Stockwatch: why I’m upgrading this mid-cap share to buy

As I noted last time with B&M European Value Retail (LSE:BME), various turnaround or cyclical type shares – impacted by fears the Iran war would lead to recession – are now rising. Actually, this goes back around a fortnight before Tuesday’s ceasefire relief rally. It is as if markets cannily anticipated both sides would reach a point of confrontation-fatigue and back off – at least for a while.

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Such shares are sensitive to swings in “risk-on, risk-off” sentiment when they involve a turnaround business, especially if rather cyclical. Marketing services firm WPP (LSE:WPP) is another example, up 10% from its March low at around 250p, and also Vistry Group (LSE:VTY) whose one-year chart might imply a possible bullish opportunity:

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

All three shares have “issues with the business”, where the market is demanding proof that they can be overcome. They are keenly sold short too. But for active traders who can stomach risk, this class of share (you can also find your own examples) probably offer greatest leverage right now.

Mid-cap vending machines operator ME Group International (LSE:MEGP) looks to me a relatively lower risk share, capitalised around at £540 million. Yes, it had to warn last November about how photobooth revenues were lower than the previous financial year to 31 October (albeit this business is well known to be ex-growth). Of more concern was a softening in demand for laundry services, which the board has majored on for growth going forward.

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But I think vending services are not a bad business. Not everyone has a washer-dryer or can find exactly the right background to take their own digital photos acceptable to passport offices. There is a price for everything and, at 145p currently, ME Group looks to be on a forward price/earnings (PE) ratio around 8x and a dividend yield above 6% with nearly twice earnings cover, which is interesting.

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

Temporary accounts delay but boost from Asda

Last February, the shares fell from 145p to 125p when ME had to delay annual results because its auditor had requested more time. Understandably, the market feared some kind of complication being argued out, and temporarily suspending the shares from 2 March was not a good look. However, the numbers came out in line with expectations on 23 March and without any material issues. Cash generation was underlined by declaring a share buyback programme up to £18 million.  

The shares have recovered that drop with the benefit yesterday of news about how a partnership has been struck with the Asda supermarket chain to install up to 700 Wash.ME laundry machines at a variety of Asda sites across the UK. This marks a substantial upgrade on 1,500 or so in the UK and Ireland, albeit a moderate 9% on 7,600 for the global total currently. The installation aim is over 20,000 machines globally.

I am a bit wary of such machines: Trustpilot reviews on ME Group break down as 68% five-star, 25% one-star, chiefly referencing the laundry services, with some stark experiences of how drying doesn’t work, which must be frustrating if you have driven to some car park and sat there having paid yet another fee. But I understand that if well-located near student accommodation, such machines can rake in cash. It is hard to argue with ME’s growth figures for this business which was first introduced in 2012.

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In the last financial year, laundry revenue and operating profit both grew around 18% - assisted by new openings – to represent 46% of profit, while photobooth revenue was 4% lower “primarily impacted by regulatory changes in Germany and a printer supply issue”. There are other smaller vending operations such as photocopying and children’s riding machines, but the essence of ME is global scope for rollout of laundry machines as a growth angle, with photobooths also contributing to cash flow as a mature business in no serious decline.

Not surprisingly, the market exacts a modest PE and material yield, yet ME’s chart shows a de-rating to February 2024 levels and the long-term financial record is plenty good aside from Covid’s disruption.

Operating margins have trended near consistently over 20%, aiding returns on capital frequently over 30%. There is no real discrepancy between reported and normalised earnings like how acquisitive companies fudge various costs, and the business looks to be self-funding given the way it has net cash than debt. If you must quibble with the 11-year financial record, the capital expenditure needs are usually enough to mean free cash flow per share usually does not exceed earnings per share (EPS).

This company has been listed since 1962, hence it has survived the 1970s energy crisis and subsequent inflation/recession.

Notwithstanding issues in the story here – where ME Group and its predecessor Photo-Me International have seen a few disruptions over the years – the raw finances suggest to me a PE of 8 and 6% yield rather disrespects this business.

Source: historic company REFS and company accounts.

Is this genuinely now a time to buy?

ME Group is a consumer services share, and it is not unreasonable to regard it as retail given the alliance with Asda and photobooths installed in some supermarkets. So remember at end-March the British Retail Consortium warned UK consumer confidence had “collapsed”.

Yet the last accounts showed the UK and Ireland only responsible for 16% of revenue, with Continental Europe making up the majority at 68% with Asia Pacific also near 16%. This significantly reflects French top management where the CEO/deputy chair owns 36.6%. While that can introduce governance issues – his son is nowadays deputy CEO, not dissimilar to Mike Ashcroft’s son-in-law installed as CEO of Frasers Group FRAS – there is a case how family “controlled” businesses are long-term survivors, even if they lack cutting-edge growth.

The last results showed only a 3% revenue rise at constant currency; otherwise, it was 2.4% to £315 million which effectively just paced inflation. Pre-tax profit rose 7% to £78 million, and consensus expects a 6% rise in net profit this year followed by 10% to £66 million in the October 2027 year. This obviously could be compromised if the Middle East conflict drags on.

I originally made a “buy” case for the old Photo-Me business at 50p at the end of 2020 when the CEO raised his stake from 23% to 28%. It reiterated the stance at 74p in mid-2021 then tempered to “hold” at 158p in February 2024.

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The buyback programme active from 23 March has coincided with share price recovery, and a mid-cap like this can be less liquid to an extent that buybacks do help squeeze the price up. Clearly, the board regards the current share price as opportune for this, besides enhancing EPS.

From a “micro” company perspective, the Asda deal affirms prospects for the laundry machines, but can the macro context allow useful growth? People resorting to laundry machines presumably do not have their own, so I would think recession affects photobooths more if travel falls.

So, it is quite a close call currently where ME Group may not merit an “overweight” rating but, at 145p, I do upgrade to “buy”.

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