Stockwatch: Great track record underpins 8% dividend yield

After M&G just bought 9% of this business, our companies analyst discusses if you should follow suit. 

How dependable are institutional share trades right now, with 'buy' trades after a company cautions on its outlook and the stock drops? We know markets are prone to over-react, and there's also an adage about how some of the riskiest purchases are "value" stocks when the economy is turning down. So perhaps the UK's future is the bigger question currently.

The question remains, what attention should you pay to regulatory press releases? Do fund managers know best, having professional teams at their disposal and the best lines of communication to CEO's?  Or does that risk being sweet-talked? Also, their capital inflows mean a constant need to allocate funds and also justify management fees. That’s a different situation to private investors who can sit pat.

A read-across to stake-building in De La Rue

ScS Group (LSE:SCS) in upholstered furniture and floorings, is in focus currently, but it is pertinent first to update on security printer De La Rue (LSE:DLAR). Last month, I was intrigued to see that Schroders (Schroders) went from a sub-3% disclosure level to own 5.8% of De La Rue, versus a stock price around 200p - down from over 450p mid-year.  

Source: TradingView Past performance is not a guide to future performance

A new CEO with a strong track record in turnarounds had been appointed to the banknote printer. I did caution a possible near-term risk would be his turning a re-organisation (already underway) into the proverbial "root and branch review" resulting in write-downs, but I rated DLAR's long-term risk-reward profile as positive:

"The question is chiefly timing, Schroders being a highly diversified institution can afford patience although I think averaging in can pay off in the long run."

Maybe I had bad luck on timing, or I am being hard on myself, but perhaps I should have given a new broom more time to sweep. A cynical view after a new CEO is appointed at a company with any history of warnings is to sit well back until the price of share option incentives has been struck.

However, I did note a new chairman had yet to buy shares and, with hindsight, insider behaviour may have been a tipping factor: on 30 October De La Rue issued a pointed update about how full-year operating profit to March 2020 will be "significantly lower than market expectations" with no care was taken to explain why, or express confidence in the longer run.  A detailed review will be provided with interims on 26 November.

I've seen curt communications like this plenty of times before after changes at the top of listed companies. De La Rue had cautioned that its 2019 year would be second-half-weighted, suggesting we should expect weak interims. So, it's debatable what the 30 October update added after a soft warning already put forecasts in question. It chiefly hit the stock – down 25% to below 150p - but Crystal Amber Fund then raised its stake from 6.25% to 7.12% and the price is now 171p.

Should we assume Crystal Amber's adding to an already chunky stake is positive because they'll have spoken to the CEO or chairman, this aiding judgment even if deriving no inside information? Or is it a classic mistake to serially average down? I retain my stance to "average in" on the basis there's a worthwhile business to wrest here, and a professional turnaround manager is now in charge. I concede that this fund adding to its stake influences my view.

M&G buys into ScS from a private equity group

Meanwhile, fund managers at M&G (LSE:MNG) have gone from a sub-3% undisclosed holding to an 8.58% stake in £84 million ScS Group. This could be seen as peanuts for a manager of £265 billion assets, although M&G is respected for contrarian investment – its longstanding Recovery Fund remains a favourite among financial advisers.  

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Such a stake is also relatively illiquid: if things go wrong it will only be possible to sell at a much lower price. Despite no official news announcement as to the seller, Interiors Monthly reported Sun Capital cut its holding from 40.2% to 24.6%, selling 6.25 million shares at 220p, having said it intended to sell at least 5.38 million.

This is the first major disposal of shares since Sun sold 51% of the company in ScS's January 2015 flotation at 175p. It could be seen as a cautious act – cutting exposure as furniture demand ebbs – yet private equity does recycle capital into new unlisted companies.

Sun made improvements after buying ScS with debt in 2008 – applying a new strategy to cut costs, grow sales and enable it to withstand adversity. The January 2015 flotation reduced debt and ScS's cash generating strengths have eliminated it. Still, it's a competitive sector - up against the likes of DFS Furniture (LSE:DFS) - where the prospectus showed ScS's market share in upholstered furniture improving from 6.5% in 2010 to 8% in 2013, likely benefiting from a firm housing market. In flooring the share was cited lower around 2%.

UK consumer/housing outlook is most likely the key

I suspect furniture may be more sensitive to home sales than the "let's upgrade" market, where kitchen/bathroom fitting has been resilient in the last decade, maybe because it can benefit a potential house sale. If your aim is to move, then you might delay buying furniture and see what suits your next house. 

Otherwise, ScS looks a very well managed operation nowadays. The table below shows a sound financial record, especially cashflow, which underpins a yield now priced near 8% with the stock around 216p. 

It marks the low end of a 200-250p range this year, given a fall in October when prelims to 27 July declared robust numbers but cautioned of "a more challenging start to the 2020 financial year, with like-for-like order intake falling 7.6% in the two months to 29 September. The period has been impacted by record temperatures seen over the key August bank holiday weekend and the increased political and economic uncertainty that the UK is currently facing."

If you believe polls pointing to a Conservative majority in the General Election on 12 December, and this lifting economic uncertainty, then ScS is a 'buy'. If you fancy it's a hung parliament leading to various referenda, 'avoid'. Remainers may also be sceptical that the latest Tory Brexit will do anything less than inflict damage. My verdict is to consider averaging in, whether that's premature like at De La Rue. 

Respectable progress since 2012

For comparison: page 7 of the 2015 prospectus (on the company's website) shows 2012 operating profit had been £979,000 on revenue of £208.3 million, a margin barely 0.5%.  Cost of sales was 54% of revenue and distribution/admin expenses also hefty, although by 2014 the gross margin was 43.8% and operating margin 2.6%. Debt costs near £3.5 million reduced just below £2 million over three years, a net £1.9 million loss before tax becoming a £5.9 million profit.

The last year to July 2019 showed underlying operating profit up 4.6% to £14.3 million on revenue up 1.5% to £317.4 million, with underlying earnings per share (EPS) up 13.1% to 30.3p and statutory EPS by 6.3% to 28.5p. Sales growth was compromised by hot weather and closure of two less well-performing stores. The balance sheet cited cash up 19.7% to £57.7 million and no debt, justifying a 3.1% rise in the total dividend to 16.7p.

On an historic basis, the price/earnings (PE) is around 7.7 and yield 7.8%, the question is whether consensus for a circa 18% reduction in net profit/EPS to £9 million/23p this financial year is fair – or whether trading is liable to worsen. I'd distinguish company-specific issues at De La Rue, although much does depend here on UK consumers and the housing market.  Some say a radical reform of stamp duty is needed to invigorate home sales.

Yield and consumer reviews offer support

Dividend growth remains projected, where ScS's cash flow statement shows the payout cost £6.6 million relative to net cash flow from operations up 18.7% to £21.3 million. With £57.7 million cash also, the dividend looks underwritten. M&G's essential logic may be that ScS's yield is priced too generously – even respecting the consumer outlook – therefore, on a long-term view, the stock price is likely to rise.  

Otherwise, balance sheet intangibles constitute just 3.8% of net assets. There's a £56.6 million lump of trade payables versus £8.8 million receivables, note 9 shows, including £14.7 million "payments received on account" also £12 million accruals – which are certainly large.

Continued investment in e-commerce supported an online sales increase of 21.7% to £16.8 million and an in-store sales app is claimed to improve the customer experience. On TrustPilot, ScS Sofas have a 4-5% "Excellent" reputation, which is some achievement given online reviews are prone to be left only after things go wrong. People who post on TrustPilot appear well-pleased all-round with quality, price, delivery and customer service.

Flashback to Howden Joinery's recovery to growth

Demand for kitchens may be quite different, but it shows how well-managed companies can win through. Recalling the 2009 recession onwards, Howden Joinery (LSE:HWDN) defied expectations of slowdown, and I was advocating its stock. It has proved a great long-term 'hold', rising from about 15p in early 2009 to an all-time high of 583p currently. 

By way of comparison, Howden has reported recent revenue up 4.9% or by 2% on a same depot basis, on track to meet expectations for about £204 million net profit this year, although earnings per share growth has settled in the high single-digits versus a forward PE over 16x while yielding about 2.25%.  

On such a comparison, ScS already prices in an element of slowdown and may be the less risky purchase. Buy.

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