Edmond Jackson's Stockwatch: Is Findel finding its feet?

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How is the risk/reward profile at this turnaround shaping up? A year ago I suggested the FTSE SmallCap shares in Findel could at least double if management re-builds earning power over three years, cuts debt and restores the dividend.

Priced then at 178p, the stock was on a forward price/earnings (P/E) multiple of about eight although the terms of credit facilities prohibited dividend payouts which cast quite a pall.

More positively the group had turned five years of losses on its continuing operations into a £1.6 million profit, the chairman said exceptional charges were over, and all the group businesses had made a promising start to the 2013/14 year.

The price recovered as high as 320p in April but slumped just below 240p by late May. This down-trend resulted from a mixed 1 April update which cited good progress especially from Express Gifts (the largest contributor) and education supplies, despite some uncertainty with school buying patterns.

Going to plan

However, Kleeneze direct selling was behind expectations with a 5.4% sales drop and losses increased at Kitbag, although the World Cup and Ryder Cup are expected to improve sales and cut losses this year.

It was a reminder how turnarounds can take longer to materialise than investors hope for, although in the three-year context I suppose things are going pretty much to plan.

Net debt has reduced by £18 million to £207 million and "the board continues to be very encouraged by the group's progress and the significant recovery in prospects over the last three years." Overall expectations were unchanged including a 7-9% operating margin range for the medium term.

The stock has tweaked up to 270p following prelims for the year to 28 March that show a 43% rise in normalised operating profit to £31.9 million on revenue up 4.8% to £514.7 million. Normalised pre-tax profit jumped 87% to £22 million although after exceptional costs it was £3.3 million, up from £0.5 million.

Within these group figures, Express Gifts confirmed 9.6% growth in revenue with operating profit up 41% and Findel Education delivered a 6.5% increase in sales and fourfold increase in operating profit; although Kitbag and Kleeneze were a drag on progress.

Cash generation

The chairman concedes their recovery will take longer than envisaged, hence a £10.1 million reduction in carrying values on the balance sheet and a £2.8 million provision for exiting loss-making contracts at Kitbag.

This division's struggle is anomalous compared with Sports Direct and JD Sports Fashion which are booming. Management blames "a significant fall in traffic for a number of partners whose sporting performance failed to match prior seasons" and the best hope currently is a reduction in operating losses.

Kleeneze has suffered from stock availability issues amid unexpectedly higher demand for some products and a fall in distributors "however the business has seen an increased level of productivity amongst its motivated, longer-term network of distributors", fresh distributors have been appointed and order management improved.

The business is said to be profitable with attractive cash generation albeit "before exceptional charges" - a good example how in turnarounds, boards are often premature with their promises of no more exceptionals.

So it is possible the downside elements to Findel's risk/reward profile are under control hence should not materially damage those businesses now performing well.

The number of customers at Express Gifts has grown by 8.3% which augurs well considering 86% of its 9.6% additional revenue growth came from existing customers; also product margins have improved due to a better focus on buying and merchandising, such that the operating margin is up from 8.3% to 10.6%.

Meanwhile Education Supplies "has turned a corner but still has more to do." Its operating profit has recovered by 415% to £4.1 million on revenue up 6.5% with international business up 17% and "uncertain market trends have continued into this financial year...though the peak sales periods are yet to come."

Willing to accept risk?

The group's annual trading pattern generally starts quietly and it will take until the AGM later in July for a more indicative update - so meaningful forecasts may not be released until then.

N+1 Singer, broker to Findel, upgraded its forecasts on 1 April and its £22 million profit target for the 2013/14 year proved spot-on - so it seems fair to consider £30 million (see table) for the current financial year may also involve management guidance.

Similarly the normalised earnings per share projection for 2013/14 had been 20.8p at the low end of consensus which proved the more accurate forecast, although this broker is at the top end for 2014/15 in projecting 28.3p - then 34p in 2015/15.

At about 270p a share the forward P/E for Findel is therefore about 10 falling to eight times although a demanding forecast means the market is likely to want to see further evidence how the current year is evolving.

There is precedent of better things ahead: Findel made over 40p of normalised earnings per share in 2009/10 when revenue was about £600 million.

A pre-tax profit margin of 6% on revenue of say £500 million would derive £30 million profit and seems a fair ballpark figure to entertain for the medium term.

So for those willing to accept some risks, this share remains a speculative 'buy', otherwise wait for the AGM statement.

As turnarounds go, Findel's progress is quite typical: good in parts and some needing more work. There is also a macro influence: if markets maintain their poise then investors are likely to seek riskier shares to harness economic recovery; but if events turn for the worse then mind the propensity for a "risk-off" sentiment swing.

Meanwhile the latest news shows various directors latterly a non-executive director adding to their holdings, so they appear confident of value.

For more information see findel.co.uk.