Shares in Quindell (LSE: QPP) have fallen by 65% over the last three months, thanks to the combined effects of the Gotham City Research bear raid in April, and yesterday’s news that the firm had failed to qualify for a Main Market listing on the LSE.
Quindell now looks cheap, but is it a buy or a sell?
Failure to list
To anyone who knows the LSE listing rules, Quindell’s failure to qualify for a Premium listing should have been obvious — so how did yesterday’s fiasco ever come about?
One possibility is that Quindell’s management insisted on continuing until it received a point-blank refusal. If so, that smacks of blind optimism — not an attractive trait in management.
Accomplished record?
On the face of it, Quindell’s management have an outstanding track record: the firm’s turnover has risen from zero to £380m in three years, and it has an enviable 28% operating margin.
I only have one concern — if I buy into a successful growth story, I expect to pay for it.
At Quindell, analysts are forecasting a 68% rise in earnings per share this year — yet even before yesterday’s fall, Quindell shares traded on a 2014 forecast P/E of just 5.4.
Why?
In my view, there are only two explanations for Quindell’s ultra-low P/E rating. Mr Market must believe either that Quindell’s profits are unsustainable, or that they are uncollectable.
The company certainly has problems when it comes to collecting debts: in 2013, it took an average of 314 days for Quindell’s customers to pay its bills. As a result, Quindell’s operating cash flow was negative last year, despite the firm declaring an operating profit of £108m.
Quindell says it is working hard to address this problem, but I believe there is a genuine risk that some of the firm’s paper profits will never be turned into cash.
Are Quindell’s profits sustainable?
Quindell’s reporting is rather vague, but the majority of its turnover seems to come from UK motor insurance claims management. This has four main elements: personal injury, car hire, vehicle repairs and administration.
Of these, car hire and vehicle repairs are high-turnover, low-margin activities that Quindell outsources, but which probably bulk up the firm’s turnover. Quindell’s expertise appears to lie in administration and personal injury claims, which it handles in-house.
I’m concerned that Quindell may rely too heavily on profits from personal injury claims, many of which could be dubious ‘whiplash’ claims.
Buy or sell Quindell?
Are Quindell’s profits sustainable, and can the business become cash generative? Ultimately it’s your decision, and will probably require further research.