A stock for 2017 - first term reports

Friday, 24th March 2017 10:11 - by David Harbage

At the beginning of the year, this blog highlighted two company shares as meriting attention in 2017: Bellway and Paysafe. Both companies announced trading results this month, prompting the writer to pen a few comments on these disparate businesses

On Monday, house builder Bellway pleased the City by reporting interim results for the six month period ending 31 January 2017 which were slightly ahead of the consensus of analysts’ forecasts. In particular, headline pre-tax profits rose 9.3% to £247.6m on a 5.9% increase in revenue to £1,148.5m. Earnings per share (EPS) in the half year rose 10.2% to 163.9p, the interim dividend was hiked 10.3% to 37.5p (the full year’s distribution is set to be covered three times by profit) and the net asset value per share increased 16.6% to1612p. Average net bank debt during the period was £106.4m (compares with £98.8m in the previous comparable half year), which represents financial gearing of just 5.5%; consider the market capitalisation (current worth of all the company’s equity) is almost £3.5bn.

Ted Ayres, the chief executive, reaffirmed a strategy of nationwide volume growth when guiding on results for the full year to 31 July 2017 – expecting to sell at least 5% more homes – and anticipating an average selling price of circa £260,000 (3% ahead of the previous year), with operating margins maintained at a record 22%. A geographic split between North and South shows a barely perceptible 49%/51% respective split, but a growing production of Social units (21%, versus 13% last time) versus Private units (79% of the total) in the half year.

While some observers might be concerned by the latter trend – perhaps anticipating lower margins on the lower average selling prices (ASP of £120,000 on Social homes), the return on capital employed (ROCE) is typically much higher as such developments are not nearly as capital intensive (often do not require investment upfront). Interestingly, HM Government’s most recent steer in addressing the UK’s housing shortage issue has been less about private build and more towards the provision of social housing and an extension of the rental sector. This will benefit builders who have actively sought to develop their ability to provide social housing and, by maintaining good relationships with local councils and other public brown land owners, have built up a significant relevant land bank. Besides Bellway, Brentwood, Essex-based Countryside Properties, the FTSE250 constituent who listed again a year ago, comes to mind with their significant Partnership strategy.

The government’s ‘Help to Buy’ project, which was extended last year to allow HMG a 40% equity stake on homes worth up to £600,000, has also been a major support for the new home builder – and helps to explain why new build accounts for more than 15% of all housing transactions in the capital. Double the proportion that applied a year ago, new homes are clearly more affordable via this scheme than the ‘second hand’ product in London. Bellway advise that ‘Help to Buy’ is used in almost 35% of completions (up from 29%) and, in London, its proposition is relatively lowly priced at an average of £425k (£367k last year).       

Bellway’s outlook statement also commented on the relative ease of replenishing the land bank, on profit margins expected to exceed historical industry norms: the group owns or controls (which essentially represents land creditors – as it will not have been paid for) 26,331 units with planning permission, up from 23,079 a year ago. Incidentally, including such land creditors would increase debt by £300m, and take gearing to 24.1%. Reservations in February and March to date have been strong, boosting the order book to £1,415m in respect of 5,465 plots.

Management commented on the availability of skilled labour (against the backdrop of Brexit) as being the greatest potential inhibitor of growth, but point to significant investment in their operational capability as countering such concerns. Aligned to this, Bellway confidently expect to regain their status as a 5 star house builder (per Home Builders’ Federation customer satisfaction survey) – joining the only other listed builder with that accolade: Barratt Developments. The recent, well-publicised example of construction woes and subsequent corporate events at Bovis proves that quality matters. Incidentally, talking of that builder, our 3 January blog mentioning Bellway’s charms speculated about the prospect of industry consolidation, referring back to the merger and acquisition (M&A) activity of ten years’ previous.       

Bellway shares have made good progress since that blog, advancing from 2455p at the beginning of 2017 to reach a new all-time high of 2842p on the day of their results. This represents a rise of 15.7% and favourably compares with the FTSE100 index which has risen 3% (from 7,120 to 7,340). However, equity valuation should always be judged from the perspective of current & future earnings potential – rather than on whether a share price is close to its high or low point. Based on 12 brokers’ estimates of EPS of 352.4p for the year to 31 July 2018, Bellway stock is priced on a price to earnings multiple of 8.0 (think of it as taking 8 years of such profit to equate to the share price) and is set to yield dividend income of 4.3% based on next year’s forecast of a pay-out of 120.8p per share. Such potential yields (earnings 12.5% or dividend 4.3%) suggest the shares are underappreciated and perhaps are overshadowed by more exciting, less domestic (think £) earners elsewhere. Given that the results were only announced this week, several of the 12 research houses monitoring the stock may still be ‘crunching their numbers’ – which are set to move, almost certainly, in an upward direction.

By contrast with the traditional manufacturing and consumer biased house building business, our second selection of another FTSE250 index member, Paysafe, could not be more different. The business model of this international electronic payments company might be more difficult to understand, but most readers will appreciate the incredible growth in both corporates’ use of online platforms to offer their wares and the boom in the personal use of mobile devices (smartphone and tablet, beyond the laptop and personal computer at home) to shop, bank and generally consume ‘on the move’, over the past decade. In the 5 January blog, the writer endeavoured to describe Paysafe’s business activities, track record of growth and potential shortcomings.

On 7 March, the company reported its full year results for calendar 2016 which featured a number of very positive financial highlights including a 63% jump in revenue to US$1bn and a near doubling of EBITDA (reported Earnings, before Interest, Tax, Depreciation and Amortisation) to $301m. However, the numbers were flattered by the inclusion of numbers from Skrill – a complimentary acquired business of similar size to Paysafe (or rather Optimal Payments, as the pre-merged business was known) – and the share price was initially marked lower, as both research analysts and fund managers sought to digest and evaluate the results.

The company has been led in entrepreneurial style by Joel Leonoff and has featured both strong organic and acquisitive growth over the past decade. Further progress was confidently predicted by management in 2017 with low double-digit organic revenue growth enhanced by ‘at least’ maintaining the current impressive 30.1% EBITDA profit margins. The integration of Skrill was achieved five months ahead of schedule and the balance sheet now appears close to being ready to facilitate the next challenge. Besides net debt having fallen from $431m a year previously to $280m as at 31 December 2016, the jump in profits means that net debt has more than halved when compared to current EBITDA.

Investors’ concern about the quality – notably in the visibility, sustainability and governance - of current earnings were addressed, as the company appointed two new non-executive directors and announced further investment in risk management & compliance (notably KYC - know your client). Moving to a full listing on the London stock exchange (from AIM) already entailed greater disclosure and the Board appreciate that regulators (in different countries) will be taking a greater interest in the business, as a consequence of Paysafe’s recent takeovers. Such acquisitions, of MeritCard and Income Access last year, have also had the desirable effect of reducing the firm’s dependence on any one customer as well as broaden its exposure to different industries.         

Management have made no secret of their ambitions to grow in this fast expanding business sector. In organic terms, further benefits of scale are envisaged from the development of ever higher capability & capacity platforms; essential given the pace of technological evolution of consumers and merchants’ payment requirements in the digital economy. Further acquisitions are a probability, and likely to be in the next year or so, rather than a possibility – with another Skrill-like size deal being large enough to promote Paysafe to FTSE100 index status.   

Paysafe stock has been in demand since our blog of 5 January, aided by subsequent positive broker notes from Barclays (610p price target), Canaccord Genuity (508p), Deutsche (550p) and Exane BNP Paribas (535p), appreciating 24.4% from 372p to 463p. Currently 10 research houses monitor the London-based firm, all have a Buy recommendation on the shares and the current consensus of these analytical forecasters suggests EPS of 42.8p for next year. This equates to a price-to-earnings ratio of 10.8 times, which is hardly demanding for a company delivering above average levels of growth. Investors are likely to be disappointed if they anticipate a dividend in the foreseeable future; generated cash is being reinvested into the business and will probably be earmarked for the next acquisition.

The bottom line, for both Bellway and Paysafe shares, is that good progress has been made to date, but their longer term appeal remains, given earnings upgrades – post the recent trading reports – and their sub-market valuation. Making sure that exposure to any one company does not become too large is sensible and, while appreciating that equity investment should be viewed in terms of years (rather than months), the prudent investor will no doubt take some profit ‘along the way’.   

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.