The Holy Grail of investing is to identify companies with potential to turn an early-stage recovery story into a multi-month earnings upgrade cycle. That’s because a company’s share price not only gets a boost from the higher level of earnings reported, but investors are likely to value the entity on a higher multiple of earnings once they have confidence in management’s ability to continue to outperform guidance.
It therefore makes sense to identify operationally leveraged companies where an increasing amount of incremental revenue drops down to the bottom line, thus boosting profit margins and creating a strong tailwind to earnings. I also seek out companies that convert a high percentage of their operating profit to operating cash flow, so can reinvest surplus cash back into the business. If the profit margin earned is attractive, then recycling cash produces a virtuous circle of increasing shareholder returns.
Companies that make earnings enhancing acquisitions can be ripe to enter earnings upgrade cycles. If the target company is purchased on a multiple of earnings below that of the acquirer, then this can lead to sharp earnings per share (EPS) upgrades even without factoring in additional cost savings and economies of scale post acquisition. Management of heavy building materials specialist SigmaRoc are dab hands at doing just that.
SigmaRoc’s earnings momentum ratchets up
- Fourth earnings upgrade since September.
- Earnings accretive acquisitions.
- Positive order momentum.
SigmaRoc (SRC:83p), a group pursuing a buy-and-build strategy in the heavy building materials sector, has issued yet another earnings beat.
Adjusted pre-tax profit surged 45 per cent to £12.2m on 76 per cent higher revenue of £124m, buoyed by the contribution from acquisitions and positive tailwinds driving end-market demand, especially across repair, maintenance and improvement (RMI) and infrastructure products. EPS of 4.5p was 9 per cent higher than house broker Peel Hunt had forecast.
Moreover, SigmaRoc has just announced the earnings accretive acquisition of four plants in Belgium which produce 250,000 cubic metres of concrete each year and make a net profit of €1.5m on sales of €22m. The €13m cash consideration is being funded from the proceeds of December’s £10m placing. The board are also extracting value from the October 2019 acquisition of CDH, a major quarrying and dimension stone company located in Belgium.
In addition to annual production of 1m square metres of Belgian Blue Stone, a high value decorative stone, CDH produces 1.5m tonnes of standard construction aggregates. Production and commercialisation of CDH’s aggregates has previously been undertaken by global building materials group LafargeHolcim which has quarrying activities co-located at CDH’s site. The inefficient royalty agreement between the parties was due to end in February 2023. SigmaRoc has now taken full control of LafargeHolcim’s production assets at CDH for nil consideration. In return, CDH will supply the group with 1.5m tonnes of aggregate per year until the end of 2024 under a take or pay agreement, earning a production margin in the process. The new arrangement is expected to boost SigmaRoc’s annual cash profit by €1m.
Analysts have taken note of the robust trading outlook, contribution from acquisitions and CDH's new arrangement with LafargeHolcim. Clyde Lewis at Peel Hunt increased his 2021 pre-tax profit and EPS estimates by 10 per cent to £17m and 5.1p, and although largely maintaining his 2022 forecasts at £19m and 5.6p, respectively, he expects further deals to drive estimates upwards over the next 12 months. Even without further earnings accretive acquisitions, the forward 2022 price/earnings (PE) ratio is only 15.
SigmaRoc’s shares have produced an 80 per cent return since I suggested buying, at 46p (Alpha Report: ‘A general election winner’, 12 December 2019), and my new target price of 100p (from 85p) factors in the latest earnings upgrades. Buy.
Playing the economic recovery
- Robust second half profit recovery.
- Operationally geared to economic recovery.
Media companies are a leading indicator of the state of the economy, so are worth keeping an eye on as they are the first to see any uptick in activity from clients who previously held back on making investment decisions. I have exposure to this market segment through UK advertising and marketing specialist The Mission Group (TMG: 84p). The ongoing recovery in the business is worth noting.
Having suffered a Covid-19 impacted first half underlying operating loss of £1.8m on revenue of £29m, the agency bounced back strongly to report second half operating profit of £3.7m on revenue of £32.4m. Net debt fell to a record low of £1.2m, and the board has just paid out a dividend of 1.53p a share. The return to profitability not only reflects self-help measures – reorganising office premises clipped £0.7m off annual overheads and £4.5m annualised savings have been made in staff costs – but a sequential improvement in trading activity since the second quarter last year. The group is also more highly operationally geared now to any improvement in trading than before the Covid-19 pandemic, a dynamic that is set to work in its favour.
A focus on the more resilient technology (contribution up 12 per cent year-on-year) and healthcare industries undoubtedly helps, as does Mission's exposure to the fast recovering North American market. April Six, the group’s specialist technology and mobility agency, performed particularly well last year, growing Amazon Web Services into an important client.
The directors have been evolving the client offering by embracing new technology, too. Last summer’s acquisition of international psychological insights and behavioural solutions consultancy, Innovationbubble, is a prime example. The business provides expert research and advice to blue-chip companies such as Asda, Aviva, and HSBC so that they can better understand what drives the behaviour of their customers and how to improve marketing activity. The addition of Singapore-based brand activation consultancy, ALIVE, expands the range of services Mission's agencies can offer by providing expert advice and results-driven activation campaigns for global brands across multiple media channels and marketing platforms.
Chief executive James Clifton is aiming for the group to return to its 2019 profit run-rate by the third/fourth quarter this year. In 2019, Mission reported pre-tax profit of £10.2m on revenue of £81m. His guidance is supportive of Shore Capital’s maintained 2021 pre-tax profit estimate of £7.1m on revenue of £71m which produces EPS of 6p, up from 1.2p in 2020, and underpins a 2.3p a share projected pay-out. Mission looks well placed to achieve that 2019 profit high water mark in 2022 and deliver EPS of 8.6p.
Trading on modest forward PE ratios of 13 and 9 for the 2021 and 2022 financial years, and offering a prospective dividend yield of 2.9 per cent, the ongoing re-rating is warranted to my target price of 110p. The holding has produced a 64 per cent total return since I initiated coverage (Alpha Research: ‘Marketing highly profitable growth', 11 October 2018), and the shares remain a buy.
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