Interactive Investor

Stockwatch: a classic ‘recovery to growth’ share and directors are buying

13th July 2021 10:21

Edmond Jackson from interactive investor

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Star investor Jim Slater might have described this as a “status change” stock, believes our own stock picker, who thinks there is catch-up potential here.
 

Last December, I drew attention to the CEO of this instant-service machines operator boosting his stake from 23% to 28%, and I suggested considering following his lead with the shares at around 50p.

Admittedly, this is a stock that has been around the block quite a few times. Photo-Me International (LSE:PHTM) listed nearly 60 years ago and had some great runs, chiefly when photobooths hit a spot for passport photos when travel was expanding.

Proliferation of digital photography has since made photobooths a mature business. Then came the late 1990s tech-stock boom and, more recently, hopes for diversification into machines for self-service laundry and fruit juices.  

Photo-Me has sometimes enjoyed a growth rating, yet a market value of £270 million after all this time does not exactly tally with growth stock status. You therefore need to choose timing quite carefully. 

10x PE if an earnings recovery is on the cards

A price/earnings (PE) ratio of just 10 times appears to be Photo-Me’s essential appeal if the company is on course to recover its recent years’ earning power (see table) as now indicated. 

The share price had advanced to 78p by early last May, compared with an 85-100p range pre-Covid; then drifted to 66p by later June but has rallied to 74p with yesterday’s release of interims to 30 April.  

The rally probably owes something to greater risk appetite among investors, but management has also guided expectations higher. Were they set low anyway, or various restructurings and new investments are now finally starting to bear fruit? 

You can defer that dilemma anyway, because Photo-Me need only deliver on a market forecast for around £37 million net profit in its current financial year to 31 October 2021, to rate a PE just shy of 10x. 

Admittedly, and unlike the two recruiters I examined last Friday, the free cash flow profile is not so exciting because (see table) capital expenditure needs are absorbing about half of operational cash flow. But, historically, the group’s operating margins have been over 20% - likewise return on capital – which reflect a decent business.  

Japan drives improvement in management’s narrative 

“International” in the plc name relates to 60% of group revenue deriving from continental Europe (significantly from France), 20% UK/Ireland and 20% Asia. Despite Japan being relatively modest in context, it has in the past driven investor expectations linked to government ID programmes – now kicking in. 

Back in December, I thought the CEO’s share buying underlined his confidence in recovery as Covid vaccines helped drive more human activity. A “speculative” tag was still necessary given photobooths revenue was down 26% from May to October and comprised 60% of group total. 

Annual results to 31 October 2020 then showed a 6% easing in group revenue – with reported profit wiped out due to £23.7 million exceptional charges linked to Covid.  

More positively, the balance sheet was robust, with £66.5 million cash and £58.5 million debt, due to be repaid by April 2025.

Self-service laundry operations were expanding – units in operation up 14% - and proving resilient due to accessibility during lockdowns. The £17 million acquisition of Sempa in 2019 – fruit juice machines in restaurants and hotels – contributed just £6.7 million revenue amid delays installing, but management was optimistic. 

The overall message, however, was Covid continuing to have a significant impact and consumer activity taking time to recover. 

Less than six weeks later, an update for the five months to 31 March then cited better-than-expected trading. That was due to photobooths serving Japanese people’s need to meet their government’s social security and taxation photo ID card scheme, over a 12-month period to September 2021. 

Annual revenue expectations were materially upgraded from £175 million to between £190 million and £200 million; and pre-tax profit from £9 million (pre-exceptionals) to a £15-£19 million range, which shows a good aspect of operational gearing. 

Otherwise, trading outside of Japan had been in line with expectations.  

“The group’s multi-country restructuring plans to improve profitability are on track to complete at the end of April 2021 and vaccination programmes continue to provide encouragement.”  

There was also a caution how Covid uncertainties remain, especially in France which is a main contributor to group results, but also Japan and Germany where possibility exists of lockdowns being revived. 

Photo-Me International - financial summary        
Year-end 31 Oct   2015 2016 2017 2018 2019 2020
Turnover (£ million)   177 184 215 230 228 215
Operating margin (%) 21.7 21.6 21.8 20.1 18.7 3.0
Operating profit (£m) 38.4 39.7 46.8 46.1 42.7 6.4
Net profit (£m)   27.9 29.1 35.0 40.1 31.2 1.1
EPS - reported (p)   7.4 7.7 9.3 10.6 8.3 0.3
EPS - normalised (p)   8.1 7.8 9.1 10.7 8.0 4.5
Operating cashflow/share (p) 10.6 10.7 13.0 13.8 15.1 13.5
Capital expenditure/share (p) 6.3 6.5 11.5 11.5 8.0 7.7
Free cashflow/share (p) 4.4 4.2 1.5 2.3 7.1 5.8
Dividends per share (p) 4.9 5.9 7.0 8.4 8.4 0.0
Covered by earnings (x) 1.5 1.3 1.3 1.3 1.0 0.0
Return on capital (%) 28.3 31.6 25.5 20.5 3.7 2.0
Cash (£m)   58.6 71.0 47.5 58.7 84.6 65.5
Net debt (£m)   -58.4 -60.2 -36.8 -25.0 -15.4 8.7
Net assets (£m)   104 122 128 143 142 114
Net assets per share (p) 27.7 32.4 34.0 37.9 37.6 30.2
Source: historic Company REFS and company accounts      

CEO adds another 3 million shares at 75p 

This upturn was good enough for the boss to raise his stake close to 29% but which appeared a cross-trade with the Dan David Foundation (representing the late founder of Photo Me) which reduced its stake by nearly 1% to just below 8%. 

A non-executive director since July 2019 also bought 53,000 shares at 77.7p on 11 May, taking his holding to 80,000.

This adds significance because last 7 July he was appointed an executive director to chair a new strategic committee for operational decisions across the group. He appears to believe it justifies more of his resource, as if Japan is no flash in the pan. 

Interims reinforce a “better than expected” theme 

The six months to 30 April show a modest 3% rise in revenue to £94.6 million and £9.5 million net profit. A 52% rise in cash generation boosted gross cash to £95.3 million or £16.9 million net. Interim diluted earnings per share (EPS) was 2.5p, but as yet there is no dividend. 

Fewer restrictions on people’s movement are cited as the main driver, although the laundry business is gaining momentum, with revenue up 23% to £23.9 million. The machines roll-out continues to petrol forecourts, and the first 100 self-service apple juice machines have been delivered alongside 2,700 orange juice machines. 

Most significantly, the CEO says: “I am confident of a return to our fundamentals more quickly than previously expected, unless the Covid situation presents new difficulties.” 

Photobooth upgrades are underway as “ID photos are proving to be a sustainable market” and unprofitable machines have been culled. 

There is a new corporate brand name change to ME Group which sounds a typical soulless alternative to the iconic “Photo-Me,” but is intended to convey a more diversified group. 

The stock could therefore be viewed as still having catch-up potential both on the chart and PE rating, versus its pre-Covid situation, with new growth elements gathering pace. 

Can EPS grow materially from a 10p base level? 

Potentially then, Photo-Me is a classic “recovery to growth” stock where these new businesses build on stable photobooths, instead of substituting their decline, which justified a low PE. 

If this more positive scenario is viable – and much does still depend on Covid and whether restrictions extend – then Photo-Me could become what Jim Slater used to describe as a “status change” stock. Its PE would trade nearer say 15x already; remember those recruiters are already on 20x in anticipation.  

Obviously, investors’ general risk appetite is also a significant dynamic and could change. But if updates sustain this new story and dividends are resumed as proof of sustainable free cash flow, then I set an initial medium-term target of 125p – rising to 150p if the strategy proves successful. 

Despite a rather volatile history, the stock’s risk/reward profile may therefore tilt favourably and I retain my stance: Buy.   

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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