Undervalued growth at iomart

Customers turn to iomart for a way to minimise the costs, complexities and security risks of storing and managing data. The Glasgow-based group owns and operates a network of data centres and the characteristics of the business are very attractive: multiyear contracts and monthly fees mean around 95 per cent of its sales are recurring, it leads the sector with a cash-profit margin of over 44 per cent, and it regularly converts more than 90 per cent of operating profits into cash. It also has a diverse customer base with no single customer accounting for more than 1.5 per cent of group revenue.

Four acquisitions in the past two years - including Backup Technology and ServerSpace - have boosted iomart's growth and broadened its product range. It recently bought Systems Up, a consultancy that specialises in 'public cloud' offerings such as Amazon Web Services. The deal complements iomart's strategy of building a 'hybrid cloud' offering to help clients choose the right mix of private and public cloud services for their existing infrastructure. It has partnered with Microsoft, EMC and others to offer a broad range of options.

The group boasts an excellent track record to match its strong growth prospects. Annual revenue and adjusted cash profits have grown at compounded annual rates of 28 per cent and 45 per cent over the past five financial years, and iomart has widened its adjusted cash profit margin from 26 per cent to 44 per cent over the same period. Moreover, broker N+1 Singer expects double-digit sales growth this financial year and next, driving adjusted cash profits up 14 per cent and 9 per cent in those respective years.

The key to iomart's growth has been its main hosting division, which accounts for 84 per cent of revenues. Including acquisitions, hosting sales rose 23 per cent last year. Expansion into the US has also paid off. Overseas sales, which are 18 per cent of the total, rose 52 per cent last year compared with 13 per cent at home. Yet despite iomart's rich prospects, its shares trade at just 14 times forecast earnings for the year to March 2017 - a discount to sector peers. There's also a forecast yield of 1.7 per cent, and management has raised the targeted payout ratio to 25 per cent, boding well for further growth. A takeover bid is also a real possibility in light of recent industry consolidation: peer Daisy, which itself was taken private last year, recently bought Phoenix IT and regulators are reviewing a merger between data centre giants Equinix and Telecity.

Iomart has faced increased pricing pressure and churn as several clients have been acquired, exited the industry or run into financial difficulties. But high-profile partnerships and a broad product range should minimise the impact on the group. True, sales and cash profits dipped at the group's smaller EasySpace division - which provides domain names, servers and email services to small businesses - last financial year. But management's diligent cost control meant the segment's cash profit margin slightly widened to 45.5 per cent, and cash generation remained strong. Indeed, that helped the group to reduce net debt by more than a fifth to £15.4m, leaving scope for further acquisitions.