Amongst the gloom...

Monday, 18th January 2016 10:27 - by David Harbage

It has been a tough start to the new year for equity markets, as concerns surrounding China’s growth (and its appetite for raw materials) and financial health (corporate and consumer indebtedness) have undermined normal ‘New Year - fresh start’ optimism. An increasing number of terrorist atrocities and spats amongst the major powers in the Middle East have not helped.

But amongst the gloom there are undoubtedly a few businesses which have shone brightly. In a less certain world, investors tend to become more risk-averse and will favour domestic businesses which they consider to be unaffected by international travails. One that caught the eye recently was the cake and specialty bread maker Finsbury Foods, which has benefited from higher demands for children’s party, cum celebration, cakes and evidence that UK consumers are keen to treat themselves to premium products in the bakery department.

On Friday, Alternative Investment Market (AIM) listed Finsbury Foods released a trading statement covering the second half of 2015, which pleased the market. The company has primarily grown by acquisition, with six major deals in the period 2002 to 2009, before picking up the cheque book again to purchase Fletchers Bakeries in 2014 and Johnstone’s Food Service last year. As a consequence of the successful integration of the latter, turnover jumped 46% (as compared to the comparable six months of 2014) to £156.6m. But, more impressively, organic growth has also progressed with like-for-like sales up 7.4%; Johnstone’s provided exposure to Europe, where revenue was 18.8% higher, as compared to the 6.1% domestic like-for-like (i.e. excluding new manufacturing, and comparing only bakeries which were in existence over both periods).

Food manufacturing has proven to be a very difficult part of the market over the past few decades, with the industry being squeezed by volatile raw material or ingredient costs and by retailers who, typically being much bigger, held pricing power. Finsbury does incorporate mainstream bakery product sold to the leading supermarkets – including own label – but it has focused on building up its higher margin offering. Investors have warmed to the prospect of lower oil prices fanning out like a benign contagion, and the board’s strategy of positioning product in value-added areas or via specialist distribution channels like Costa Coffee or Thorntons. Gaining licenses over Star Wars, Frozen, Peppa Pig, Minions, the Simpsons and other Disney branded cakes provides appeal, its Weight Watchers product offers differentiation while, in premium bread, the proposition features Vogel ‘s seeded breads, Cranks organic and Village Bakery rye bread.

Finsbury shares have performed well, rising from 25pence five years ago, and 60p a year ago, to 113p today. In the year to 30 June 2016 earnings are forecast to rise 8% to 8.3 pence, and the dividend to 2.8p – putting the shares on a PE ratio of 13.7 and offering a dividend yield of 2.5%. If the company, which has had to invest heavily in new automation, can continue to find attractive earnings-enhancing ‘bolt-on’ acquisitions, it will continue to keep its shareholders happy (directors own nearly 3%, Ruffer 17%, Miton 12%). However, in the short term, the stock appears to ‘be up with events’.

There are undoubtedly other domestic businesses which appear well insulated from the current turbulence impacting the international stage. Investors would be well advised to consider demographic or other trends in which they feel comfortable; certainly most commentators would suggest that a UK consumer focus – such as housing, per previous blog, or demand for motor cars - offers more appeal at the present point in time. Historically, over the longer term, housing and the motor industries have been viewed as cyclical and been rated more lowly by the market (primarily because profits will be less reliable). Speaking of motor cars, last Thursday the finance director of Private & Commercial Finance Group made an initial purchase of 165,038 shares in his new (he joined in August) employer’s firm - which provides consumer finance for motor vehicles and specialist business finance for small & medium size enterprises (SMEs).

In December, the company announced very strong trading in its half year to 30 September 2015 and suggested the full year results would be ahead of the market’s expectations. Rather like Finsbury, the stock has almost doubled over the past year (from 12.5p to 24p) and appears to represent a fair valuation at current levels: for the year to 31 March 2017, PCF are projected to deliver earnings per share of 2.05p, and a dividend of 0.25p, which would represent an earnings multiple of 11.7 and an income yield of 1%.      

Written by David Harbage for lse.co.uk on the 17th January 2016

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.