For good measure, I also want to see the 14-day relative-strength indicator (RSI) oversold, and extremely so if possible, on a share price retracement back to the long-term trend line. The reason for this is that the technical set-up is more often than not very favourable for a sharp bounce at this major support level. Therefore, if the 14-day RSI is oversold too on a successful retest of the support, then the subsequent share price recovery can be very strong indeed. Remember that the whole point about opening a new trading position is to maximise your return in the shortest available time frame.
This subject is also highly relevant for another one of the companies on my watchlist, Aim-traded software company Sanderson (SND: 66p), a specialist in multi-channel retail and manufacturing markets in the UK.
I have been monitoring the chart action closely in the past few weeks and noted that the share price has now pulled back from the multi-year high of 75p at the end of November to its 200-day moving average. Interestingly, that long-term trend line was tested twice in the last eight days of February and on both occasions the share price kissed the line before buyers came in. This has created potentially a hammer type bottom on the candlestick chart which is a bullish sign.
For good measure, there has been positive divergence on the 14-day RSI whereby the readings on this indicator at the intra-day lows of 59.5p at the end of February were no lower than at January’s share price low when the price was much higher. This also suggests that the selling pressure is waning and a major turn is in the offing in advance of a move to my target price of 80p. It would also be one that is fully supported by the fundamental investment case.
E-commerce driving growth
Having initiated coverage on Sanderson when the price was 33.5p ('A valuable stock check', 18 Jul 2011), the shares have made steady progress underpinned by the company’s operational performance and specifically by a focus on software targeted at the e-commerce retail market.
At the annual meeting last week, chairman Christopher Winn noted that "online sales, e-commerce and catalogue sectors continue to experience double-digit growth rates, fuelled by the adoption of mobile solutions across all markets." It's only reasonable to assume these trends will continue in the future given that e-commerce sales in Sanderson's multi-channel retail segment increased by 10 per cent to £2.6m in the financial year to end-September 2013. This revenue stream now accounts for well over a third of the division's revenues.
Moreover, with the benefit of an increasing contribution from higher-margin proprietary software sales, Sanderson’s gross margins rose by 4 percentage points to 87.6 per cent on revenues of £13.8m (from £13.4m in 2012). The forward order book is strong too, reflecting ongoing product development, especially in mobile and tablets.
It’s also easy to see why these positive trends will continue given that Sanderson works in partnership with clients primarily to deliver e-commerce software systems that underpin their online operations and enable them to cross-sell products, offer a '3D' secure payment process and integrate online offerings with other parts of their business. Sanderson’s systems can also generate major benefits for clients, including boosting their return on investment (ROI). For instance, one customer has reported a three-fold increase in ROI from his Sanderson system within the first year. It's also a fast-growing segment of the retail sector to be operating in; analysts at Forrester predict the e-commerce segment will grow at a compound annual growth rate of 10 per cent a year out to 2017.
Sanderson's ongoing investment in proprietary software for mobile devices makes a lot of sense too; m-commerce now accounts for 10 per cent of the company’s revenues from a standing start only a few years ago. In fact, such is the pace at which consumers and businesses are embracing new technology, analysts at investment bank Morgan Stanley forecast that mobile users will exceed desktop users for the very first time this year. This adds substance to the prediction by Verdict Research that m-commerce will drive e-commerce sales up by half in the next five years. That should be very good news for Sanderson’s profits.
Bumper profit growth
Following last week’s annual meeting, analysts at both Charles Stanley and WH Ireland both expect Sanderson’s revenues in the financial year to end September 2014 to increase by 16 per cent to £16m. So with margins on the rise too, then pre-tax profits are predicted to rise by around 23 per cent from £2.2m ended to £2.7m. On this basis, WH Ireland is forecasting underlying EPS of 4.5p, up around 10 per cent year-on-year. The earnings figure has been adjusted to take into account a placing which raised £3.5m at 55p a share following Sanderson's acquisition of One iota, a provider of mobile applications for retailers including Thorntons, Littlewoods and Superdry.
The acquisition further expands Sanderson’s business into mobile applications and provides the latest mobile technologies to its existing client base. One iota's MESH technology, a cloud-based technology that integrates existing back office systems to optimise a retailer's applications, looks a smart add on to Sanderson e-commerce solutions offering. The funds raised will also be used to accelerate the development of the company’s mobile solutions business; and increase sales and marketing activities.
According to finance director Adrian Frost the aim is to raise One iota's annual sales by a half to about £1m the end of this year. If achieved, and with the benefits of ongoing organic growth and being part of a much bigger company, the unit has potential to generate profits "in the range £250,000 to £350,000." That may seem an optimistic target, but by feeding off Sanderson's financial strength and listed company status, One iota should be able to target and close new business deals that would not have been possible previously due to its smaller size. It’s worth noting too that according to Mr Winn One iota has made a very positive start since being acquired at the start of October.
This is not the only deal Sanderson's has made to boost exposure to e-commerce in it's multi-channel retail division. The acquisition of e-commerce solutions company Catalan in a £500,000 deal last August looks equally smart. I understand that Catalan's cash profits are running at a monthly run rate of around £10,000 and there is potential to lift annual profits to £150,000 on sales of £1m.
Profit forecasts well supported
In light of the Catalan and One iota acquisitions, analysts’ profit forecasts of around £2.7m look very well supported for the current financial year. Of the £16m of revenue forecast in the 12-month period, around £8.5m is already recurring, reflecting pre-contacted revenues, the margin on which covers two-thirds of Sanderson’s overheads. In addition, the two aforementioned acquisitions should be able to contribute annualised revenues of around £1m by the September year-end. The company started the financial year with a £1.9m order book too. So, given the growth of both the e-commerce and m-commerce segments, I firmly believe that the double-digit revenue growth predicted this year is realistic as is the £500,000 profit uplift.
It’s worth pointing out that the £5.4m paid for One iota in October 2013 included £2m of deferred consideration which is paid if certain performance targets are achieved over the next three financial years. This means that the acquisition was priced on a bargain basement 10 times operating profit on the initial consideration. Including the deferred consideration the earnings multiple rises to what would be a fair valuation of 16 times annual operating profit, but that fails to acknowledge the funding structure of the deal which effectively means that roughly three-quarters of the deferred consideration pays for itself.
Sanderson unfairly rated well below peers
So with profits set to surge this year, and the company confirming last week that its like-for-like order book and order intake is ahead of last year (excluding the contribution from acquisitions), buoyed by an increasing level of new customer contract wins, Sanderson’s current rating looks far too low.
In fact, strip out net cash of £4.5m, worth 9p a share, from the current share price and the company is being rated on a prospective PE ratio of 12.5, around a third less than the software and computer services sector average rating. Sanderson also pays a dividend, having raised the payout by a quarter to 1.5p a share last year. Analysts predict a total dividend of 1.6p a share for the 12 months to end-September 2014, implying a prospective yield of 2.4 per cent or almost five times higher than the yield on the FTSE Aim Technology index.
Offering a combination of growth, yield and exposure to the retail and higher growth manufacturing markets, I feel a forward rating of 16 times earnings estimates net of cash is a far more appropriate rating. Needless to say, with over 20 per cent upside to my target price of 80p, and the share price bottoming out, I rate Sanderson shares an attractive buy on a bid-offer spread of 63p to 66p.
Please note that I am working my way through a very large number of updates following the release of trading statements and financial results from several of the companies on my watchlist. These include announcements from other 2014 Bargain shares in this year’s portfolio, Barratt Developments (BDEV) and Taylor Wimpey (TW.) and last year's constituent, Heritage Oil (HOIL). I will also be publishing investment updates following announcements from Bovis Homes (BVS), BP March & Partners (BPM), First Property (FPO), and Macau Property Opportunities (MPO).
