I recommended buying the shares at 109.5p ahead of yesterday’s half year results announcement (‘Moulded for trading gains’ 16 Aug 2016), targeting fair value around 140p, having first recommended buying when Epwin listed on the Alternative Investment Market at 100p a share a couple of summers ago ('Moulded for gains', 29 Jul 2014).
The first half results were solid enough with underlying revenue flat at £124.9m and operating profit edging up slightly to £8.1m, excluding the contribution from three acquisitions: Wrexham-based Ecodek, a leading manufacturer and supplier of wood plastic composite; Tamworth-based Stormking, a leading supplier of moulded GRP building components to the housebuilding and construction industry in the UK; and National Plastics, a national distributor of building plastics to the trade. These businesses contributed £18.4m of revenue and £3.7m of operating profit on a margin of 20 per cent, a performance that warrants the combined consideration of £50m paid including earn-outs. The profit from acquisitions aside, strategically they made sense by enhancing Epwin's product offering and cross selling opportunities into existing sales channels in its core repair, maintenance and improvement (RMI) market.
The acquisition of National Plastics for £10m during the period augments Epwin’s smaller fabrication business and highlights the board’s strategy to use its lowly geared balance sheet to make earnings accretive acquisitions. It also signals their intention to improve the performance of this division which has lagged behind that of the extrusions and mouldings business. That's because before accounting for central overheads, Epwin’s fabrication unit only made £1.1m of operating profit on revenue of £52.8m in the first half, whereas the extrusions and moulding division posted operating profits of £11.6m on turnover of £90.5m, including 11 per cent like-for-like profit growth. The senior management team at the fabrication unit has been beefed up to address this underperformance.
But even after accounting for the softer trading conditions in the fabrication business, and after factoring in the contribution from those acquisitions, Epwin’s first half revenues still rose by 15 per cent to £143m and its pre-tax profit and EPS increased by around a third to £10.4m and 6.1p, respectively. House broker Zeus Capital’s revenue estimate of £299m for this year and £317m for 2017, up from £256m in 2015, looks achievable to me. On this basis, expect pre-tax profits to rise by 24 per cent to £24.3m this year, increasing to £26.3m in 2017, to deliver EPS of 14.2p and 15.3p, respectively. This means Epwin’s shares are trading on less than 8 times forward earnings for 2016.
There is scope for further bolt-on deals too because net borrowings of £29.9m equate to only 37 per cent of shareholders funds, and with Epwin predicted to generate £12.1m of free cash flow this year, then net debt could fall sharply to £21.3m by the end of December.
In turn, this robust cashflow performance will enable the board to satisfy earn-outs on the acquisitions and have enough cash left over to hike the dividend from 6.4p to 6.6p a share as analyst Andy Hanson at Zeus predicts, a payout covered more than two times by forecast EPS. The cash cost of the payout is likely to be covered more than three times over by forecast operating cashflow of £30m, reflecting the fact that underlying operating profit estimates of £25.6m are calculated after deducting the non-cash depreciation charge of £7.9m, so operating cashflow is much higher than reported profits. A dividend yield of 6 per cent is attractive in my view as is an earnings multiple half that of peers. There is clear value in the shares and I maintain my buy recommendation.
On solid foundations
Full-year results from Leeds-based property development and investment company Town Centre Securities (TOWN:320p) delivered the numbers I was anticipating when I rated the shares a trading buy at 310p ('Yielding for gains', 1 Sep 2016).
Net asset value per share rose by almost 4 per cent to 357p in the 12 months to end June 2016, slightly ahead of Liberum Capital’s estimates, driven largely by a like-for-like property valuation uplift of 2.2 per cent and a 10 basis points compression to 5.7 per cent on the initial yield used to value the portfolio. Strip out valuation movements and EPRA profit before tax edged up to £6.6m to deliver EPS of 12.4p, a performance that led the board to hike the dividend by 5 per cent to 11p a share, the first increase since 2010.
Given that scope for further yield compression looks limited, the key driver of Town Centre’s share price will be the value created by its development programme as it's current portfolio is 98 per cent let. Bearing this in mind, the board has outlined details of each development in quite some detail and highlighted the incremental profits that will be earned and the likely boost to net assets too.
The programme includes the redevelopment of Merrion House in Leeds, encompassing a refurbishment of 120,000 sq ft of offices and the addition of 50,000 sq ft new office space. The £41m scheme should complete at the end of 2017 and £29m of the project cost is being funded by joint venture partner Leeds City Council. The initial rent of £1.65m on the scheme will add £900,000 to Town Centre’s current income of £18.6m and add £9m to its net assets of £190m.
The £10m redevelopment of the Merrion Hotel in Leeds, located opposite the Leeds First Direct Arena, a 13,000 capacity entertainment venue, should complete next April and will add £600,000 to cash profits. The project includes a 134 room Ibis Styles hotel and 4,000 sq ft Marco Pierre White restaurant. Also slated for completion in April 2017 is a 136 bedroom hotel on Whitehall Road, part of the Whitehall Riverside Scheme in the West End of Leeds, which has been leased to budget hotel operator Premier Inn on a 25 year lease with an initial annual rent of £680,000. The £10m development is forecast to boost Town Centre’s net assets by £1.5m and add £400,000 to net income.
Importantly, Town Centre’s board have the firepower to make selective property purchases as well as rolling out its development programme. That’s because it has a loan-to-value ratio of only 49 per cent, reflecting net borrowings of £183m on the £367m portfolio which includes the £31.6m development book and £21.8m portfolio of car parks. Moreover, the company has substantial headroom on its banking facilities, having renewed £105m of revolving credit lines on improved terms.
Trading 11 per cent below net asset value, and offering a 3.4 per cent dividend yield I still see a further 22p a share of upside to my 335p target price after factoring in the payment of the final dividend of 7.9p a share which goes ex-dividend on 1 December and is payable in early January. This has proved a decent holding as I first advised buying the shares at 198p ('A high-yield play in the north', 18 Feb 2013), since when the board have paid out total dividends of 34.4p a share to give a total return of 75 per cent on an offer-to-bid basis. Run profits.
Cello still on track
Shares in Aim-traded pharmaceutical and consumer strategic marketing company Cello (CLL:106.5p) broke above last summer’s seven-year highs around the 106p level after I recommended buying at 105p ahead of yesterday’s half year results (‘Marketing a break-out’, 5 Sep 2016).
The release was pretty much as I had anticipated with headline operating profits flat in the first half, the only negative being the drag on operating margins in the health division by the small consumer unit. I had flagged this issue in my article, albeit as a result of this analyst Johnathan Barrett at brokerage N+1 Singer now expects to reduce his full year pre-tax profit estimate by £400,000 to £10.2m to give modest growth in EPS to 8.5p.
Still, it’s worth noting the strong performance and good order levels in the rest of Cello's health segment, and in the US in particular; the fact that there has been no noticeable impact on client spending behaviour as a result of the EU referendum, and income pipelines remain robust; and Pulsar, the company's social media analytics software proposition, increased its client base by a third in the first six months of this year, and that’s after almost doubling last year.
I would also flag up that Cello’s net borrowings more than halved year-on-year to £4.8m on the back of tighter working capital management, so balance sheet gearing is only 7 per cent of shareholders funds. In turn, this cash generation has enabled the board to lift the interim payout by almost a fifth to 1p a share, and based on a revised payout ratio of 40 per cent we can expect a similar hike in the full-year dividend to around 3.45p, implying a prospective yield of 3.3 per cent.
I would also point out that with sterling weakening dramatically this year, this is having a positive impact on the sterling value of Cello’s overseas earnings. For instance, the company made around $3.5m of its headline operating profit in the US in 2015. However, in the first eight months of this year, the average sterling:US dollar exchange rate has fallen from £1:US$1.51 to £1:$1.41 and will decline to £1:$1.372 if the current spot rate holds at £1:US$1.32 for the rest of the year. This currency tailwind added £300,000 of profits to Cello's US operations in the first half, and I would expect at least the same currency benefit in the second half.
In terms of my estimate of fair valuation, Cello's Signal marketing business is probably worth around eight times cash profits and its health business around 10 times cash profits, implying an enterprise value of £112m after factoring in debt. A fair value per share of at least 125p seems sensible to me.
Rated on 12.5 times earnings, offering a 3.4 per cent prospective dividend yield, and with a currency tailwind set to underpin profit estimates for some time yet, I continue to see decent upside in Cello’s shares. Buy.
