40. Watkin Jones
It’s a sector of the market that is attracting more and more attention, which is why already established Watkin Jones (WJG) has rather stolen a march in the student housing sector. And that’s because it’s not actually a landlord at all, merely a conduit between the shortage of purpose built accommodation on the one hand, and the wall of institutional money looking for a decent low-risk return on the other.
The other big attraction is that it offers an end-to-end service starting with land procurement, planning, construction and asset management. All this is done for a price, and is funded by the institution, which in this case is more likely than not to be a university, thereby minimising Watkin Jones’ balance sheet risk. And it’s worth noting that for the 1.8m students in the UK there is only purpose-built accommodation to serve 550,000.
The company’s most recent transaction was the forward sale of the student accommodation element of its Christchurch Road development in Bournemouth. This comprises 454 beds and completion is due in the summer of 2017, which means that all the developments due for delivery in the year to September 2017 have now been forward sold. For the following year, 1,840 of the 3,485 due for delivery have been pre-sold, and a further 1,530 have planning consent.
There is even one development for 511 beds pre-sold for delivery in the 2020 financial year. And to enhance the property management side it bought Fresh Student Living, which specialises in the operational management of purpose-built student accommodation, just prior to Watkin Jones’ flotation in March 2016. Beds under management of 8,310 in the year to September 2016 are already contracted to rise to nearly 18,000 by 2020.
The business model has also been extended to cover residential developments, from starter homes to executive housing and apartments, and the build-to-rent sector is growing fast, offering institutions the attraction of a decent yield while owning an appreciating asset.
The first private rented sector scheme in Leeds for 322 units has been completed, and there is another 132 unit development site at Sutton. Rising interest rates may pull traditional investors back into the fixed-income market at some point, but it’s likely that such a trend is years away before interest rates outpace the return on build-to-rent. Since we tipped Watkin Jones (107p, 7 July 2016), the shares have risen by nearly 40 per cent, and we believe there is more to come. Buy. JC
39. FW Thorpe
Investors looking to assess the comparative merits of FW Thorpe’s (TFW) investment case have been thwarted by a dearth of ‘sellside’ coverage. Instead, they have Andrew Thorpe, chairman of the family-run lighting business, pointing to the inconvenience of having to meet overtime bills as a result of a surge in sales at the half-year mark. The resultant wage bill nibbled away at operating margins, although with earnings up by a fifth shareholders might be slightly bemused by the chairman’s distress.
If anything, business at the flagship Thorlux Lighting business has been strengthening, while underlying operating performance has improved due to rationalisation measures. That’s not to say that capital isn’t being allocated where opportunities exist; the company has boosted capacity through the purchase of an 1,800 sq m factory unit in Redditch for subsidiary TRT Lighting, which will also provide a back-up facility for the nearby Thorlux business.
Product development continues apace, borne out by the introduction of the ‘SmartScan’ product: a new advanced wireless lighting control system, which has “immediately found favour” with many of Thorpe’s customer base. With the possible exception of its Compact Lighting business, the company is set fair, evidenced by a return on equity of 15.7 per cent. It’s well understood that those returns are underpinned by beefed-up regulatory provisions that have driven the rollout of low-energy light emitting diode (LED) systems through industry. Growing environmental concerns over the amount of heat emitted by traditional fluorescent lights has made people shift to energy saving systems. The company’s own environmental credentials have improved on the back of a carbon offset project in Monmouthshire, which has seen a doubling of tree stock to a total of some 150,000 plantings.
Regulatory changes are providing a structural driver for growth, and there are undoubted benefits in terms of energy and maintenance bills; increasingly, customer behaviour is being driven by cost-saving initiatives, rather than regulatory considerations. True, investors need to be aware that at some point the market will approach saturation point, although that may be some way down the track. Persistence Market Research projects that by the end of 2025, over $125bn-worth of LED lightings will be sold globally, with sales expanding at a compound rate of 16.6 per cent a year.
That’s a major positive for FW Thorpe, regardless of any concerns over overtime rates, and shareholders will also have noted continued expansion in overseas markets. The company’s Australian office is doing well, although its UAE operation is looking to build market share. Hold. MR
38. Impellam
Recruiters have faced a tough time in the UK following the vote to leave the European Union. Impellam (IPEL) sought to address this risk in 2015 through the acquisition of healthcare specialist Global Medics and US managed services specialist Bartech. 2016 marked the group’s first full year as – in its own words – “a global workforce solutions provider”, rather than a strictly Europe-based business.
The move appears to be paying off, delivering synergies of £2.1m for the year and expanding its capabilities in a range of industries such as automotive, healthcare, energy and telecoms. The rest of the business also performed well, increasing revenue by a fifth to £2.1bn and gross profit by almost a quarter to £289m. It also reduced net debt by £22.9m to £95.3m.
The group has performed impressively in a challenging market. Its strategy for diversification appears to be paying off and its balance sheet is improving. Given all this a rating on the shares of eight times forecast earnings looks too cheap. Buy. TD
37. Young’s
There’s something oddly reassuring about a Young’s pub – and you might even be inclined to take that view from an investment angle. The shares, up 13 per cent over the past 12 months, now trade at around a 45 per cent premium to underlying assets. That’s at the upper end of the historic rating, but the predictability provided by strong cash flows and a 19-year unbroken sequence of dividend increases explains why the shares are so well supported.
Management could hardly be accused of standing still, but people attracted to a Young & Co’s (YNGA) pub tend to value constancy over gimmickry and comfort over aesthetics, so there’s a strong focus on the provision of quality food, while the current consumer swing towards craft beers fits in with the brewer’s traditional offering on that score.
Nevertheless, although we continue to favour the bucolic business model, the current rating does look a little stretched, so we’re looking at our recommendation ahead of publication of the full-year figures, and therefore leave this one under review. For now, sight tight. MR
36. Johnson Service
It has become almost obligatory when covering Johnson Service (JSG) to point out that textile rental is an unglamorous market, but that isn’t stopping the company from banking impressive growth. Shares are up by more than a quarter per cent since we tipped the company in April 2016, comfortably beating the FTSE 350 as a whole. This can be attributed in large part to the company’s focus on its textile rental unit. It dumped its dry cleaning division in January 2017 for £8.25m. Dry cleaning had been facing tough conditions, and shedding it allows the group to focus on growing the higher-margin rental business.
The focus has paid off, with the textiles business delivering 45 per cent growth in pre-tax profit to £33.8m for the year to 31 December 2016. This has been delivered through the group’s longstanding strategy of combining organic revenue growth – which the group estimated was around 5.5 per cent, compared with 4.5 per cent in 2015 – with strategic acquisitions.
In 2016, it acquired Zip Textiles, Chester Laundry Limited and Portgrade for a total of £56m. These have begun delivering synergies sooner than expected, which helped push revenue up 36 per cent to £257m for the year and improve earnings. The expanded geographic reach from these deals, combined with the potential for more, means the group’s strategy is unlikely to change in the near future. Management estimates the textile rental sector is worth £1.3bn in the UK alone, a little over five times the size of the group’s current revenue, so the growth potential is clear.
All these acquisitions have had a negative effect on the company’s balance sheet, pushing it to net debt of £98m at the year-end, from £71m the year before. This has to be balanced against a strong trading performance and £28.7m in equity raised in April 2016. The same month, it agreed a revolving credit facility for £120m. Using the group’s own figure of adjusted operating profit excluding notional interest, it has interest cover of 11.4 times.
The shares are still trading at around 15 times forecast earnings, which is not particularly cheap. However, with plenty of room left for both organic and acquired growth, we think the shares more than justify the current price. Buy. TD
35. Restore
We upgraded document management company Restore (RST) to a buy at its last results, after it released figures outlining impressive growth – more than 40 per cent growth in revenue and adjusted profit before tax. This requires stripping out nasties, however, including £10.3m in restructuring and redundancy following the acquisition of Wincanton Records Management and shredding company PHS DS.
The company has continued with its strategy so far in 2017, complementing organic growth with bolt-on acquisitions. Since the December year-end it has made three acquisitions, two in secure shredding and one in IT recycling. Net debt increased to £72.3m at the year-end as a result of the 2016 acquisition, and likely higher following the more recent ones, but the group’s borrowing capacity also increased to £97.5m from £80m.
Restore is a growing business operating in a niche area. The shares are still trading at 17 times forecast earnings, which we think represents good value. Buy. TD
34. MP Evans
Shareholders in MP Evans (MPE) were recipients of a 5p special dividend during 2016, in addition to the 15p payout for the year-end – all told, a 129 per cent hike from the previous year.
But the agri-business wasn’t only popular with income seekers; it was forced to rebuff an approach from fellow Malaysian plantation owner Kuala Lumpur Kepong Berhad, which fell some way short of independent valuations. The flurry of valuations, though, have lifted the share price two-thirds over the past year.
Consolidation has probably been the overriding feature of the palm oil industry since the turn of the millennium as producers look for scale to offset the threat posed by substitution oils, so the producer may well come into the crosshairs again at some point.
There are mixed signals on trading, though. MP Evans flagged an “encouraging” outlook for the palm oil industry, despite foreseeing price pressure ahead from a recovery in south-east Asian output. For the moment, high inventory levels continue to undermine prices, but with $75.3m in cash at the year-end, there’s no reason to think that the largesse is at an end. Buy. MR
33. Gamma Communications
If you were to pinpoint an underlying reason why reported profit at Gamma Communications (GAMA) has more than doubled since 2012, consider the rapid transformation under way in the business telecoms market.
Companies are communicating in a range of ways across the digital spectrum, thereby generating demand for cost-saving, versatile cloud PBX and SIP trunking (voice over internet) systems. These secular trends are supporting Gamma’s growth, along with the determination of management to keep in step with technological change.
The group employs a novel marketing strategy via a third-party commercial channel network, now numbering around 1,000 partners, together with a direct business arm. Looking ahead, marketing should draw benefit from the release of a ‘converged’ mobile PBX, providing a unique point of differentiation against competitors.
Through 2017, we anticipate market share gains and an improved showing from Gamma Mobile, launched during the second half of 2016. The shares, trading at 22 times forecast earnings, are certainly priced for growth, but we think the premium to the sector is justified given its strong product offer. Buy. MR
32. Summit Germany
Summit Germany (SMTG) is operating predominantly in one of European property’s hottest spots – the Berlin office market. And the business model is proving to be highly lucrative. Summit identifies properties where there is scope to sweat the asset for greater rental income after a bit of refurbishment work.
This meant that in the six months to June last year net rental income grew by nearly a third, and funds from operations or cash flow jumped by nearly a half. And there is plenty of room to improve on this, given that occupancy is at 87 per cent. Part of the success in acquiring the right property comes from having an in-house asset management platform, which helps to capitalise on market opportunities as they arise. Summit also benefits from easy availability of debt with extremely low interest rates, typically around the 2 per cent level. The property portfolio currently includes over 1.4m sq m of land generated from 102 properties and around 650 clients. Buy. JC
31. Redde
Redde (REDD) is trying to reduce its reliance on traditional sources of insurance market revenue. That means expanding its range of services beyond its core motor hire and repair business. Core to this was the acquisition of FMG at the end of 2015, which broadened Redde’s accident and fleet management capabilities – the acquired company provides such accident and specialist recovery services to the fleet leasing, insurance and direct fleet sectors, and has around 300,000 vehicles under management. However, it also provides roadside recovery services to the Highways Agency under long-term contracts, for broken-down vehicles on motorways and A-roads in the north of England and Scotland.
This acquisition is bedding in well, contributing £61m in revenue during 2016, or around 22 per cent of total revenue for the year. A downside to the success of FMG in winning new business has been a drag on profitability, since roadside repairs attract lower margins than providing motorists in accidents with replacement vehicle hires. As a result, house broker N+1 Singer lowered its forecast gross margin for the full year very slightly to 25.2 per cent from 25.9 per cent, compared with 25.8 per cent in 2016.
Nevertheless prospects for the core accident management business look good. Sales here were up more than a fifth during the first half. Management’s aims to continue this increase in new business by enhancing the user experience, particularly online. That has meant increased investment in its telephony, IT systems and online portals to increase accessibility for customers. This has already started to pay off – repair cases increased by 70 per cent in total. Management recently rebranded the accident management business and fleet operations as Auxillis.
Analysts at N+1 Singer expect pre-tax profit of £39.5m during the 12 months to June 2017, giving EPS of 10.5p. This is up from £34.7m and 9.3p, respectively, the previous year. Growth has been driven by a revenue upgrade on the back of higher case volumes than previously expected.
Redde does not just offer good earnings potential, but also a healthy income, with a forecast dividend per share of 10.5p for this year. At 160p a share, this indicates a yield of 6.6 per cent for 2017. The shares trade at around 15 times forward earnings, a discount to the five-year average of 19 times. We upgrade to buy. EP
For our complete run down from 50-1 see below:
And for 100-51:
