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OPINION

Client wins boost Sanderson

Client wins boost Sanderson
June 10, 2014
Client wins boost Sanderson
IC TIP: Buy at 72p

Operating profits in the first half to the end of March 2014 increased by 20 per cent to £1.2m on a near 25 per cent increase in revenues of £8m. Moreover, with the period end order book up 56 per cent year on year to £2.47m, it’s only reasonable to expect Sanderson to hit analysts' pre-tax profit estimates of £2.7m for the 12 months to the end of September 2014, up from £2.2m in fiscal 2013. The return from the investment in sales and marketing efforts can also be seen in a near doubling of the order intake to £4.2m, with 12 new customers gained and each one placing orders worth an average of £143,000.

It’s equally reassuring to see that recurring revenues continue to rise, up 11 per cent to £4.41m in the six-month period, to account for more than half of total revenues. The gross margin earned from recurring revenues covers 70 per cent of annual overheads and, even without any new customer wins, the company generates annual operating profit of £1.5m. But Sanderson is not only winning more business from existing clients, but it is also winning new ones which is driving profits upwards. On an underlying basis, analyst Peter McNally at Charles Stanley Stockbrokers believes that revenue growth was in mid-single digits in the six-month period.

In the multi-channel retail software business the seven new customers include brands WCF Home Shopping and Cloggs, while in the manufacturing business there were five new client wins including Prima Foods. The food and drink sector has proved a boon for the manufacturing division, which also sells into engineering, plastics, aerospace and electronics and print.

Furthermore, these client wins are justifying the £600,000 investment over the past three years to accelerate sales and marketing efforts. Overall, the manufacturing business increased both revenues and operating profits by over 8 per cent to £3.23m and £367,000, respectively.

Cross-selling opportunities from acquisitions

It was also clear from the results release that the acquisitions made last year are fully justifying their worth. Last October’s acquisition of One iota, a provider of mobile applications for retailers, is helping to drive growth by offering the latest mobile technologies to Sanderson’s existing client base. To recap, One iota's MESH technology is a cloud-based technology that integrates existing back-office systems to optimise a retailer's applications. In the six-month period, One iota contributed £154,000 of operating profit on revenues of £788,000, exceeding my own expectations. It also exceeded the expectations of Mr McNally, who had pencilled in a £1.1m revenue contribution for the full 12-month period. The £154,000 profit figure compares well with the £193,000 One iota made in its previous financial year.

To put that performance into some perspective, the contribution from the acquisition accounted for a sixth of the multi-channel retail division’s sales and almost 40 per cent of its profits. A 45 per cent rise in the period-end divisional order book to £1.2m indicates that we can also expect a bumper second half from this segment.

The One iota acquisition now looks a bargain because the £5.4m consideration included a deferred element of £2m only payable if certain performance targets are achieved over the next three financial years. This means that the acquisition was priced on a bargain basement 10 times operating profit on the initial consideration and the funding structure is such that three-quarters of the deferred consideration in effect pays for itself.

It’s worth noting too that the cross-selling opportunities I anticipated in my previous analysis are now coming through. The acquisitions made by the company are also benefiting from Sanderson's financial strength and listed company status so can now target new business deals that would not have been possible previously.

e-commerce and mobile driving growth

Another key take for me is that Sanderson’s value for money proposition, whereby its product offering offers clear tangible benefits for customers, continues to drive robust growth and no more so than in the e-commerce and mobile segments. These accounted for over a third of the £4.2m record order intake in the period.

It’s also reasonable to expect these positive trends to continue for some time yet. That’s because Sanderson works in partnership with clients primarily to deliver e-commerce software systems that underpin their online operations and enable them to cross-sell products, offer a '3D' secure payment process and integrate online offerings with other parts of their business. Sanderson’s systems generate major benefits for clients, including boosting their return on investment (ROI). For example, one customer has reported a threefold increase in ROI from his Sanderson system within the first year.

And as I have pointed out previously, it's a fast-growing segment of the retail sector to be operating in: analysts at Forrester predict the e-commerce segment will grow at a compound annual growth rate of 10 per cent a year out to 2017.

Sanderson's ongoing investment in proprietary software for mobile devices certainly makes sense too: analysts at investment bank Morgan Stanley forecast that mobile users will exceed desktop users for the very first time this year; and analysts at Verdict Research predict that m-commerce will drive e-commerce sales up by half in the next five years.

Attractive valuation

Ultimately, these positive trends are reflected in an improvement in shareholder returns. For the 12 months to the end of September, analysts predict Sanderson’s adjusted EPS will rise from 4.1p to 4.5p to support an increase in the dividend from 1.5p last year to 1.8p a share. Previously, analysts had expected a dividend of 1.6p a share, but the board have just declared a 20 per cent hike in the interim payout to 0.8p a share, so those dividends forecasts were significantly upgraded. The shares go ex-dividend on 16 July with a payment date of 15 August.

The board certainly have scope to adopt such a progressive policy since the company’s net cash increased from £4.5m to £5m in the past six months alone as a large proportion of net profits was converted into cash. The current cash pile equates to almost 10p a share or the equivalent of 15 per cent of Sanderson’s market capitalisation of £36.4m. In addition, the forecast dividend of 1.8p is covered 2.5 times by post-tax earnings, so cover looks comfortable.

For a company exposed to the high-growth e-commerce and m-commerce markets, a cash adjusted prospective PE ratio of 13 doesn’t seem exacting to me. For good measure, there is a 2.5 per cent forward dividend yield to offer an income stream for investors. That’s five times higher than the yield on the FTSE Aim Technology index.

To put the undervaluation of Sanderson into some perspective, small-cap software companies Craneware (CRW) and Tracsis (TRCS) are both trading on 23.5 times cash adjusted forward earnings per share, while my long-term favourite Netcall (NET) is rated on 21 times earnings estimates on the same basis. Given analysts at Brokerlink, Charles Stanley and WH Ireland expect Sanderson to increase pre-tax profits to between £3m and £3.1m in the financial year to September 2015, on revenues of around £17m to £17.3m, then such a low earnings multiple looks anomalous for a company delivering double-digit profit growth. Analysts also predict a further hike in the payout to 1.9p a share next fiscal year, so the progressive dividend policy is set to continue.

Technical set up and target price

I have been closely monitoring the chart action too. Interestingly, having pulled back from a multi-year high of 80p at the end of April to the rising 200-day moving average, Sanderson’s share price has bounced strongly, which is an encouraging sign that the bull run is intact. For good measure, the share price has recaptured the 50-day moving average (around 70p) and appears primed to make progress back to my target range of 80p to 85p. This also coincides with analyst price targets around 80p.

It’s also clear that with the moving average convergence divergence (MACD) indicator above its signal line, and the 14-day relative strength indicator (RSI) showing a reading of only 50, then there is scope for Sanderson’s share price to make further progress given the shares are not yet overbought.

So, having initiated coverage when Sanderson’s share price was 33.5p almost three years ago ('A valuable stock check', 18 Jul 2011), I have no reason to change my upbeat stance. Offering potentially 18 per cent upside to the upper limit of my fair value range, the shares rate a buy on a bid-offer spread of 69p to 72p.

■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'