This subject is of interest to me right now because I have been closely monitoring the progress of Stadium Group (SDM: 75.5p), a specialist provider of niche electronic technologies and manufacturing services to leading Original Equipment Manufacturers (OEMs) in the industrial, marine, aviation, transport, lighting, automotive and security markets. Established for over a century, the company employs about 800 people in the UK and Asia, manufacturing power products, intelligent interface & displays, wireless devices and integrated electronic manufacturing services (iEMS).
The key take for me in the company’s full-year results in March was that the heavy lifting has now been done in reorganising and streamlining the business to reduce the cost base and put in place a platform for growth. Significant costs have been taken out of the iEMS business following the closure of the company’s Rugby site and the transfer of operations to Hartlepool. In Asia, the head office in the region was moved to the company’s factory in mainland China following the closure of the Hong Kong office. The financial savings aside, the operation has been winning more ‘China to China’ contracts as a result and has been invited to tender for larger business opportunities. So although competition in the iEMS segment remains highly competitive, analyst Jon Lienard at broking house N+1 Singer expects the unit to double operating profits to £1.5m on sales of £31m in the current financial year to end December 2014.
The benefits of restructuring aside, Stadium pulled off a smart looking acquisition a couple of years ago when the company purchased IGT Industries, a designer and manufacturer of intelligent displays for the professional electronics market, the critical technology through which users control professional electronic systems. IGT's capability includes back-lit capacitive touchscreens and switching products, as well as traditional membrane switches. Under its first full-year of ownership, the business grew sales by 40 per cent on a like-for-like basis, so has already made a significant contribution. Expect more of the same this year as analysts at N+1 Singer predict the division will grow operating profit by 36 per cent to £900,000, on turnover up from £4.7m to £5.4m, making the £4.2m cash acquisition price now look like a bargain.
Admittedly, Stadium’s power products business endured a tough time last year, but the unit’s order book is now strengthening off the back of some sizeable new contracts, a positive trend which started in the second half of last year. Mass production from this unit should start to ramp later this year too, setting the potential for a strong profit recovery in 2015 when analysts predict divisional profits will bounce back to £1m, up from around £800,000 forecast this year.
Earnings enhancing acquisition
Next year also promises a major profit contribution from the recently announced acquisition of United Wireless, a specialist in the design and manufacture of electronics for the machine-to-machine (M2M) wireless sector. United’s technology supports wireless connectivity between devices, primarily cellular networks, and acts as a specialised wireless integrator for OEMs. United has a strong customer presence in the automotive and telematics sectors, and also works with OEMs in the areas of 'infotainment' and vending, industrial equipment and asset tracking. It’s a hot market to be operating in too.
According to research from Berg Insight Research, global demand for M2M wireless devices is forecast to expand at a compound annual growth rate of 24 per cent over the next five years, with the number of cellular M2M device subscribers predicted to rise to almost half a billion by 2018. Importantly, Stadium is not overpaying for this growth potential.
That’s because in the first nine months of its current fiscal year, United Wireless made operating profits of £900,000 on sales of £6m, so the acquisition price of £8m, including deferred consideration of £2m, hardly looks exacting. And because Stadium had an ungeared balance sheet at the end of 2013, it has been able to borrow £5m of the purchase price from an existing five-year credit facility with HSBC and has settled the £1m balance of the initial consideration in shares. Analyst Jon Lienard at N+1 Singer expects the wireless segment to contribute revenues of £9.2m and £1.3m to Stadium’s operating profit in 2015, inline with United Wireless’ current run rate of profits, fully justifying the purchase price.
Massive earnings upgrades
Factoring in the improvement of profits at both iEMS and the interface and display division, analysts now predict Stadium’s pre-tax profits will surge by 50 per cent to £2.7m on a 12 per cent hike in revenues to £47.1m in the fiscal year to end December 2014. This bottom line growth also reflects an improvement in operating margins due to the operational leverage of the business.
But this is only part of the story because with the acquisition of United Wireless being funded by a relatively cheap line of credit, then this will boost next year’s profits significantly. In fact, after factoring in an additional £100,000 profit contribution for the iEMS business, the profit recovery at the power products unit mentioned above, and an additional £200,000 of profit contribution from the interface and display business, then N+1 Singer forecast a 50 per cent jump in Stadium’s operating profit to £5m in 2015. True, finance charges will rise from £300,000 to about £500,000 next year, but even after factoring this in the company’s pre-tax profits are set to surge by more than half from £2.7m to £4.2m.
On this basis, expect EPS to rise sharply from 5.1p last year to 6.9p in 2014, ramping up to 10.5p in 2015. These forecasts look very sensible to me having drilled down through each business unit and analysed how margin improvement and revenue growth is set to drive profits. So not only are the shares trading on a modest 11 times earnings estimates for the current fiscal year, but assuming the 50 per cent plus EPS growth in 2015, the multiple drops sharply to a bargain basement 7 times forecasts next year.
There is a dividend too. Having committed to a target dividend cover of three times earnings through the cycle, Stadium’s board paid out 1.2p a share for the 2013 financial year. This means that with EPS set to ramp up, the respective dividend forecasts are 2.1p in 2014, rising to 2.7p in 2015. On this basis, the shares offer an attractive 2.7 per cent prospective yield, increasing to 3.5 per cent in 2015.
True, Stadium has a net pension liability of £4.5m, funded by a £790,000 annual contribution over the next three years. However, this contribution is already factored into the profit estimates above. In any case, operating cash flow of £2m last year easily covered this pension liability and with 30m shares in issue there was enough cash left over to fund the £360,000 cost of the dividend too.
Target price
Interestingly, Stadium’s share price is on the cusp of breaking out through this year’s high of 77p dating back to February. Beyond that the obvious target is the 95p level, a 10-year high dating back to early 2005. If the price can hurdle that level as I anticipate, then there is nothing from a technical perspective to stop a run up to the 125p previous support level which dates back to the late nineties.
In the circumstances, I feel that a 12-month target price of 105p, or the equivalent of 10 times 2015 earnings estimates, is not only justified on fundamentals, but also by a very positive technical set-up to. Trading on a bid-offer spread of 73p to 75.5p, and offering 36 per cent share price upside to my target price, I rate Stadium shares a decent recovery buy and one with significant earnings growth potential.
■ 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'
