Edmond Jackson's Stockwatch: Swallowfield

Despite uninspiring results for the financial year to end-June 2013, it is interesting to note how three directors of AIM-listed Swallowfield have bought a total £93,600 worth of shares at 78p at the low-end of its five-year chart - a level more akin to 2009 stockmarket values.

In a snapshot: it only needs confidence in earnings per share (EPS) being restored to 10p, with scope to recover further towards the 21.6p achieved in 2007/08, for market value to climb above 100p. A new chairman and chief executive with strong backgrounds have been appointed, and the supplier of cosmetics, toiletries and other household products derives about two-thirds of its revenue from the UK - so if consumer recovery steadily builds then such a company should prosper

There is obviously a risk this recovery proves too dependent on credit and fizzles, also as a result of higher living costs and sticky wages. But unless there is another consumer slump, Swallowfield's risk/reward profile looks supported by a business review underway, aimed in particular to cut costs. Net tangible assets of 109p a share ought to continue to limit downside risk, being more significant a prop than the prospective yield - below 3%.

Since the share price had only drifted slightly from a low 80p level during September/October, for the directors to buy, it is interesting to consider if they are seeing an improvement in the business. Swallowfield is due a trading update in the next week or so; last year it issued one on 15 November citing more difficult trading conditions, however the message at last September's prelims was "stabilisation, focus and returning to profitability" despite expectations for the UK and European economies to remain fragile for at least the next 12 months. The outlook in September cited "a number of customer wins in the second half (which) will positively impact future performance."

There has not been any other directors' trading since May and June 2012 when the previous chairman bought two lots of 5,000 shares at 120p. His resignation last April was in order to lead a rescue of Axminster Carpets, while the incoming chairman has a track record of turning around Nichols plcas chief executive, stepping down there in May to build a non-executive portfolio career. This was followed in June by the appointment of a new chief executive with managing director and sales & marketing positions at PZ Cussons and Colgate Palmolive.

He has just bought 40,000 shares and the new chairman 50,000 shares after what should be enough time to assess the group.

Mind that, genuine earnings progress is not expected until the 2014/15 year. Among data sources, only Company REFS cites a forecast - from N+1 Singer, the company's broker, for pre-tax profit of £500,000 and EPS of 3.3p in the current financial year - i.e. a price/earnings (P/E) ratio well into the 20s - then £1.25 million and 8.6p respectively in 2014/15 whereupon the multiple drops near 10 times. Most likely this forecast has been issued with some guidance from management, and hopefully is conservative like it should be. So Swallowfield is interesting for patient investors, assuming a reasonable UK recovery evolves.

While the last financial year showed nearly two-thirds of turnover being UK-derived, the remainder principally continental Europe, exports are being targeted partly to substitute for the top three customers changing supplier - which largely explains a 16% revenue decline to £48.6 million. So it will be interesting to see what the next update may have to say if there is further improvement on a 34% rise in exports representing 35% of revenue. Obviously when some elements of revenue decline then other percentages automatically increase; for example the top three accounts recently fell to 32% of revenue compared with 52% a year before. Sales growth of 21% was however achieved across a balance of more than 40 customers.

Clearly management must address costs. For example, "cost of sales" being 89.4% of 2011/12 revenue did not leave much margin for a revenue decline and this percentage rose to 91.8% in 2012/13; hence gross profit has fallen 34.9% to just under £4 million. Since "commercial and administrative costs" are prone to be relatively fixed (e.g. head office), they have reduced only 1.5% for a £497,000 operating loss that swelled with exceptional items and finance costs to a £1.2 million loss. A competent turnaround plan should be able to address most of these cost issues but mind further exceptional costs in doing so. Net debt has also increased from £4.1 million to £5.7 million.

The business review will be one key to sentiment. Last September it was said to be taking "a number of months to complete and to eventually map out the future direction, shape and financial goals of the business over the next three to five years." Since there are only 11.3 million shares issued, it means profit can quickly improve earnings - if making for tight trading.

For more information see swallowfield.com.