Firstly, a key take for me in yesterday’s results was the doubling in sales orders from new customers to in excess of £2m in the first half to 31 March 2016. In turn, this helped boost order intake by over a fifth to £6m and led to a 13 per cent rise in the period-end order book to £3.2m. It also reflects the benefits of prior and ongoing investment in sales and marketing, not to mention the fact that the company’s suite of software products and services has tangible benefits for customers as they typically lead to cost savings, often within 12 months of implementation.
Secondly, forward guidance from chief executive Ian Newcombe is pretty upbeat as he points out that “whilst the board continues to adopt a cautious approach, the very strong order book and healthy balance sheet, together with an extensive list of sales prospects, provide a good level of confidence that the business will continue to make further progress in the full-year.” The company has a habit of being notoriously cautious in its guidance which skews the risk to the upside when it subsequently over delivers, so this upbeat trading outlook is well worth noting. It also suggests that having posted a 7 per cent rise in operating profit to £1.47m in the period then analysts expectations of a 9 per cent rise in pre-tax profits to £3.46m in the 12 months to end September 2016 looks firmly on the cards to produce a double digit rise in EPS to 5.6p and support a near 10 per cent hike in the dividend per share to 2.3p. The first half payout was raised by 11 per cent to 1p.
Thirdly, it’s worth flagging up that having successfully made several bolt-on acquisitions in the past, the company is again on the look-out for more deals to complement its existing operations. Chairman Christopher Winn notes that “a number of potential opportunities are currently being developed”. Bearing this in mind, Sanderson ended the first half with net funds of £3.4m, a sum worth 6p a share, and that’s after paying out £1.5m of deferred consideration on previous acquisitions, around £657,000 on the final dividend, and making planned investment in management, sales and delivery capacity for its fast growing digital retail software business. This robust cash flow performance reflects the ability of the company to convert substantially all of its profit to cash. The earn-out payment of £1.5m also highlights the success of the board in backing the right acquisitions that hit their profit targets.
Fourthly, although investors are undoubtedly attracted by Sanderson’s high growth digital business, and specifically prospects for a cloud-based technology that integrates existing back-office systems to optimise a retailer's applications, the company's enterprise software business has returned to growth and is now converting a number of previously delayed projects into firm orders. There has been particularly “high level of sales orders” from the food and drink, logistics and wholesale cash and carry sectors. The point being that the positive trading outlook from this part of the company contrasts markedly with a subdued performance a year ago, so further underpins prospects for a very decent second half as the board indicate. Importantly, these prospects are not fully priced in.
Lowly rated
That’s because once you strip out net funds from Sanderson’s market value of £46.6m, its enterprise value of £43.2m equates to only 11 times cash profit estimates of for the 12 months to end September 2016, a marked discount to the software and IT services sector average multiple of 14.6 times. That’s a low rating for a company that is generating decent growth, highly cash generative, on the look-out for acquisitions to deploy some of its cash pile, and offering exposure to a high growth digital retail technology business that's earning chunky profit margins and offering opportunities in both m-commerce and e-commerce.
The undervaluation relative to peers is even more extreme when you compare the respective PE ratios. In fact, strip out net cash of 6p a share, and Sanderson’s shares are priced on 14 times likely underlying EPS estimates of 5.6p for the 12 months to end September 2016, falling to 12.6 times EPS estimates of 6.25p the year after. That represents a huge discount to small-cap software companies Tracsis (TRCS:475p) and Craneware (CRW:795p) which are rated on 19 and 22 times cash-adjusted earnings estimates (July 2017 and June 2017 period ends, respectively).
The latest trading update certainly impressed analysts enough to prompt them to revisit their fair value estimates. Head of research Eric Burns at broking house WI Ireland raised his target price from 83p to 92p post results. I have gone further and see fair value closer to 95p, up from my previous target of 90p. Needless to say, I continue to rate Sanderson’s shares a buy.
