For starters there was positive divergence on the chart when the share price made an intra-day low of 47p in mid-December, but the 14-day relative strength indicator (RSI) did not confirm the price action as it was higher than at the previous low of 51p in mid-October. That’s always a good sign that the negative share price momentum is running out of steam and a tradable rally is on the cards.
Secondly, the moving average convergence divergence (MACD) momentum oscillator had a positive cross over in late December, albeit the line is still below zero. Thirdly, having failed to sustain a break below the 50p price level there was a bullish price move on the daily candlestick chart on Wednesday, 7 January when Communisis share price rose 8 per cent on the day. There were some sizeable share volumes traded the previous two days, perhaps signalling that a potential stock overhang had been cleared.
Interestingly, a close above the September high of 57.25p would be a very bullish signal indeed, and one from a technical perspective I expect to happen. It should be followed too as it would improve the odds significantly that the share price can make a sustained attack on that key summer resistance level of 70p. Bearing this in mind, and the fact that Communsis’ shares are now priced on a bid-offer spread of 55p to 55.5p, it’s worth noting that the 14-day RSI has a reading of 60, so is nowhere near overbought, thus improving the chance that the recent turn in the share price could be the real deal and support a sustainable multi-week rally. Importantly, the fundamental case for investing is highly supportive too.
Strong fundamentals
Following an upbeat third quarter trading update in mid-November that highlighted the ongoing strong revenue growth on the back of contract wins, support services analyst Andy Brown at brokerage N+1 Singer predicts a 20 per cent rise in fiscal 2014 revenues to £326m to lift pre-tax profits by a quarter to £14.6m and produce EPS of 5.6p, up from 4.7p in 2013. Consensus is for EPS of 5.2p so Mr Brown’s estimates are top of the range. On this basis, expect an 11 per cent increase in the dividend from 1.8p to 2p a share, covered 2.8 times over by net earnings. This means at the current share price the shares are rated on a modest 10 times likely earnings for fiscal 2014 – Communisis has a 31 December year-end – and offer a 3.6 per cent dividend yield.
But that only tells part of the story as this year will reap the full benefits of some major contract wins - including one with banking giant Lloyds Banking Group (LLOY: 74p) to handle all the in-bound imaging and mail processing services for the bank – new acquisitions and geographic expansion. It will also see further low margin legacy contracts replaced by higher margin contract wins which will have a material impact on profitability.
The combination of the upside from last year’s acquisitions, ongoing costs savings and cross selling opportunities across the company from the new businesses acquired, explains why Mr Brown expects another step change in profitability this year. For 2015, N+1 Singer forecasts pre-tax profits of £18.8m on revenues of £332m to produce EPS of 7.1p – higher than consensus of 6.4p - and a dividend per share of 2.2p. On this basis, the current year forward PE ratio is only 8, and the prospective yield rises to 4 per cent. To put this rating into some perspective, the support services sector trades on a PE ratio of 14, so Communisis is being rated on a huge 43 per cent earnings discount to the sector. Please note that there could be upside to N+1 Singer’s estimates as I discuss below.
Sound balance sheet
And it’s not as if the valuation anomaly is a value trap due to strained finances. At the end of the half-year in June, net bank borrowings of £33.3m represented less than 50 per cent of the company’s enlarged debt facilities of £70m. Fluctuations in working capital increased the level of indebtedness between reporting periods so that average net bank debt during the first half of last year was around £45m, but that still only represented a third of shareholders funds of £140m.
Moreover, average net bank debt equated to only two times cash profits earned for the twelve months to June 2014, and adjusted operating profit for the period covered interest payments 3.8 times, well within banking covenants. After settling interest charges and corporation tax, net operating cash flow was around £6.8m in the first half last year, a third of which was used to pay dividends to shareholders, and the balance was then recycled into making value accretive acquisitions.
Factoring in N+1 Singer’s net debt forecast of £36.6m at 31 December 2014, this means that Communisis' enterprise value (market value plus net debt) equates to only 5.5 times its 2014 estimated cash profits of £27.2m.
A sound acquisition
Those cash profits are set to rise sharply again too. N+1 Singer had been pencilling in cash profits of £31.6m in 2015, but this was before Communisis announced the acquisition of Life Marketing Consultancy, a research and insight-led marketing agency servicing consumer group clients in the food, drinks, technology and pharmaceutical sectors. The deal completed last week and continues Communisis’ expansion into higher margin business lines. It also offers cross selling opportunities for marketing services across its portfolio of businesses, primarily in social media, video, digital production and content marketing, as well as potential cost savings. It looks a sensibly priced purchase.
Life Marketing produced cash profits of £1m on revenues of £7m in 2013 and is expected to report cash profits of £1.4m in 2014. Communisis is paying £14m initially for the business, funded by: issuing 8m new shares at 50p each to the vendors – these have a one-year lock-in; a two-year bank guaranteed promissory note worth £9.3m; and making a cash payment of £700,000, equating to the net cash on Life Marketing’s balance sheet on completion. There is also deferred consideration of up to £9.3m based on Life Marketing’s average adjusted cash profits in 2015 and 2016, and cost savings realised by the end of 2017. Of this earn-out £2m will be issued in shares.
Factoring in the funding structure of the acquisition, I would expect it to be earnings enhancing this year and next, so there could be upside to the aforementioned EPS forecasts for fiscal 2015.
A year of delivery
Clearly, there is execution risk as the company has been winning substantial amounts of new business which has to be profitably fulfilled. It’s therefore reassuring to know that Communisis’ management team applies stringent criteria to all new contracts being tendered for: they have to be consistent with an internal objective of delivering double-digit operating margins on sales; an internal rate of return of 20 per cent on capital employed; and a maximum payback period of three years. This means that the rates of return earned are well in excess of the cost of equity and the blended cost of capital.
Apart from the 10-year outsourcing agreement with Lloyds which was entered into at the end of March 2014, Communisis also won a contract extension with a major client, consumer product giant Procter & Gamble (US: PG. - P&G) last April. This covers a range of P&G brands focused on retail across Europe and runs until 31 December 2019. Both these contracts underpin the hefty uplift in revenues expected this year.
True, the company also has to bed down its acquisitions – it made three last year for a total consideration of £9.1m. But I feel the management team led by chief executive Andy Blundell are up to the task and fully expect Communisis to report another upbeat pre-close trading update in the next few weeks ahead of full-year results on 5 March 2015.
Target price
So with the share price appearing to have bottomed out, I rate Communisis shares a strong buy on a bid-offer spread of 55p to 55.5p ahead of the pre-close trading statement. Please note that I first advised buying Communisis shares at a price of 28.5p ('Small-cap trading buy', 13 February 2012) and recommended banking profits 18 months later at 63p ('Taking profits', 6 August 2013). I then re-initiated coverage 11 months ago (‘Making the right communications’, 3 February 2014), having factored in the raft of new contract wins and the change to the company’s earnings growth profile. My last update was following the half year results in August when the price was 67.5p (‘Communicating a break-out’, 20 August 2014). My fair value target price remains 85p.
Motoring ahead
Nationwide Accident Repair Services (NARS: 79p), the largest dedicated provider of automotive crash repair services in the UK, has posted a significant earnings beat this morning, prompting a 12 per cent rally in its share price.
Analyst Robert Sanders at brokerage Westhouse Securities had expected the company to deliver a 15 per cent hike in revenues to £180m in fiscal 2014 and report pre-tax profits of £4.9m, up from £3.1m in 2013. But a bumper final quarter's trading has meant that revenues will come in at £184m and combined with improved operational efficiencies and economies of scale, underlying pre-tax profit is now forecast at £5.26m. Expect EPS of around 9p a share and a maintained dividend of 2.9p.
Moreover, the net cash position of £1.5m at end December is significantly ahead of Westhouse’s forecast of £5.5m of net debt. The cash flow performance is even more impressive considering the company spent more than £13m relating to the acquisitions of Howard Basford and Gladwins in the year. It also means that with cash generation strong, and borrowing facilities in place, the cash rich company has ample resources to target further earnings enhancing bolt-on acquisitions.
Factoring in the benefits from the two acquisitions and also major contracts signed in 2014, Westhouse is maintaining its 2015 pre-tax profit and EPS estimates of £5.7m and 10.1p, respectively, based on £200m of revenue. Offering 33 per cent share price upside to my target price of 105p, I maintain the shares are a value buy rated on just 8 times fiscal 2015 earnings estimates and underpinned by a 3.6 per cent dividend yield.
Please note that I last updated the investment case when the price was 70p (‘Exploiting valuation anomalies’, 18 November 2014), having initiated coverage when the price was 77p ('Time to motor ahead', 18 Feb 2014).
Finally, I will update the investment case on both stock broker Arden Partners (ARDN: 47p) and fund manager Charlemagne Capital (CCAP: 13p), constituents of my 2014 Bargain share portfolio, after the companies have issued trading updates in the next week or so.
■ 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'
