An app investment
Shares in Aim-traded software company Sanderson (SND: 57p), a specialist in multi-channel retail and manufacturing markets in the UK, are marking time just below a seven-year high of 60p hit last month. True, the shares have done well since I initiated coverage two years ago when they were trading at 33.5p ('A valuable stock check', 18 Jul 2011), and have now achieved my 60p target price, but the company has just announced a smart looking acquisition which makes me believe there could be further decent upside in the shares on a six-monthly basis.
That’s because Sanderson is further extending its mobile capability with the acquisition of One iota, a highly respected provider of mobile applications for retailers including Thorntons, Littlewoods, Superdry, and Very.co.uk. The acquisition will provide the company with a talented team of 20 employees, including 14 developers, and should easily integrate into Sanderson's existing e-commerce operations. It will also help Sanderson expand further into mobile applications, win new customers, and provide the latest mobile technologies to its existing clients.
Strategically, it makes a lot of sense as Sanderson’s ongoing investment in proprietary software for mobile devices has clearly been paying off; mCommerce now accounts for 10 per cent of the company’s sales, having shot up by 162 per cent in the six months to end March. Moreover, analysts at broking house GECR believe that with strong demand being shown by mCommerce customers, this should be an area of significant growth for the company in the years to come.
Seeking the holy grail
Clearly, Sanderson’s management team have been impressed by One iota’s leading product, MESH, a cloud-based technology that integrates existing back office systems to optimise a retailer’s applications. They are not alone as technology analyst Peter McNally at broking house Charles Stanley notes “the platform is positioned for the retail 'holy grail' of omni-channel commerce, where retailers deliver a single branded experience across all customer channels, including online, mobile, in-store, and social media. The company’s ability has allowed it to qualify for Facebook’s Preferred Marketing Developer Program.”
It’s also a very profitable and fast growing business as One Iota increased revenues by 31 per cent to £665,000 in the financial year to January 2013 to generate operating profit of £193,000. For the seven months ended 31 August 2013, One iota reported unaudited turnover of £610,000 and profit before taxation of £210,000. It is only reasonable to expect this momentum to continue because as part of a larger business there is scope to grow sales and profits markedly by leveraging off Sanderson’s balance sheet strength and plc status. This should enable One iota to close new business that previously might not have been possible due to its size, according to Mr McNally.
Furthermore, with greater financial resources behind it, Sanderson board “believes it can grow One iota’s revenue to £1.1m within the next year with its backing.” In order to do this, Sanderson has raised £3.5m through an institutional placing at 55p a share, or 12.3 per cent of its enlarged share capital. The proceeds will be used to fund the integration of the MESH technology with existing Sanderson ecommerce solutions; accelerate the development of Sanderson mobile solutions business; and increase sales and marketing activities.
The £5.43m acquisition has also been sensibly structured with only £750,000 of the initial consideration paid in Sanderson shares and £2.38m in cash, and a further £2m of the balance deferred and dependent on One Iota achieving performance targets over the next three financial years.
On this basis, the acquisition is priced at less than 10 times operating profit on the initial consideration and 16 times including the deferred consideration. However, with only 55 per cent of the consideration payable upfront, Charles Stanley estimate that the deferred payments have been structured in such a way that effectively pays for roughly 75 per cent of that consideration itself.
Planned strategy to increase exposure to e-commerce
It’s worth pointing out that the acquisition is part of planned strategy to increase exposure to e-commerce in Sanderson’s multi-channel retail division. For instance, a few months ago the company used £500,000 of its burgeoning cash pile to acquire e-commerce solutions company Catalan. Moreover, I would not be surprised to see Sanderson make further deals in this high growth area.
It’s certainly a hot area to be operating in as Sanderson’s operating profit from its multi-channel retail division jumped a fifth to £0.61m in the six months to end March, buoyed by projects for Aspinal of London, JoJo Maman Bébé and Axminster Tool Centre. Future demand is well underpinned, too, because the company makes its money by offering software products and services that have the benefit of reducing costs or improving the efficiency of their business. That's important in a low-growth environment where companies have a keen eye on costs.
For example, Sanderson works in partnership with clients to deliver e-commerce software systems that underpin their online operations and enable them to cross and upsell products, offer a '3D' secure payment process and integrate online offerings with other parts of their business. It's a fast-growing segment of the retail sector, too; analysts at IMRG, the industry association for e-retail, and Capgemini, a leading consultancy, estimate that UK online sales will grow by around 12 per cent in 2013, having grown by 14 per cent in 2012.
Value in the shares
As I noted previously, investors have been warming to the merits of Sanderson’s business. They have good reason too; the company reported a 13 per cent hike in operating profits from ongoing operations in the six months to end-March 2013. And with cash generation strong, net cash rose by 9 per cent to £4.5m in the period. So, even after factoring the acquisitions of Catalan and One Iota, I still believe that the company’s proforma cash is at least £5m. Following those acquisitions, and the placing, Sanderson will have 51.5m shares in issue, valuing the company at £29.3m. In other words, I estimate the current cash pile is around 16 per cent of the current share price.
In turn, this offers scope for the board to further reward shareholders by raising the dividend. Analysts at WH Ireland expect the full-year payout for the 12 months to end-September 2013 to be raised by a quarter to 1.5p a share. The interim pay-out was lifted 30 per cent hike to 0.65p a share. On this basis, the shares offer a prospective yield of 2.6 per cent.
Low rating
Reassuringly Sanderson has confirmed that it is trading bang in line with broker earnings estimates for the financial year to end September 2013. Analysts at both WH Ireland and GECR predict the company will report pre-tax profits of £2m and EPS of 4p, which means the shares are trading on a forward PE ratio of 14, a hefty discount to the software and computer services sector average of 19.
However, once you factor in Sanderson's share hefty cash pile, then the forward PE ratio is only 11, or 40 per cent less than the sector average. That seems anomalous for a company specialising in some fast growing segments of the retail software market and one that is expected to lift EPS by a third to 4p for the financial year to end September. Moreover, that modest rating drops even further next year based on conservative looking earnings estimates. Analyst Emanuil Halicioglu at brokerage GECR is expecting Sanderson to report pre-tax profit of £2.3m on revenue of £14.6m in the financial year to end September 2014. On this basis, earnings per share rise to around 4.34p which would underpin another hike in the dividend to 1.6p.
However, Mr Halicioglu notes that "while we believe that we could see the synergies begin to emerge from Sanderson's recent acquisitions within the next 12 months, we prefer to be prudent and are waiting for signs of growth before upgrading our forecasts." In other words, if management's guidance is correct, then there is ample scope for earnings to be upgraded as the year progresses.
So, ahead of a pre-close trading statement in a few weeks time, and financial results scheduled to be released at the end of next month, I am very comfortable maintaining my buy recommendation with Sanderson shares priced on a bid-offer spread of 55p to 57p. In fact, I have upgraded my fair value target price from 66p to 70p, equating to a rating of 13.8 times prospective earnings net of cash.
In the past fortnight, I have published 13 other articles on the following companies or trading strategies:
■ Global Energy Developments ('Waiting for pay dirt', 23 Sep 2013)
■ IQE ('IQE profit-taking presents buying opportunity', 23 Sep 2013)
■ 32Red ('32Red worth a punt', 23 Sep 2013)
■ Spark Ventures ('Banking on more cash returns', 24 Sep 2013)
■ Macau Property Opportunities ('Blue sky territory', 24 Sep 2013)
■ KBC Advanced Technologies ('Riding an earnings upgrade cycle', 24 Sep 2013)
■ Inland ('Buying opportunity ahead of results', 25 Sep 2013)
■ US Dog share portfolio ('Easy as pie', 27 Sep 2013)
■ Conygar ('Shrewd insider buying at a property play', 30 Sep 2013)
■ Netcall ('Ringing the right tune', 1 Oct 2013)
■ Eros ('Ringing the right tune', 1 Oct 2013)
■ Bloomsbury Publishing ('An e-commerce winner', 2 Oct 2013)
■ Simon Thompson's share recommendations, 2 Oct 2010
■ Inland ('Property plays with foundations, 7 October 2013)
■ Terrace Hill ('Property plays with foundations, 7 October 2013)
Finally, in response to requests from dozens of readers, I have published an article outlining the content of my new book, Stock Picking for Profit: 'Secrets to successful stock picking'
