Interactive Investor

Stockwatch: upside for this cheap share with attractive dividend

10th June 2022 10:17

Edmond Jackson from interactive investor

Now nearing a key price point, companies analyst Edmond Jackson shares his optimistic view of this small-cap stock.

A bullish update from £300 million “instant-service equipment group” Photo-Me International (LSE:PHTM) has seen its stock jump 20% from around 70p to 84p, currently 83p. 

Performance has so far been ahead of expectations in the financial year to 31 October. Revenue is up 24% and it appears operational gearing has raised pre-tax profit guidance into a £47 million to £50 million range.  

It essentially affirms what the CEO said at the 12 July 2021 interim results: “I am confident of a return to our fundamentals more quickly than previously expected, unless the Covid situation presents new difficulties.”  

Nearly a year ago, I therefore re-iterated a “buy” stance at 74p having initially made the case in December 2020 at 50p after the CEO raised his stake from 23% to 28% (via a trade with Photo-Me’s founder). 

The stock has traded sideways in the last 11 months and investors are justifiably wary that it can achieve “growth” status. Yet, barring a recession, its risk/reward profile favours upside. 

Modest single-figure PE and a useful yield 

Mind, this group changed its financial year from end-April to October, in 2020. 

Applying last year’s 23% tax charge to median net profit guidance of £48.5 million derives £37.3 million net profit and earnings per share (EPS) of 9.9p with 378 million shares issued. So, at around 83p, the forward price/earnings (PE) ratio is 8.4x.  

That is modest if Photo-Me’s prospects are looking up; also because if you apply a 2.0x earnings cover to the dividend, a circa 5p a share payout (it was over 8p pre-2019) implies a prospective yield just over 6%.  

The historic table shows a strong record of free cash flow in support of dividend payouts, and Photo-Me is not engaging the current fashion for buybacks.  

Moreover, the 31 October 2021 balance sheet had £99.4 million cash versus (say) a 5p dividend costing £18.9 million.  

Cutting £20.1 million near-term debt and £44.3 million long-term debt might be said preferable, given £3 million finance costs, also the board might prefer to retain cash for another acquisition.  

But at least the scope to restore higher dividends is clear. 

A genuine turning point or more like a re-adjustment? 

With just over half of operating profit deriving from photo-booths in the last financial year, might “a significant increase in revenues, driven by photo-booths” reflect fleeting demand for passport applications as travel resumes in the wake of Covid? 

The increase has been driven by France and the UK, where restrictions have eased. It therefore offers some hope for trading will pick up when restrictions in Asia ease more significantly, although Japan only represented 19% of last year’s revenue versus 68% from continental Europe and 13% the UK/Ireland. 

The photo-booths business may indeed be viable in the long run given it can be tricky for personal digital photography to deliver precisely what passport authorities require, and bespoke photographers are costly.  

But I think a long-term investment in Photo-Me requires confidence, its wider strategy of “instant service equipment” offers growth – otherwise, the stock is a trade on a re-rating. 

The update proclaims “strong progress…underpinned by the roll-out of the new corporate brand strategy, ME Group.” It appears another soulless re-naming of a plc to an acronym aims here to shift perception away from photo-booths as a mature business. Yet the group so far remains in the listed company space as Photo-Me International, with no change to its stock ticker. 

Laundry machines continue to be emphasised, with 53 a month installed during the six months to end-April and “further significant international growth expected in the laundry division in the current months and years”. 

A new low-cost laundry machine, the “Flex”, is being installed across Europe, with early trading results said “extremely positive”. Meanwhile, food vending – including a new pizza offer – is said “proving very attractive and a great future development opportunity”.  

In the last financial year, laundry-related revenue grew 15% to represent 25% of group revenue. This division launched in 2012 in France and has extended to the UK, Ireland and Portugal. The self-service units operate 24 hours from supermarket car parks and petrol station forecourts. Town-centre launderettes are also offered where competition is limited.  

Food service is a relatively recent development, with the 2019 acquisition of an equipment maker for freshly squeezed orange juice. Apple, pineapple and grape juice machines have been developed although Covid compromised roll-out.  

Despite a significant increase in supply chain and raw material costs, management says the group’s strong market positions offer significant pricing power – hence their confidence, revenue will increase by at least 20% this year. 

Is a steady rather than radical transformation 

Mind how this essential story – of applying cash flow from the mature photo-booths business to new vending operations – has existed for well over 20 years. With Photo-Me’s stock soaring in early 2000, I recall having my photo taken by one of its new kiosks to create mini personalised stickers.  

Meanwhile, the stock has been highly volatile. Back in 1999, it started the year at around 80p and soared to near 500p before the tech-stock bubble burst. A slump then bottomed out near 15p in October 2002 and, despite a subsequent recovery to around 150p, the 2008 crisis took it back to 15p. 

No disrespect to management’s recent initiatives, but the strategic story has persisted a long time – with laundry and fruit juice/food as relatively recent initiatives. 

In the April 2018 year, hopes ran high for Japan after the government introduced an ID card programme. But this proved non-compulsory and, hence, after investment, photo-booths did not benefit as expected and a thorough restructuring was required of the Japanese subsidiary. It was a chief reason why the stock dropped from around 185p to below 100p, then met with the challenges of Covid.   

A slump in performance for the April 2020 year was explained by Covid, which impacted continental Europe sooner than the UK. Mind that a halving of profit versus a 15% group revenue fall looked another example of operational gearing, so watch out if a stagflation scenario proves worse than expected, affecting Europe besides the UK. 

Photo-Me International - financial summary
Years to 30 Apr until 2020 then to 31 Oct

  2015 2016 2017 2018 2019 2020 2021
Turnover (£ million) 177 184 215 230 228 215 214
Operating margin (%)             21.7 21.6 21.8 20.1 18.7 3.0 13.7
Operating profit (£m) 38.4 39.7 46.8 46.1 42.7 6.4 29.3
Net profit (£m) 27.9 29.1 35.0 40.1 31.2 1.2 21.7
EPS - reported (p) 7.4 7.7 9.3 10.6 8.3 0.3 5.7
EPS - normalised (p) 8.1 7.8 9.1 10.7 8.0 4.5 5.7
Operating cashflow/share (p) 10.6 10.7 13.0 13.8 15.1 13.5 14.2
Capital expenditure/share (p) 6.3 6.5 11.5 11.5 8.0 7.7 7.6
Free cashflow/share (p) 4.4 4.2 1.5 2.3 7.1 5.8 6.6
Dividends per share (p) 4.9 5.9 7.0 8.4 8.4 0.0 2.9
Covered by earnings (x) 1.5 1.3 1.3 1.3 1.0 0.0 2.0
Return on capital (%) 28.3 31.6 25.5 20.5 3.7 2.0 14.8
Cash (£m) 58.6 71.0 47.5 58.7 84.6 65.5 99.4
Net debt (£m) -58.4 -60.2 -36.8 -25.0 -15.4 8.7 -34.9
Net assets (£m) 104 122 128 143 142 114 128
Net assets per share (p) 27.7 32.4 34.0 37.9 37.6 30.2 33.9

Source: historic company REFS and company accounts. Past performance is not a guide to future performance.

A portfolio hedge against the UK economy 

Another scenario could be that the UK continues to suffer – primarily due to leaving the EU single market, with the costs and strains of dealing with Covid lumped on top. 

With only 14% of revenue deriving from the UK/Ireland, this stock therefore offers useful diversification from most domestically-oriented small if not mid-caps.  

Yet some would say the French economy – which appears Photo-Me’s largest market, given its long-term French management – has its own deficiencies. 

This company’s narrative does have some tendency to hype, yet Poundland says people have even reduced buying essential goods and ProCook PROC has today warned on revenue/profit after just six months as a listed vendor of kitchen equipment. 

It being a difficult environment, I would not get excited over Photo-Me lest in due course management has to temper its message.  

This is also a public company of 60 years and still a small-cap. Yes, potentially it is at an inflection point as Covid restrictions ease, but a “growth” profile is yet to be established. 

I see scope for recovery to over 100p in the medium term, so long as high energy prices do not result in a wider recession. Buy. 

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

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