CPL Resources, decent margin of safety

Most people would run a mile from this company: AIM-listed recruitment company (highly cylical) that operates entirely in Ireland (basketcase economy). Looking at the valuation and the financials tells a different story however.

At year end 2008 the company had EURO 36m in cash, and 35m in trade receivables (limited impairment risk). The only liabilities were 24m trade payables. No debt to speak of. So the net asset value for the company (not including any long term assets) was EURO 45m, or 1.21 EURO's per share. The current share price is 1.61 EUROs, although I bought in back in July on the London listing around £1.2. At the lows it got down to below 1.oo EURO, a 20% discount to the net current assets.

It seems to me that buying a business such as this at around book value (or ideally at a discount) is an extremely attractive proposition. Why? Three reasons.

Firstly, despite the highly cylical nature of the gross profit, the business model faces little risk of actually going under. There is no debt. It is also fairly easy to downsize the business by reducing the workforce, although admittedly there comes a point where the fixed costs associated with branches become too high.

Secondly, even if operating profit is negative, it is unlikely that the business will burn through its cash. Trade receivables are 40% higher than trade payables, which means the business releases working capital as it shrinks. Therefore, it is not unreasonable to assume that current cash levels will at least stay where they are (even if net current assets fall slightly as the business downsizes).

Finally, the potential upside is really quite high. In the good times recruitment companies can trade up to 4-5X book value. Earnings can recover quickly once the decline stops. Even if this is a 2-3 years away, it still makes the investment attractive. Given that the downside appears to be rather limited, this investment offers an attractive asymmetric risk-reward profile. For sure, CPL is not at the quality end of the recruiters. For choice I would much rather own Hays or Michael Page, but both of these shares already trade at big premiums to their tangible net asset values (despite also being essentially breakeven).