Dividend Power: May 2015

Thursday, 28 May 2015

Palace Capital - a smaller capitalisation property gem

Palace Capital: This is not a well-known name, being new-ish to the market with a capitalization of just £78m. The focus is on secondary commercial markets outside London (e.g York, Leeds, Staines, Milton Keynes), with architectural merit not being a buying criteria! George Osborne’s stated aim of re-invigorating the economic performance of northern England suits them just fine. The non-exec Chairman is the venerable Stanley Davis (ex-IRG Registrars), who is not prone to unnecessary risks, especially with a personal 7.7% stake. His lieutenant is another veteran, Neil Sinclair, with a surveyor, Richard Starr, doing the heavy lifting. They have just recruited an FD, Stephen Silvester, who has experience as Group Financial Controller at NewRiver Retail. Since around autumn 2011, when the current team took over, a good shareholder list has been built up, led by Polar Capital, Schroders, Henderson and Quantum. The mixed blessing is that these four, plus Stanley Davis, own some 57% of the equity. Today’s £20m equity raise (for another portfolio acquisition) might help reduce this concentration a smidge depending on who is offered the stock.

In these annual results, to 31^st March 2015, the pre-tax profit is £4.6m (against a 14 month £1.4m last time). The net asset value has increased smartly to 396p from 357p and a guidance beating annual dividend of 13p has been declared. Going forward the group wants to pursue a progressive dividend policy. Gross debt at year-end was £36.2m, giving a modest loan to value of 35.2%. Forecasts are hard to come by (the brokers are Allenby and Arden), but this is a business in a growth phase, operating in a healthy market where further value creating opportunities will be found. Today’s deal for example is a mixed-use site in Northampton, anchored by an Ibis Hotel and Vue Cinemas, with a weighted unexpired lease length over 13 years and an initial yield of 8.86%. The company states that there is much more still to be extracted from the previous deals, which is encouraging for NAV enhancement. So the shares are quoted at 385p, a slight discount to the historic NAV, and a 13p dividend for a handy 3.4% yield. Getting hold of stock may be tricky (although regular placings may help over time), but, trading at a discount to the sector, this looks like a share price with further to go and good dividend prospects to boot. (Neil Cumming^,28^th May 2015)

These comments are not a personal recommendation to deal. Any investments can fall as well as rise in value, so you could get back less than you invest. I may have a financial interest in some of the stocks written about. www.dividendpower.co.uk or e-mail at info@dividendpower.co.uk Twitter: @DividendPower

Wednesday, 27 May 2015

De La Rue - a passport to better times?

De La Rue: The 40% annual dividend cut had been widely expected since the interim was cut by a similar amount. This is symbolic of what a tough couple of years it has been for De La Rue, but the arrival of new CEO, Martin Sutherland, from security specialist Detica (now part of BAe Systems) is a new chapter. It doesn’t look as if there are any quick fixes though. These annual results, to 28^th March 2015, show revenues down 8%, pre-tax profit down 25.4% (at £57.7m) and eps down the same at 45.3p, with margins hit by pricing pressure in the currency (banknote) business. This all pretty much in line with reduced expectations after last autumn’s warning, but are hardly pretty. A small mercy is that they did retain the Bank of England contract, for 10 years, the loss of which would have been catastrophic. Despite this the order book at year-end was £243m, down sharply from last year’s £307m, with pricing still under industry-wide pressure. The group is now embarking on a major cost saving initiative, but the proceeds are ear-marked to be re-invested in the business rather than flowing to the bottom line. Although net debt was up £21.1m at £111.0m, this is manageable in the context of operating profits of £69.5m, with cash conversion a healthy 123%.

Looking ahead it will be a tough ask to hit the 45p of eps in FY2016, but that would be a PE of 11.2x at today’s soggy 504p. The stated aim is to pay 25p of dividend again in FY2016, which would be a yield of almost 5.0%. So far, the new CEO’s strategic review has concluded that the group’s shape and scope is appropriate, albeit with a future emphasis on “higher growth and more profitable markets”. So that is less bank note printing and more security products/features/ID services. It is not stated how long this tilt will take to effect, or what short term impact on the bottom line there will be, (so 45p of eps in FY2016 may be toppy?). However, this could be somewhere near the bottom for the group’s fortunes and if the reduced dividend holds, then the yield is a comfort. There also remains the long-term strategic attractions of De La Rue to a bidder. So having been lukewarm on the shares last October at 480p, I would now be more optimistic at current levels. (Neil Cumming^,27^th May 2015)

Tuesday, 26 May 2015

Marks & Spencer - Brown Suede Skirts are in!

Marks & Spencer: Marc Bolland has waited for a long time for some plaudits for his work at M&S, so he must be a relieved man. The delights of the brown suede skirt, eh? However, the question still remains as to how sustainable this new success is? On food M&S seems to be about as good as Waitrose, with no pretence at competing with the discounters. In clothing, the fashion element still seems to be very patchy, with Next still leading the way overall whilst Primark increasingly dominates the cheap end of the market. So, whilst these annual results to 28^th March 2015 have been well received, I am still doubtful as to whether this retail juggernaut can build momentum.

At the topline sales were up 0.4% at £10.3bn, with underlying pre-tax profits, after several years of decline, up 6.1% at £661.2m. As guided General Merchandise gross margins grew smartly, by 190bps, making up for another poor LFL sales figure. A glimmer of light here though, is that the final quarter did show positive LFL sales. In food, gross margin was up 30bps, with just a smidge of LFL sales growth. The international business had a tough year, with operating profits down 24.8% to £92m, as sluggish European economies and various currency headwinds whipped in. Capex was cut sharply to £526.6m, down £183m, with free cash flow rising £96.3m to £524.2m. The full year dividend was 18p, up 5.9%. The added excitement here was the news that, rather a la Next, M&S wants to start annual capital returns, starting with a £150m share buy-back. This sounds good, but is fairly modest compared to the £9.8bn market capitalisation and fell short of many expectations. Still it is a start and a signal of confidence.

Looking ahead the group is guiding for another 150bps-200bps of General Merchandise gross margin uplift, with the ambition of some sales growth. Another single digit bps improvement in food gross margins is cited, offset by 4% extra costs alongside 4.5% of new space (largely Simply Food), whilst capex will be steady in the £500m-£550m range. So if the ship can hold a steady course, then the lower level of capex should play its part in generating the extra cash to hand back to shareholders. Consensus forecasts for FY2016 are for eps of 35p, giving a PE of 16.9x at 592p (a price level last seen in late 2007). A 19p dividend would produce a yield of 3.2%, but a £150m buy back can be seen as an additional 1.5%. The next year looks promising enough, so that M&S can keep on this new track and maintain a more cheery share price. However, having missed this year’s bull run in the stock, I would still be fretting about the Next/Primark/Waitrose competitive threat and remain cautious. (Neil Cumming^,26^th May 2015)

Thursday, 21 May 2015

Royal Mail - Whistl while you work

Royal Mail Group: After the Christmas demise of City Link, there must have been a further modest whooping when Whistl suspended (forever?) its delivery service recently. However, that was only one of the varied challenges facing Royal Mail. In the internet age, parcel delivery should be a growth industry, but it is economically sensitive. It is also very competitive, as shown by their major customer Amazon setting up their own delivery system and stalling Royal Mail’s parcel volume growth. (That is before we get onto the potential for drone delivery.) Meanwhile, Royal Mail’s Universal Service Obligation is a difficult cost to shift, but there are plenty of other costs to attack. However, with hundreds of years of heritage some of the organisational rigidity is pretty baked in, with a labour force that is still heavily unionised. So how have they done so far?

In these 52 week results (to 29^th March 2015), revenue nudged up 1%, whilst pre-tax profits rose to £569m from £421m. Operating profit was £595m (FY2014: £488m) after transformation costs of £145m (FY2014: £241m), with a 40bps improvement in operating profit margin. Eps came out at 42.8p (FY2014: 30.8p), on the back of which the dividend was raised 5% to 21p, from last year’s notional 20p. Free cash flow grew to £453m, helped by lucrative property disposals, helping to see net debt shrink from £555m to £275m. After some neat pension footwork at flotation, they can state that the IAS pension surplus (yup!) increased by £1.1bn to £3.2bn. Whilst they outline tough trading conditions and a reliance on Christmas trading, they are on track to meet forecasts so far this year, alongside a commitment to grow dividends.

The problem appears to be that improving the top line is challenging and cost cutting is a finite exercise. Yet the group has got good cash generating characteristics and huge strength as the incumbent, even if there are plenty of pea-shooters aimed at them. Before getting too gloomy, it is worth pointing out the example of the tobacco industry where dividend growth has been handsome, despite the vilification of the industry. Consensus forecasts seem to be for an eps fall next year, which seems harsh. If they match this year’s eps of 42.8p, then, at 500p, the PE is 11.7x. A dividend of, say, 22p would be a yield of 4.4%. These look attractive valuations to me, but after the run that the shares have had, perhaps there will be cheaper days to pick them up. (Neil Cumming^,21^st May 2015)

Electrocomponents - increasing dividend risk

Electrocomponents: I am now getting very worried about the dividend here. There is a new CEO in place, Lindsley Ruth, who joined in April. Now comes the, not too surprising, news that the long standing FD, Simon Boddie is going in September. In November, Ruth is planning to present plans to improve performance after a “disappointing” FY2015, whilst meanwhile, “actions to address underperformance are being intensified”. This all sounds like a man looking at kitchen sinks in B&Q. In these annual results, to 31^st March 2015, headline revenues were down £6.9m to £1,266.2m after currency moves and fewer trading days provided a £50m headwind. Pre-tax profits were £96.1m (-5%), with eps down 19% at 13.2p. The dividend was, as expected, held at 11.75p.

There are many gloomy references, but here are some examples. Improving revenue growth is proving elusive, with UK sales down 2%, offset by 6% International growth. Broadly, this sales pattern has continued into the early part of FY2016. UK profit contribution was down £9m “due to revenue and gross margin declines”. Overall group gross margin slipped 130bps to 44.6% as currencies hurt and sales growth in lower margin territories failed to offset sales lost in higher margin areas (i.e. UK). Further pressure on margins came from a drive to grow corporate accounts, involving increased discounting. Better news was that the balance sheet remains in good nick, with net debt/EBITDA at 1.3x whilst free cash flow was £52.3m (FY2014: £58.3m).

I am finding it difficult see any encouragement for analysts to pencil in eps growth. So after 13.2p in FY2015, perhaps we should look use 13p for now as a FY2016 number. That 13p may still be too optimistic if more margin is used to attempt a kick-start of the sales growth. The shares have rallied this year and are at 239p, for a PE of 18.4x. Now, I don’t see why Ruth will want to saddle himself with that dividend, when he can (is) casting aspersions at the previous team. Why not cut and then look clever by growing from a lower base? So a two times cover would be 6.5p of dividend for a yield of 2.7%. I was lukewarm on the shares at 201p in February and at 239p I would suggest claiming discretion as the better part of valour. In November, investors can assess the new plan at the interims and decide if they want to jump back on board. (Neil Cumming^,21^st May 2015)