Interactive Investor

Stockwatch: Hot share for a hot summer

6th June 2017 09:23

Edmond Jackson from interactive investor

Does a hot start to June portend a bumper year for £200 million AIM-listed hire group of pumps, heating and air conditioning equipment? Higher margins on air conditioning equipment, hired predominantly from June, makes Andrews Sykes second half-year oriented, and it has already posted strong 2016 results on 11 May, reflecting operational gearing - where revenue changes are amplified in profit.

Revenue rose a respectable 9% to £65.4 million, but operating profit leapt 20% to £15.8 million after a 17% increase in 2015. It's a tad frustrating that the release doesn't specify what extent this revenue rise reflects a weak pound, given over a third of revenues involve continental Europe, the Middle East and Africa.

However, management did insist that "the underlying trading performance in our overseas subsidiaries shows a significant improvement compared to last year."

Intrinsic support for dividend growth

According to the Company REFS table (below) there are no published forecasts, partly reflecting a volatile history where you were forever guessing what prospect of a cold winter and hot summer - ideally with spells of flooding alongside firm construction activity - to optimise performance.

Andrews Sykes Group - financial summary      
year ended 31 Dec201120122013201420152016
       
Turnover (£ million)53.858.461.156.460.165.4
IFRS3 pre-tax profit (£m)14.914.815.011.813.417.5
Normalised pre-tax profit (£m)11.413.112.910.011.315.2
Operating margin (%)21.621.620.616.818.723.2
IFRS3 earnings/share (p)27.026.227.222.025.634.2
Normalised earnings/share (p)18.922.322.218.020.628.8
Earnings per share growth (%)-17.217.9-0.3-19.114.739.4
Price/earnings multiple (x)     16.6
Annual average historic P/E (x)  11.015.417.915.7
Cash flow/share (p)27.132.134.827.029.236.4
Capex/share (p)5.59.88.77.610.711.2
Dividends per share (p)6.67.117.823.823.823.8
Yield (%)     5.0
Covered by earnings (x)2.93.11.30.80.91.2
Net tangible assets per share (p)80.596.610499.7103114
       
Source: Company REFS      

But Andrews Sykes appears to be gaining better consistency. I originally drew attention at 330p in November 2015 after a stock down-trend from 2014, on the basis a 7% prospective yield was secure - the implied 23.8p per share dividend requiring just over £10 million hence was underwritten by £19.7 million cash reserves besides a strong cash flow profile. Thus, the stock had to rise to more appropriately risk the dividend.

The 2016 results show net cash inflows from operations up 25% to £15.1 million, helping cash reserves up 10% to £22.8 million and bank debt down 16% to £5 million - there are no other material liabilities e.g. the pension fund is in £1.2 million surplus.

The board speaks of "returning value to shareholders whenever possible." It implies that unless the wider economy turns down, or interest rates soar to compromise "the search for yield", then the stock is intrinsically supported at its current market price of 478p due to a quality 5% yield (or better, with dividend growth) at this level.

Operational gearing and enhanced returns

Last February I drew attention at effectively the same share price, although my sense of intrinsic value was lower than the company has proved in respect of 2016.

I suggested a normalised pre-tax profit scenario of about £13 million, with statutory profit higher and EPS in the region of 23-30p. Yet the group has delivered a big "beat", with £17.5 million and 34.25p respectively.

Notably, 2016 did not involve weather extremes: operating profit in the main business unit, UK and Northern Europe, rose from £11.3 million to £13.8 million; and, although pumping and de-humidification was stimulated by floods in Northern Britain at end-2015/early 2016, the absence of a hot summer didn't help air conditioning.

The directors say overall better performance was due to "robust operational management," while, alongside developing existing businesses, "the expansion of non-weather dependent niche markets benefit the performance of our specialist hire divisions.

"This year's result further demonstrates that with a diverse product range we are able to return a strong performance despite the absence of any significant extreme weather conditions."

It was likely a strategic response similar to challenges in 2013 amid "unhelpful" weather patterns also economic weakness in continental Europe.

In principle, this should mitigate volatility in the stock and support its rating, although a recession would still hit services that are often discretionary than essential corporate spending. Weather extremes - climatologists warn of generally - may still be influential, the bugbear being mild winters and cool summers.

Capital expenditure has prioritised assets that give a good return, with £6.2 million invested in the hire fleet during 2016, up by £600,000 and ahead of a £4.5 million wasting depreciation charge. There was also £0.7 million spent on property, further plant and equipment, all in support of future growth.

Note also, the Middle East continuing to do well, with a 26% rise in operating profit to £2.9 million which relates significantly (as ever) to construction/development activity, e.g. Sykes Pumps. After-tax profit has also benefited from £1.7 million net finance income versus £0.2 million in 2015. That's due to re-translation of inter-company cash balances, as sterling weakened versus the euro and the United Arab Emirates' Dirham.

So, while the stock rose over 500p only to hit profit-taking, the results hint at latent strength enhancing medium-term prospects. Who knows what will become of summer as wet and windy conditions sweep in this week. Despite some long-range forecasts hinting at a three-month heat-wave arriving from Africa and the Continent, it would be a gamble to expect one. Yet the core fundamentals suggest you are making your own luck with this stock anyway.

Share buybacks also under consideration

The AGM will seek authority to resume share buybacks after a year off doing so: up to 12.5% of the issued share capital. Quite what extent this may reflect the chairman's family controlling interest, and their desire to mitigate rising taxation on dividends, although government raiding shareholders this way applies nowadays to all.

The question is more about whether buybacks are compelling to enhance value now the stock trades on about 15 times earnings (although such is its historic annual average rating), and what opportunity cost by way of dividend growth now payouts have levelled at 23.8p for three years?

As support, might it be more effective to maintain a 5% yield (with dividend growth) should the stock rise over 500p, or buybacks be a better prop? The chairman cites vaguely, buybacks having proved "for the benefit of all shareholders" and does not indicate a progressive dividend policy like boards of directors tend to where practical.

It is possible they believe buybacks offer more flexibility lest the economic cycle turns down. If the board were to entertain dividend growth then only maintain the payout, the sense would be not meeting expectations.

Ultimately, a decision to buy Andrews Sykes afresh assumes more that central banks can keep UK/European economies ticking over rather than weather-specific scenarios. If so, the group's underlying improvements imply further upside from operational gearing and investment to a 500-550p per share area, at the higher end if there's a hot summer.

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