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OPINION

Worth a consultation

Worth a consultation
October 22, 2015
Worth a consultation

These are themes that Bearbull touches on from time to time. All the while, however, there is an investment life to be lived. That means finding stuff to buy and sell and, as I hint, maybe now will be a decent time to dabble. After all, London's shares, as measured by the All-Share index, have recovered a little - they're 7 per cent above August's pit - but they're also well below the peak; more than 9 per cent off April's all-time high.

Specifically, the Bearbull Income Portfolio needs a new holding - maybe two - because about 10 per cent of its value will be turned into cash soon when the takeover of safety-equipment maker Latchways (LTC) completes. One interesting candidate that hoves into view is RPS (RPS), whose shares offer a dividend yield of 4 per cent-plus at their current 238p.

What's unusual is that shares in this provider of consultancy services, mostly to the energy, construction and planning sectors, are more readily associated with growth than with income. So much so that their average dividend yield for the past 10 years is barely more than 2 per cent, while their average rating - measured by the multiple of 'basic' earnings - is over 18 times. True, the current rating of the latest 12 months' earnings is not that much lower - it's 16.5 times - but that's chiefly a comment on RPS's struggle to generate growth, meaning that its earnings have fallen even further than the share price.

Services to the energy industry are its biggest activity - in 2014 they accounted for 41 per cent of its £505m revenues and 49 per cent of its £79m operating profit - so it follows that growth will falter given the current backdrop. In the first half of 2015, group revenue was little different from the previous first half while operating profit shrank by 12 per cent to £20.6m. That contraction wholly related to RPS's energy services operation, where profits dropped 40 per cent. Its planning and environmental divisions all recorded higher profits.

Recovery in the energy division - where RPS will, say, provide seismic data for an oil-drilling campaign - is unlikely any time soon. But it's not as though RPS is even remotely threatened, and - according to the iron law of mean regression - at some stage profits will revive and the share price should anticipate that. So, true, I have to acknowledge that, if I buy the shares now, I'll be lucky to get the helping hand of momentum. Still, I can live with that if I'm confident I'm getting good value.

At the current price, I can make a case, but perhaps not a compelling one. Assuming that the average free cash flow per share for the past five years - almost 17p - is sustainable in the long term, then a required return of 8 per cent (think of that as a price/cash-flow multiple of 12.5) is sufficient to justify the current share price. That's not demanding and RPS's cash flow has been unusually stable, although maybe on a downward trend in that period. Using accounting profits from the income statement as the value driver produces a similar figure, so it looks fair to conclude that the value of RPS's equity is firmly underpinned at the current level.

But finding upside potential is trickier. That's largely because RPS does little capital spending and relies heavily on acquisitions for its growth. In the past five years management has spent £183m in cash on acquiring businesses, compared with just £42m on capex. That could well be sensible since the nature of RPS's business means growing via acquisitions of adjoining businesses - whether geographically or in a related service - is smarter than opening new offices.

The difficulty is that RPS may not generate a sufficiently high return on capital to justify that outlay. As so often, return-on-capital data, while so important, is also fuzzy. However, assuming that returns are driven by average operating profits for the past five years, then RPS's return on equity filters down to barely more than 8.5 per cent. That's pretty much the target level for an average investor's cost of equity, meaning that, for every £1 of equity that RPS commits, it only generates £1 of market value, which rather defeats the object of the spending in the first place.

Of course a fair expectation is that returns will improve, certainly when the energy industry once more lends RPS a helping hand. Which implies that if you put RPS shares into a high-yield portfolio, they will do a job. Not the most ringing endorsement, it's true, but far worse candidates have turned out well for the Bearbull funds.