S&U growth portfolio candidate

S&U plc is engaged in the provision of consumer credit and motor finance operating as Loansathome4U and Advantage Finance respectively.  I do not have a holding in this company (epic code: SUS).

Market/Index	FTSE Small Cap	Industry	Banking Services
Sales	£55.0m	Earnings	£10.9m
Market Cap	£183.7m	Share Price	1565p
Norm. EPS	91.7p	Historic P/E	17.1
Est. 2014 growth	19.6%	Prospective P/E	14.2
Est. 2015 growth	21.7%	Prospective P/E	11.7
Rolling PEG	0.56	SGR	9.8%
PBV	2.87	Historic Yield	2.95%
ROE	19.8%	Operating Margin	28.7%
5 yr BV + Div return	14.4%	5 yr FCF return on BV	11.1%

The Business
S&U was founded in 1938 and floated on the stock exchange in 1961; the company is a consumer and motor finance provider, with over 140,000 customers.  Loansathome4u provide valued home credit facilities to customers via over 500 agents across the UK and Advantage Finance provides non-prime finance for motor vehicles through brokers and dealers.

S&U appears to have been a conservatively run business, with the levels of impairment on loans made, being at an acceptable level and well under control.  It is not uncommon for operators in non-standard personal lending to see impairment levels in the mid to high 30 per cent of revenue range:

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S&U typically will charge interest rates that would appear very high compared to standard lending, but is a fraction of that charged by payday lenders.  A typical customer may have had some credit problems in the past, but a recent good history and an income in the range of £17-27k pa., borrowing £500 from Home Credit over 9 months or £5,000 over 4 years from Motor Finance, for interest rates that may range between 40-90% pa.  Home Credit is managed by local agents who visit borrowers on a regular basis, many are repeat customers over many years.  Motor Finance is managed through brokers and agents and approximately 20% of applicants for loans are approved and of those about 20% agree to convert.

Competition for the Home Credit division is Provident Financial, Shopacheck, Morses and a large number of small localised operators.  The largest competitor for the Motor Finance Division is Secure Trust Bank.

Home Credit represents 57% of group revenue and 36% of pre-tax profits and Motor Finance 43% and 64% respectively.  Motor Finance is the growth engine in the business, with Home Credit supplying steady profits and cash generation.

The management of the business is conservative in nature and the consistency of this approach & culture is made possible by the tenure of the members of the board, who have been with the business from 14 to 38 years.  The directors own just over 13% of the business, although the Coombe family in total own a declared 52% with a charity (Wiseheights Ltd) owning just over 20%, so the level of free float is quite small and therefore low levels of liquidity.

The company does run a small defined benefit pension scheme, but at their previous year-end at 31 January 2013 had a small surplus of £20k.

Quality
S&U's trading performance has been consistent, with earnings & EPS increasing by almost 13% pa over the past 5 years and just over 18% pa over the past 3 years.  Over the past 5 years ROE has improved each year from 13.7% in 2009 to 19.8% for the trailing twelve months to 31st July 2013.

Free cash flow has historically been strong, but over the past 18 months has decreased, this is due to the substantial expansion in the Motor Finance loan book increasing from £55.6m in 2011 to £82.8m at their interim results, with the loan loss provision increasing by just £3.6m.

Operating margins have consistently been above 20%, increasing from 21.9% in 2009 to 26.9% last year and 31.8% at the interim stage this year.  This increase is due to an improving impairment charge, most especially in the Motor Finance division (see chart above) and good cost control on admin costs supporting the rising income.

Gearing is just 39% and interest is covered almost 30x; this low level of gearing offers the business the ability to leverage additional business over the coming years and bridge the expected 20% growth from a sustainable growth rate (SGR) of 9.8% (see table above).

I would judge that the Home Finance business has a narrow economic moat due to switching costs associated with moving to a new provider of finance and network effects due to "word of mouth" locally and the positive effect of the local agents within a community.  The Motor Finance business has a narrow economic moat due to switching costs associated with moving to a new provider of finance.  These switching costs provide a very narrow economic moat as it only applies while the loans are in place.

Value
On a prospective P/E for the year ending 31 January 2015 of 11.7, a P/BV of 2.87 and EV/EBIT of 12.8, S&U is reasonably priced for a stock that is growing EPS at 20% pa (2009 to 2015 estimates).  Compared to Provident Financial on a P/E of 12.8 for 2014 earnings growing at 12% pa (2010 to 2014 estimates)

On a discounted cash flow valuation I would judge that the business has an intrinsic value of 1850p an 18% premium to today's price.

Add to this an expected dividend yield of 3.6% for next year and it makes for an interesting prospect.

Momentum
As with any stock, if there is little SP momentum, then it may take some time for demand to exceed supply and push the SP up to its true value.  S&U does seem to have good momentum though with a 1yr relative strength of 54% and good SP momentum over the past 2 years as demonstrated by the chart below:

Click on chart to enlarge

Summary
A reasonably priced share, with good growth prospects and strong financial returns.  They have a committed management team with a good stake in the business, but the family ownership along with a long standing investor in the form of a charity, does create an illiquid share.  One to ponder on as a long-term investment.

Growth portfolio candidates

Candidates for the growth portfolio

These are the current candidates for the growth portfolio using the filters that I detailed in my post on 26 April here.  This will produce companies that have a recent record of managing good growth, are expected by the market to grow over the next 12 months at a rate of at least 15% and are reasonably valued.




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I have ranked the top three in each criteria above green, orange & yellow for 1st, 2nd or 3rd.  The companies I have shaded in blue also appeared in a previous screen, GBO and BKG on 3rd May 2013 and BRK on 10th June.

 

The performance to date of those two previous screens are detailed below:

 

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As always the screen should be just the start of the due diligence that is required to ascertain whether a stock is worthy of investment.

 

I am currently looking at S&U (SUS) and if I have the time will I will post the results of that analysis, or at least a summary of it.

 

 

 

Anite interims

Anite is a global provider of hardware and software solutions, systems integration and managed services within its core markets of Wireless and Travel. I have a holding in my growth portfolio (epic code: AIE).

 

Anite released their interim results today and were in line with the trading update in October, commented on here.

Group revenue fell by 6% to £57.5m due to a 21% reduction in Handset Testing revenue.  Like-for-like revenue declined by 17% for the group due to a 33% decline in Handset Testing if we exclude the Propism acquisition.

With the Handset Testing just breaking even in the period the Group adjusted operating profit declining 63% to £5.3m. 

Adjusted profit before tax was £5.1m down from £14.3m last year and adjusted diluted EPS reduced 65% to 1.2p and statutory diluted EPS reduced from 27p to 0.2p.

Despite the lower earnings, free cash flow (FCF) was £3.8m compared to £3.5m last year.  The FCF generated was spent on - acquisitions £1.8m, dividends £3.6m and purchase of own shares for an employee trust £3.4m, resulting in net debt of £6m compared to £0.9m at the start of the year.

The interim dividend has been maintained at 0.575p as management state that "...despite the reduction in year on year profitability... the Board believes that trading in the first half of the year reflected temporary market conditions..."

Looking at sales and orders in more detail, there was some positive news as can be seem from the table below and with the book to bill ratio above 1 for the Handset Testing division this possibly marks a turning point in its fortunes.

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Management believe that with a tenfold increase in mobile traffic between 2013 and 2019 (see Ericsson mobility report here) there will be no let-up in cellular network overload and this will drive the need for continued technology innovation in handsets and therefore the testing that they require from the Handset Testing division.

Mangement expect that the roll-out of LTE 4G networks will continue to benefit the Network Testing business in the second half and over the next few years.

The Travel business has a £75.2m order book and this is expected to be mined over the next 5-10 years.  The long term prospects for continued growth will be dependent on the ability to land new and renew existing maintenance contracts.

My expectations for the full year are unchanged from my previous estimates here that produced full year underlying EPS of 4.9p.  

 

             

Tesco 3rd qtr IMS

One of the world’s largest retailers.  I have a holding in my income portfolio (epic code: TSCO)

Tesco issued their 3rd Qtr IMS today and the sales information was in line with expectations, but did not make comfortable reading.  Like-for-like sales were down in all retail areas, UK was down 1.4%, Europe down 4.0% and Asia down 5.1% (these sales exclude petrol, but include VAT).  Sales at Tesco Bank increased by 0.9%.

Overall sales declined by 0.8% and management stated that "...Despite the challenging conditions in many of our markets, we are performing in line with market expectations for the full year..."

Consensus market expectations for the full year are:

Sales £65,085m (range: £64,064-66,186)

PBT £3,217m (range: £2,805m-3,355) statutory

EPS 30.99p (range: 29.55-32.51p) underlying

Div 14.78p (range: 14-15.5p)

I would be inclined to pitch my own expectations at the low end of the range, with the possible exception of the dividend, that I think management would be loath to cut from last year's 14.8p given the earnings cover and pressure from institutional investors.

It was always going to be a long haul returning Tesco to some sort of growth, it remains to be seen whether Clarke will be given the time to achieve this.

Pearson acquisition

An international media and education company, providing educational materials, technologies, assessments and related services to teachers and students.  Owner of The Financial Times and part owner (47%) of Penguin Random House.  I have a holding in my income portfolio (epic code: PSON).

Coming fast on the heels of their disposal of Mergermarket, commented on here, today Pearson announced the acquisition of Grupo Multi, the leading adult English Language Training company in Brazil.

They will acquire Grupo Multi for approximately £440m (R$1.7bn) in cash and the assumption of £65m (R$0.25bn) of debt. In 2012, Grupo Multi generated operating profits of £42m (R$130m), so an EV/EBIT valuation of 15x in the local currency.

Pearson is paying a full price for what is the largest provider of private language schools in Brazil, they serve over 800,000 students across more than 2,600 franchised schools.  Brazil is one of the world's largest English Language Learning markets with the English Language Training market estimated to be worth £2bn (R$7bn), hence the price.

So Pearson are losing £25m EBIT from the Mergermarket disposal and replacing it with £33.7m EBIT (at today's exchange rates) from the acquisition of Grupo Multi for a net outlay of £123m (£505m for Grupo Multi less £382m from Mergermarket), in addition to greater exposure to a fast growing emerging market. 

 

Pearson disposal

An international media and education company, providing educational materials, technologies, assessments and related services to teachers and students.  Owner of The Financial Times and part owner (47%) of Penguin Random House.  I have a holding in my income portfolio (epic code: PSON).

Today Pearson announced that they have agreed the sale of The Mergermarket Group to funds advised by BC Partners for an enterprise value of £382m, payable in cash; this values the business at 15x operating income.

Mergermarket was acquired by Pearson back in 2006 for £101m plus a subsequent earn-out; revenues for the period to 31 December 2012 were £100m with operating income of £25m and profit before tax of £23m.

This is part of Pearson's strategy to focus on global education through digital technologies.  This will again raise questions as to the future of the Financial Times within the Pearson Group.

 

Compass Group finals

Provides contract food, catering and support services to a wide range of commercial businesses and government departments operating in over 50 countries.  I have a holding in my income portfolio (epic code: CPG).

Compass Group announced their full year numbers yesterday and underlying results were as indicated in their trading statement, commented on here, on 26 September 2013.

Briefly - revenue grew by 3.9% to £17,557m and 4.3% on an organic basis.  Underlying operating margins improved by 20 bps to a record 7.1% and underlying pre-tax profits grew by 9.2% to £1,188m.

Underlying EPS grew 12.5% to 47.7p and a final dividend of 16p was proposed - an increase of 13.5%, bringing the full year dividend to 24p up 12.7%.  

On the surface, this looks to be a good set of results, but there were some weak areas:

Although underlying EPS grew by 12.5%, reported EPS declined 26.6% to 23.4p, due mainly to a £377m goodwill impairment charge.  This is an increase on goodwill impairment, relating to the Granada merger in 2001, as a result of increases in the UK gilt yield that is part of the calculation in valuing expected cash flows from a business unit.  Put simply too high a price was paid by Compass in merging with Granada back then and, future profits and hence the net book value of the company are depleted. 

Europe & Japan continue to suffer and revenue fell by 3% on an organic basis to £6,039m, this had the effect of decreasing profits by £60m although this was offset by productivity improvements that produced a 60bps increase in operating margins.  Consequently operating profits from this division increased by £23m to £420m, this must be considered a good outcome in difficult markets.

The largest region North America continues to perform well and grew revenue on an organic basis by 8% to £8,150m, while improving operating margins by 10bps; all of which had the effect of increasing operating profits by £59m to £657m.

The Fast Growing & Emerging regions grew revenue organically by 10.2% to £3,368m, although operating margins fell by 30bps due to exiting some non-core contracts and implementing a new regional management structure, so operating profits increased by just £7m to £242m.

Financially Compass is in a strong position, net debt is just 0.8 of EBITDA and operating cash flow is  89% of net debt.  Free cash flow (FCF) was £681m for the year, similar to last year and gearing just 45%, with interest covered over 10 times.  Compass returned 19% on their average capital employed in the business a good margin over my estimate of their WACC of 8.3%.

Owners' earnings (dividends plus growth in NBV) have increased by a CAGR of 16% over the past 5 years and FCF has returned 19.5% over the same period. 

The increase in the dividend was by my reckoning the 12th successive year and has grown by a CAGR over that period of 12.7% pa.  This is an impressive record, more so since recent increases have not faltered, with the full year dividend for the period just ended having doubled over 5 years.  For those that are concerned with the 0.98 dividend cover from earnings for this year, dividends declared over the last three years have represented 63% of FCF (covered 1.6x), as FCF can move around from one year to the next, it is more meaningful to view it over an extended period such as three years.  This is both generous to shareholders, but comfortable for the company. 

At today's closing price of 922p Compass is fully valued at 17.9x this year's expected earnings and with a forward yield of 2.77% offers a below average income.  Some may argue that with these growth rates in the pay-out this may be a price worth paying, but there is little in the way of a margin for safety and remember it will take almost 5 years to catch up and replace the lost alternative dividend with say a 4% yielding stock with little or no growth.  Although having stated that, I currently have no intention of selling, but would not add to my position with any spare funds.

On a discounted cash flow basis I have calculated an intrinsic value of 925p per share for Compass.  This assumes that this year's FCF grows by 10% pa for the next 10 years, in perpetuity for 2.5% pa and I have used a cost of equity of 9.8% as the discount rate.

This note would not be complete without some comment on the new share repurchase plan announced of £500m, this follows on from two previous repurchase plans totalling £900m.  At a P/NBV of almost 6 this is value destroying for shareholders; companies should only repurchase their own shares when they are considered to be well below their intrinsic value.