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The Aim 100 2019: 60 to 51

The Aim market has become more respectable than ever
May 2, 2019

60. M&C Saatchi

As traditional advertising agencies grapple with rapid change in the digital advertising space, M&C Saatchi (SAA) is embracing new technologies as additional marketing channels for its creativity. A differentiated business model predicated on organic growth focuses on establishing new ventures against a backdrop of larger peers who typically wait for acquisitions. Using Amazon’s Alexa and Google’s Assistant, Send Me A Sample is “the world’s first voice-activated product trialling platform”, already being deployed on major brand campaigns, including by the likes of Coca-Cola.

 Although new business and pitch costs depressed headline operating profits in the Middle East and Africa and Asia and Australia last year, the group expects this investment to be returned in 2019 through improved net revenue and margins. M&C is trading at 16.5 times forward earnings, a premium to its peers on a two-year historical basis. But following another record year in 2018, this year has started well, and management expects “good progress in 2019 and beyond”. Buy. NK

 

59. FW Thorpe

Lighting specialist FW Thorpe (TFW) had a mixed first half to its financial year. A slow start to the year by Thorlux, the group’s main lighting division, dragged overall UK revenues down £4m. But record order levels over the final few months brought Thorlux’s order income back to 2018 levels. And as of March, the division was eagerly expecting the delivery of new laser-cutting metalworking machinery. 

A sterling 2017 twinned with challenging trading conditions has made things look sub-par, and FW Thorpe hopes to kick on in the second half. It expects the benefits of overhead cost reductions to lift operating profits, which were 10.3 per cent down on last year’s half-year results. Efforts to reduce its exposure to economic and political turbulence in the UK, meanwhile, are working. Overseas revenues now sit at 41 per cent of overall turnover, although these were down by £1.5m. The group has ground to make up over the coming months, so we stick at hold. AJ

 

58. Iomart

As a cloud computing group, Iomart (IOM) is competing with tech giants such as Amazon’s (US:AMZN) web services platform. Luckily, management says the market is so large it can succeed with only a small piece, differentiating itself with “great customer service and flexibility”.

So far, it is working. The group’s April pre-close trading update revealed a 6 per cent increase in cash profits, while investments in sales and marketing have led to a “significantly larger pipeline of prospects”. The group also bolstered its UK operations with its acquisition of LDeX, a technology company providing connectivity and data centre services. Management said the deal would bring a diverse, new customer base while adding two complementary locations.

Shares in Iomart have performed well since we tipped them in January and we think the group’s investment in sales and marketing have the potential to further boost performance, especially in light of its proven ability to generate high levels of recurring revenues. Buy. TD

 

57. CareTech

Last year was transformational for healthcare provider CareTech (CTH). Costs associated with its takeover of care home rival Cambian last October took a bite out of annual statutory pre-tax profits, but growth projections for the newly enlarged entity are strong. The plan is for the two brands to continue running independently, but there will be “no material change” to the number of operational sites, meaning the combined business will have a national presence spanning 450 homes and schools, and hopefully helping 4,500 vulnerable young people and adults. Under the terms of the deal, CareTech has, in effect, only purchased Cambian’s child services business; it fully intends to keep running adult services of its own.

As for how integration of that deal is progressing, a group statement in March suggested recent trading had been in line with management’s expectations. This marked the first update since the Cambian deal was cleared by the Competition and Markets Authority (CMA) in mid-February. Even so, in combination with the sudden and sad passing of CareTech’s finance director, Michael Hill, there appears to have been little delay to the integration process – something analysts at Panmure Gordon describe as encouraging. As the two businesses work together, it’s expected CareTech will be able to claw back roughly £3m within the first year as management teams are reorganised and Cambian’s head office is moved. A roll-out of IT systems should also help to buck up margins.

There have been some concerns as to how the enlarged group will handle its leverage position. In the March update, management admitted that pro-forma net debt to cash profits is expected to be under four times, while the property portfolio was valued at £774m on 19 September 2018, leaving the loan-to-value ratio at approximately 40 per cent. In January, the group also completed a second ground rent transaction with Alpha Capital, raising £32.6m in cash to help strengthen the balance sheet and provide further capital for investment. Initial fee discussions with local authorities are also pointing to a possible increase in fees compared with last year – encouraging given the rise in group costs thanks to the national living wage.

It’s still early days for the integration of Cambian into the wider CareTech group. But the shares still only ask new investors for nine times forward earnings. That probably reflects the risks associated with elevated debt levels and Cambian’s historically weak margins, but it’s worth a punt in our view. Buy. HR

 

56. MP Evans

Investors considering buying shares in palm oil companies must first come to terms with the impact the production of this oil has on the environment. Beyond this, they must consider the impact of comparable oils, as companies that use this oil in their products can easily swap it for alternatives such as soybean oil depending on which is cheaper at the time. This brings us to the impact of supply and demand, which will dictate what palm oil companies can charge for their product. 

MP Evans (MPE) reported “record production” of crude palm oil last year, with crops up by a quarter to 192,500 tonnes. Perhaps unfortunately for MP Evans, substitute vegetable oils also saw a surge in yields, resulting in a 16 per cent decline in the average palm oil price to $598 a tonne. Naturally, management is optimistic that this price decline will reverse in the current financial year, even though the price in March was still 13 per cent lower than 2018’s average. Global palm oil stock reached a record level by the end of last year, so we’re less optimistic of a change in fortune. Hold. JF

 

55. Team17

Team17 (TM17) has made a strong start to its life as a publicly traded company. The group beat revenue expectations for the year to December 2018, launching 12 games in the year and setting the stage for a similar number in 2019. It has launched three games since the start of 2019, with two more announced so far.

The group develops original games, and also works with independent developers through its games label. Both are expected to contribute to future growth, although the group is highly sensitive to changes in the sales mix. Gross margins in 2018 fell 11 percentage points to 46 per cent due to a higher proportion of third-party game launches. However, the mix is expected to stay roughly level in the coming years.

As a developer, Team17 is expected to benefit from the rise in game streaming, evidenced by Alphabet’s (US:GOOGL) recent announcement of Stadia, its foray into the sector, and Snap’s (US:SNAP) acquisition of Playcanvas. Buy. TD

 

54. Eddie Stobart Logistics

Eddie Stobart Logistics (ESL) started trading on the UK market in 2017, but it is not totally unfamiliar with life as a public company having been spun out of Stobart Group (STOB). Since going it alone, it has pursued a strategy of growth by acquisition. The most recent of these was the £52.8m deal to buy The Pallet Network, a pallet distribution business operating across the UK and Ireland. The purchase is meant to help Eddie Stobart build scale, as well as give it the ability to provide integrated logistics services for its clients, thereby enhancing its commercial proposition. Naturally, such a strategy comes at a cost, which was a 55 per cent rise in receivables to £231m during the last financial year, and a subsequent net cash outflow.

Once these businesses are fully integrated into Eddie Stobart’s business, cash flows may indeed recover. However, if it continues to push along with this growth-by-acquisition strategy, it is likely to come at the expense of its current net cash position, and indeed may force it to take on some debt. Like-for-like growth has so far remained steady, but margins have slimmed. Given the potential negative impact of Brexit on the logistics sector, we maintain our hold recommendation. JF

 

53. Redde

Between late February and early March, shares in accident management, fleet operations and legal services business Redde (REDD) fell nearly 50 per cent in a matter of days despite chief executive Martin Ward’s assurances that half-year numbers represented “another good set of results”. It would appear that the market looked past these reassurances towards a narrowing gross profit margin and warnings that the coming months would present a tough comparator for the second-half numbers. The 2018 financial year benefited from extreme weather at the beginning of the year, as snowy weather creates ideal conditions for an accident management business.

An increase in the number of credit hire cases, coupled with a rise in debtor days and money spent on improving its IT systems and claims portal put a strain on working capital. Trade and receivables, along with payables, were up by around a quarter, which along with a drawdown of cash and equivalents, slashed the value of net current assets by nearly a fifth. In this light, it may seem a surprising move by management to maintain the interim dividend at 5.5p, as it means that 86 per cent of first-half net earnings will be paid out as income to shareholders. This is especially surprising considering Redde doesn’t have a cash buffer to fall back on in tough times. It has since updated the market that it has not been successful in securing the renewal of a hire and repair contract with a large insurer.

This is not the first time Redde has run into trouble. A post on shareholder Woodford Investment Management’s website details Redde’s troubles around the last financial crisis. At the time, its balance sheet came under increasing pressure as the process to handle claims began to lengthen, and its business model – funding the cost of the replaced vehicle from inception to the settlement of a case – began to backfire. The old management team was ousted and replaced with a team that downsized, restructured and returned the company to growth. Given the performance in recent months, some may wonder whether there is more work to be done. The current management team may be trying to shore up confidence in a recovery, since the chief executive, chief financial officer and chairwoman have all been buying up shares since the dramatic share price fall. We won’t be following suit until evidence emerges of a sustained turnaround. Hold at 117p. JF

 

52. Alliance Pharma

Alliance Pharma (APH) shares could be back on track thanks to a set of results that met the market’s expectations. Most encouragingly, the ‘international star’ product portfolio continues to perform well. These products have “a distinct USP”, chief executive Peter Butterfield told us at the time of results in late March, as well as high margins, a range of international rights and future growth potential.  

The portfolio plays host to Nizoral, a medicated anti-dandruff shampoo that Alliance bought from consumer healthcare giant Johnson & Johnson (US:JNJ) last June for £60m. The first product licence is expected to transfer into Alliance’s ownership in the second half of 2019. In fact, product launches appear to be the utmost priority at Alliance. In the fourth quarter this year, it will launch Xonvea, for the treatment of nausea and vomiting in pregnancy (NVP), in Ireland, following the product’s launch in the UK last October. On 16 times forward earnings, the shares look like fair value. Hold. HR

 

51. Restore

Office services group Restore (RST) has found itself in a position of having to, well, restore confidence after a spluttering end to the last calendar year. It looks to be succeeding, but we suspect it would only take the slightest stumble to set investors on edge once again.

The group’s shares had been trending downwards through last year when it announced the departure of Charles Skinner, its well-respected chief executive, who has been at the helm since the group rebranded in September 2010. The shares dropped following the announcement, and again in January when it announced its shredding operations had experienced “lower volumes than budgeted for” over the year. Luckily, when the 2018 results were released, they were impressive enough to prompt the shares to rise by a tenth, despite announcing the departure of finance director Adam Councell this coming August. The shares are still trading towards the bottom end of their 12-month range, and we expect this will persist while the new management team wins the confidence of investors and analysts.

However, there is still plenty to like. The integration of TNT Business Solutions is now mostly complete, following a brief delay while the Competition and Markets Authority investigated the deal. In the latest numbers, the acquisition was the main factor in a 22 per cent bump in operating profits. Two of TNT’s large sites predominantly serve the UK public sector, opening up a market Restore’s management describes as “immature”. Its ability to cross-sell and grow its government work will be a crucial driver of confidence, but investors would do well to keep the perils of public sector outsourcing in mind and watch margins and exceptional items closely.

Further deals are expected. Management has previously said it plans to spend £20m-£30m a year to consolidate its markets. Investors should keep a close eye on organic growth and net debt levels as it does so. Annual net box growth is an important indicator of growth in the records management division – the group’s biggest in revenue terms – and the start of two major contracts won in 2018 looks set to give the business a boost in the first half of 2019. The group’s recent performance is reassuring, but management turnover means it must prove itself all over again this year. Hold. TD

 

 

Aim 100: Part 1

Aim 100: 100-91

Aim 100: 90-81

Aim 100: 80-71

Aim 100: 70-61

Aim 100: 60-51