When a major shareholder sells, it's time to pay attention

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Reliance Worldwide was one of the hot floats of 2016. Surprising, really, when you consider it makes plumbing fittings. If you're struggling to get excited, you're not alone.

Someone did a good job of marketing it, though. When I looked at the beginning of the year, the share price was around $3.10 and the stock was trading on an enterprise value to EBITDA multiple of 15 and three times revenue.

Those numbers are high, especially for a newly listed manufacturing company. Some savvy investors won't even look at a float until it's been listed for three years. Of course, the share price is up around another 20% since.

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But in August something strange happened. Jonathan Munz, the Reliance Worldwide chairman, reduced his stake in the company from 30% to 10%.

The move would be less noteworthy but for the haste with which he sold. When a director and 30% shareholder sells two-thirds of his holding within days of his stock coming out of escrow, it's worth asking why.

The situation has parallels with iSentia, a company that turned out to be a disaster for those who bought its shares in 2015 and 2016. They hit a high of $5 early last calendar year and have since fallen more than 60%.

"Positive" news has been flooding out of Reliance Worldwide in recent months. First was the announcement in May that the company had acquired Holdrite, a supplier of "engineered product solutions" to plumbers and contractors.

After a quick look around that company's website, the wonderful word "di-worse-ification", coined by legendary US investor Peter Lynch, sprang to my mind.

Then there was the fact that Reliance Worldwide handily beat its 2017 prospectus forecasts. At the 2017 results release, the company also provided nice, neat guidance for 2018: $145 million to $150 million of earnings before interest, tax, depreciation and amortisation (EBITDA).

That represents a minimum profit increase of 20% over the 2017 figure. However, up to half of the growth will come from the Holdrite acquisition.

There are more red flags waving. Home Depot, which accounts for 32% of Reliance's revenue, has destocked some of the company's products in certain regions in the US. The company has explained it away - and it coincides with Lowe's rollout of Reliance's SharkBite range - but customer concentration remains a big risk.

The parallels with iSentia are striking. In August 2015 iSentia acquired King Content. The company announced the acquisition would be "EPS accretive in the high single-digit range".

That same day iSentia said it had exceeded its 2015 prospectus forecasts. It also forecast EBITDA growth of around 20% for the 2016 year (again, some of that growth was ascribed to King Content).

Within days, Quadrant Private Equity had sold its remaining shares. The company's managing director sold around a fifth of his holding the next month.

Our concerns proved well founded. King Content was a disaster and multiple profit downgrades followed.

Is Reliance Worldwide another accident in waiting? No one can say for sure. But there's no room for error with the stock trading on a 2018 forecast price-earnings ratio of 29.

Munz is, of course, perfectly entitled to sell his stock at any time. But he seems to think there are better places for (most of) his money than Reliance Worldwide.

Reliance shareholders should take note. Bitter experience has shown that major shareholders selling stock as soon as they are able to can be an ominous sign.

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James Greenhalgh is a senior analyst at Intelligent Investor (under AFSL 282288), owned by InvestSMART Group Limited. James graduated with a Bachelor of Commerce shortly after the 'recession we had to have'. After stints in financial planning and with stockbroking firm County Natwest, he realised that poring over annual reports was his true vocation. James has 24 years of investing experience under his belt, with almost half of them at Intelligent Investor. His main areas of focus are the retail and media sectors. To unlock Intelligent Investor stock research and buy recommendations, take out a 15-day free membership.