Stockwatch: An attractive business at a fair price

Is AIM-listed GB Group prime for the times? Cyclicals can offer trading opportunities - being currently at risk, and maybe plunging too far when they warn - however, most investors will prefer those operating in new growth areas, hence resistant to any wider downturn. Such stocks are an elite minority hence prone to high ratings given their scarcity value.

GBG also shows AIM is not necessarily a vipers' den of high-risk stocks, being ramped and de-ramped. Its five-year chart is strong but not so volatile, and at first sight looks late to take interest. Yet GBG is still a relatively small company engaging a big opportunity, as a global leader in identity proofing and solutions.

Its website shows the various applications from online criminal record, driving licence and employee checks, to ID verification and credit risk management. The validity of its technology is evidenced by recent client wins including Microsoft, Waitrose, John Lewis, Worldpay and the Serious Fraud Office. Be aware, acquisitions are also helping performance, given the last financial year to 31 March showed a 49% increase in pre-tax profit to £5.9 million on revenue up 37% to £57.3 million, albeit with organic revenue growth of 15%.

Strong financials and update in October

Capitalised near £300 million with a current share price of 240p, GBG trades on five times annual sales and a 12-month forward PE of 29 (consensus forecasts) - seemingly pricey. By comparison with a prime technology growth play, ARM Holdings similarly trades on 29 times forward earnings, and over 17 times sales. A high price/sales ratio is usually explained by high margins e.g. ARM enjoys an operating margin of 50.3% versus GBG on 18.8%.

I make this comparison not to imply "GBG is the next ARM", but note that where a technology has strong competitive positioning, you can expect to see high ratings. ARM has traded on an exalted price/earnings (PE) since listing in 1998, recently moderating from over 80 times historic earnings to about 60, while Company REFS cites GBG's historic PE rising progressively from 16.1 times in 2011 to 41.5 times this year.

Looking forward, however, the PEG ratio (PE multiple divided by the earnings growth rate) is about 1 times or lower (see table), implying value according to this classic growth stock ratio. While PEGs are a snapshot in time and the 2015/16 outlook involves a 50% jump in earnings per share, at least the ratio is not pricey.

With a strong underlying story it would need an epic market crash for this stock currently to de-rate - amid last August's jitters, GBG slipped only from about 230p to 217p then advanced to 245p in September. Not to suggest ratings don't matter, but it shows that GBG is perceived as attractive relative to the vast majority of companies geared to the wider economy. It is also not so widely followed being AIM-listed, and a trading update due mid-October may raise awareness.

End-July AGM statement affirmed progress

The recent context is one of meeting rather than beating expectations, the AGM being told of "a positive start to the year and on track to deliver sustained revenue growth." Last year's 20 October trading update simply quantified the progress as a rise in operating profit over 40%, so it will be interesting to see how this year's progress translates. GBG has been investing for international expansion (constituting 19% of group revenue in the year to end-March 2015) and in support of its GOV.UK verify service project.

With identity data intelligence growing fast as e-commerce and regulation expand, it should be resilient versus economic cyclical risks. "Our dual approach of expanding our leading global product portfolio and entering new markets and territories means that we are ideally positioned to benefit from these market drivers."

Acquisitions integral to development strategy

It's wise to be wary when acquisitions are significant to progress; they raise risks as well as potential rewards, and financial results look seductively more attractive. In fairness to GBG, its track record of identifying and integrating appropriate firms is good, with group accounts free of typical warning signs. The table shows cash flow per share around or more often significantly ahead of earnings per share, i.e. deals are not being used to mask poor cash generation. The 2014/15 cash flow statement shows net cash from operations up 20.5% to £11.3 million, enabling £18.7 million to be spent on acquisitions - supported also by £11.3 million from placing shares at 137.5p.

Acquisitions will remain an important part of future growth, i.e. continue to boost support financial results. While the cash demands imply modest dividend payouts - with earnings cover of 3-4 times expected, for a prospective yield under 1% - GBG is anyway a long-term capital growth play, dividends are more to satisfy institutions and proof of cash controls.

Chief executive builds stake

There hasn't been genuine and meaningful insider buying since the finance director added 24,000 shares at 145p last November, to then own 365,035 shares - among GBG's equity schemes is a share matching plan where his investment was promptly doubled, then last June both he and the chief executive benefited from exercising options to buy shares at 2.5p.

Then the company made another matching award as if "one scheme on top of another", my point being this is not the same as outside investors buying the shares - or indeed any non-executive directors. Later in June, the chief executive exercised 750,000 options selling 452,275 shares at 208p to cover costs and taxes arising, retaining 297,725 shares and holding 2,316,045 overall. It's good in the sense of management growing its equity exposure, if better to see cash purchases.

GBG therefore looks an attractive business at a fair price, amid very few genuinely contra-cyclical. It looks to merit attention ahead of October's update.

For more information see gbgplc.com

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.