When a company reports that underlying pre-tax profits more than doubled to over £900,000, and the order book is strengthening, then the business is clearly moving in the right direction. It was also clear to me that the benefits of the restructuring of the iEMS business means that full-year pre-tax profit estimates of £2.7m for the company as a whole are well underpinned. That unit delivered profits of almost £500,000 in the first half on revenues of £14.8m, a significant improvement on the £300,000 loss in the same period of 2013. Moreover, with operating expenses reduced by £700,000 on a normalised basis, and cost savings coming through, the £1.2m full-year operating profit predicted for the unit by analyst Jon Lienard at brokerage N+1 Singer looks very achievable based on a second half revenue forecast of £15.2m.
As I noted when I initiated coverage on Stadium five weeks ago when the share price was 75.5p (‘Switch onto the Stadium of light’, 30 July 2014), the heavy lifting has now been done in reorganising and streamlining the business to cut overheads and put in place a platform for growth and orientate the focus more to a technology led group. Significant costs have been taken out of the iEMS business following the closure of its Rugby site and the transfer of operations to Hartlepool. In Asia, the head office in the region was moved to mainland China following the closure of the Hong Kong office. As a result the iEMS operation has been winning more ‘China to China’ contracts and I understand that the “pipeline remains positive”.
Strong order books
N+1 Singer’s earnings estimates are also underpinned by the growth coming through from the acquisition of IGT Industries, a designer and manufacturer of intelligent displays for the professional electronics market. This is the 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. Mr Lienard at N+1 Singer predicts the division will grow operating profit from £660,000 to £900,000 in 2014 on turnover up from £4.7m last year to £5.4m. With the division’s order book currently up 60 per cent then I feel this business can easily deliver on these forecasts with the benefits of a stronger second half performance as orders are fulfilled.
True, Stadium’s power products business put in a relatively flat first half profit performance, but having booked operating profits of £407,000 in the six-month period to end June the unit is well on course to deliver the £800,000 of profit N+1 Singer predict for the full-year. In any case, reported profits were held back by investment made in Stadium’s low-cost Asia facility, so the profit figure is somewhat misleading. In my opinion, a far more reliable indicator of future prospects is the top-line growth now coming through on the back of some sizeable new contracts and the forecast ramp up in mass production this year. This offers clear scope for a decent profit recovery in 2015 when analysts predict divisional profits will bounce back to £1m.
Benefits of acquisitions
I also understand that the integration of this summer’s acquisition of United Wireless, a specialist in the design and manufacture of electronics for the machine-to-machine (M2M) wireless sector, is bang on target. United’s technology supports wireless connectivity between devices, primarily cellular networks, and acts as a specialised wireless integrator for OEMs.
To recap, 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. Prospects here look promising because 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.
To fund the acquisition, Stadium borrowed £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. There is also a £2m earn-out if certain targets are achieved. The major benefit of the acquisition will be seen next year when Mr Lienard at N+1 Singer expects the wireless segment to contribute revenues of £9.2m and £1.4m to Stadium’s operating profit. Given United Wireless made £900,000 of profits in the first nine months of the fiscal year to end September 2014, then that forecast looks sensible in my view.
Expect bumper earnings and dividend growth
So with Stadium benefiting from earnings growth from debt funded acquisitions, margins improving on existing businesses on the back of costs savings, and the order book robust, then I have every reason to believe that the company will deliver the 50 per cent surge in pre-tax profits this year. This assumes the company can grow second half revenues from £20.8m to £24.6m to produce second half pre-tax profits of £1.8m, up from £1.5m in the same period of 2013. On this basis, expect full-year adjusted EPS to rise sharply from 5.1p last year to 6.9p. If achieved this means the shares are currently priced on 13 times prospective earnings. And with cash flow robust - free cash flow more than doubled to £1m in the first half this year - the board are able to return chunks of cash back to shareholders through a very progressive dividend policy.
In fact, the first half dividend shot up by more than half to 0.7p a share. Furthermore, based on a commitment to target dividend cover of three times earnings through the cycle, expect the payout per share to be around 2.1p for the full-year, up 75 per cent on the 1.2p declared in 2013. If that’s not attractive enough then with EPS predicted to ramp up to 10.5p a share in 2015 - based on a 50 per cent increase in pre-tax profits to £4.2m as the full benefits of the United Wireless acquisition are seen - then that dividend could rise steeply again. Indeed, Mr Lienard at N+1 Singer is forecasting a payout of 2.7p a share for the 2015 fiscal year. On this basis, the prospective yields are 2.3 per cent and 3 per cent, respectively. Add to that aggregate EPS growth of more than 100 per cent over the 2014 and 2015 fiscal years, and I strongly feel that a forward PE ratio of less than nine is modest to say the least.
Needless to say, priced on a bid-offer spread of 89p to 92p, and offering a further 14 per cent upside potential to my 12-month target price of 105p, I continue to rate Stadium shares a decent buy.
■ 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'
