Camkids' full-year results released last month were much as expected with revenues ramping up by more than 18 per cent to £103m at current exchange rates and both operating profit and post tax profit rising by 14 per cent to £29.1m and £21.6m, respectively. Net cash ended the year at £30m, or 60 per cent of the current market capitalisation of £50m. In other words, strip out the cash pile and the company's equity is being valued on a miniscule one times last year's net profits. Moreover, with cash flowing into the business post the year-end as inventories have been turned into cash and distributors settled accounts, Camkids has confirmed that net funds reached £37m, or 49p a share, by the end of February.
Cash flow and financial strength of the balance sheet are not the issues vexing my grey cells. In fact, current assets of £79m, mainly cash and receivables, exceed all liabilities five times over. And we are getting a chunk of those assets for free because Camkids' market capitalisation of £50m is a quarter less than its net asset value of £68m. Reassuringly, and having increased its payment terms from 90 to 120 days to bring Camkids in line with industry peers, the company has no bad debts and all trade receivables are less than 120 days old. I am not concerned about the 20 per cent rise in year-end trade receivables last year either as these hit a seasonal high in the final quarter to coincide with a pick-up in sales ahead of the Chinese New Year. In any case, the company's revenues rose by 19 per cent in 2013 so you would naturally expect receivables to grow, too.
Perhaps news that the company is boosting its marketing spend to raise its profile and brand awareness, specifically through television advertising, has worried investors in light of new guidance for a flat sales performance in the second half of the current year. However, this should be put into some perspective because this year's marketing campaign will cost £3m and Camkids is still expected to report pre-tax profits of £26m on flat revenues, albeit a decline from £29m in 2013. Admittedly, it means that analyst Matt Butlin at brokerage Allenby Capital now only predicts EPS of 25.8p, down from 28.8p in 2013. But to put that into some perspective, with the company's equity being valued at 19p in Camkids current share price, the implied valuation of the business is a miserly 0.8 times forecast net earnings. In my view, not even the profit shortfall can explain the share price weakness.
The dividend can't either. True, the payout was less generous than analyst Matt Butlin of Allenby had predicted: the final dividend of 2.3p was shy of his 3p a share estimate. But this still meant Camkids declared a full-year dividend of 4.3p a share and one covered six times over by EPS of 28.7p. It also means that with the shares being offered in the market at 68p, the historic yield is still pretty attractive at 6.3 per cent.
Ultimately, I believe there are the two key issues that have been weighing on the shares, both of which need addressing: a massive ramp-up in capital expenditure and a stock overhang. Let me explain.
Capital spending plans
In the results release, Camkids' board announced that the company is planning a £19m investment in new headquarters and facilities to enhance its research and development (R&D) activities, and provide the infrastructure to support recent e-commerce initiatives, and logistics operations. Phased over the next three years, the plan is for all Camkids' other operations to migrate to the new headquarters. The planned investment will easily be covered by the company's current cash pile of £37m.
Clearly, to make an investment equating to 40 per cent of a company's market value is sizeable in anyone's book, but the rationale behind it does stack up. Namely, Camkids' manufacturing facility in Jinjang, which encompasses the R&D facility and support staff, is operating near full capacity and expansion on the current site is not an option given the local government have decided to increase the size of the road running alongside the facility. It should also enable the company to better attract and retain key staff, and maintain a competitive advantage in what is a competitive market place. Camkids has 104 staff in its current R&D centre.
In other words, it's not just a case of ramping up manufacturing capacity - Camkids apparel and accessories businesses are both outsourced and enjoy higher margins - but also about investment in the business to maintain profitability and competitiveness. It's also worth noting that the company's cash flow over the next three years will easily cover the planned investment without dipping into the bumper cash pile. For instance, Camkids generated operating cash flow of £29.5m before movements in working capital last year, of which a quarter was then spent paying income tax, and a further 30 per cent used to increase inventories and trade receivables. That still left £13.5m over for dividends to shareholders of which the 4.3p a share full-year payout will only use up £3.2m. So even if the dividend is held at the current level for the next three years, there is ample cash flow to fully fund £19m planned capital expenditure. That helps explain why Mr Butlin is predicting a year-end cash pile of around £40m, rising annually by around £9m for both 2015 and 2016.
Or put it another way, assuming Camkids can generate average cash profits of around £28m over the next three financial years, down from £29.3m in 2013, then even after paying out dividends equating to 6.3 per cent of the share price each year, and embarking on a £19m capital investment project, the cash pile will still be worth the company's current market capitalisation by the end of 2016. In the circumstances, it is only reasonable to conclude that the weakness in Camkids share price in the past three months has little to do with the investment in new facilities.
A stock overhang
What does explain the performance is a stock overhang. At the IPO, shares equivalent to 23 per cent of the company (around 17m of the 74m shares in issue) were granted to contacts who helped with the historic growth of the company, none of which are involved in the day to day running of the business. The lock-up period expired earlier this year and resulted in some of these shareholders aggressively selling down their holdings, clearly to the detriment of other shareholders.
In fact, there have been seven notifications to the London Stock Exchange this year from four investors who have sold down part of their holdings, all of whom no longer have a notifiable interest in Camkids' issued share capital. More importantly, these investors are now bound by new lock-in agreements that run until March next year. I estimate that 75 per cent of the overhang has now cleared as a result of these sales having scanned all the announcements from these investors. This means that we are far closer to the end of the overhang.
Moreover, with these four investors unable to sell down any more shares for a further 10 months, then the selling pressure that has depressed Camkids share price is now easing. Evidence of this can be seen on the company’s share price chart as the price found strong support on four occasions in the first half of last month at the 55p level with positive divergence on the 14-day relative strength indicator (RSI) on each retest.
From my lens, a low could now be in place as the share price is now recovering strongly from those aforementioned intra-day all-time lows. Moreover, on a bid-offer spread of 66p to 68p the share price is making headway to the previous support level of 82p. This was breached at the end of March and led to the heavy selling of the shares. But in the absence of further selling by the investors who, by my reckoning, now control around 4.2m of the 75m shares in issue, then there is clear potential for Camkids share price to recover back to that 82p level, and well beyond to the 88p listing price in December 2012 and the 200-day moving average at 95p. Beyond that the next target is February's high is 104p, or 50 per cent above the current share price.
Admittedly, the February's high may seem some way off, but given the shares are currently trading on less than one times cash adjusted earnings, even at a price 50 per cent higher the multiple would still only be 2.5 times earnings estimates for this year on the same basis.
Sales trends
A much higher rating is also warranted by the fact that to date Camkids has not been impacted by rivals discounting due to the resilience of its end markets in children's clothing and the less crowded outdoor sportswear markets such as hiking, climbing and skiing.
By targeting the children's market, Camkids has been a beneficiary of China's one child policy, which has led to a generation of 'little emperors' being spoiled by four grandparents and two parents in each family. Camkids' products are marketed as a vintage 'western brand' and positioned in the mid to high-end price bracket. This business focus differentiates Camkids from general sportswear companies, which tend to target crowded markets for running, basketball, soccer and tennis. These specific end markets have endured a torrid time due to intense competition and overproduction.
Admittedly, even Camkids isn't completely immune to certain trends otherwise the company would be putting in more than a flat sales performance as is now forecast this year. That said, this is mainly down to the fact that a mild winter in China means that inventory levels have to be cleared with some of its distributors and retailers. This had a direct knock on effect on orders placed at the spring fair in Beijing, which were inline with last year even though the company is selling through 185 more outlets (1,285 in total) than at this stage in 2013. Historically, orders placed at the spring and autumn/winter trade fairs have been an accurate indicator of revenues trends, hence guidance for a flat sales performance this year.
But even if the company has to work harder for each sale, and has to forego some of its margin to invest in marketing, then that is hardly a deal breaker given the business enjoys gross margins of 37 per cent on sales. It certainly can't justify the miserly current rating.
So, having vexed my little grey cells, it is only rational to conclude that Camkids' share price has been massively oversold mainly due to an unforeseen stock overhang. However, with that largely now cleared, it is also reasonable to believe that the shares will continue to make up their lost ground. As Agatha Christie once said: "If you are to be Hercule Poirot, you must think of everything." A lesson learned for the future.
Please note that I am still working my way through a list of companies on my watchlist including: Inland (INL), API (API), Charlemagne Capital (CCAP), Oakley Capital Investments (OCL), Thalassa (THAL), Taylor Wimpey (TW.), Barratt Developments (BDEV) and Bovis Homes (BVS).
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