Redcentric is at a watershed moment, but could be about to prosper.
The £192 million, AIM-listed IT services group Redcentric (LSE:RCN) looks to be at a watershed moment, both for its chart and fundamentals.
Over the last six months, it has trended down from 158p, finding support at 112p last December and 115p last Tuesday, blipping to 126p at once stage yesterday then easing to 120p.
Redcentric’s long-term chart is less of a benchmark, given a rally from 85p in 2013 to near 200p by mid-2016 was proven false by an accounting issue surfacing in November 2016.
Various directors departed and the stock slumped to near 70p. A sideways trend followed until Autumn 2019, when a new rally took the price over 150p in September 2020. However, this was part-fuelled by speculation while the board was negotiating with potential offerers towards a sale.
It was hard to sense if these were genuine approaches to Redcentric or the board was just exploring options, as no funded offer materialised. The onset of Covid-19 took the stock down briefly to 80p and its current level is effectively pre-Covid.
A play on cloud and IT, but without the froth
If forecasts for £11 million net profit in the current year to 30 March, and £12.8 million in 2022, are fair, 120p represents a forward price-to-earnings (PE) ratio in the mid to high teens, with the underlying yield around 2%.
As of last September, net assets were 70p a share, albeit 94% constituted by intangibles. A sense of it being fairly priced is supported by the board declaring a buyback programme last November when the stock was considered to represent value, but has yet to do so.
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More positively, Redcentric has a high element of recurring revenues and a relevant product portfolio across networks, cloud, communications, IT security and professional services. A strong operating base has been honed as businesses adjust to more e-commerce, working from home, security issues and so on.
Its stock is devoid of the froth seen with so many other IT-related stocks, especially in the ‘cloud’ space. If rising inflation continues to undermine Nasdaq valuations (like yesterday), with a wash-over here, it has relatively less downside risk.
The narrative at last November’s interim results was: “business performing very well with revenues growing, strong profit margins and excellent cash generation”.
This enabled re-instatement of an interim dividend – 1.2p a share – as well as the share buy-back programme (temporarily suspended due to Covid-19).
Essential features of Redcentric recall to me, what the late investor Jim Slater used to describe as a “status change” stock. And, not surprisingly, an investment firm run by his son Mark has accumulated an 11.4% stake.
This holding has risen from 10.1% in early January, when Lombard Odier Asset Management declared a 5.9% stake (from sub-3% undeclared). It is as if they both took some of Coltrane Asset Management’s 22.5% stake it sold from mid-December. Not a great verdict from Coltrane in New York, but they may have other fish to fry.
Accounting issue has weighed for four-and-a-half years
The previous CEO, CFO and a former finance director all departed in November 2016, with the current CEO joining swiftly as CFO later that month. He had had 25 years’ experience in senior financial roles, and the current CFO arrived in 2017 with 20 years’ experience.
Yet it took until last June for the Financial Conduct Authority (FCA) to publicly censure the company for market abuse, requiring it to offer £11.4 million to investors who bought shares in the year to November 2016. This was partly resolved by a placing of 5.25 million shares at 110p last July, incurring 5.6% dilution.
Last September, the FCA also began criminal proceedings against three previous bosses, hence the scandal has hung over the stock.
First-half 2021 year marked the first genuine upturn
The recent years’ record since 2016 (see table) has been uninspiring, apart from around £100 million annual revenue to be working with. There is also an inherently cash-generative business model – as shown by annual operating cash flow of around £13 million, versus modest capital spending needs. Broadly, it should just need work on margins geared with astute marketing, to define a recovery-to-growth stock.
The March 2020 annual results were still rather mixed, with overall revenue 6% lower with a doubt over the claim to “recurring” revenues given they eased 4% to represent 89% of the total. Earnings per share (EPS) and the dividend grew by 25% and 31% respectively, although cash generation eased 23%. Profits rose due to efficiencies from integrating historical acquisitions and improving processes across the group.
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Admittedly, Redcentric has yet to show meaningful return on equity numbers to warrant being a genuine growth stock. Where also, ideally, you would see capital retained than ‘returned’ via buybacks and dividends.
Last November’s interims underlined how revenue had grown in each of the previous five quarters, with a 7% like-for-like increase in revenue to £46.2 million, with the recurring element at 89%.
That could be said to justify a PE in the mid to high-teens PE, especially now it appears margins have been sorted out. Operating costs eased 6.3% to £16.4 million and cash flow conversion to operating profit rose from 100% to 105%. It was a good all-round outcome versus mixed annual results before.
On a normalised basis there was £7.6 million operating profit, EPS of 3.6p and £12.9 million cash from operations – as if in line with the consensus estimate for 7p. For this size of company it probably reflects guidance to its broker anyway, which if prudent leaves scope for modest surprise on the upside.
During the period, some £4 million cost savings were well ahead of expectations for £2.8 million, helped by vacating three data centres in London and merging three network platforms into one. A new enterprise resource planning, or ‘ERP’, system is said to provide a single, scalable platform with significant future benefits.
Redcentric - financial summary
Year end 31 Mar
|Turnover (£ million)||94.3||102||105||100||93.3||87.5|
|Operating margin (%)||9.2||-4.8||-2.9||0.9||-0.3||-10.0|
|Operating profit (£m)||8.7||-5.0||-3.0||0.9||-0.3||-8.7|
|Net profit (£m)||8.0||-4.2||-2.4||0.5||-2.0||-10.6|
|IFRS3 earnings/share (p)||5.3||-2.9||-1.6||0.3||-1.3||-7.1|
|Normalised earnings/share (p)||5.6||0.1||0.8||1.1||-0.5||-1.7|
|Operating cashflow/share (p)||10.1||-1.4||4.3||13.3||11.9||12.2|
|Capital expenditure/share (p)||4.1||5.6||4.5||4.5||3.1||2.7|
|Free cashflow/share (p)||6.0||-7.0||-0.3||8.7||8.8||9.6|
|Covered by earnings (x)||1.5||-0.6||0.0||0.0||-0.9||-8.6|
|Net debt (£m)||7.3||37.7||39.5||27.7||17.6||34.6|
|Net assets per share (p)||65.5||56.0||51.5||52.2||50.7||40.3|
Source: historic company REFS and company accounts
Net debt has also halved over six months to £17 million
Subtracting lease liabilities, financial debt has come down even further – to £1.1 million versus £16.5 million at September 2019. Lease liabilities constitute £15.9 million within net debt, down from £23.5 million.
Given the rise in interim revenue, it appears good working capital management that trade receivables are down 8% year-on-year to £17.9 million, also trade payables down 5% to £18.6 million.
Aside from heavy intangibles – inherent for an historically acquisitive IT services group – the balance sheet affirms good financial discipline from the current management.
Overall attractive, as IT stocks go
The dilemma for generalists is not fully appreciating the competitive position of various services involved. You have to rely on performance numbers to make a judgement.
Meanwhile, industry specialist analysts can be prone to overdo recommending what should be paid by way of premium, for the best-placed firms. Plenty of that went on in 1999-2000 and is happening again on Wall Street now.
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Being a relatively fast-moving industry, an IT stock should not constitute a heavy portfolio weighting anyway.
Slater’s 11.4% position will be in a substantially diversified context for his investment firm overall.
Going back a couple of decades, I recall getting lucky with IT stocks Sanderson and Lynx, focusing on essential aspects of the businesses and numbers. It appears a fair chance Redcentric is at a turning point to prosper. ‘Buy’.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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