Interactive Investor

Stockwatch: An intriguing long-term buy

31st October 2017 09:24

Edmond Jackson from interactive investor

Do chunky share sales here exemplify bosses wary to preserve gains in stocks that have re-rated sharply as the bull market matures? Or does the rise partly signal a business set to reap benefits from weaker sterling, given its predominantly overseas sales?

Since mid-2016, shares in Vitec, the £500 million equipment supplier for global broadcast and photography accessory markets, have more than doubled to a current all-time high at around 1,130p; and yet the five-year table shows revenue/earnings trending volatile-sideways, likewise forecasts.

In its favour, Vitec enjoys strong market share - over 80% in some broadcast sectors - although this side of the group especially can be cyclical. It experienced a sharp downturn post-2009, curdling with various ill-considered acquisitions and strategic moves in the early 2000s.

Yet, a new chief executive since 2009 has delivered good returns for shareholders, disposing of non-core loss-makers, re-focusing R&D and re-locating manufacturing to lower-cost countries.

I first drew attention to Vitec in June 2010 at 400p, then later on at 630p in August 2015; both times with the forward price/earnings (PE) at about 10 times with a prospective yield of over 4%. Benefits from the restructuring were taking time to be realised, but the boss had re-invested his bonuses/dividends which bode well; and so it has proved.

Now, with the stock having soared in the last year, albeit with profits yet to recover to 2012 levels and the yield thus reduced to about 2.5%, he and another insider have opted to sell down.

Two bosses cut equity exposure by nearly a third

This last month has seen two disposals in the trading window between the 10 August interims and a trading update due 16 November. On 4 October, the chief executive sold 75,000 shares at 1,103p "for personal reasons", retaining 201,031 shares. Then, on 18 October, a senior manager sold 50,000 shares at 1,084p, retaining 115,766 shares.

Who knows, they might each be buying a holiday home, but the sales are relatively similar. Good corporate governance implies no awareness of adverse change in the message given at the 10 August interims – Vitec being on track to meet expectations for 2017 as a whole – and yet it's the first material selling for a long while, the stock re-rating having reduced the yield below what might be considered a prop.

Mixed yet net positive effects of weaker sterling

Vitec's chart is similar, if less pronounced, than the trebling in LSE:GAW:Games Workshop since the EU Referendum, that company deriving 75% of revenue overseas, principally the US and continental Europe i.e. the strong dollar/euro boosting sales also profits translation.

Yet, Vitec gained 91% of 2016 sales overseas, mainly the US then Europe and Asia Pacific. The 2017 interim results reflected this by way of adjusted pre-tax profit up 24.5% to £19.3 million in statutory terms, albeit 14.7% for continuing operations at constant currency; on revenue growth of 9.6% or 3.1% for continuing operations at constant currency.

But there's a dilemma with any stock generating predominantly overseas earnings, the proportion of costs also born in foreign currencies. For Vitec, this meant H1 2017 saw a £3.8 million adverse impact on operating expenses and management taking care to affirm expectations for the full year assuming no significant change in exchange rates.

More positively, on a speculative view, the strong dollar/sterling exchange rate combines with Vitec's generally leading market positions to make it attractive to a US acquirer.

Cash flow well ahead of EPS

The five-year table is useful to illustrate this virtue, where from 2013 onwards cash flow trends roughly around 1.5 times annual earnings, thus supporting a strong element of capital expenditure besides a payout some twice covered by earnings.

In H1 2017, for example, Vitec also enabled £18.1 million debt to be repaid such that total bank debt at end-June was £71.3 million against £18.7 million cash, the net finance charge clipping 10% of operating profit.

It's an aspect some investors will respect for investment value, enabling investment for long-term capital growth and a strong element of payout. And, although a forward PE in the mid-teens currently looks pricey against an annual average historic multiple of about 10 times, price to cash flow multiples are lower.

Possibly this helped encourage traders to propel the stock higher, although even with the payout approaching 30p per share, a mere 2.5% yield means fresh buyers - currently supporting the price – require confidence in medium-term growth.

It's bolstered, for example, by acquiring the JOBY and Lowepro camera accessory brands last September for a total £23.7 million, said to offer growth and margin improvement opportunities. It also bought RT Motion Systems for up to £3.4 million, providing wireless lens control systems; expected to "materially" enhance earnings per share in 2018 and beyond. What of underlying progress though?

Quality cyclical as a means to diversify from UK

The last operations review read mixed if well enough: a recovery in photographic markets boosting that side's interim operating profit by 23.6% to £11 million on revenue up 14% to £78.4 million. On the broadcast side a challenging US studio market was partly offset by good performance in Europe and the Middle East, such that continuing operations' operating profit rose 29.3% to £10.6 million on revenue up 15% to £86.5 million.

With the US asset rentals market increasingly competitive, a business here was sold such that its lower revenue and a £0.4 million equivalent interim loss were kept out of the continuing operations' numbers. Yet, despite their being enhanced by currency factors, they are plenty respectable.

I continue to rate this stock a cyclical because demand for photographic and broadcast equipment dials into media activity, which relates to advertising trends, thus essentially reflecting the wider economy.

Last July, the International Monetary Fund projected a 3.5% rise in overall global output for 2017 and 3.6% in 2018, while noting mixed prospects for the medium term. The IMF believes that cyclical a rebound could be stronger and more sustained in Europe, yet monetary policy normalisation in the US could trigger faster-than-expected tightening i.e. higher interest rates.

I'd disagree: for example Jerome Powell, the favourite to next chair the US Federal Reserve Board, is the relative liberal in the line-up of candidates – i.e. any rate rises will be small and well spaced-out.

Mid-November update key in the short term

So, the bosses' selling has a rationale to preserve gains, yet the broad context – of a circa £500 million business that's a global leader in international markets – makes this a quality choice versus stocks geared more to risks with the UK economy.

If Vitec does deliver a damp squib anytime and its price drops to re-charge the yield, it may hasten a takeover. If the global economy remains robust, then its growth-stock credentials can strengthen, hence a PE over 15 times and 2% yield be its "new normal".

Both scenarios make the 16 November update intriguing, and the business to study beforehand. "Long-term buy" looks the overall objective stance, but take care as to timing.

Vitec Group - financial summary         Consensus estimates
year ended 31 Dec 2012 2013 2014 2015 2016 2017 2018
Turnover (£ million) 345 315 310 318 376
IFRS3 pre-tax profit (£m) 16.1 20.4 20.1 18.5 10.5
Normalised pre-tax profit (£m) 44.7 33.6 34.1 25.1 40.2 37.0 46.4
Operating margin (%) 13.9 11.8 12.1 9.2 11.8
IFRS3 earnings/share (p) 13.4 31.8 29.3 29.2 20.1
Normalised earnings/share (p) 75.5 61.8 60.9 44.0 86.6 60.4 75.8
Earnings per share growth (%) 89.9 -18.2 -1.3 -27.7 96.7 -30.2 25.4
Price/earnings multiple (x)         13.0 18.7 14.9
Annual average historic P/E (x)   8.3 9.9 10.4 12.9 10.1
Cash flow/share (p) 56.3 91.9 79.7 72.4 118
Capex/share (p) 31.5 43.1 38.5 35.8 17.5
Dividends per share (p) 21.0 22.4 23.4 24.2 25.0 28.5 29.6
Yield (%)         2.2 2.5 2.6
Covered by earnings (x) 3.7 2.8 2.6 1.8 3.5 2.1 2.6
Net tangible assets per share (p) 106 99.6 71.1 80.0 91.2
Source: Company REFS              

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