Edmond Jackson's Stockwatch: Is Begbies rated too cautiously?

Should there be an inverse correlation between the performance of a listed insolvency adviser and the UK economy?

How relevant are AIM-listed Begbies Traynor Group's trading updates for stock selection across industries?

The financial summary table appears to suggest a broad link considering a profits boost in 2010 after the 08/09 crisis, with a drop from about £7.7 million to £5.2 million projected for its current year to end-April now economic recovery is spreading.

A latest "red flag" alert from this group says: "Recovery firmly established with financial distress levels down 7% year-on-year"; however on a quarterly basis they have increased by 4% which is attributed to heavy rain keeping people at home, also the post-Christmas slump as consumers tighten belts after excess festive spending.

It quite affirms how the UK economy is consumer-driven with people running down their savings or resorting to credit; although it has just been reported that wage growth and employment are picking up.

Notably for supermarket shares, Begbies cites "critical" distress in food retailing up a massive 86% which coincides with Tesco announcing a 7% fall in pre-tax profit for its year to 22 February 2014.

The report does not elucidate which food retailers are involved; it appears a result of competitive pressures where Aldi, Lidl and Waitrose are gaining share at the expense of Tesco, Morrison, Asda and Sainsbury.

Morrison’s signalling a price war and other supermarkets responding may also be a factor.

Ultimately value could appear as a result, especially considering Morrison has substantial property assets limiting downside, but the price war and "distress" reports like this are fresh news so could run for a while.

Hotels have seen a 23% jump in reported distress, media 16%, bars and restaurants 7% and general retailers 4%.

Much of this could be justified by bad weather discouraging people from going out although an uptick in distress for media is notable lest it involves difficulties selling advertising.

Media and marketing services are linked and generally a sensitive leading indicator for business confidence.

As with food retailing however it could also reflect structural change in the industry, for example digital media prospering at the expense of traditional print. Mind also that insolvencies are prone to peak in the early stages of economic recovery when some firms lack working capital to meet rising demand. So an insolvency adviser can indeed prosper with economic recovery.

It might seem a bit odd how construction - especially house building - has seen the most significant improvement, considering the weather. Yet builders tend to say, rain is not really a problem in winter compared with frozen ground, so possibly the mild wet conditions have helped.

Begbies is more specific, citing extension of the Help to Buy mortgage scheme and changes to annuities in the Budget stimulating interest in property by pension funds.

"Construction is likely to be one of the sectors witnessing the most improved financial health over the coming quarters." The question is what extent this is factored into share prices given the momentum construction and house building shares have enjoyed, versus liability for sentiment to change when interest rates inevitably rise.

But with the home selling season getting underway at Easter and house builders reporting good results, positive sentiment is likely to continue. Construction should also continue to benefit from ultra-low interest rates as demand improves.

Begbies also cites financial services benefiting from renewed market confidence and flotations returning to pre-recession levels - with March the most significant month for money raised since July 2007.

Such a trend favours shares in corporate stockbrokers for example AIM-listed Panmure Gordon and also supports a bull market because it provides new stories to engage buyers.

I have a couple of reservations in that flotations have involved a long tail of private equity owners selling (having been stalled since 2008/09) and demand has benefited significantly from the Bank of England’s loose monetary policy. A positive reading is private equity re-allocating capital for new deals, thereby a catalyst for economic growth, but mind how flotations are at a high level and tend to be cyclical.

So Begbies' report is interesting to consider what financial trends may be involved and their sustainability; but I would dig deeper.

Are BEG shares rated too cautiously? At 44p the forward price/earnings (P/E) multiple is under 10 times and prospective yield over 5%, twice covered by forecast earnings.

The vast majority of cyclical shares have re-rated from such a combination that was widespread a couple of years ago. A 6 March trading statement cited "challenging" market conditions after a 9% fall in the number of corporate insolvencies in England and Wales during 2013, however a winter improvement in activity as usual.

Together with the benefit of cost savings it means the board is confident about expectations for the current financial year to end-April and "the group remains in a strong position to take advantage of opportunities to develop and enhance the business, both organically and through selective acquisitions."

The end-October balance sheet didn't show much flexibility though, with £4.3 million cash versus £22 million long-term borrowings with finance costs taking 21% of £2.6 million earnings before interest, tax and amortisation. The group has £35 million debt facilities hence moderate scope for development, in context of a £44 million market cap.

Begbies appears likely to consolidate its position as "the UK's leading business rescue and recovery specialist" than diversify, so this ratings blend of modest P/E and useful dividend yield is likely to persist. It reflects risks with a varying market, yet Begbies' financial record can still be considered robust. BEG shares are therefore attractive as part of a diversified income share portfolio, with low expectations prevailing and scope to surprise on the upside.

For more information see www.begbies-traynorgroup.com.