Interactive Investor

Stockwatch: One to follow despite cyclical risks

14th August 2018 11:35

Edmond Jackson from interactive investor

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After a decent run for its shares since 2009, companies analyst Edmond Jackson considers the prospects for this broadcast and photographic market specialist.

Companies reporting mid-year results are tending not to excite - offering  an "in-line with expectations" message, including for their overall 2018 results.

It often makes valuations look fair to full, which in the context of a long business cycle since 2009 and edginess over Brexit and now Turkey, makes it tempting to consider locking in gains.

Yet this is just what potential trade buyers of British companies want, and if sterling remains weak then it's likely more offers will appear like the bid for IT recruiter Harvey Nash I covered last week. 

That one shows how firms with strong positions in international markets have special appeal, and their stock having limited liquidity will make it easier to get control while funds raise liquidity ahead of a possible jittery period.

Not to encourage speculation around Vitec Group (The) or a case for holding its non-index equity on bid prospects, but this near £600 million company is a good example of investors’ current dilemma - yet ongoing opportunity too.

Probably "high enough" after a long run from 2009

After the 2008 crisis, weak broadcast markets dealt a blow to this international supplier of products/solutions for the broadcast and photographic markets.

Cuts in corporate advertising budgets hit a company that had already quite lost its way making some less than brilliant acquisitions and diversifying into air traffic control.

The stock plunged from 575p, on a price earnings multiple of around 20 times, to 150p in 2008. Then a new chief executive was appointed to re-focus and when I drew attention at around 400p in June 2010, on a 4.5% yield, it was encouraging how he was re-investing his bonus and dividends, while re-building revenues.

My 600p target ensued as the P/E rose to the mid-teens, as was part of my rationale, and currently around 1300p it's about 16 times consensus for 2018, easing below 15 times for 2019 if that year’s forecast for about 8% earnings growth is fair.

Not as highly rated as in 2007 when that cycle topped out, Vitec yields only about 2.5% at this price level, with net tangible assets around 100p a share, so is exposed to any whiff of a profit warning.

Thankfully analysts are quite cautious about 2019 although Vitec also looks a good example how such projections may only be ball-park: either firms will beat them or get clobbered if a slowdown manifests. You need to look critically at which equity portfolio holdings are more likely robust or vulnerable, and stay aware.

Vitec Group - financial summary           Consensus estimates
year ended 31 Dec 2013 2014 2015 2016 2017 2018 2019
               
Turnover (£ million) 315 310 318 376 353    
IFRS3 pre-tax profit (£m) 20.4 20.1 18.5 10.5 27.4    
Normalised pre-tax profit (£m) 33.6 34.1 25.1 40.2 57.1 47.1 52.0
Operating margin (%) 11.8 12.1 9.2 11.8 16.9    
IFRS3 earnings/share (p) 31.8 29.3 29.2 20.1 20.1    
Normalised earnings/share (p) 61.8 60.9 44.0 86.6 50.2 82.5 88.9
Earnings per share growth (%) -18.2 -1.3 -27.7 96.7 -42.0 64.2 7.8
Price/earnings multiple (x)         26.1 15.9 14.7
Annual average historic P/E (x) 8.3 9.9 10.4 12.9 10.3 24.0  
Cash flow/share (p) 91.9 79.7 72.4 118 44.3    
Capex/share (p) 43.1 38.5 35.8 13.7 24.2    
Dividends per share (p) 22.4 23.4 24.2 25.0 27.7 31.7 33.0
Yield (%)         2.1 2.4 2.5
Covered by earnings (x) 2.8 2.6 1.8 3.5 6.1 2.6 2.7
Net tangible assets per share (p) 99.6 71.1 80.0 115 105    

Source: Company REFS         Past performance is not a guide to future performance

Strong market shares buttress cyclical risks

 As Vitec's "recovery to growth" stock profile has shown, this is a good business to buy into when there's a disruption in its markets, as strong market shares will see it through.

The approximate sense has been, about 40% for photographic tripods and auto prompters, and up to 80% in broadcast camera pedestals, with some consumer items exposed to low-cost rivals in a recession. Its geographic revenues profile is about 48% US, 21% continental Europe, 18% Asia Pacific, the UK only 9% and Rest of World 3%.

So unless Brexit proves disruptive to European exports or the US economy surprises on the downside, Vitec looks pretty well-balanced especially to capitalise on US strength.

Management contends (see "continued progress" within the latest interims) that technology and social media are driving fundamental changes to the image capture and content creation market; that its three “solutions” divisions - imaging, production and creative - are highly customer focused.

Product innovation, digital expansion and getting closer to customers can expand share; and margin improvements and also carefully targeted acquisitions can deliver growth. Time will tell how resistant the group is to any advertising downturn which proved an Achilles heel a decade ago.

Overall mixed progress at the half-year stage

Headline figures are encouraging – helped by "significant market-leading new products" launched at the end of 2017, if varied according to currency translation.

It’s tricky to decipher if Vitec is a net beneficiary of lower sterling as you might expect, which ought to spur export sales and when translating overseas revenues back.

Revenue and profit figures contrast in this respect: interim continuing operations' revenue is up 16% at constant exchange rates, if only by 11.2% on a reported basis, to £183.3 million; yet with the operating margin rising from 13.1% to 13.9%, normalised pre-tax profit is up 24.4% to £24.5 million as reported but only 19.2% at constant exchange rates.

Otherwise continuing operations' EPS is up 15.5% to 39.5p: good overall performance, if hard to say how reflective of "peak cycle". Management cites benefits also from streamlining actions, describing 2017 as a "transformational year...repositioning the group for further progress", amusingly the exact same words Harvey Nash used in its results last May, when I drew attention to bid prospects.

On the imaging solutions side, interim revenue is up 25.6% to £98.5 million and adjusted operating profit by 10.4% to £14.9 million, although exceptionals gave a boost and stripping out currency gains revenue meant flat revenue, a 4.3% rise in operating profit achieved by productivity savings.

Production solutions' revenue is up 2.5% to £57.1 million but adjusted operating profit jumped 50% to £9.9 million helped by higher margins on Winter Olympics' work and currency benefits. Otherwise at constant rates revenue was 6.9% higher and adjusted operating profit 31.8% higher.

That strong sales of lights and tripods were offset by adverse currencies shows you can’t directly assume a UK-domiciled business operating overseas is necessarily a beneficiary of weak sterling.

Creative solutions' revenue fell 10.1% to £27.7 million or 2.5% at constant currency, affected by a fire when revenue was growing at 9% hence a return to growth is expected currently. Adjusted operating profit rose 7.7% to £7 million albeit boosted by £4.7 million from the fire’s insurance claim; or by 16.7% at constant exchange rates.

Strong balance sheet supports organic growth

Although intangibles constitute 60.4% of net assets, Vitec has an overall robust financial position with £70 million debt virtually all long-term, supported by £27 million cash and current assets twice current liabilities. 

In the 2017 financial year, dividends took a modest £12.4 million of £35.1 million net cash generated from operations, so although £27.7 million total investment was covered by £32.4 million proceeds from disposals, Vitec’s balance sheet and cash flow profiles support continued development.  

The characteristics of this group offer sound credentials to be tucked away in a SIPP or ISA, it seems wrong to sell purely because the economic cycle must turn down sooner or later; respecting also that weak sterling and any future profit warnings enhance takeover prospects.

Thus a "hold" rating, though I’d say it’s a strong one unless updates dash assumptions; which investors with fresh money should keep fingers crossed for. Yes Vitec is fair if not full value, recognising maturity of the cycle, yet its overall credentials merit taking (an) interest. Hold.

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

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