The company is a minnow of the stock market with a market cap of £12.1m, so the shares can be volatile, especially given Pittards has a lower than average free float. In fact, the top six shareholders control over two thirds of the 9.26m shares in issue. Institutional investor Artemis holds an 18 per cent stake and HH Discretionary Trust a further 14.7 per cent, but it has been the sale of almost 500,000 shares by Mr Gyllenhammar through his investment vehicle Bronsstädet AB that prompted a price slump post Pittards full-year results in mid-March. In aggregate, the disposals equate to 5.4 per cent of the issued share capital and means Mr Gyllenhammar’s shareholding has been reduced to 12.89 per cent of the company.
To compound matters, chairman Stephen Boyd sold off 200,000 shares last week at a price of 120p to provide the "working capital needed for other business interests". Mr Boyd still owns 162,000 shares in Pittards. Clearly, it's none of my business what these interests are and how Mr Boyd wishes to fund them. But it’s hardly surprising that the shares have fallen since that announcement as investors take fright. In fact, the price is now well below the buy in level of 177p when I initiated coverage ('Bargain basement recovery play', 11 February 2014).
It is also reasonable to believe that many investors who were holding the shares in the likelihood of a bid will have had their enthusiasm tempered somewhat. To recap, Pittards received an unsolicited indicative cash offer from an unnamed suitor last autumn, but this was rejected by the board on valuation grounds. Clearly, if the chairman has been selling, and a major shareholder too, then a bid is not an imminent prospect.
But it’s equally true that the shares are now very underrated. To put this into some perspective, the company more than trebled reported operating profits to £2m last year and delivered pre-tax profits of £1.7m, or more than 6 per cent ahead of estimates from house broker WH Ireland. On an underlying basis, EPS surged from 6.7p to 15.7p. So at the current price of 130p, the shares are trading on little over eight times historic earnings.
Currency woes
True, chairman Mr Boyd announced at the annual meeting in mid-May that the "weak dollar is adversely affecting the business and will result in a lower first half profit than last year". In the first half last year, Pittards reported operating profit of £1.1m on revenues of £18.4m. Currency movements are significant as 90 per cent of sales are derived from overseas.
Factoring in an average exchange rate of £1=US$1.65 for the calendar year, up from £1=US$1.56 in 2013, analyst John Cummins at brokerage WH Ireland has downgraded his revenue expectations from £39m to £37.5m, up from £35.8m in 2013. He has also reined back his pre-tax profit estimate from £2.5m to £2m, but that is still a marked increase from profits of £1.7m in 2013. On this basis, expect EPS of 18.5p rather than 22.7p previously forecast. Still, this is well ahead on the 15.7p reported in 2013 and means that the shares are priced on a modest seven times downgraded earnings estimates. That rating seems harsh given the company is expected to grow EPS by 17 per cent this year.
It’s also worth pointing out that Mr Boyd confirms that "the order book has increased over recent months in all parts of the business and sales volumes are accordingly expected to steadily improve during the year. Skin prices have settled at a slightly better level than in 2013, though hide prices remain firm, and we anticipate a stronger second half result". Moreover, Pittards management team are taking all appropriate measures to control costs and mitigate the dollar impact. WH Ireland have factored in around £200,000 of cost savings into the aforementioned profit estimates for this year which I believe are achievable to mitigate the impact of the weaker US dollar.
Clearly, earnings downgrades are never a good thing but they have to be put into perspective. In the case of Pittards, the company is growing on an underlying basis and the downgrade is the direct consequence of currency movements rather than a deterioration of trading.
Strong balance sheet
It’s also worth noting that Pittards has no financial concerns to warrant such a low rating: net debt of £7.1m equates to 41 per cent of shareholders' funds of £16.9m and is well within the company’s debt facilities. Mr Cummins at W.H. Ireland predicts a reduction in net borrowings to £6.9m by the year-end.
In addition, the company is being valued 28 per cent below book value of 183p a share even though there is hidden value in the balance sheet. That’s because property, plant and equipment is in the books for £6.1m, reflecting a policy that has seen these assets depreciated at a historic annual rate of between 10 to 33 per cent. But the bulk of these assets have already 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.
Furthermore, I understand that the replacement cost of each of the company’s two main production facilities is around £18m which means the last reported book value per share of 183p woefully underestimates the true worth of the assets Pittards owns.
Target price
True, my previous 250p target price may seem a long way off and WH Ireland target price has been reined back from 270p to 220p post the annual meeting trading update. However, even at 220p the shares would only be trading on 12 times earnings estimates and on a modest 1.2 times conservative book value. That valuation seems fair to me and 220p is my new target price.
So although Pittards shares have fallen steeply since I initiated coverage in February, I still rate them a decent medium-term value buy on a bid-offer spread of 125p to 130p and one where bid prospects are in the price for free.
■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'
