Half-year results from the Leeds-based company clearly showed that this is a business enjoying a strong earnings recovery and one that realistically has quite some way to run. In fact, underlying operating profit increased by 22 per cent to £4.4m in the latest six-month trading period and there was significant margin improvement, too, reflecting the benefit of restructuring to slim the cost base and a move into higher-margin and more profitable work.
The business is now split into two divisions: special production and sourcing (SPS), which encompasses security printing, direct mail contracts and print management, and the smaller but exciting digital marketing and data mining unit, Intelligence Driven Communications (IDC). SPS is still the main profit generator, reporting first-half profits up 15 per cent to £4.6m on sales of £74.6m, a rise of 4 per cent. But SPS's operating margins of 6.2 per cent are just under half those of IDC, which made profits of £1.6m on £13.6m of revenues in the same period.
So to get Communisis's total operating margins up to 10 per cent in the medium term, double the level reported in the first half of 2012, the company has gone through a major cost-cutting and site consolidation programme which involved closing five of its 14 sites to cut £4m from the cost base. Some of these savings are now being used to fund a move up into higher-margin data, digital and creative services to drive revenues ahead.
Communisis has also sensibly reduced exposure to financial services, which now accounts for less than half of revenues compared with 57 per cent a year ago and over 70 per cent at its peak, by increasing business activity in retail, telecoms and consumer goods sectors. A move in international markets is promising, too, and revenues from this segment now accounts for 5 per cent of turnover, up from 3 per cent at this stage 12 months ago.
Bolt-on acquisitions
It's worth pointing out, too, that Communisis made three small acquisitions in the first half of this year which not only broadens its product offering, but offers obvious potential to sell new services to its existing client base. For instance, the company's creative services operations now include the building of websites, mobile and other digital applications following the £1m acquisition of UK-based specialist software production agency, Kieon. And the £375,000 investment in Yomego, a social media agency, looks like money well spent as Communisis can now offer clients valuable services that measure the effectiveness of online and off-line marketing campaigns. Interestingly, the third deal - the purchase of a 49 per cent equity stake in The Garden Marketing for £543,000 - has brought in a major new customer relationship with a blue-chip financial services provider as well as enhancing Communisis's service offering when tendering to clients.
Communisis can certainly afford to make these bolt-on acquisitions as net borrowings at the end of June were only £27.5m, or just over 21 per cent of shareholders' funds of £128m, well within the company's £50m credit facilities. Moreover, the combination of the acquisitions and the operational progress made this year has led broker N+1 Brewin to upgrade its numbers for 2013 and 2014, which offers reassurance that the strong earnings growth we are currently seeing is set to continue.Earnings upgrade cycle
For the current financial year to end-December 2012, the broker expects underlying pre-tax profits to increase from £9m to £10.5m and produce adjusted EPS of 5.7p, up from 4.4p reported in 2011. And following 5 per cent upgrades, pre-tax profits are now forecast to rise to £11.2m and £11.8m, respectively, in the next two financial years to produce EPS of 6.1p and 6.5p. To put the strength of the earnings upgrade cycle into perspective, those 2013 estimates are 26 per cent higher than N+1 Brewin's numbers in March last year.
However, this earnings upgrade cycle has yet to be reflected in the company's valuation as the shares, trading on a bid-offer spread of 33.25p to 34.5p, are still only rated on 6.1 times current year earnings forecasts, falling to 5.7 times in 2013. There is a decent yield, too, as factoring in a 10 per cent increase in the half-year payout to 0.55p (ex-div: 5 September) and a likely 10 per cent hike in the final dividend to 1.1p as analysts predict, and the prospective yield is a healthy 4.8 per cent.
Substantial asset backing
If this wasn't attractive enough the shares are seriously deep into bargain basement territory if we adopt a balance sheet approach as the company's market value of £48m is a fraction of its net asset value of £128m. Or, to put it another way, we are getting 57p a share of assets thrown in for free for every share we buy at 34.5p. So, although Communisis's share price (TIDM: CMS) is up around 20 per cent (on an offer-to-bid basis) in a flat market since I first highlighted the company's recovery potential six months ago when they were trading at 28.5p, on any basis they are still hugely undervalued. I continue to rate the shares a strong medium-term buy and maintain a conservative target price of 45p, which, if achieved, offer us a potential 28 per cent further upside.
