The key attraction to me is that the business offers exposure to the UK's repair, maintenance and improvement (RMI) market at a favourable point in the economic and housing cycle. But I have built a 'margin of safety' into my recommendation as based on guidance that the company will produce pre-tax profit of £10m on revenue of £119m in the financial year to the end of October 2014, then the entry point is a modest nine times expected EPS of 12p. Moreover, analysts at research firm Edison predict that the board will declare a dividend of 1.5p a share with the forthcoming full-year results, and raise this to 8p a share for the current fiscal year, implying an 8 per cent dividend yield at the listing price of 100p.
So, with Entu's shares being offered in the market on a bid-offer spread of 102p to 105p, this means that investors who missed out on last month's placing are able to get on board close to the listing price. Importantly, the main board directors are incentivised to pursue a generous dividend policy as chief executive Ian Blackhurst and finance director Darren Cornwall own 12.5 per cent of the equity between them.
Moreover, having run through the numbers, and analysed the company's business model in quite some depth, I feel that the bumper prospective payout is achievable even after taking a conservative view and assuming that Entu's earnings growth grinds to a halt. Not that Edison predicts that will happen as analysts Toby Thorington and Roger Johnston are forecasting a further sales uplift in the current financial year to drive pre-tax profit and EPS up 10 per cent to £11m and 13.3p, respectively, on a 7 per cent increase in revenues to £127m. On that basis, the prospective dividend would be covered almost 1.7 times by post-tax earnings.
Bumper cash flow underpins dividend
It's well worth noting that due to the nature of Entu's asset-light business model - it doesn't actually manufacture products, so has minimal working capital requirements - the company is able to turn a high proportion of its operating cash flow into free cash flow. That's because inventory held is largely against firm orders so there is no need for Entu to hold high stock levels, which reduces the capital tied up in stocks. In fact, the forward order book is generally around five to six weeks, which means that fluctuations in trade receivables and payables largely offset one another.
And with only £500,000 or so needed for capital expenditure each year, this means that Entu should be able to generate annual free cash flow of somewhere between £7m and £10m, according to Edison. That certainly seems possible for a company forecast to have turned in £10m of operating profit in the financial year just ended, and predicted to generate £11m in the current fiscal year, a sum that easily covers the cost of the dividend and leaves enough cash left over for increased capital spend if required.
Indeed, based on 65.5m shares in issue, valuing the company at £69m, that 8p a share dividend would eat up only £5.3m of Entu's free cash flow, leaving surplus cash available to invest in the business. To put this cash generation into some perspective, Entu's cash pile is expected to have trebled to £4.2m in the six-month period to the end of October 2014.
Clearly, the business has to be operationally strong enough to justify buying the shares in the first place, irrespective of the enticement of a bumper potential payout. On that score, Entu ticks the right boxes.
The right structure
Operating through a network of 65 offices, and using over 1,000 independent sales agents, three-quarters of Entu's revenues and 60 per cent of its operating profit comes from supplying and installing consumers with energy-efficient home improvement products. These are mainly sales of windows, doors, garage doors and conservatories from the company's regional brands, including Zenith, Weatherseal, St Helens Glass, Norwood and Europlas.
Entu has a target market of 27m domestic homes in the UK, of which two-thirds are owner occupied. The company currently has a 2.6 per cent market share and boasts a database of 1m customers for whom it has undertaken installations in the past. Furthermore, having built a branded independent network of 14 installation hubs since the company was formed in 2008, its national network covers 80 per cent of the UK mainland population within one hour of any one of its hubs. Entu sources products mainly from Epwin (EPWN: 108p), so it has a direct impact on that company's prospects.
The other main part of the business is repair and renewal service agreements offered as part of a product sale agreement. This takes the form of extended cover in the form of an insurance plan in addition to standard product warranties. It's a decent income stream, accounting for £1.8m of profit on £2.2m of revenues in the 2013 financial year and covers a wide range of products. For example, Entu supplies boilers, heat pumps, regulators and remote heating controls in its energy generating business and has re-entered the home insulation market at the end of last year as part of an agreement with British Gas to aid compliance with ECO Order obligations. The company also earns commission from third-party finance packages where these are used to fund the purchase.
Solid investor base
On listing four existing shareholders (including management) sold down half their holdings and are subject to a 12-month lock-in period post the listing. These include both Mr Blackhurst and Mr Cornwall. The company did not raise any money at flotation and the free float is 50 per cent.
Major shareholders on the share registrar include the founding Brian Kennedy Group of Companies (30 per cent stake), Premier Fund Managers (9.1 per cent), Axa Investment Managers (8.65 per cent), Miton Asset Management (6.1 per cent) and River & Mercantile Asset Management (4.2 per cent). Importantly, Entu now has the paper to make complimentary acquisitions to supplement its organic growth.
In my view, the combination of a low capital intensive business model and one generating high returns on capital employed, and a board aiming to pay out a high percentage of free cash flow as dividends, is likely to appeal to investors. True, the company is off the radar at the moment, having had a low profile Aim float at the end of October, but I expect investors to warm to the merits of the business when it publishes its full-year results next February. They are likely to make for a good read.
Needless to say, I rate Entu's shares a decent income buy and have a target price of 130p, or the equivalent of 10 times earnings estimates for the fiscal year to October 2015.
■ 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'
