Ann: DuluxGroup delivers solid profit growth, page-17

Thanks fxb258, for sharing your thoughts.

I can see where you are coming from, and evidently, your concerns appear to be largely framed around your:

1.) macroeconomic outlook (credit demand, interest, and
2.) perception of elevated valuation for DLX.

I won't deal with Point 1.) because that is always go.ing to be subjective and I am also of the view that getting macroeconomic forecasts right is a difficult brief and not something that I observe people being able to successfully on any sustainable basis.

Point 2.), namely, DLX's valuation: As you say, a market value of $2.5bn being supported by $150m of NPAT, which implies a P/E multiple of 17 times does look expensive; at best, certainly not cheap.

But I think that often just looking at one basic valuation methodology in isolation, such as P/E multiple, can be misleading, because it ignores both differences in capital structure as well as financial pedigree of a business.

In DLX's case, the company currently has around $370m in Net Debt, supported by some $260m in EBITDA, so Net Debt-to-EBITDA of just ~1.4x. For a highly cash-generative company like DLX (where Operating Cash Flow covers Maintenance Capex bya factor of ~6 times) that reflects a business with meaningful surplus capital, which the market obviously values, but which the P/E multiple fails to capture.

EV/EBITDA, which does account for the balance sheet position, is under 11x which, for a company with DLX's market position, brand strength and pricing power (all resulting in a 35% ROE) does not look at all demanding a valuation multiple.

And then, when one takes it the next step further and considers that a significant proportion of EBITDA converts to Free Cash Flow, using a FCF yield measure to value DLX, FCF Yield to Market Cap is between 6% and 7%.

And 6% free cash flow returns, in the context of risk-free investment returns being closer to 2%, looks quite cheap, even on a risk-adjusted basis.

I guess what I am saying is that, sure, on one particular rudimentary valuation measure, the stock does look "expensive", but when viewed on some more nuanced measures - which is what the market does, I believe - any over-valuation signs are not evident.

Don't get me wrong; you might indeed make money on your short position on DLX because you get the macro call right; its just that to me it is not the most obvious shorting candidate around.

No matter.
To perpetuate the cliche': each to their own.

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