Stockwatch: A fat dividend and limited risk

Despite mixed 2014/15 prelims and a dip in stock price to 108p, the income/growth credentials of £350 million holding company Stobart Group merit attention. Strong asset backing virtually guarantees a 6p a share dividend for the foreseeable future (given continued scope for property disposals) and the group's principal division - "biomass" for green energy - has enjoyed a near 17% rise in annual revenue to £68.4 million.

Brokers have anticipated a sharp jump in pre-tax profit to £17.5 million for the financial year to end-February 2016, if probably on an adjusted basis and still implying quite a high price/earnings multiple of around 20 times. But net tangible assets of 88.4p a share and a firm 5.5% prospective yield, limit downside risk and make Stobart an attractive longer-term play as its energy and aviation interests develop.

Re-positioned in green energy and infrastructure/services

The group's history shows its biomass energy side starting quite recently in 2010 via a controlling interest in a forest products group, with full control in 2011. This involves sourcing old timber and low-grade softwood for carbon power plants, an activity that should have a sound long-term future as renewable energy establishes itself.

In springtime 2014, a 51% controlling stake in the Eddie Stobart transport and distribution business was sold for £195.6 million, enabling £55 million funding for biomass development, a £35 million share buyback programme, and repaying a £100 million loan that had been an interest burden. This left a group operating mainly in energy, railway maintenance and two regional airports, also with investments in property and logistics.

While apparently still disparate, Stobart's transport/logistics interests help support the biomass side, and, indeed, the biomass transport business was not included in the sale. Stobart is therefore in a strong position already as the UK's leading supplier of waste wood fuel to renewable energy plants. In the group's last financial year the supply of biomass rose 29% to 1.2 million tonnes and four major long-term contracts recently won will deliver a further 1 million tonnes from March 2017. But operating profit for this energy side only rose 5.4%, which partly explains why the stock is subdued.

London Southend Airport passengers up 9% to 1.1 million

While the group's claim to be "a major new London airport" feels like bravado, Southend likely does have a long-term role both for its region and helping reduce strains on Heathrow. "We are seeing interest from large European operators who see it as a very attractive option to serve the London market," says Stobart. If successful long-term then the airport could end up being bought by a transport/property group i.e. a potential exceptional gain and return of capital (some years away). Southend airport was acquired in 2008 followed by Carlisle in 2009, although less is said about progress there beyond achieving planning permission for a freight centre with construction now underway. Encouragingly, operating profit has moved from around break-even to £1.4 million.

However, the group's rail side saw a 20% slip to £2.8 million operating profit which needed explaining rather than cite a 35% jump in revenue (more on that later). "Exciting opportunities" are anticipated for its engineering services with more spending predicted on the national rail infrastructure in the years ahead.

Infrastructure side has supported the dividend

£27.2 million cash was generated from property disposals over the last financial year and "this strategy will continue in the coming years", which effectively underwrites the 6.0p a share dividend hence 5.5% yield. One key portfolio is cited as having a return on investment of 20.7% since acquisition in 2012, although this is quite a snapshot-period when asset prices have been increasing.

Recent years have also been positive for asset values as a result of QE and economic recovery, but mind the UK has risks also - such as chronic deficits that could eventually hit sterling and general investor confidence. Looking forward, this division will invest in processing sites for the biomass business and improve its margin by processing up to half of product on Stobart-owned sites. It therefore exemplifies how the group's shares offer a relatively secure dividend with longer-term capital upside.

Income statement still needs to improve

A key reason the market price is subdued is all such fine objectives are yet to be proven at Stobart’s reported bottom line. Selling 51% of the transport business will slash the circa £10 million net interest bill; but despite last year's 17.6% revenue surge to £116.6 million, overall operating expenses have remained substantial at £113.5 million (or £120.1 million on an underlying basis) hence another year of significant loss: £9.4 million pre-tax.

The expenses - and how they can be mitigated in future - should have had better clarification in what is a complex results' statement. So the investment case needs qualification on this matter, some investors may first prefer to see improvement perhaps at the interim results later in October. Conservative income investors will also want to be satisfied on the earnings score, rather than assume asset disposals can keep supporting the dividend for years to come, although such doubt further explains why the market prices the stock so as to exact a 5.5% yield - as compensation for the uncertainty.

That the chief executive owns nearly 9% of equity is reassuring - Stobart will get there in the end. Certainly he is pursuing shareholder-friendly policies by maintaining a significant dividend and spending £34.8 million on share buybacks which will help improve EPS. Not surprisingly, the reporting emphasis is on "underlying EBITDA" which has grown by 69.4% to £18.8 million and by 9.1% to £12.0 million excluding investment realisations. Yet the share price reaction makes clear, investors prioritise the pre-tax measure of profit - or at least are put in two minds when they see a big contrast between underlying and reported variables.

So mind an aspect of speculation that Stobart can tidy up its financial statements to jolt its shares out of a volatile-sideways trend over the last five years.

All-considered, however, risk now appears to lie on the upside.

For more information see stobartgroup.co.uk.