Buy the UDG sell-off

Now the shares trade on 20 times earnings and we think investors have overreacted. Arguably, management was right to hold back on acquisitions until companies that meet their threshold (chiefly, a likely 15 per cent return on capital employed within three years) came along. Recent purchases are all highly profitable, which means profit margins are expected to expand to 12.7 per cent by 2022, from 10 per cent in 2017. Create NYC and SmartAnalyst – which were bought in July – will begin to contribute to group profits in the final quarter, meaning UDG is still on track to hit its target of 18 to 20 per cent constant-currency EPS growth in the year to September 2018.

It's true, the short-term outlook is marred. Management has had to take a $10m (£7.8m) impairment on an underperforming division (which has now been sold), while the pharma marketing division is set to report a decline in underlying operating profit in 2018.

But we think the long-term potential is being overlooked. Pharmaceutical outsourcing remains a fast-growing trend because of the rising complexity in the industry and UDG is ideally placed to capitalise on this. Its communications division is well diversified and offers a range of services that many of its competitors do not, while the Sharp packaging business can deal with the demands of hard-to-manufacture medical devices. Broker Peel Hunt expects that revenues at these two divisions will grow annually by 10 per cent and 7 per cent, respectively, between 2017 and 2022.

And then there is the opportunity for further acquisitions. In the past three years UDG’s cash conversion has averaged 117 per cent of underlying operating profits and it is expected to continue exceeding 100 per cent in 2018 and 2019. This means UDG has plenty of fire power to fund further deals. Including assumed acquisition contributions, Peel Hunt forecasts adjusted operating profit that will grow by more than 20 per cent in each of the next four years.  

That is why we think the rating at 20 times forecast earnings for 2018-19 looks like a decent entry point – especially as, on average, the shares have traded at 25 times earnings over the past two years. What’s more, UDG leads the pack when it comes to income. The company's dividend is expected to be nearly two times covered by free cash flow in 2018-19, which may mean the payment of a special dividend.