In the 12 months to end September 2014, Sanderson’s operating profit increased by more than 20 per cent to £2.7m, in line with analysts’ expectations, driven by a 16 per cent increase in revenue to £16m. These profits should result in a near 10 per cent rise in adjusted EPS to 4.5p and support a 20 per cent rise in the dividend to 1.8p a share. On this basis, the shares are trading on 13 times earnings and offer an attractive 2.7 per cent dividend yield.
However, with the cash pile rising a fifth to £6m, or the equivalent of 11p a share, this means on a cash adjusted basis the shares are only priced on 12 times earnings. That’s a significant discount to other small cap software companies. To put this rating into some perspective, Tracsis (TRCS: 330p), Craneware (CRW: 505p) and Netcall (NET: 59p) are all rated around 20 to 21 times fiscal 2014 earnings. It’s worth pointing out that the year-end cash pile was 10 per cent higher than that forecast by analyst Peter McNally at Charles Stanley Stockbrokers, highlighting the company’s robust cash generation.
The value on offer is also supported by an order book of £2.4m, up 20 per cent year-on-year. On a like-for-like basis, the order intake has risen by 10 per cent and the value of contracts signed with new customers has increased by more than 15 per cent to £1.9m. Recurring revenues account for more than half of the total and the gross margin earned on this business covers 70 per cent of annual overheads. So even without any new customer wins, the company is making annual operating profit of £1.5m.
New business driving growth
But it’s clear that Sanderson is winning new business. In particular, last October’s acquisition of One iota, a provider of mobile applications for retailers, is driving growth by offering the latest mobile technologies to Sanderson’s client base. One iota's MESH technology is a cloud-based technology that integrates existing back-office systems to optimise a retailer's applications. It’s proving popular as in the latest 12 month trading period One iota has more than doubled the £193,000 of profit and £660,000 of revenues it reported in its last full financial year prior to last autumn’s acquisition. Moreover, the business has just secured a record order worth over £400,000 to implement an iPad-based solution to a major retailer. This will help sales assistants maximise instore sales and assist shoppers in buying out of stock products or those available in the retailer’s other stores.
It also makes the acquisition of One iota look a very astute buy as Sanderson only paid £3.1m upfront, is paying deferred consideration of £50,000 every six months in the three-year period post completion, and has an earn-out of £2m based on profit targets being achieved in the three years to end September 2016. In other words, the company has bought a fast growing business operating in a sexy part of the software market for well under 10 times current annual operating profit based on the initial consideration paid. Furthermore, and given the heady rate of progress, it is fair to assume that a sizeable proportion of the deferred consideration is now going to be paid from the profits earned by One iota in the three-year period post completion. That’s smart business.
Another key take for me is that Sanderson’s value for money proposition, whereby its product offering provides obvious tangible benefits, continues to attract new customers. It is also clear to me that the ongoing development of own proprietary products deployed on mobile devices, such as smart phones and tablets, is driving incremental sales growth especially in the areas of warehouse automation and solutions.
Target price
True, Sanderson shares have drifted 7 per cent in an Aim market down 12 per cent since I last updated my view (‘Client wins boost Sanderson’, 10 June 2014), but they have still doubled since I initiated coverage when the price was 33.5p three years ago ('A valuable stock check', 18 Jul 2011). I have been a buyer ever since.
Importantly, I still feel that a fair value of the equity is in the price range 80p to 85p. At the lower end of that range, coinciding with the all-time share price high hit at the end of April, the shares would be rated on 15 times cash adjusted earnings. That’s still a deep discount to peers.
So offering 20 per cent share price upside to a realistic target price, I continue to rate Sanderson shares a decent income and growth buy on a bid-offer spread of 64p to 67p.
Please note that I have written 20 other columns in the past fortnight including one other today, all of which are available on my IC homepage...
■ Simon Thompson's 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 stockpicking'
