Interactive Investor

Stockwatch: does this small-cap have a recession-proof dividend?

15th November 2022 11:27

Edmond Jackson from interactive investor

This company has had a great year and analyst Edmond Jackson’s tip is in the money. But after a name change, further analysis is required to decide whether the business is able to deliver further gains for shareholders.

Last June, I made a “buy” case for (then-named) Photo-Me International at 83p, arguing a recovery case to over 100p. 

Its name has since changed to ME Group International (LSE:MEGP) with a new ticker – MEGP – which to my mind is a faux pas given the emotional connotation of an acute medical condition. Why do marketing people forever trash iconic names for acronyms? 

Anyway, the aim is to reflect diversification across laundry kiosks and food/drink vending machines, from the group’s historic link with passport photo booths and digital photo printing. 

Raising guidance for second time in three months 

The stock tested 112p in August after the interim results upgraded expectations, only then to slide back to a mid-80p range by October. But yesterday it jumped 10% to 105p after a full-year trading update again raised guidance.  

Management says a strong market position is helping to pass on higher supply chain and raw material costs, and there has been stronger demand for all the group’s services. The only glitch is subdued Asian trading while pandemic restrictions remain in place. 

Mind how recent momentum partially reflects extra demand for passport renewals as travel resumes, which may settle back in due course – when attention will shift to whether laundry and food/drink retailing can drive growth in likely tough times.    

Full-year revenue is guided a modest 2% higher to a £256-£262 million area, and EBITDA (near operating profit) similarly to an £82-£85 million range. Yet before exceptional items, this latest upgrade at the pre-tax profit level may be as much as 10%, to a £52-£54 million range. 

The stock rise capitalises ME to near £400 million versus capability of making net profit in the order of £40 million (median guidance of £53 million pre-tax after 25% corporation tax) hence earnings per share (EPS) of 10.5p and a modest forward price/earnings (PE) multiple of 10x. 

New policy to pay out over 50% of after-tax profit 

This dividend policy was declared at the August interims, “reflecting strong performance of the group post-Covid restrictions, and confidence in the future”.  

It is supported by a decent free cash flow profile (see table below). Despite material capital expenditure over the years, since the October 2019 year this has only absorbed around half of operational cash flow, and free cash flow may be at least 8p a share in the October 2023 year.  

This compares with consensus for 12.5p a share of dividends in respect of the October 2022 year, implying a cost of £47 million versus end-October cash over £38 million.  

A 6.5p special dividend has been paid in addition to the 2.6p interim dividend, given payouts were suspended in respect of the 2020 financial year amid lockdowns. 

If ME proves relatively recession-resilient and EPS is sustained in the region of 10p, then a 5p dividend – costing £19 million – implies a circa 4.75% yield at a 105p stock price. While material enough to support the stock, it is perhaps fair pricing for now, until ME shows it can navigate tighter consumer spending ahead.  

Past operating margins of 20% more likely relate to glory years in photo-booths, but in support of the payout policy, margins have recovered from low single-digit percentages into the mid-teens and returns on capital employed likewise rebounded to around 15%. 

ME Group International - financial summary
Years to 30 Apr until 2020 then to 31 Oct

 2015201620172018201920202021
Turnover (£ million)177184215230228215214
Operating margin (%)21.721.621.820.118.73.013.7
Operating profit (£m)38.439.746.846.142.76.429.3
Net profit (£m)27.929.135.040.131.21.221.7
EPS - reported (p)7.47.79.310.68.30.35.7
EPS - normalised (p)8.17.89.110.78.04.55.7
Operating cashflow/share (p)10.610.713.013.815.113.514.2
Capital expenditure/share (p)6.36.511.511.58.07.77.6
Free cashflow/share (p)4.44.21.52.37.15.86.6
Dividends per share (p)4.95.97.08.48.40.02.9
Covered by earnings (x)1.51.31.31.31.00.02.0
Return on capital (%)28.331.625.520.53.72.014.8
Cash (£m)58.671.047.558.784.665.599.4
Net debt (£m)-58.4-60.2-36.8-25.0-15.48.7-34.9
Net assets (£m)104122128143142114128
Net assets per share (p)27.732.434.037.937.630.233.9

Source: historic company REFS and company accounts

The 2019 year disappointed after ID card policy shifted in Japan, for which management had invested to capitalise.  

Apart from yield, the stock is not exactly propped by net assets: the end-April figure was £143 million of which 23% constituted intangibles, hence net tangible assets per share of 29.1p. 

To sustain a bull run in its stock, I therefore think ME’s narrative has to at least remain resilient.  

Is this group finally breaking with a volatile history? 

I have been positive on this stock since end-2020 at 50p, when the CEO raised his stake from 23% to 28% (via a trade with the group’s founder) and I re-iterated “buy” at 74p in mid-2021. 

Yet its long-term chart has been a roller-coaster. I recall from the 1999-2000 tech-stock boom, Photo-Me reaching ridiculous highs – seemingly on hopes for photo-kiosks printing personalised stickers and the like. A subsequent slump related partly to the tech-bubble bursting, but also accounting issues and criticism of incestuous business practice. 

A next major phase of uncertainty, from 2018, was photo-booths being pressured by improvements in personal digital photography. It prompted diversification within a “vending” theme, such as laundry outlets in car parks and fuel stations, unfortunately disrupted by 2020 lockdowns. 

The self-service, fresh fruit juice equipment market was entered in 2019 by acquisition, and in 2021 it bought a French pizza vending equipment company. 

Fresh fruit juices are being expanded to include grape, kiwi and pear, and last October, larger capacity pizza kiosks launched. 

While these are hardly break-through concepts, health concern in favour of fresh fruit – versus sugary soft drinks – may help sustain demand.  

Likewise in pizza and other easy-to-vend food items, relatively cheap eating out could prove lucrative during recession. Do you recall how Pizza Express proved a barnstorming growth stock from the early 1990s recession? 

Yet when management cites its machines being upgraded via a partnership with Digitiz.me, a “ground-breaking” digital platform, and “a new industrialisation process enabling us to decrease production costs and optimise logistics costs”, I tend to regard this as essential to stay competitive and conserve margin. 

If they can also buy and successfully integrate further acquisitions, then yes, it could position ME well for growth on the other side of a 2023 recession.  

Due to long-time French management – despite being a UK-domiciled company – 66% of interim revenue was derived from continental Europe, with Asia Pacific at 22% and the UK/Ireland likewise.  

So, if the UK economy faces a particularly hard time in the next two years, ME could be a relatively better stock to hold than other modestly priced UK small caps that are more domestic in focus. Assuming Covid restrictions do abate in Japan and China, they could substitute much shortfall in a chronically-pressured UK.  

Admittedly, France is also exposed to recession as the full effects of global interest rate rises manifest in six months to a year’s time.   

What of CEO succession? 

Serge Crasnianski is 80 years old and came into the group when his key-cutting and business card printing company was acquired by Photo-Me in 1994, to become its manufacturing business. 

He was however ousted as CEO by shareholders in late 2007 as the group moved into losses, then became a non-executive director in 2009, and then joint CEO before full re-instatement in 2010. 

Owning 35.5% of the equity, he may have stronger boardroom influence than most CEOs, and in due respect his long experience plus a big shareholding has delivered a strong listed company today.  

The Frenchman here is also relatively youthful to the 102-year-old Jacques Murray who is vice-chair of circa £200 million Andrews Sykes AIM ASY, another respected services group. 

But in due course a successor will need affirming, which to mitigate uncertainty should be when ME is performing well. 

Current stock pricing looks fair, potentially heading into recession. I would wait for some cooling in the narrative, before adding. Hold. 

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

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