A trading update for the first four months of the year revealed an eye-catching 24 per cent growth in order intake making the period the strongest ever start to a year the company has delivered. If the forthcoming EU Referendum is causing any caution amongst consumers, it’s clearly not being felt by Safestyle’s customers. The company is also delivering this stellar performance when rivals have been flagging which suggests that when it reports its pre-close trading update in July we can expect further market share gains.
It’s only fair to point out that the continued outperformance of competitors – Safestyle’s market share rose by almost 100 basis points to 9.46 per cent in 2015 – reflects a major cost advantage that enables the company to win business on price alone. In some cases, Safestyle can sell products at a 20 per cent discount to other window companies' prices and still generate industry leading operating margins of around 12 per cent. And rivals have been struggling or simply unable to match Safestyle's subsidised credit offer which was launched in June 2015 through Barclays Partner Finance and offers customers a range of finance packages including: 24 months interest free credit; 12 months buy now pay later; or interest bearing credit at 4.9 per cent APR over a period of 36, 60 or 120 months.
Of course, Safestyle has to pay Barclays a subsidy on these credit offers, but analysts believe it has been able to pass through price rises this year to recoup the gross margin lost. In fact, given the sales growth being generated, analyst Andy Hanson at house broker Zeus Capital now expects Safestyle to raise revenues by almost 11 per cent to £165m this year and generate a gross margin of 37 per cent, up from 36.6 per cent in 2015. In other words, the cost of the credit offer has been more than recouped by the increase in business won.
It’s not just cheap credit that has been driving sales either. New products are playing their part too. For instance, the company installed 108 conservatories last year, and I understand that the target of 450 installations this year will be “comfortably met”. In fact, analyst Ian Osburn at brokerage Cantor Fitzgerald believes that nearer 600 conservatories could be sold. In addition, the company has moved into the heritage window market by offering a new coloured range of windows for listed properties in the UK which are generally restricted from installing white uPVC windows.
The company is also benefiting from a favourable replacement cycle of PVC windows as products installed in the 1980s and early 1990s come to the end of their useful life. In a fragmented market, the company has become the “go-to solution” for customers, according to analyst Matthew McEachran at broking house N+1 Singer, which also explains the outperformance of rivals.
In the circumstances, it’s hardly surprising that analysts upgraded their earnings estimates by around 5 per cent post the trading update with N+1 Singer now expecting top of the range full-year EPS of 20.4p, up from 17.7p in 2015, based on pre-tax profits rising by almost 14 per cent to £21.5m.
Admittedly, the company is up against tougher year-on-year comparatives in the second half of this year, but N+1 Singer’s forecasts only factor in the year-to-date earnings beat so if the positive sales momentum is maintained, and there is little reason to expect order intake to fall sharply unless there is an external shock to the UK economy, then earnings risk looks firmly skewed to the upside. Mr Hanson at Zeus Capital also sees potential for upgrades to his current year EPS estimate of 19.6p.
Bumper cash returns
There are decent prospects of the progressive dividend policy being maintained too. Buoyed by a cash conversion rate of 95 per cent (the ratio of net cash inflow from operating activities to cash profits), Safestyle’s net funds almost doubled to £16.5m in 2015 which has enabled the board to hike the full-year payout per share by nearly 10 per cent to 10.2p. The final dividend of 6.8p per share is being matched by a special payout of the same order, payable to shareholders on the register on 17 June 2016. That payout equates to 4.8 per cent of the company’s current market capitalisation of £227m, but with operating cash flow likely to be about £20m this year and set to produce free cash flow of £15m, then even after that payout analysts believe that the company should end this year with net funds of around £13.5m, or almost 18p a share.
The point is that once you adjust the share price for next month’s payout of 13.6p per share, and strip out a likely year-end cash pile worth 18p a share, then Safestyle’s shares are only trading on little over 12 times prospective cash-adjusted earnings for 2016, hardly a punchy rating for a company that has decent prospects of delivering double digit average earnings growth over the next three years. A free cash flow yield (free cash flow as a percentage of the company’s market capitalisation) well north of 8 per cent for next year is attractive too.
Of course, there are always risks to any investment. For Safestyle the primary ones are a downturn in its markets, a worsening of the UK repair, maintenance and improvement (RMI) market, tightening of credit conditions for customers, and the risk of a rival forsaking profit for market share gains. However, having considered these factors, I still feel that the sales momentum in the business is strong enough to propel the shares upwards towards analysts raised target prices of 300p, implying 11 per cent upside once you factor in the 13.6p dividend payment.
So, having initiated coverage at 138p when the company floated on the London junior market ('Window of opportunity', 23 December 2013), and last recommended running profits at 275p ahead of the recent trading update (‘Exploiting a window of opportunity’, 23 March 2016), I have no hesitation maintaining my positive stance.
Trading on a forward cash-adjusted PE ratio of 12, and offering a prospective dividend yield of 4 per cent based on a ‘normal’ payout of 11.2p for the current financial year, my advice is simple: run your healthy profits with a new target price of 300p. Run profits.
