Stockwatch: Sports division drives success at this PR firm

I keep my nose to the ground for "good companies at a decent price" with no other agenda. Yet I keep sensing a similar stock profile especially in cyclicals: e.g. just like marketing services group WPP in the FTSE 100 index, the FTSE SmallCap shares in Chime Communicationsrocketed in 2013 then dropped in 2014 despite forecasts for earnings per share to re-rate massively.

The price fell 20% from its 374p peak since the New Year, recently to 300p; then rose to about 325p around a strong set of interim results on 27 August; but has dropped back to 310p. The dilemma is a fat, historic price/earnings multiple of about 40 times which drops to 12 if forecasts are dependable.

I drew attention two years ago around 200p when 2012 interims showed the benefits of a strategic shift towards sports marketing - driving a 66% hike in continuing businesses' operating profit. It has so far meant quite a lumpy financial profile though: an irony with the stock's 2013 rally was this happening amid 2012 prelims then 2013 interims showing mixed figures albeit firm underlying business. The re-rating - so typical - also reflected market bias towards cyclicals as a means to play economic recovery, and exuberance after years of loose monetary policy.

Latest interim operating profit is up 25% to £17.2 million with earnings per share (EPS) up 25% to 11.41p and the dividend by 15% to 2.53p; although earnings cover for total annual dividends is expected to pan out at about 3 times (see table) for a prospective yield of about 2.7%. Commercial momentum certainly needs to continue given EPS forecasts of 26p or better for the full year, and 2015.

Management says recent benefits from the Winter Olympics, FIFA World Cup and Commonwealth Games will persist in the second half; for example the World Cup has involved 29 separate projects, eight of which were directly for FIFA and 21 for sponsors, which positions the group well for the 2016 Rio Olympics with some contracts already being negotiated.

Next year should benefit from the Rugby World Cup and Ashes in the UK and the ICC Cricket World Cup in Australia; then in 2016 quadrennial events such as the Rio Olympics and UEFA European Championships.

Reliance on major events could ease with the sport & entertainment division's growth: now operating in seven of the top 10 sports by value globally. Comparing the first half of 2013 with 2014, it has risen from 31.5% to 38.9% of group operating income while the operating profit element has improved from 39.1% to 56.4%.

So to destabilise the uptrend would need a shock economic slowdown - say in response to the Ukraine crisis, combined with political change in the UK - to hurt Chime's other marketing services, likely more sensitive to the business cycle.

They are performing overall firm if slightly varied in performance: e.g. advertising, PR and healthcare communications; and cited "achieving new business with major international companies" although I would mind an aspect of needing to "run to stand still" with such contract-based work; and it will remain cyclical. So the progress of the sports & entertainment side is axiomatic.

Even if economic numbers do soften, experience has shown sport as resilient - indeed prospering even during recessions; as if sport nowadays provides escapism similarly as movie halls used to be popular in hard times. The growth of British Sky Broadcasting Group and Sports Direct testify to this, however BSkyB is now capitalised at over £15 billion - in the dilemma that "elephants don't gallop" - and Sports Direct approaches £4.4 billion, compared with just over £300 million for Chime. It has critical mass to capitalise effectively, while small enough to enjoy a financial boost.

Chime has twice before in recent years (see table) achieved EPS well over 20p, despite a relatively flat revenue trend, although circa £37 million profit versus 26p EPS (as projected) tells you greater shares in issue nowadays. The total number has nearly doubled to 99 million over the last four years, as a result of acquisitions, so indeed the group has to re-rate profits substantially.

The interim release notes that WPP has been exploring a sale of its 17.5% stake, i.e. removes related bid speculation but may only represent WPP tidying its group structure than a verdict on Chime. It may also reflect the only way to divest a small-cap stake is when the outlook is bright enough to generate demand. This is interesting for prospective buyers because a sense of "stock overhang" now introduced could weigh on Chime shares, but once the stake is placed a near-term aspect of uncertainty would be removed i.e. the stock could then rally.

In terms of financial risk, net debt has increased from £19.7 million to £46.5 million relative to net assets of £182.7 million - dependent on £217.4 million goodwill and £18.4 million other intangibles. This is fairly typical of "people businesses" and although interim finance costs trebled to £1.5 million they were in context of £17.2 million operating profit and £30.9 million cash - so finances are manageable.

While there have not been any material directors' dealings lately, the chief executive owns 480,000 shares and the finance director 407,000 - the last trades being increases of 5,000 and 2,000 shares respectively. The chairman has also added 5,000 shares to own 49,800. So the directors' equity stance is net positive.

Chime is therefore worth watching because weakening economic numbers and uncertainty over the WPP sale may conspire for more share price drift - yet the sport and entertainment side is gaining power as the group's main engine, worth having exposure to.

For more information see chimeplc.com