Window of opportunity

So, when the largest retailer and manufacturer of uPVC windows and doors for the UK homeowner replacement market listed on the Alternative Investment Market (Aim) last week, I was intrigued to find out more about how this business is run. It’s just as well I did because there are clear and sound fundamentals supporting this niche part of the repair and maintenance and improvement (RMI) market and ones that look strong enough to warrant a modest investment in the shares of the new Aim-traded company, Safestyle (SFE: 135p).

Currently, Safestyle has a 7.5 per cent market share of the replacement window market, having undertaken installations at 50,000 properties last year. On average 4.6 units were installed per dwelling, so the company sold 232,000 windows in total which netted it £110m, or £2200 per property excluding VAT. There were around 3m replacement windows sold in the UK last year and though the market has declined from around 5m a decade ago, this isn’t stopping Safestyle from growing strongly, having increased its share of the market from 4.4 per cent since 2007.

Part of the reason for this outperformance of rivals is down to the fact that the company is the lowest cost national retailer and maker of uPVC windows and doors, so has a cost advantage over smaller firms. It also has the advantage of being able to target market its audience in a more focused and cost efficient way given its greater scale. To give you some idea of the total size of the market, there are currently around 525,000 properties each year which replace uPVC windows given the 20-year lifecycle of this type of glazing. This means that there is a large market for Safestyle 1,460 self-employed agents, 800 door-to-door canvassers and 100 telephone based sales team to aim at before one of its 65 surveyors visits the customer’s property.

The other advantage that Safestyle offers is that it holds very little inventory as the business has its own inhouse manufacturing facility near Barnsley which makes bespoke double glazed window frames and doors. The jobs are then sent to 10 depots across the country prior to collection and fitting by one of Safestyle’s 475 approved installers.

Moreover, with the majority of sales paid for in cash - only 20 per cent are financed by credit - and costs low and prices keen, then Safestyle has been winning market share at the expense of rivals who are unable to compete. In turn, with gross margins steady at around 36 per cent over the past three financial years, and revenues on the up, operating margins have been rising too. In fact, in the first half of 2013 the company reported a bumper operating margin of 12.4 per cent.

Bumper margins boost profits

The net result is that the company’s profits and cashflow have been rising strongly. On an underlying basis, pre-tax profits increased from £7m on revenues of £98.6m in 2011 to £9.5m and £110m last year. Analyst Toby Thorrington at research house Edison predicts a further rise to £14.5m and £124.6m, respectively, in 2013. On this basis, EPS are set to soar by over half from 9.1p in 2012 to 13.9p when the company reports its fiscal 2013 results in March. This means that the shares are trading on less than 10 times earnings. Furthermore, with limited working capital requirements, operating cashflow generation is healthy at around £15m a year which should generate free cash flow of £11m or so next year. So, with 77.8m shares in issue - valuing Safetsyle at £103m - there is ample scope for the board to declare a bumper dividend.

And this is exactly what Edison predict. Mr Thorrington is pencilling in a 5p a share dividend to be declared for 2013, rising to 8p a share in 2014. The company can certainly afford that payout next year as it would only cost £6.2m, or 56 per cent of free cashflow. And with net cash on the balance sheet expected to be around £4.3m at the December 2013 year-end, there are no financing issues to prevent the board from being generous. On this basis, the prospective dividend yield is very attractive at 6 per cent.

Market well underpinned

There is obvious scope for demand to pick up next year too which makes Edison’s 2014 forecast of revenues of £130m, pre-tax profits of £15m and EPS of 14.4p look too conservative.

For starters, the UK economy is clearly starting to recover and, with house prices rising and higher loan to value mortgages available, this is boosting housing transactions. That’s important because this is a positive lead indicator for demand in the RMI market which has historically increased in the two years after transactions levels have started to pick up.

Secondly, Mr Torrington notes that Safestyle is targeting "a further increase in market share by pursuing a regional expansion strategy to boost its presence in the south of England." That looks a sensible strategy given the increased demand for housing in the affluent region in recent years due to population and employment growth which in turn has put greater pressure on existing housing stock.

Thirdly, as energy bills rise, consumers are now more aware of needing to become more energy efficient, and that includes replacing drafty old windows and doors with new doubled glazed units.

So, underpinned by a robust financial position and with capacity to raise production volumes, the company looks primed to outperform a recovering market, and one which Safestyle has become major player in, having built its presence through the 2007-2012 downturn. As a result the risk to those earnings estimates looks to the upside.

Favourable valuation

Following hefty share prices rises this year, the ratings of Safestyle’s peer group have risen markedly in the past 12 months. These companies include tile retailer Topps Tiles (TPT: 128p) which trades on 22 times earnings estimates for the 12 months to March 2014; bathroom accessories and shower manufacturer Norcros (NXR: 23p), which is rated on 11.5 times EPS estimates for the 12 months to March 2014; builders merchant Travis Perkins (TPK: 1775p) on 15 times calendar 2014 EPS estimates; and kitchen maker Howden Joinery (HWDN: 328p) on 18.5 times on calendar 2014 EPS estimates.

By comparison, Safestyle is rated on less than 10 times 2013 EPS estimates falling to 9.2 times 2014 forecasts. That’s half the rating of Howden which is probably the best comparable. And the rating is equally attractive when you adjust for Safestyle’s cash rich balance sheet. On an enterprise value (market value less cash plus borrowings) to cash profit basis, Safestyle trades on a multiple of 6.4, or half that of Howden, implying scope for the anomalous valuation gap with rivals to narrow.

Long-term shareholders on board

It’s clearly worth noting that the founder of Safestyle sold out his 90 per cent holding of 70m shares to institutions at the time of the Aim flotation. According to announcements made to the London Stock Exchange, seven institutions have so far declared holdings totalling 34.5m shares, or 44.2 per cent of the issued share capital. These include Investec, Henderson Global Investors, AXA and Schroders. In other words these are long-term investors. I have also complied a table with all the major holders including management: chief executive Stephen Birmingham and sales director Kiran Misra both hold 5 per cent stakes in the company.

Safestyle's major shareholders

True, institutions were able to buy the shares at 100p in the placing and the market price is currently 135p, having fluctuated in the range between 130p and 140p in the past week since the listing last week. But with long-term holders on board, and 90 per cent of the share capital in the hands of only 17 parties includign directors, this means that Safestyle’s shares could absolutely fly on any positive news. And with the company set to announce a 50 per cent plus increase in underlying profits in its full-year results in March, and a bumper payout for shareholders, then we do not have long to wait to benefit from the catalyst to narrow the valuation anomaly with peers.

Offering a forward yield of 6 per cent, and trading on only 9.2 times earnings for 2014 based on Edison's conservative looking forecasts, Safestyle shares rate a buy on a bid offer spread of 132p to 135p. My earnings driven target price is 200p which if achieved offers almost 50 per cent share price upside.

Finally, due to unprecedented demand, my new book, Stock Picking for Profit, has sold out and is being reprinted for delivery the week beginning Monday, 6 January 2014. As a special promotion to IC readers, the first 100 pre-orders for the book placed online with YPD Books and quoting offer code ICOFFER will receive complimentary postage and packaging. The book can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213. The book is only being sold through YPDBooks and no other source. It is priced at £14.99, plus £2.75 postage and packaging. Telephone orders will continue to incur the £2.75 charge.

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