Admittedly, Pittards is a minnow of the stock market with a market cap of £15m, so its shares can be volatile, especially since the free float is lower than average. In fact, the top six shareholders control over two thirds of the 9.26m shares in issue, including a 14.9 per cent stake held by activist investor Peter Gyllenhammar through his investment vehicle Bronsstädet AB. Institutional investor Artemis holds a 18 per cent stake and HH Discretionary Trust a further 14.7 per cent, so in effect the top three shareholders control the company. And it was news that Mr Gyllenhammar has sold a total of 300,000 of his 1.69m shares in Pittards that prompted the sell-off.
That’s because the company was a bid target last autumn and received an unsolicited indicative cash offer from an unnamed suitor. This was rejected on valuation grounds. Some investors will have been betting on a new bid approach, so news that the largest shareholder has been selling down his stake will have dampened their enthusiasm. However, as an independent company in a strong earnings recovery, the shares are woefully underrated and at the current level there is no bid premium at all in the share price. This looks a great buying opportunity to me and based on sound fundamentals, too.
Strong earnings recovery
When Pittards released its 2013 full-year results a few months back, the company more than trebled reported operating profits to £2m and delivered pre-tax profits more than 6 per cent ahead of estimates from house broker WH Ireland. After factoring in a share consolidation post the December year-end, and adjusting for exceptional items which depressed the figures in 2012, underlying EPS surged from 6.7p to 15.7p. This means the shares are now trading on a miserly 10 times historic earnings.
And the earnings recovery has further to run. For instance, the business has been benefiting from a higher contribution from dress glove making at its African facility and there are plans to expand this niche area alongside industrial glove production. Product launches and new initiatives are having a positive impact on profits as is a change in the sales mix towards a lower concentration of commodity-style leathers and a greater focus on product manufacturing, including bespoke garments, which enjoy higher gross margins.
Given the heritage behind the brand, and the focus on high quality products, there seems scope for Pittards to exploit the 'Made in Britain' movement in overseas territories through its Daines and Hathaway brand. The appointment of Godfrey Davis as a non-executive director is an interesting move to support Pittards' growth plans in the luxury end of the market. Mr Davis is non-executive chairman of Mulberry (MUL), having previously been chief executive of the luxury handbags retailer for 10 years.
It’s worth flagging up the operational gearing of the company. According to analyst John Cummins at brokerage WH Ireland, "both the Yeovil and Ethiopian facilities could more than double current volumes with little in the way of further investment". To put this into some perspective, Mr Cummins estimates that every £1m of additional sales generates pre-tax profits of £200,000 which explains why his forecast 8 per cent rise in revenues to £39m in the current financial year is expected to boost pre-tax profits by half to £2.5m and lift adjusted EPS increases from 15.7p to 22.7p.
The upside from new products will drive part of this growth. For example, Pittards has been making inroads into lucrative sports markets; Sta-Soft, the world's best selling golf glove, is one of its products. And earlier this year a major customer, FootJoy, launched D.N.A. footwear incorporating Pittards' all new Chromoskin leather system, a full grain leather that is supple, lightweight, and completely waterproof. The business also supplies global retail brands such as Hermes, Nike and Marks & Spencer. You can even buy a Pittards iPad case.
So once you combine the top-line growth with the benefits of lower-cost production in Ethiopia, better sourcing of raw materials, and greater efficiencies in shipping leather direct from Ethiopia to the Far East, it’s reasonable to expect profits to soar on higher margins.
Admittedly, an increase in skin prices is a risk as is weakness in the US dollar. As a rule of thumb, every one per cent move in the sterling:US dollar exchange rate equates to a £200,000 hit on profits. But with the shares only trading on 10 times historic earnings, and a miserly seven times current year estimates, we have a ‘margin of safety’ built into those forward profit estimates to compensate for any further currency weakness.
Balance sheet strength
Importantly, Pittards has no financial concerns to warrant such a modest rating: net borrowings of £7.1m equate to 41 per cent of shareholders' funds of £16.9m and is well within the debt facilities.
There is hidden value in the balance sheet, too, because property, plant and equipment is in the books for £6.1m, reflecting a policy that has seen these assets depreciated at a historic rate of between 10 to 33 per cent per year. But the bulk of these assets have now been fully depreciated even though they have a considerable useful life left. That helps explain why the non-cash depreciation charge halved to £355,000 last year and so proved less of a drag on reported profits.
Pittards' management team estimate that the replacement costs of either of the two main production facilities is around £18m each at current exchange rates. Or put it another way, the company’s reported book value per share of 183p woefully underestimates the true worth of the assets Pittards owns.
Positive chart set-up
If an earnings recovery and single-digit earnings multiple were not enough reasons to buy the shares, the chart set-up suggests the next move will be upwards. For starters, the 14-day relative strength indicator is on the floor and has a reading of 10. The price has also retraced almost half the price move from last summer lows to this year’s high and is close to testing the 200-day moving average. So with the shares already massively oversold, this suggests a sharp bounce could be on the cards towards the March high of 210p. Beyond that the April 2011 high of 247p is still a realistic target.
If achieved, the shares would still only be trading on a 2014 prospective PE ratio of 11, hardly a punchy rating for a company in a strong earnings recovery. Offering 50 per cent upside to my 250p target price, I rate Pittards' shares a value buy on a bid-offer spread of 157p to 162p on a six month basis.
Please note that I am working my way through a list of companies on my watchlist that have reported results or made announcements recently including: Eros (EROS), Inland (INL), API (API), Charlemagne Capital (CCAP), Oakley Capital Investments (OCL), Thalassa (THAL), Camkids (CAMK), Taylor Wimpey (TW.), Barratt Developments (BDEV) and Bovis Homes (BVS).
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