In the latest six month trading period to end March, Sanderson’s turnover increased by 20 per cent to £7.9m which was in part down to contributions from acquisitions. However, on an underlying basis, like-for-like revenue growth was robust enough at 4 per cent and an order book of £2.46m, up from £1.6m at the same stage last year, reflected strong order intake from both existing and new customers. Most of these orders are expected to be booked in the second half, thus offering reassurance that the company will hit analysts’ full year revenue estimates of £16m, up from £13.8m in the previous fiscal year.
It was also comforting to see that recurring revenues accounted for £4.4m of the £7.9m turnover in the first half, or more than half of the total. This was inline with the previous financial year and with the benefit of eye-catching gross margins of 87 per cent, reflecting a higher level of Sanderson owned proprietary products and services, underlying operating profit jumped by a fifth to £1.2m, or 45 per cent of full-year forecasts.
A positive outlook
It’s also easy to see why these positive trends will continue for some time yet. That’s because 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 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 a fast-growing segment of the retail sector to be operating in too; 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 certainly makes a lot of sense; the company’s order intake generated from the m-commerce and e-commmerce segments accounted for 30 per cent of the total in the past six months. 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 further substance to the prediction by Verdict Research that m-commerce will drive e-commerce sales up by half in the next five years.
Last autumn’s acquisition of One iota, a provider of mobile applications for retailers including Thorntons (THT), Littlewoods and Superdry, is also helping to drive this growth by offering the latest mobile technologies to Sanderson’s existing client base. One iota's MESH technology is a cloud-based technology that integrates existing back office systems to optimise a retailer's applications. The plan is to raise One iota's annual sales by a half to about £1m by the end of this year. According to finance director Adrian Frost the unit has potential to generate profits in the range £250,000 to £350,000 by feeding off Sanderson's financial strength and listed company status and by targeting new business deals that would not have been possible previously.
The smaller acquisition of e-commerce solutions company Catan last August is also working out well and is delivering monthly cash profits of around £10,000 with potential to ramp up to annual profits of £150,000 on sales of £1m.
Expecting bumper profit growth
So with the benefit of acquisitions coming through, and the businesses generating decent underlying revenue growth, it’s only reasonable to expect Sanderson to hit WH Ireland’s pre-tax profit estimate of £2.7m for the 12 months to end September, up from £2.2m in fiscal 2013. On this basis, adjusted EPS rises from 4.1p to 4.5p and supports an increase in the dividend from 1.5p to 1.6p a share as analyst Eric Burns predicts.
The hike in the payout could easily be higher because with the company’s net cash rising from £4.5m to £5m in the past six months alone, the current cash pile equates to almost 10p a share or the equivalent of 15 per cent of Sanderson’s market capitalisation of £36m. In any case, the raised dividend is covered almost three times over which is comfortable by any measure.
Please note that pre-tax profit growth has outpaced EPS growth due to the greater number of shares in issue following a placing to fund the One iota acquisition last October. However, it was a very sensibly priced deal because the £5.4m consideration included a deferred element of £2m which is paid only if performance targets are achieved over the next three financial years. This means that the acquisition was priced on 10 times historic operating profit on the initial consideration, rising to 16 times including the deferred consideration. But that overstates the true cost because the funding structure means that three-quarters of the deferred consideration actually pays for itself.
For a company exposed to the high growth e-commerce and m-commerce markets, a cash adjusted prospective PE ratio of 13.5 for fiscal 2014 doesn’t seem exacting. For good measure, there is a 2.4 per cent dividend yield to offer an income stream for investors or almost five times higher than the yield on the FTSE Aim Technology index.
To put this attractive valuation into some perspective, small cap software companies Craneware (CRW), Tracsis (TRCS) and my recommendation earlier this week Netcall (NET) are all valued on around 22 times cash adjusted earnings estimates for their current financial years. Sanderson’s rating seems anomalous by comparison especially since I can easily foresee a further 15 per cent upside in Netcall’s share price (‘Betting on an earnings beat’, 22 April 2014).
Technical set up and target price
I have been monitoring the chart action closely in the past few weeks and have noted that having pulled back from a multi-year high of 75p to the rising 200-day moving average, Sanderson’s share price has bounced strongly. This is always an encouraging sign that the bull run is intact. For good measure, the price has recaptured the 20-day moving average (just below 70p) and looks poised to launch an assault on the March 2014 and November 2013 highs which previously capped progress around the 75p to 76p level.
With the moving average convergence divergence (MACD) indicator both positive and above its signal line, and the 14-day relative strength indicator (RSI) only 60 then there is ample scope for Sanderson’s share price to make new highs given the shares are not yet in overbought territory.
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 and now have a new target price range of between 80p to 85p.
Needless to say, having initiated coverage on Sanderson when the price was 33.5p ('A valuable stock check', 18 Jul 2011), I have little reason to change my positive view and continue to rate the shares an attractive buy on a bid-offer spread of 71p to 73p.
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