Each month, Richard Beddard trawls through annual corporate results for candidates for his Watchlist and the Share Sleuth portfolio of companies that satisfy key valuation metrics.
Computacenter (CCC): smart acquisitions drive revenues
Computacenter will report results for the full year to December in the new year and publish its annual report later in spring, but the signs are that the company will have followed a strong 2017 with a stronger 2018. In the first three quarters of the current year, it has reported revenue 11% higher than the same period a year ago – a figure that does not include the contributions of two acquisitions in September, right at the end of the third quarter.
Computacenter sells hardware, software and services to large companies and government departments. Reselling IT has a tough reputation. Resellers add little value, which is why they are sometimes dubbed “box shifters”. Low value added means thin profit margins: Computacenter’s margins are typically between 2 and 3% after tax, requiring it to shift large numbers of boxes to make a decent profit. The impressive thing about Computacenter, though, is that it has steadily increased profitability since the financial crisis. In the year to December 2017 it earned a 14% return on capital, compared to 6% in 2008.
Selling IT is going through a bit of a purple patch as businesses and their strategies are increasingly driven by data. The migration of software and data to internet services also means companies are changing their IT. For over two decades, Computacenter has developed two other strands of the business to help customers manage change. The managed services division runs IT systems for customers, and the professional services division advises senior IT managers. Together, services account for 30% of Computacenter’s revenue, and probably earn the company higher profit margins. They also provide an alternative avenue for growth, should the shift to internet services mean Computacenter’s customers require less kit.
The acquisitions are logical additions to Computacenter, which already earns 60% of its revenue from Germany, France and Belgium. One is a Dutch firm, adjacent to Computacenter’s European interests, and the other is an American firm. Computacenter already has a business in the US serving European customers operating there, but the acquisition brings it native US customers and a wider range of products and services.
A share price of £11 values the enterprise at about 15 times adjusted profit. The earnings yield is 5%.
DotDigital (DOTD): boost from tax credits
The year to June 2018 was another year in DotDigital’s uninterrupted growth record. The company grew revenue 35% and profit 18%. It has no debt, and its cash balance was only partially dented by the acquisition of Comapi, an omnichannel messaging service.
Before last November, DotDigital’s only product was dotmailer, an online marketing platform that links to companies’ business systems to create, test and send email campaigns. DotDigital says dotmailer occupies a sweet spot in the market, offering the features of “enterprise level” platforms at a lower price. As the name suggests, dotmailer primarily sends email. The addition of Comapi will enable DotDigital’s customers to interact with their customers in many more ways, including SMS (text) messaging, webchat, and social media platforms like Facebook and Twitter.
Often the additional contribution of acquisitions can hide perturbations in the performance of the acquirer, but DotDigital’s revenue increased 15% excluding revenue from Comapi in 2018. The acquisition advanced one of DotDigital’s three strategic objectives, product innovation. It is also investing heavily to introduce artificial intelligence and machine learning into dotmailer, and to integrate it with more e-commerce and customer relationship management systems, another goal.
The hike in investment clouds the accounting somewhat and demonstrates how rapidly digital marketing is changing, but DotDigital is investing from a position of strength in a market that is growing in multiple dimensions.
As businesses adopt digital marketing strategies, the market for software is forecast to grow at a compound annual growth rate of 14% over the next five years. As DotDigital integrates dotmailer with more e-commerce systems, it can reach more merchants (it estimates it now reaches 50% of all merchants globally). And as market leader in the UK, DotDigital is making great strides abroad, its third strategic goal. Overseas profitability is high and revenue grew 33% in 2018. The company entered the US market in 2012, and most of the rest of the world is still pretty much virgin territory.
Unsurprisingly, perhaps, the growth story is reflected in the share price of 83p. It values the enterprise at just shy of £250 million, or about 30 times adjusted profit in 2018 after applying tax at the standard rate. The earnings yield is just 3%. DotDigital pays very little tax though, due to research and development tax credits, so shareholders are getting a higher return currently. Taking tax out of the equation, its earnings yield is more like 4%.
Finsbury Food (FIF): tasty earnings yield
Finsbury Food lifted adjusted profit by 3% in the year to June 2018, while revenue fell 3%. The company described it as a stable and resilient performance in a hostile trading environment due to a “shock” rise in the price of butter, higher prices for other ingredients, less spendthrift consumers and tightfisted retailers like Tesco and Booker, who are combining so they can drive down the prices they pay suppliers like Finsbury Food.
That verdict means overlooking £13 million of one-off costs relating to the curtailment of contracts and leases, and redundancies at two loss-making bakeries, which Finsbury Food closed. Deduct these costs from profit and the result in 2018 was an operating profit of £5 million, as opposed to the adjusted figure of £18 million.
The adjusted figure is probably a truer reflection of Finsbury Food’s profitability in a more typical year, and on that basis the company is in pretty good health. In the year to June 2018 it made a return on capital of 19%, bang on the long-term average. That number, though, may still flatter to deceive because Finsbury is a product of a large number of acquisitions (and some disposals). The acquisitions did not come cheaply; if you add the cost of goodwill – the amount paid by Finsbury above the value of the assets it acquired – to capital, the firm’s return on total invested capital is much more pedestrian. Average return on total invested capital is just 8%.
Finsbury Food acquired Kara, which supplies coffee shop chains with cake, bread and croissants, in 2014, doubling its revenue and diversifying its customer base. In September 2018, just after the end of the financial year, it acquired Ultrapharm, which bakes gluten-free bread – a growth market. The company is scaling up so that its bakeries are more efficient and it can strike harder bargains with ingredient suppliers and hold its own in negotiations with the supermarkets. Neither of the acquisitions were particularly cheap, though, and unless the businesses grow under Finsbury Food, shareholders will not get an adequate return.
A share price of 114p values the enterprise at just under £200 million or 12 times adjusted profit in 2017. The earnings yield is 8%.
James Halstead (JHD): working hard for profits
Like Finsbury Food, vinyl flooring manufacturer James Halstead is working hard to stand still. The company lifted revenue 4% but profit remained unmoved in the year to June 2018. The company is famously profitable, however. In 2018 return on capital was 33%, just under its long-term average.
During the year Polyflor – James Halstead’s biggest brand, manufactured in Manchester and Teeside – launched Palettone, which it claims is the largest new range by any manufacturer for many years. Polyflor is a commercial brand, used in offices, laboratories, retailers, schools, hospitals, and in ships, trains and buses. The company’s luxury vinyl tile brands, Karndean and Expona, also launched new ranges.
Polyflor pioneered the development of vinyl flooring in the 1950s, and it quickly displaced linoleum products. Today the company sells vinyl flooring all around the world. Its success, though, probably has more to do with sales than with the product, which is basically made from oil and salt. The company prefers to deal with customers directly, or with designers and architects, supporting them with a full design service. By controlling distribution in this way, Polyflor shares less of its profit with distributors and gains a better understanding of what customers want.
The problem for shareholders is that profit growth appears to have flatlined. James Halstead says it would have grown more but for the £2 million additional cost of trials, samples and marketing materials to support the launch of Palletone, a cost that should generate higher revenues in future years. But James Halstead needs to innovate if it is to grow and justify the current market valuation.
A share price of 400p values the enterprise at about £900 million, or about 23 times adjusted profit. The earnings yield is 4%.