Interactive Investor

Stockwatch: A share to buy at multi-year low

22nd September 2015 10:24

Edmond Jackson from interactive investor

With its chart plunging to multi-year lows around 105p, is the fall in leading electronics component distributor Premier Farnell already overdone?

A reliable strategy is buying industry leaders when sentiment is against, especially where the dividend mitigates holding risks. Possibly the market will continue in reactionary mood towards cyclical firms warning, as if this is not meant to happen after years of central banks' stimulus. While perturbing - the outcome of many years of quantitative easing (QE) and negligible interest rates - all this paves the way for buying opportunities when the market over-reacts.

The table shows Premier Farnell with an historic pre-tax margin of about 8%, hence quite sensitive to revenue changes, and management's latest downgrades imply the forward PE may actually be about 11 times. But whether or not the stock trades lower in due course, as an industry leader it ought to be higher over two years. Key questions are whether the global economy will trend weaker to further compromise earnings, and a de-based dividend is sufficient compensation for this risk.

Analyst downgrades not reflected

Flowgroup - financial summary
Consensus estimate
Year ended 31 Dec2011201220132014201520162017
Turnover (£m)991973952968960  
IFRS3 pre-tax proft (£m)93.31056974.869.1  
Normalised pre-tax profit (£m)93.388.274.7777464.569.6
IFRS3 earnings/share (p)1820.913.213.912.8  
Normalised earnings/share (p)1815.814.814.514.113.314.7
Earnings per share growth (%)68.4-12.4-6.4-1.8-2.5-5.610
Price/earnings multiple (x)    7.57.97.2
Cash flow per share (p)15.618.42012.913.3  
Capex per share (p)5.3663.75.8  
Dividend per share (p)9.610.410.410.410.410.410.7
Yield (%)    9.89.810.1
Covered by earnings (x)1.91.51.41.41.41.31.4
Net tangible assets per share (p)-5.61.80.93.7-2.8  
Source: Company REFS.

Mind any databases implying a yield of 10%, like the Company REFS table shown, as broker downgrades in response to the latest interim results have yet to appear. The interim dividend was cut from 4.4p to 2.6p implying a total dividend of possibly 5.0p or so, the board saying it will target "a sustainable and progressive dividend with cover of 1.5x to 2.0x".

What has unsettled the market is Premier's tune changing adversely, and regarding the US and UK which have been considered relatively strong economies. A July update cited daily group sales slowing from 5.4% to 1.2%, also adverse exchange rates contributing to a 10% slip in operating profit. September's interims now say the slowdown has continued into the seasonally weaker second half, implying lower operating profit for this current period and indicating full-year adjusted operating profit of £73-77 million. This implies brokers' estimates will need reducing again, by about 15%, with 2015/16 earnings per share I estimate around 11p and the trend thereafter crucial. Not as if the PE multiple is running riskily high though - it's under 10 on latest guidance.

Adding to the sense of seriousness, an operational review commenced in July and last month the chief executive was replaced by the finance director on an interim basis. "The review has highlighted the extent of change in the business that is necessary to allow it to compete effectively in an increasingly digital marketplace."

More positively, "the review is making good progress...we believe implementing the results will improve the group's operational and financial performance." It will be interesting to see whom the board selects as permanent CEO, and what extent the new boss's remuneration is geared to improving shareholder value.

Debt is high, but manageable

The 2 August balance sheet had £59.0 million short-term debt and £229.4 million longer-term debt, versus £51.3 million cash, implying net gearing of 290% - albeit with goodwill/intangibles representing 105% of £81.7 million net assets. Hardly a balance sheet offering comfort, and likely contributes to why the stock has nearly halved this year alone.

Yet the latest results show total net finance costs of £7.5 million covered five times by operating profit – i.e. barring a steep recession the situation is manageable. There is £187.9 million headroom on bank facilities to September 2019 and together with the cash, will help repay preference shares maturing in 2016. Robust cash flow also aids debt management - the interims show adjusted free cash flow at 8.4% of sales, reflecting better inventory turns and strong working capital management.

Looking further ahead, the strategic review has identified the sale of Akron Brass, a manufacturer of fire-fighting equipment, nozzles and valves, "an excellent business, but which does not fit strategically within the portfolio given the group's refocus on its core distribution activities". Proceeds should help cut debt as the interims show Akron making £6.6 million operating profit with a 17.7% margin, on £37.3 million turnover.

Furthermore, the US Fed backing off a rate rise conveys central bankers being cautious and likely to maintain stimulus if economic indicators are soft. So while Premier's balance sheet isn't what you want to see, it would take a more serious downturn to become a real risk.

No directors' buying as yet

Admittedly, it would help to see insiders snap up stock now the company is out of its closed period, but there has so far been no trading since a "PDMR" or senior manager sold 5,546 shares at 167p last July out of a 10,912 share award at 167p. He continues to own 41,553 shares but investors may want to see more insiders buying to bolster a sense that this sell-off is excessive. If you aren't yet persuaded by Premier's fundamentals, this is worth looking out for, although insiders can't divine the global economy and they don't always buy around lows. The current chief executive owns 204,000 shares, although the other (non-executive) directors' ownership is modest.

A stock to average into

This piece may seem premature if Premier's markets are at the early stage of cyclical downturn. However, the de-based dividend should start to provide support with the stock currently at 106p. Revenue disappointments in the Americas and the UK (respectively 46% and 30% of last year's revenue) certainly clash with a sense that these economies are among the most firm.

So Premier and other electronic components' firms merit attention as wider indicators, whether or not their shares are your taste. As an industry leader with an improvement programme underway, Premier stands a fair chance of trading higher on a two-year view, hence a question of timing: assuming a prospective 5% yield, it looks appropriate to steadily average in.

For more information: premierfarnell.com

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