Edmond Jackson's Stockwatch: Findel

Do the latest preliminary results for the year to 29 March 2013 establish a platform for further upside in the shares of home shopping and educational supplies group Findel?

In the second half of 2012, FTSE SmallCap-listed Findel more than trebled to above 180p. However, this was from a low 50p range and the price has been much higher: near 1,500p in 2009 when the company enjoyed substantially greater profits (see table).

More recently, investor confidence has been low due to bank debt of around £260 million weighing on net assets, which are just over £100 million, and net interest charges of about £10 million (plus £3.4 million exceptional interest charges lately). This has been the case despite a 2011 balance sheet restructuring that followed accounting irregularities on the education supplies side.

Together with a bumpy financial record, Findel has been perceived as a classic high-risk smaller company share, so as risk factors have reduced it has re-rated. The bull case therefore rests on continuing risks being defeated, given the shares trade on a modest earnings rating.

While Express Gifts, the main division offering home and leisure items by direct mail and accounting for 45.3% of £580.6 million group revenue, is doing well, Kleeneze at 8.5% of revenue remains in decline, albeit at a slower rate after management changes. Last year's wet summer was blamed, however door-to-door selling may have had its heyday.

Kitbag, at 12.1% of revenue, is benefiting from the post-Olympics enthusiasm for sports and should move into profit in due course. Education Supplies, at 17.8% of revenue, is thriving on new catalogue launches and contract wins, and has just been showcased with an analysts' visit, so management must be optimistic.

The remaining 2012/13 revenue was mainly Healthcare, supplying rehabilitation and care equipment, however this division has recently been sold for £24 million cash due to its investment needs.

The reason behind this disposal shows Findel still somewhat constrained by debt: while core net debt reduced by £11.6 million to £120.2 million over the last financial year, overall net debt edged down only 2.4% to £225.2 million - compared with £100.5 million net assets, all represented by goodwill and intangibles. It is hard to see the debt being cut significantly without an equity issue and given steady improvement in Findel's rating I speculate this might happen in a year or two.

Another liability to bear in mind is the net deficit on group pension schemes, which has increased from £13.0 million to £19.7 million due to actuarial losses reflecting lower corporate bond yields.

At 178p currently, Findel trades on eight times its broker's 13 May forecast of earnings per share of 22.1p for the current financial year to end-March 2014, which was above recent consensus and likely involved guidance from management. Possibly other brokers will upgrade in response to an "encouraging" start to the new financial year, given analysts tend to be cautious towards turnarounds and look for evidence.

But Findel has no dividend prospects for the foreseeable future as its credit facilities prohibit pay-outs. This is again, partly why a rights issue looks likely since a more appropriate debt/equity ratio would help restore dividends.

The chairman's statement goes as far as is wise, to promise that exceptional charges (for various reorganisations and changes) are effectively over - such that the group's continuing operations have turned around from five years of losses to report a profit of £1.6 million. All the businesses are said to have made a good start to the current financial year with encouraging trends.

It will be interesting to watch how Express Gifts, the main financial driver, evolves. Despite a difficult consumer environment, its 2012/13 sales grew by 13.4% with the customer base up by 8% and operating profit by 15.9%. "Our improved offer in terms of value and range continues to prove attractive and the investments we have made are beginning to bear fruit."

Given quite a complex group restructuring, some of the figures vary - within Findel's financial statements, broker forecasts and Company REFS' view of normalised earnings; also considering the continuing operations. This has probably been another deterrent for investors, besides trading issues and debt, but the numbers' profile should simplify henceforth. There has also been a 20-for-one share consolidation taking the company out of the penny-share league.

So at this stage, Findel is "out of the woods" in terms of poor trading and near-term debt risks, but is still in rough grass as regards its ongoing burden of liabilities it needs to shake off. There is no margin of safety other than a fairly low price/earnings multiple against a turnaround plan that has gained some results and looks to have further traction. The UK's avoidance of further serious recession also helps.

Altogether Findel's risk/reward profile offers upside, since if management can progress over, say, three years to rebuild earning power, cut debt and restore the dividend, the shares can double from where they trade today.

For more information see findel.co.uk.