Stockwatch: Buy into this five-year plan

Can growth in digital marketing buck wider risks affecting the business cycle? According to eMarketer, digital increased from 15% of UK marketing spend in 2007, to 47% in 2014, and most marketing services firms report their strongest growth in this segment. So it's initially odd how FTSE Small Cap-listed Creston, which in recent years derived just over half its revenues from digital and online, saw its earnings slip from 2013 (see table) and is not yet expected to regain such earning power. This is explained partly by investment for growth and client budget volatility early in the 2013/14 financial year, which admittedly points to downside risk should the global economy worsen. In its last financial year to end-March, 66% of group revenue derived from the UK, 19% from continental Europe and 15% rest-of-world. Digital and online revenues grew 7% to represent 55% of the total.

Early stage of a five-year development plan

More positively, and why Creston merits watching, it is one year into a five-year strategy involving a new brand - "Creston Unlimited", launched last November - bringing together a range of digital technology-based, marketing services to blue-chip global clients. Essentially, the aim is a fuller service offering with international capability, an interesting growth prospect for a circa £90 million company - it's big enough operationally to pitch at multinationals, while small enough financially for the gains to impact value.

Mind the cheer-lead factor, but Creston's chief executive cites: "a real feeling of momentum and energy across our group...we are encouraged by the early successes in our new strategy which gives us a strong platform to deliver value to shareholders over the medium term." His words coincide with an 8% rise in the total dividend to 4.2p a share, and forecasts imply a prospective yield of 3%. While it's not exactly a prop, a reduction in earnings cover from nearly seven times implies the board is more confident about Creston's earnings and cash profile. (Mind how numbers in the Company REFS table along with other databases, reflect the actual timing of dividend payments.)

Chart highs, albeit forward PE around 10 times

Admittedly the five-year chart represents a high, the current market price of 154p being a tad off 155p, after a firm if rather volatile rally from early 2012. Unlike many cyclicals, at least Creston did not de-rate in 2014 then consolidate sideways: after profit-taking the bull trend soon re-established. This implies shareholders ought to be broadly satisfied and more inclined to treat the stock as a tuck-away, than trading chip.

The undemanding forecasts imply the price/earnings (PE) multiple will ease from 12 near 10 times which initially looks fair enough given the forecasts and marketing services' tendency to be exposed to firms' cost-cutting. But as the five-year plan continues to evolve, there is upside potential also. When the current chief executive replaced Creston's founder-CEO upon retirement early in 2014, he said: "I will look to strengthen the group offer beyond brand strategy and insight consultancy at the core of its creative and digital marketing offer." As the former finance director and chief operating officer who had been with Creston since 2004, he was considered to have the right balance of experience and vision for the next stage of development.

Communications & Insight, also Health

73% of group revenue derives from a spread of services including advertising and PR to social and digital marketing, also research and insight - so it is fair to classify the stock as a cyclical despite capital growth attractions with the development plan. This side of the group has seen a 5% annual revenue increase against a 3% slip on the health marketing side which recently represented 27%. Currency translation issues only mean about 1% differential in the figures.

The last financial year saw three acquisitions and four partnerships - for example last November, extending a partnership with Serviceplan, a leading European marketing communications group, where assignments have been won in Germany and the Middle East. Further international partners were added last April: Propeller Communications, a US-based digital healthcare communications agency; also Future Foundation, a global consumer trends and insight consultancy. April also heralded a key acquisition: 51% of How Splendid, a London-based digital design and development consultancy, for an initial £8.7 million cash and up to £7.5 million in deferred payments. This company made £1.2 million pre-tax profit on revenue of £4.0 million in its year to end-March 2014, relative to Creston's near £10 million profit last year.

No debt and deep pockets

While the end-March 2015 balance sheet showed 91% of £117.3 million net assets as goodwill and intangibles, there was no debt and £8.3 million cash - applied in April regarding How Splendid. The group also has a £25 million revolving credit facility which largely explains a £200,000 annual finance charge (by way of non-utilisation fee). A £2 million share buyback programme appears nearly complete, thereby scope exists for progressive dividend growth - considering how adjusted operating cash flow rose 15% to £8.6 million as the cash conversion rate improved and is targeted to do so further. Possibly the board is waiting to see more progress with the five-year plan, but there looks scope for higher shareholder returns.

All considered, it looks fair to regard risk as being on the upside, targeting 175p to 200p a share over the next two years as earnings and their rating improve. While this kind of business is in the front-line of any recession, Creston's financial strength would enable it to make attractively-priced acquisitions in a downturn. Customers also tend to be loyal to their marketing agencies even though budgets can vary. So despite the chart high, there are good reasons to consider the stock as a tuck-away.

For more information see creston.com.