Interactive Investor

Edmond Jackson's Stockwatch: Iraq conflict could hurt Driver

20th June 2014 00:00

Edmond Jackson from interactive investor

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Do the AIM-listed shares in niche consultancy services firm Driver Group represent value after six months of steady retreat? The price has drifted from a 132p high late last year to what looked like a capitulation briefly below 90p in May and are currently 103p.

The fall started late last year despite an increase in the final dividend at the 9 December 2013 prelims, although a prospective yield just over 1.5% means attention is largely on earnings.

If forecasts by the company's broker - Charles Stanley Securities - are fair then Driver has entered a growth period and its shares trade on about 12 times earnings for the year to end-September 2014, reducing to nine times for 2014/15. A low numerical base enhances the price/earnings versus growth (PEG) ratio, a classic measure of growth shares, which may be as low as 0.3 when anything under 1.0 implies value. So long as the forecasts are borne out.

Driver Group - financial summary
Broker estimate
Year ended 30 Sep2009201020112012201320142015
Turnover (£million)20.5 16.417.426.3  
IFRS3 pre-tax proft (£m)1-0.80.41.22.6  
Normalised pre-tax profit (£m)1-0.50.51.62.63.24
Normalised earnings/share (p)3.2-1.51.44.77.38.711.4
Earnings/share growth rate (%)-44.8  23554.719.230.7
Price/earnings multiple (x)    14.2129.2
Price/earning versus growth (x)    0.30.60.3
Cash flow per share (p)4.2-24.34.38.5  
Capex per share (p)1.30.50.20.81.2  
Dividend per share (p)31 11.21.61.7
Covered by earnings (x)1.1  6.27.15.46.7
Net tangible assets per share (p)18.11516.31524.3  
Source: Company REFS.

Driver specialises mainly in dispute and advisory services for construction and engineering projects, also project services.

Trett acquisition

It has a leading position in the Middle East and Europe, representing customers in tendering, forming consortiums and project disputes.

Project management involves specialist work such as public-private partnership hospital projects in South Africa - with gross margins highest in expert services and lowest in the project services. So a key question for this stock's rating is what extent these specialist services may offer resilient growth or are dictated by the wider business cycle.

The table shows performance was indeed hit following the 2009 financial crisis; however prospects need considering in the light of a game-changing acquisition of Trett Consulting in May 2012 for £3 million cash and where £14 million revenue and marginal profitability was achieved in 2011.

This deal looked a very good matching of operations and in terms of potential rewards, is said to create a global platform for group services hence a potential step-change in earnings. But as so often is the case with small companies taking on the world by acquisition, it has also introduced risk, with US business recently subdued which rather upset the trend in group reporting. Also some investors might regard any exposure to South Africa as unwise.

"Strong pipeline"

Last December's outlook statement at prelims cited "a strong pipeline of opportunities ahead which gives the board a high level of confidence in the outlook for the remainder of the financial year" (to end-September 2014).

Yet the 27 February AGM it then warned of a slow start to the year in Africa where three hospital projects had been suspended by the South African government; also "American workloads remaining subdued" which together would impact performance in the first half year; although good progress in Europe, the Middle East and Asia Pacific (over 90% of the business) means "continued confidence in the remainder of the year".

Driver's European operations (mainly the UK) and the Middle East have good profitability with margins of 13% and 27% respectively whereas the group operating margin was 7.1% due to lower margins elsewhere and central costs; however the medium-term target is over 10%.

The 20 May interims then revealed a near 20% slip in pre-tax profit to £1.1 million despite revenue up 7% to £19.9 million, a reminder how even minor setbacks at a small company can dent a financial release. The latest outlook anticipates "a better performance in the second half year (i.e. April to September) as new offices, especially Australia and Hong Kong, start to deliver benefits".

The directors have yet to seize on this for share buying though, now restrictions are lifted after interims. The last trade was when the chief executive rather astutely exercised nil-cost options on 750,000 shares last December and sold them at 120p, although he also exercised options on 500,000 shares at 21.5p and increased his share stake by this amount to just over two million. The finance director owns just 10,000 shares.

Not to make too much of this for, as a small company, Driver's board has only five directors; but if they were buying it would strengthen belief in forecasts.

What could go wrong?

The balance sheet is respectable with just under £3.3 million borrowings in context of £10.7 million net assets - of which £3.5 million represents goodwill and intangibles which is fair enough for this kind of business.

There was £1.1 million cash at end-March, down from £2.3 million at end-September 2013 as trade receivables rose. Given this context and Trett's Houston, Texas office introducing a blip to group reporting, it seems likely that management will develop its existing operations than acquire further for the time being.

What could go wrong? The main risk is more likely a stalling of international business decisions if a major sectarian conflict in the Middle East spreads from Iraq just as the US Federal Reserve winds back monetary stimulus. Trett's subdued US trading is a reminder how this economy may still be vulnerable. The oil-rich Gulf states presently see little risk of conflict spreading, although the jihadist campaign has already taken a lot of people by surprise.

For investors willing to engage a bit more risk and recognise inherent uncertainties with small caps, Driver is at an interesting stage currently - both as a company and share price wise - as it moves to gain the full benefit of the Trett acquisition. If you need more evidence, watch whether any directors buy.

For more information see driver-group.com.

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