Buy SIG for recovery upside

All through the downturn, SIG has been busy cutting its cloth to fit, identifying cost synergies and disposing of underperforming assets. The German roofing business was sold off for a net gain of £7.2m, for example, and even without this, management has generated annualised cost savings of £7.9m, with £5.1m expected to be realised in the coming year. Keeping a tight hold on the purse strings meant that core operating costs were down slightly last year, and the return on capital employed edged up from 8.6 per cent to 8.8 per cent, which is a significant advance on the 5.3 per cent return achieved in 2009. Net debt remained a modest £121m, and while up £16m from a year earlier, this was after a £10m increase in net capital expenditure to £38m and £16.4m paid out on nine acquisitions, with spending on further acquisitions expected to reach as much as £50m in the coming year.

Inevitably, the recovery story is a rather patchy one at the moment. Poor trading in the first half of last year was not helped by the extreme weather conditions, and like-for-like sales dipped by 3.1 per cent. But sales gathered momentum in the second half, rising 2.2 per cent. In fact, after stripping out discontinued operations, sales were up by 4.4 per cent. This would have been higher still without the poor weather that affected the roofing division, with volume and pricing pressures trimming UK gross margins by 40 basis points. In mainland Europe, which accounts for just over half of group sales, trading remained tough, with like-for-like sales dropping in France, Germany and Benelux countries, although turnover was up in Poland. This left sales down 1.5 per cent on the previous year, although currency movements meant that in sterling terms sales were up 3.8 per cent. There were other bright moments here too. In France, for example, SIG estimates that the market for insulation and roofing materials fell by 5.3 per cent, while SIG's like-for-like sales were down just 1.1 per cent.

In the UK and Ireland, the group opened a net eight new sites, bringing the total up to 323, and turnover rose by 5 per cent. However, on a like-for-like basis, this was trimmed back to just 0.8 per cent, as sales at SIG Energy Management fell by 60 per cent. The government's energy-saving incentive, Green Deal, may still be at the embryonic stage, but the rationale supporting a reduction in energy costs has not disappeared; it has simply been moved down the line. It's also worth pointing out, though, that the energy management division now accounts for less than 1 per cent of group turnover.

Trading in the current year has started well, albeit against some weak comparatives, and SIG expects to benefit from a continued strong revival in the UK housing sector. Non-residential activity is expected to remain broadly flat, although this should mark an end to year after year of decline. And, as chief executive Stuart Mitchell points out, the nature of the business means that sales kick in much later in the construction cycle, and he expects to see an uptick in demand towards the third and fourth quarters of this year.

Shares in SIG are trading at 17 times 2014 forecast EPS, which is cheap compared with CRH on 26 times and Kingspan on 23 times. Perhaps more pertinently, though, the shares promise much upside based on the price-to-earnings ratio of just 0.44 times - a classic measure of value for recovery stocks. This compares with a 2007 peak of 0.96 times, and gives the shares plenty of scope to re-rate as profitability builds, and there is plenty of potential here given that operating margins of 3.9 per cent are well below the peak of 6.5 per cent achieved in both 2006 and 2007. The dividend yield is not too impressive, but it should be noted that throughout the downturn the dividend has been increased every year, and covered nearly three times by net earnings suggests that there is room for further increases.