quick read-through of the audit report and you are correct, as I can't find any issues mentioned/implied in that article.

However, the impression from that news story and how I read it, implied the auditor had an issue, not the website proving the news. However, now reading the report I'm not sure where that 'news story' is coming from.

Mark Simpson

Sometimes, you get autogenerated content that misses the point. Or is perhaps old content. When they had large debt and the change of control occurred, they may well have had a qualified audit. I don't have any concerns in this area today, nor do the auditors today, it appears, but a reminder that it is always worth reading the audit report. Thanks.

DarthTrader

30th Aug '23

This hasn’t aged too well. Commentary and rankings have missed the risk here as shown by price action today

31st Aug '23

Yes, I found the H1 numbers a little disappointing on the sales and earnings, with LfL sales down around 10%. Although, there seem to be some specific reasons for this - primarily some destocking by Amazon and custom sales in the US being delayed. This means that H2 looks to be better than H1, so I still think they will be able to do around 25c for the full year, unless there is further significant deterioration in consumer confidence. This is down quite a bit on the previous year but not disastrous.

The positive is that free cash flow has been excellent at over $10m in the 6m period versus a $60m market cap. The bulk of this has come from the better collection of receivables, but these now match payables in size, and there is still $20m of inventories, so this doesn't look like an unsustainable move in working capital. They haven't achieved it by cutting back on book development either, as investment here matches amortisation. This cash flow means that they have paid down all long-term debt and now have $9.3m net cash, completing the de-risking exercise started by the current management team.

In light of this, the reaction to the H1 results looks a bit of an overreaction to me. We have gone from a historical debt-adjusted P/E of around 6 when the article was written to a forward cash-adjusted P/E of under 5 at the current share price (if I am right about H2 being stronger). Even in these small cap markets, that is a stand-out valuation for a company that isn't in financial difficulty. Valuation alone is a poor indicator of short-term returns, though, and of the factors I said I'd like to see in the article:

A longer track record of sustainable growth
The introduction of forecasts into the market
The return of a significant dividend payout

...they have slightly blotted their copybook on the first, and there is no news on the other two. So still work to do if they want to see this return to previous highs.

Quarto: Illustrating a SuperStock

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Mark Simpson

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