Interactive Investor

Stockwatch: New highs predicted for this share

22nd March 2016 10:09

Edmond Jackson from interactive investor

Can Cello  break out of an approximate 80-100p range it has traded for the last two years? The five-year chart context for this AIM-listed pharmaceutical and consumer strategic marketing stock shows a strong advance from 38p in 2013, then a volatile-sideways trend from 2014, which peaked at 104p.

It was rather typical of cyclical stocks rising as quantitative easing boosted risk appetite, giving way to a period of consolidation as investors took profits and probed true value.

Cello's habitual gap between statutory and normalised profit - with restructuring, start-up costs, remuneration and VAT matters stripped out to create "headline profit" - doesn't help clarity. Moreover, Company REFS (figures in the table) takes its own approach on such matters.

The latest 2015 prelims show statutory pre-tax profit of £4.8 million versus headline of £10.0 million, which bumps up the price/earnings ratio from about 11 times (on a forward basis) if Cello keeps generating and categorising costs like this. Yet the overall numbers affirm a continued growth scenario, and management says 2016 has started well with encouraging bookings momentum continuing from fourth-quarter 2015.

With a main focus on healthcare marketing and also fast-moving consumer goods, Cello is becoming an operation able to boost the competitive advantage and earnings for larger marketing services groups, i.e. worth noting as a long-term bid target.

Cello units evolving well

To an extent, the exceptional items result from growth initiatives generating costs in recent years: Cello Health integrated behind a single brand nearly two years ago, and a new office in San Francisco has achieved strong progress on the US West Coast. It is involved in market research and consulting, such as planning on how best to market a new drug, and represents about 70% of group operating profit on a circa 20% operating margin.

Acquisitions have brought scale benefits and new sources of future global growth are entertained, partly as a result of this single-branded "Health" approach which enables more collaboration.

With North America the chief market, a biotech consultancy has also been started in Boston and the Chicago office continues to expand rapidly. It has all helped a 19.8% rise in US-derived revenue to £40.4 million equivalent, in context of £157.3 million group total. The division's product range has expanded, e.g. in quantitative and digital research, with a new launch this year of a social media-based approach jointly with Cello Signal for clients needing large data sets.

A key objective is the two divisions collaborating on campaigns such as cancer screeningHowever, the consumer side of Cello Health has seen deferral of some projects, which impacted margins, hence a modest 3.7% advance in headline operating profit to £8.8 million.

Overall, it continues to look the most promising aspect of Cello Group, with demographics favouring healthcare spending and a strong US private healthcare sector.

The relatively smaller Cello Signal serves global consumer and business-to-business clients and saw a 15.1% advance in headline operating profit close to £4.0 million, despite a 5.3% rise in gross profit lagging the 11.3% progress by Cello Health.

Likewise, a single client-facing brand is said to be the driver for "material new client wins", in the financial services and utility sectors. A growing strategic relationship with Facebook is hoped to benefit Pulsar, Cello's social media monitoring and analytics platform, which made a £0.2 million operating loss, but is expected to be profitable this year.

A key objective is the two divisions collaborating on campaigns such as cancer screening, alcohol abuse and healthy eating. Cello Signal is less specialised than Cello Health, but should similarly benefit from a long-term trend away from mass market advertising. It can, however, be more cyclical and volatile according to clients' budgets and sentiment.

Hedge fund is upbeat

An interesting valuation approach derives from a European smaller companies' hedge fund, Ennismore Fund Management, which is Cello's main shareholder owning 9.2%. You might reckon "they would say this, then", but the fund's latest newsletter notes "extreme mispricing" in the stock currently.

The managers do not appear concerned by Cello's habit for exceptionals; they focus on valuing the two divisions separately, with Health deserving a premium multiple of 16 times operating profit after tax due to its "structural growth, specialisation and scale", versus Signal on a multiple of 10 times (which they also believe is appropriate) to target a return over 50% on the stock by end-2017.

This was written before Cello's results, i.e. at a modestly lower price, but shows how some in the market are looking past the differences between statutory and headline profits. This fund has achieved annualised returns of 12.3% to 15.0% according to share class since its launch 17 years ago.

Balance sheet intangibles but only £4.2 million net debt

The table shows persistently negative net tangible assets, inherent to an acquisitive "people business" group. At end-2015, £70.8 million net assets constituted £73.7 million goodwill and there were also £1.1 million intangibles. However, the principal longer-term debt has reduced by 26.2% to £9.1 million as net cash from operations nearly doubled to just over £7.0 million.

Meanwhile, the cash flow statement shows only £1.4 million spent on investment versus £2.2 million on dividends, with the balance sheet showing year-end cash down 5.7% to £5.2 million, i.e. scope to continue acquiring and also grow the dividend. Net debt is, therefore, down from £7.2 million to £4.2 million.

So, despite concern about how Cello seems to "normalise" its costs opportunistically, and assuming no economic slump to impact the consumer side, this group looks positioned to deliver better. I have drawn attention variously since the 30p level as a sound AIM stock (e.g. useful to mitigate inheritance tax), and, considering the results statement, Ennismore's optimism appears justified. 2016 ought to be a year of establishing new highs.

For more information see their website.

Cello Group - financial summaryConsensus estimates
year ended 31 Dec2011201220132014201520162017
Turnover (£ million)128135160170157  
IFRS3 pre-tax profit (£m)1.21.45.53.84.8  
Normalised pre-tax profit (£m)5.17.28.37.6 10.711.1
IFRS3 earnings/share (p)-0.90.24.32.63.5  
Normalised earnings/share (p)4.57.67.77.17.999.3
Earnings per share growth (%)-3167.71.7-8.612.113.63.6
Price/earnings multiple (x)    12.51110.6
Price/earnings-to-growth (x)    10.83
Cash flow/share (p)74.310.72.3   
Capex/share (p)1.42.21.61.7   
Dividend per share (p)0.91.723.12.633.2
Yield (%)    2.733.2
Covered by earnings (x)4.64.342.4332.9
Net tangible assets per share (p)-13.6-8.8-5.1-6.4   
Source: Company REFS

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