A small-cap trading buy

The business is split into two divisions: special production and sourcing (SPS), which encompasses security printing, direct mail contracts and print management, and the much smaller but more exciting digital marketing and data mining unit, Intelligence Driven Communications (IDC). SPS remains the main profit generator, reporting profits in the first half of 2011 a third higher at £4m on flat sales of £71.3m, as new business wins made up for falling volumes from existing customers. But margins are less than half those of IDC, which generated margins of 12.6 per cent on profits of £1.42m in the same six month period.

So to get the company's operating margins up to 10 per cent in the medium term, the business is going through a major cost-cutting and site consolidation programme. By the end of last year, five of the company's 14 sites had been closed and around £4m cut from the annual cost base at a one-off cash cost of £2m, half of which will be used to fund a move up into higher margin data, digital and creative services. This will not only help drive revenues ahead, but with higher margins on new business wins the incremental effect on profits will be dramatic.

For instance, when Communisis reports its 2011 results in a few weeks time, analysts at Brewin Dolphin expect revenues to have risen by a modest £8m to £201m, but underlying pre-tax profits to have soared from £6.1m to £8.5m. On this basis adjusted EPS rise from 3p to 4.3p. And with new contract wins offsetting lost business, including a deal worth £10m a year with global consumer goods giant Procter & Gamble and a new contract with Nationwide Building Society which will see revenues rise fourfold to £10m, then turnover is set to rise sharply this year. The business will also benefit from a much lower cost base.

As a result Brewin Dolphin sees scope for revenues to rise 8 per cent this year to £216m which would in turn drive adjusted pre-tax profits up by 20 per cent to £10.2m and produce underlying EPS of 5.2p. The board was certainly confident enough to have raised the interim dividend last July by a hefty 16 per cent to 0.5p a share and brokers are pencilling in a similar rise in the final dividend to take the total pay-out to 1.5p.

There is no doubt that Communisis can afford the raised payout as net borrowings of £25.9m are a modest 19 per cent of net assets of £135m and, having refinanced credit lines a year ago, the company’s credit facilities now run until August 2014. Dividend cover is very comfortable, too, as the 1.5p a share payout is almost three times covered by post-tax earnings and means the prospective yield is an attractive 5.2 per cent.

Moreover, for a company generating double digit earnings growth, there is obvious value in the shares as they are only rated on 6.7 times 2011 earnings estimates, falling to a miserly 5.5 times in 2012. They are also deep into bargain basement territory if we adopt a balance sheet approach as the company’s market value of £39.2m is over £96m less than net asset value. Or put it another way, we are getting 70p a share of assets thrown in for free for every share we buy at 28.5p.

In my view, with contract wins and cost savings underpinning a strong profit recovery, it is highly unlikely the shares are going to mark time at this level. I rate them a strong buy and have a six-month target price of 45p.

On solid foundations

If you followed my advice at the start of this year to buy shares in the seven FTSE 250 housebuilders ('Solid foundations', 4 January 2011) you will be sitting on a 15 per cent average gain on those holdings, which is well ahead of the 10.6 per cent average first quarter gain from the sector since 1980. I also recommended buying a small number of Societe Generale FTSE 100 covered put warrants, SY29, to create a classic long-short pair trade to guard against general market weakness. The pair trade has worked out brilliantly well and we have made a net return of 12 per cent in only 28 trading days, a healthy 9 per cent more than the FTSE 100 which has risen 3 per cent since my article was published. That's good enough for me and I am banking profits early.