Interactive Investor

Stockwatch: Stick this share in your SIPP or ISA

13th March 2015 09:00

Edmond Jackson from interactive investor

Are marketing services groups flagging wider prosperity ahead? They can be a litmus test of consumer confidence impacting on companies’ spending - for better or worse - with a consequent impact on the business cycle. So their robust outlook currently augurs well versus fears over a US interest rate rise in a wider deflationary environment.

The dilemma for stock-pickers is high-profile firms such as WPP showing a strong five-year chart that has advanced further of late, hence vulnerable to any market setback. Small caps were neglected until 2013, then the good ones got squeezed up as sentiment shifted to "risk-on", only to fall back from mid-2014 as deflationary fears gripped markets. While the value opportunity may not be as stark as 2012, it currently merits interest.

Risk appears to weigh on the upside

The chart for FTSE Small Cap-listed St Ives is a good example, with very strong gains to 225p during 2013 and the first half of 2014. When I first drew attention near 90p in October 2012 the company had posted impressive results for its 2011/12 year to 1 August, such that its stock traded on a price/earnings (P/E) of 5 and a prospective yield of 7% covered 2.5 times. As investors sought wider means to play the economic recovery, St Ives became a recovery-to-momentum play then fell to 170p.

St Ives - financial summary
Consensus estimate
Year ended 1 Dec201020112012201320142015 (13 months)2016
Turnover (£m)291297329323331 
IFRS3 pre-tax proft (£m)13.216.96.45.511.9 
Normalised pre-tax profit (£m)17.220.713.915.91531.433.7
Normalised earnings/share (p)14.816.810.81210.818.819.6
Price/earnings multiple   (x)   16.59.49
Cash flow per share (p)35.719.10.926.121.2
Captial expenditure per share (p)7.2-0.41.95.28.5
Dividend per share (p)2.33.55.366.77.68
Yield (%)  3.84.34.6
Covered by earnings (x)6.64.92.22.11.72.52.4
Net tangible assets per share (p)68.453.824.620.3-18.3
Source: Company REFS.

The price is currently 177p after interim results to 30 January where it trades on 9 times forecast earnings and a dividend yield of 4.4% covered 2.5 times by expected earnings. Yet the company appears on course to nearly double its earning power (see table) which is quite a status change.

The current rating already factors in some risks with the business cycle and a relatively tight market in the shares. Just under £15 million interim pre-tax profit has been achieved in its first-half year versus expectations of £31.4 million for the full year to 1 August, with management saying the second half (from 1 February) has started well and "with an improving economic climate allowing clients to increase their marketing spend, we remain confident of a positive outcome for the full year."

Successful re-positioning towards marketing services

When St Ives' shares traded on an annual average P/E of about 6 times in 2011 and 2012, the group was perceived mainly as a "price-taker" print services group exposed to pricing fluctuations over the business cycle. The latest results, however, affirm 74% of £16.3 million underlying operating profit being generated by strategic and marketing activation services - to international consumer brands across all major sectors, from Johnson & Johnson healthcare to HSBC which employs five businesses across the group.

A quarter of these revenues derive from clients outside the UK, with offices also in North America, China and Singapore. Aims are: to grow through collaboration between individual group businesses and investment in their existing brands; continue the international drive to large high-growth markets; and make complementary acquisitions. Assuming no major setback for the global economy, it’s an attractive proposition.

Not to dismiss Clays, which is the market leader in UK book printing and "a valuable additional source of profit and cash generation." You may have seen reports how the feared demise of printed books in favour of Kindle touch-screen readers is un-founded, with print volumes stable for the first time in several years. Clays has agreed with Penguin Random House, the UK's largest trade publisher, to undertake all their UK monochrome book production under a new multi-year contract. Together with other contract wins and extensions, some 80% of Clay's workload is secured for the next three to six years. This is significant because investors had been taking a negative view of book prospects, which weighed on the stock’s rating.

Two acquisitions contributing to the status-change

2014 saw the £21.7 million acquisition of digital marketing agency Realise, also the £20.9 million purchase of healthcare communications consultancy Hive, leaving the group with just over £12 million cash and £55 million longer-term loans (no short-term debt) relative to net assets of £122.3 million (mind, 133% of which is goodwill and intangibles, as typical of people businesses). That doesn't leave much headroom for further significant acquisitions currently, although the board still specifies complementary businesses as an objective.

The income statement shows £7.5 million finance costs substantially offset by £6.1m investment income, relative to £16.3 million underlying operating profit. Various other charges such as amortisation and re-measuring a deferred consideration meant a net £10.5 million "non-underlying" related charge, accounting for some reports of a like-for-like drop in interim net profit to £1.1 million from £7.1 million.

The table also shows cash flow per share having turned strongly positive - over 20p in the last two financial years - relative to modest capital expenditure needs. Interim cash generated from operations edged up to £17.2 million, clipped by a rise in income tax to £3.2 million, however. Nearly £5.5 million went on investment and £6.6 million on dividends. St Ives therefore looks in a firm position to grow its dividend despite the interim payment being up just 5% to 2.25p versus underlying earnings per share of 9.2p. A 4.4% prospective yield should indeed now be helping the stock establish a floor at about 170p.

Good credentials as a tuck-away share

St Ives is an unlikely business to lure growth-stock traders into a frenzy, but it is a sound operation for the likes of a SIPP or ISA where you want a good chance of benefiting from the tax break than hit losses, punting higher up the risk/reward scale. If the global economy can stay resilient then the price is in buying territory.

For more information see st-ives.co.uk.

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