Interactive Investor

Stockwatch: A 6.6% yield plus capital growth

20th October 2017 10:29

Edmond Jackson from interactive investor


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Does a 50% hike in quarterly dividends imply further upside at transport and support services firm Stobart, despite a roller coaster profits profile? And is such an expansion of payout policy secure?

At about 270p, Stobart yields 6.6% based on an 18p per share total dividend, with latest interims raising the payment from 3p to 4.5p, thus affirming forecasts last August/September. So, it's not as if the expectation is new, though underlining it certainly helps.

Otherwise, the forward price/earnings (PE) ratio is all over the place and net tangible assets per share were 101.9p at end-August. Much, therefore, rests on the dividend: if this extent of payout is judged risky according to economic change (some 90% of revenue is UK derived, 10% Europe and Ireland), then the stock is liable to drift. However, if business development and profits continue to evolve then it's a generous yield which bakes in capital upside.

Market initially pleased, then ponders 

A circa 5p rise ahead of these results initially extended another 5p, albeit below the "ceiling" levels of 300p the shares breached briefly last July and September. The chart has involved a re-rating from about 100p (in a volatile range) until mid-2016 given the table shows a major profits uplift from then after.

I've drawn attention variously from 120p based on yield, director buying and development prospects: last March at 200p I pointed out how a new deputy chief executive - an ex-boss of easyJet - had invested £247,000 mostly at 190p per share, despite a forward PE of some 26 times.

On results day the stock then lost its 5p gain, possibly on doubts when getting to grips: Stobart is highly diversified by modern standards, thus projections are tricky, especially whether to believe the declared dividend policy.

Payout supported to 2022?

A three-times re-rating in two years begs questions as to group earnings power and cash in support, going forward, the worst-case scenario being this 50% hike in the dividend as representing hubris before the UK economy turns down.

Management's narrative has a growth theme, but mind it's now eight years since the last recession and Stobart's businesses have a cyclical flavour. The group has also enjoyed the benefit of £112 million net cash proceeds from a part-disposal of Eddie Stobart Logistics, albeit mainly applied for debt reduction.

Significantly the interim statement proclaims: "the group has financial resources in place to support the dividend to 2022 at which point the dividend will be supported through operating income."

An 18p per share dividend implies an annual cash need of £63.4 million: currently the end-August balance sheet shows £39 million cash, long-term debt having been cut from £133 million to £26.1 million and short-term debt from £18.3 million to £10 million, hence why cash is up only modestly from £30.7 million despite the disposal proceeds.

The interim cash flow statement explains all such changes, though starts with a £10.4 million outflow on operations, up from £8.6 million, i.e. it would be more comforting to see stronger operational cash flow given the extent of dividend.

The reserves section to the balance sheet does show over £127 million retained earnings, although the usual sense is this to be applied for investment or paying down debt than distribution. So, the published statements might better substantiate why the payout policy is "supported to 2022".

Profit from Logistics part-disposal booked "above the line"

Another oddity is the interim report including the £124 million profit on the disposal as part of "underlying" profit, seemingly bizarre, which Stobart justifies by way of an Investments side making occasional disposals i.e. "normal" profit (if you can agree).

It spruces up an interim income statement that otherwise shows nearly £126 million total operating expenses versus £125 million revenue. It also scatters PE multiples such that the Company REFS table indicates a 2018 multiple of 7.2, then it's quite a stretch to assume £32.2 million pre-tax profit for the 2019 year, representing near 35 times earnings.

It's some challenge to judge how a diverse set of businesses - in ongoing development - will pan out for performance.

Stobart Group - financial summary           Consensus Estimates
year ended 28 Feb 2013 2014 2015 2016 2017 2018 2019
Turnover (£ million) 76.8 99.2 117 127 129    
IFRS3 pre-tax profit (£m) 3.0 -10.2 -9.4 10.0 -8.0    
Normalised pre-tax profit (£m) 6.6 -2.2 -7.1 11.2 19.2 136 32.2
Operating margin (%) 20.3 8.8 -8.8 3.0 9.2    
IFRS3 earnings/share (p) 1.0 -3.1 -2.4 2.7 -2.7    
Normalised earnings/share (p) 1.4 -1.8 -1.7 2.0 5.0 37.4 7.8
Earnings per share growth (%) -74       104 653 -79.1
Price/earnings multiple (x)         54.1 7.2 34.5
Annual average historic P/E (x) 71.4 103   55.4 54.3    
Cash flow/share (p) 2.4 7.1 -4.3 0.5      
Capex/share (p) 6.1 -0.6 -9.7 9.3      
Dividend per share (p) 6.0 6.0 6.0 6.0 10.0 18.0 18.0
Dividend growth (%)         66.7 72.4 4.4
Yield (%)         3.7 6.4 6.7
Covered by earnings (x) 0.2     0.4 0.5 2.2 0.4
Net tangible assets per share (p) 50.6 98.3 88.4 87.5 78.8    
Source: Company REFS              

Operations narrative reads quite encouragingly

It's rather mixed, but that goes with diversity. The Aviation unit, i.e. UK airports and services, appears to be evolving well: a 25% year-on-year increase in passenger numbers at London Southend Airport, where a fourth easyJet aircraft will be based from next summer.

Eleven new routes are also being developed for Flybe, to better exploit Southend's local catchment of 6.4 million people, and with two more aircraft.

Revenue and operating profit are up sharply due to acquisitions made last February and this side is anticipated "to grow and create significant value for the group" due to its ability to serve London e.g. with a new executive jet centre from this November.

At Carlisle airport, new commercial operations are being explored. There's also an Aer Lingus franchise that has enjoyed strong summer trading supported by cost reductions, and an aircraft leasing business acquired last February.

Stobart's Energy business targets processing 2 million biomass tonnes by end-2018, though has experienced delays commissioning new power stations, hence near-term volumes are down by a third, although profitability per tonne is ahead of target and long-term volumes are said unaffected. Despite current challenges management is very positive about the division's medium to long-term prospects.

Rail & Civil Engineering is broadly on track to achieve profit targets despite a revenue reduction due to scale-backs by National Rail, this revenue decline mitigated and profit actually put ahead by internal group work on processing sites for Energy divsion and improvements at Southend airport. It's incestuous but shows how the conglomerate structure has an aspect of self-support.

Infrastructure & Investments holds the group's commercial properties and investments in renewable energy plants, bolstered in the period by an £11.6 million disposal profit.

Altogether this reads positively for medium-term prospects, and it's still early days for easyJet's ex-chief operating officer to make an impact, he looks a very good catch to maximise value of the airports and regional airline. I'd still take any 2019 projection with a decent pinch of salt.

Can you trust the dividend commitment?

It's what the investment rationale reduces to, now the board has gone on the record implying an 18p per share dividend for the next five financial years. If genuine then it's a major prop and merits serious attention by income investors.

Yet, it's such a long-term outlay, I'd interpret more as objective than promise, given companies do need to maintain cash flexibility and the UK has seen one of its longest expansions since the trough of 2009.

But then I'm inherently cautious. If you respect the management here, then continue to tuck this stock away for long-term capital upside backed by superior yield.

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