How WH Smith can hit record high

On a day when markets couldn't decide which way they wanted to go, newsagent chain WH Smith stood out. It issued a well-received trading update four weeks ago, so Tuesday's 5% rally was fuelled solely by a bullish assessment of the company by a leading City scribbler.

Investec Securities analyst Kate Calvert said back in January that Smiths was "a very well run, defensive, highly cash generative company, with attractive structural growth opportunities in Travel."

Now, after reassessing prospects, Calvert believes the global growth opportunity for Smiths is "material". It's a view predicated on further growth in the international business – selling newspapers, magazines books and so-called "impulse buys" at airports and railway stations in 24 countries outside the UK.

Smiths' travel business now generates 58% of group operating profit. "As the drag from its much lower growth High Street business falls, the gap between group growth and Travel should start to narrow and drive a higher growth rate for the overall group," explains Calvert.

She believes there's potential for double-digit earnings growth at the division for the foreseeable future. That'll be driven by a forecast compound annual growth rate (CAGR) in air passenger numbers of 4.9% per year to 2040.

It's already gained critical mass in the Middle East and Australia, contracts have been renewed, and new business won in Germany, Spain and Singapore – the word's sixth busiest international airport – is significant.

"From a valuation perspective, we have historically focused on a combined yield element of total shareholder returns (TSR)," writes Calvert. "However, as the earnings growth rate picks up as we expect, with the investment case increasingly a play on International

Travel, we believe the focus should switch back to the earnings element of TSR.

"This is likely to drive a re-rating, in our view, as a mid-teens double-digit TSR per annum looks a real possibility over the medium term."

Indeed, a price/earnings (PE)-to-TSR ratio of 1.5 times compares with a sector average 1.9 times, which Calvert believes is hard to justify given the anticipated ramp up in the sustainable earning growth rate.

"A rating closer to the sector average PE/TSR would be more appropriate, in our view, and reflect not only its higher growth prospects but the strength of its cashflow and capital returns."

It's why Investec upgrades its rating from 'hold' to 'buy' and raises its price target by 23% from 1,550p to 1,900p. At that price, Smiths would be valued at a PE/TSR of 1.8, calendar year 2017 PE of 18 times and combined yield - ordinary dividend and equivalent yield of a £50 million share buyback - of 5%.

Having established technical support at 1,600p following January's update, Smiths shares touched 1,710p on Calvert's upgrade, their highest since 23 June. Make it to 1,900p and the shares will have surpassed their previous best of 1,893p recorded in April 2016.

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.