This once recovery play is now a solid buy

Supreme (SUP:109p), a distributor and manufacturer that sells a range of products to discount retailers and supermarkets (B&M, Home Bargains and Poundland are all customers), has issued its third positive trading update since last autumn, prompting analysts to upgrade their earnings estimates again.

The group's vaping division has been the key driver, delivering exceptional organic growth from its flagship brand, 88vape.com, earnings-accretive acquisitions (Liberty Flights, Cuts Ice and Flavour Core), market share gains in e-liquids and favourable market conditions. These positive trends look set to continue and are being aided by the UK government’s recently renewed efforts to reduce the prevalence of smoking, targeting vaping as a safer alternative and offering 1mn smokers over the next two years a free vaping starter kit to tempt them to give up tobacco.

In the 12 months to 31 March 2023, Supreme’s vaping division reported 72 per cent higher revenue of £75mn, prompting analysts at Equity Development to upgrade their group revenue estimate from £138mn to £150mn and raise their annual cash profit estimate from £18.5mn to £19.4mn. True, that’s still shy of the £21mn cash profit reported on revenue of £131mn in 2022. The divergence is due to the impact of last year’s customer overstocking and a slowdown in consumer sales in the lighting category, accounting for a tenth of last year's revenue. However, the high-margin lighting business is bouncing back – Equity Development estimates that divisional revenue recovered from £6.2mn in the first half to £8.8mn in the second – a positive sign given that the unit previously generated £27mn of revenue.

It’s worth pointing out, too, that raw material price inflation is abating in whey protein – a staple ingredient for fitness supplements. In the past six months, the price of protein concentrate has fallen 37 per cent, a positive for Supreme’s sports nutrition and wellness business, which accounts for a tenth of group sales. Market watchers will also note the resilience of UK consumer confidence, as highlighted by the recovery in the GfK Consumer Confidence Barometer since last autumn.

Forecasts on the upgrade

Equity Development has taken note of these multiple dynamics, upgrading its revenue estimates from £150mn to £162mn for the 12 months to 31 March 2024, and predicts that Supreme will deliver 16 per cent higher cash profit and pre-tax profit of £22.6mn and £16.2mn, respectively. On this basis, expect adjusted earnings per share (EPS) to bounce from 9.7p (2023) to 11p (2024), implying the shares are rated on a modest 12-month forward price/earnings (PE) ratio of 10.

Moreover, projected annual free cash flow of £12.3mn (10.5p a share) is forecast to wipe out estimated current net debt of £3.4mn and place Supreme in a £6mn net cash position by 31 March 2024, adding weight to expectations of a 2.5p-a-share payout. On this basis, the prospective dividend yield is 2.3 per cent.

So, having last advised holding the shares, at 88p (‘A light at the end of the tunnel’, 5 July 2022), I feel they now rate a buy ahead of annual results on 5 July 2023. A move above January’s 118.5p closing high would be a buy signal from a technical perspective, and one worth following given the potential share price upside to the target prices of Berenberg (170p) and Equity Development (190p). Buy.

■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com. The books are  priced at £16.95 each plus postage and packaging (P&P) of £3.95 [UK], or both books can be purchased for the promotional price of £25 plus P&P of £5.75.