Interactive Investor

Edmond Jackson's Stockwatch: A pitch-perfect stock for your ISA

29th July 2014 00:00

Edmond Jackson from interactive investor

Another "quality cyclical" reports trading well ahead of last year. After I noted on 18 July, how Mid 250-listed Michael Page Group cited increasing momentum in international recruitment, AIM-listed Cello Group has declared underlying profit growth of over 10% for the six months ended-June.

Service firms like these two support the case for ongoing economic recovery (barring no external shocks) as their clients invest for growth. Cello is involved in healthcare and consumer strategic marketing services, an area that's quite sensitive to the economy if more resilient than advertising. Healthcare consulting is showing very strong growth as it expands in the US, hence additional acquisitions and talent are being sought.

On the consumer side, Cello Signal "has experienced a very strong period of like-for-like gross profit growth, as core clients have continued to spend robustly, and the enhanced service offering of Cello Signal has gained rapid market traction." This partly reflects specialist growth in digital marketing as firms scramble to establish capability, although Cello has positioned itself well for this trend. Encouragingly for longer-term prospects, "many of the core growth areas within Cello Signal are still in the investment phase of their development."

Cello Group - financial summary
Consensus estimate
Year ended 31 Dec2009201020112012201320142015
Turnover (£m)124125128135160
IFRS3 pre-tax proft (£m)-5.754.931.231.385.46
Normalised pre-tax profit (£m)4.575.835.127.238.349.1810.1
Normalised earnings/share (p)7.736.554.527.587.717.58.3
Earnings/share growth rate (%)-0.13-15.3-3167.71.72-2.7210.7
Price/earnings multiple (x)11.912.311.1
Cash flow per share (p)6.8610.27.044.2610.7
Capex per share (p)1.481.911.372.171.62
Dividend per share (p)1.251.320.91.7222.52.7
Yield (%)2.172.722.93
Covered by earnings (x)5.865.44.964.333.9833.07
Net tangible assets per share (p)-25.3-25.3-13.6-8.84-5.12
Source: Company REFS.

The board indicates the group should "at least" meet full-year expectations (see table) which are not particularly demanding - the slight slip in earnings per share resulting from more shares in issue following acquisitions. After re-rating from 37.5p over the last 18 months the share price consolidated in the region of 85p to 95p, awaiting more proof that growth is resilient.

Rewarding shareholders

There is also the effect of Cello stock occasionally being sold by business vendors who want to crystallise value while demand exists (the market for these shares being relatively tight). Yet it would need a major jolt to business confidence to upset the positive trend. This is not an early-stage AIM share on a fancy rating; the table shows cash flow often in excess of earnings and low capital spending needs, the type of established business that tends to reward shareholders. With the 12-month forward price/earnings (P/E) multiple of 11.5 times and a near 3% yield covered three times, there is justified support. Investing just requires patience to let Cello's potential unfold.

Last year's 14.8% increase in gross profit to £74.7 million (11.4% like-for-like) was helped by various start-ups in 2012 and robust economic recovery in the UK where Cello derives 66% of revenue. With about 20% of revenue being US-derived and 10% from continental Europe, Cello will be affected by currency translation while sterling trades strongly, although profit forecasts are not running high enough to risk a warning.

So the organic growth story continues since I drew attention at 35p in January 2012 when management signalled robust trading and raised the dividend - with the forward P/E multiple then about 5 times and yield near 5%.

Director deals

The directors are steady buyers of stock, which I noted in September 2012 and this trend continues. For example last October the finance director bought 17,724 shares at 62p and the chief executive 7,710 at 64p then on 3 June the chief executive bought 15,000 shares at 87.4p and the finance director 8,500 at 86.7p to own 238,500; then on 17 June the chief executive added a further 10,000 at 87p to own 953,779.

None of the directors have sold down their holdings since last year's re-rating and after the update the price has settled at 92p.

On the face of it, Cello has substantially deployed its end-2013 cash reserves of £6 million, on the acquisitions of Line Digital last April and iS Healthcare Dynamics in May, however a reported 122% rate of cash conversion from 2013 operating profit ought to be replenishing this capability. Year-end borrowings were £9.5 million, principally longer-term, and may continue to reduce with cash generation. So Cello should be well-positioned also to keep acquiring as it sees fit.

Useful ISA pick

While these marketing services are not immune to disappointments with global growth, the group should now be more resilient than advertisers. So while a growth P/E in the high teens is unlikely, a multiple of five was excessively low for this group and 11.5 times still looks attractive considering its robust progress. The shares remain a useful constituent for an ISA, as I suggested at 68.5p at the end of last year, for while they are unlikely to multiply in the next year or two they offer a much better risk/reward profile than early-stage shares that typify AIM.

A danger since accelerated taper relief was abolished for AIM shares (20% capital gains tax after one year of holding and 10% after two years) and ISAs being opened to them, is no ability to offset losses against gains when ISAs are outside the tax system. So if your ISA has a spread of enterprising shares and the majority fall in price, any winners may still leave your ISA's net position hard-hit. The track record of Cello shows why this kind of share with sound earnings, dividends and prospects, is a wiser choice for any tax-exempt vehicle - SIPPs also.

For more information see www.cellogroup.com

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