For good measure, if the company is in an earnings recovery mode, having undergone a period of restructuring, then in effect we are getting the potential for a takeover in the price for free. A classic example of this was television shopping channel Ideal Shopping Direct, which delivered a robust earnings recovery a few years back and one that caught the attention of a suitor. It also delivered bumper returns for us when the company was taken over. And I have found another such undervalued company that is ticking all the right boxes and where suitors have already been prowling.
A good fit
Pittards (PTD: 177p) is minnow of the stock market with a market cap of £16.4m, but it has been around for almost 190 years, having been founded in 1826 by Charles Pittard who started operating as a leather dresser in Yeovil, Somerset, an area that has become synonymous with leather and gloving. At the beginning of the 20th century, the company first started to experiment with different skins and hides and began importing the Cabretta or 'Hairsheep' skins to make its famous soft and subtle leather. In the 1920's, Pittards began trading with Africa, a region of the world it still has very strong ties with today.
This type of skin was put to good use when, just before the outbreak of the second world war, Pittards started to produce the now renowned 'Pilots' leather for gloves for the RAF and as a result became a protected industry during the war years. Other innovations include the invention of the first guaranteed 'washable' dress leather in the 1950s, and enhanced leathers including flame retardant and water resistant products.
Fast forward to the 1980s and Pittards developed the water resistant WR100 leather which opened the doors for collaborations with sportswear labels. The technology was incorporated into sport-specific products providing water and stain resistance, breathability, durability and stay-soft feel. The company formed a working relationship with Titleist/Foot-Joy and created Sta-Sof, the world's best selling golf glove.
Since then the Pittards' brand has become synonymous with high quality and high performance and the company now supplies global retail brands such as Hermes, Nike and Marks & Spencer. You can even buy a Pittards iPad case made by the company's Daines and Hathaway subsidiary, a maker of fine leather goods in Walsall since 1922.
In 2012, the company played its part in the London Olympics by assisting Peter Wilson, double trap shooting gold medallist, in personalising his shooting vest, and by manufacturing stylish athletes' kit bags for Nike.
Profitable investment opportunity
It's not only an interesting story, and part of our heritage, but there is an equally interesting investment opportunity. That's because following a restructuring in 2012 after Pittards suffered from a double whammy of a global increase in hide and skin prices, including Ethiopian sheepskins, and the introduction of 150 per cent crust tariffs on exports from Ethiopia, the company's profits have been bouncing back strongly.
This partly reflects a change in sales mix towards a lower concentration of commodity-style leathers, and an easing in skin prices, but also improved efficiency levels at the Ethiopian glove making factory. As part of the reorganisation, some staff were made redundant at the Yeovil site, reflecting the reduced need for leather operatives following the transfer of more sheepskin production to the company's tannery in Ethiopia.
The business has also been benefiting from a higher contribution from dress glove making at that African facility and there are plans to expand this niche area even further alongside its industrial glove production. Other product launches in the past year include new aviation leather interior products. All these initiatives are having a very positive impact on profits.
In fact, in the first half of last year Pittards' operating profits increased sevenfold to £1.1m on a modest 1 per cent rise in sales to £18.2m. And following a trading update at the end of last week, analyst John Cummins at broker WH Ireland predicts that the company will more than treble pre-tax profits to £1.6m on flat revenues of £37m for the whole of 2013. On that basis, EPS rises from 6.6p to 15.7p. True, the weaker dollar had a negative impact on raw material costs in the final quarter and as a result full-year profits were slightly lower than the £1.8m WH Ireland had been predicting, but nonetheless it's clear that the new focus is working.
Moreover, assuming a very modest increase in revenues to £39m in the current financial year to the end of December 2014, WH Ireland predict pre-tax profits will surge more than 50 per cent to £2.5m to produce EPS of 22.7p. That means the shares are trading on 11 times last year's earnings, falling to a bargain basement eight times 2014 estimates. These forecasts look realistic to me since the combination of lower-cost production in Ethiopia, improved sourcing of raw materials around the world, and greater efficiencies in shipping leather direct from Ethiopia to the Far East, rather than via the UK, are all helping to drive operating margins higher.
For good measure, the shares are also trading bang in line with book value of 182p, so we are able to buy into this recovery story without paying a premium to the company's net asset value. There are no financial concerns to justify such a discount, either. In fact, the company's net debt of £6.7m at the end of June represented only 39 per cent of shareholders' funds of £17m and was well within the debt facilities the company has with Lloyds Bank, having transferred its facility from RBS at the end of 2012.
Beefing up the board
Interestingly, given Pittards product innovation and the opportunity to exploit this further, the company has just appointed Godfrey Davis as a non-executive director of the company. Mr Davis is also non-executive chairman of Mulberry (MUL), having previously been chief executive of the luxury handbags retailer for 10 years. Not only does the appointment bring a wealth of experience in the luxury leather goods sector, but given his contacts this should prove highly beneficial to Pittards' growth strategy in the luxury end of the market. There also seems an obvious opportunity here for the Daines and Hathaway brand to further exploit the 'Made in Britain' movement in new overseas territories, while the intellectual hub in Yeovil continues to focus on innovation, design and the development of the brand into the consumer arena.
Potential bid target
It's worth noting, too, that with Pittards' shares so lowly rated, and profits bouncing back strongly, then we are getting a free ride on the potential for a takeover given the shares are trading at net asset value.
I am not the only one thinking along these lines as the company received an unsolicited indicative cash offer from an unnamed suitor at the end of September. Having consulted with its major shareholders at the time, the board unilaterally rejected the offer on valuation grounds. However, with the top six shareholders controlling approximately 71 per cent of the 9.26m shares in issue, including a 18.25 per cent stake held by activist investor Peter Gyllenhammar through his investment vehicle Bronsstädet AB, then clearly if a cash offer was attractive enough it would not be difficult to get a majority of shareholders to back it. Institutional investor Artemis holds a 18.9 per cent stake and HH Discretionary Trust a further 14.7 per cent, so in effect the top three shareholders control the company.
Positive chart set-up
If the combination of an earnings recovery, single-digit earnings multiple and potential for a bid were not compelling enough reasons to buy the shares, then the chart set-up is equally positive.
Having based out a year ago, Pittards' share price has been making steady progress and, at 177p, looks destined to test the 212p high from last March. Beyond that the April 2011 high of 247p is a realistic target. If achieved, the shares would still only be trading on a 2014 prospective PE ratio of 11, hardly a punchy valuation for a company in a strong earnings recovery.
So, ahead of results scheduled to be released in the week of Monday 17 March, and offering 41 per cent share price upside to my 250p target price, I rate shares in Pittards a value buy on a bid-offer spread of 170p to 177p. My time frame for this trade is six months.
