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'Bottom
Up' Investing 3 of 5
For bottom-up
investors the individual company entries are the first port
of call. After analysis, any company of interest can be put
in context by looking at the REFS on line tables.
All investment
analysts have their own investment beliefs, preferences and
particular ways of analysing an investment.
The value
of Jim Slater’s Zulu Principle approach can be demonstrated,
for example, by taking Debtmatters – an Investing
for Growth recommendation in the past - to show how to
decide whether or not a growth share is a worthwhile candidate
for one’s portfolio.
(Note:
this illustration is based on REFS on line data from the
11th July 2006 and should not be construed as a recommendation.
Also the REFS on line data is dynamic and changes from day
to day).
One might
notice the shares of Debtmatters in the table of growth companies
with very high growth rates, or more likely in the table
of shares with ‘Low PEGs for Growth
Companies’.
In this particular case Debtmatters has a very low and attractive PEG of
0.12.
Alternatively,
your broker might have drawn the company to your attention,
stressing the rapidly growing underlying market for IVAs
(Individual Voluntary Arrangements), which for individuals
is a less drastic alternative to bankruptcy and which is
Debtmatters’
main source of revenue.
Over the
last few years consumers have embarked upon an unprecedented
spending spree. The upshot is that UK consumer debt is now
running at almost £1.2 trillion. The number of IVAs registered
with the DTI in the year ending
2005 exceeded 20,000, almost double the number in 2004.
Based
on current monthly run rates these are expected to double
again to in excess of 40,000 in 2006. Meanwhile, company
figures released for the year to March 2006 show that Debtmatters
increased its new IVA case run-rate faster still.
Your
appetite whetted, you now need to check the REFS on line
financial statistics in more detail.
First,
you should glance at the REFS graph. It gives you an instant
overview of a share that has performed exceptionally well
since it listed on AIM in June 2005 at 65 pence.
EPS have been growing
at a heady pace which seems set to continue, for example
up by 623% in the FY 2006 and forecast to grow by a further
191% in FY 2007. Relative strength has been excellent at
+270% over the last twelve months, +96.3% over the last six,
+24% over the last three and +9.2% during the last month
(to July 11th 2006). Clearly the strong momentum is continuing.
The
average PER over the last two years has
been 96.7 and 76.2 reflecting its historic meteoric growth
in earnings, so the company usually commands a high multiple.
However, the prospective PER of 14.5 is
now well below the normal limit of 20 specified for growth
shares in the Zulu Principle.
What
is more Debtmatters is continuing to grow at an extraordinary
rate, which makes the share look exceptional value. This
enables one to soften other criteria, like cash flow and
balance sheet strength (more on this below).
Next,
one should check the KEY STATISTICS. The
market cap of £91.8m puts Debtmatters in the top 150
companies by market capitalisation on the AIM Index (i.e.
within the top 10%).
Promotion
to the Main Market seems unlikely in the short term, so there
is no need to look at REFS on line’s table of Promotion
Candidates. However, at the company’s present rate
of growth Debtmatters may consider such a move in a couple
of years.
A prospective
dividend yield of just 0.21% plus a blackish moon tells you
that low dividend yields are typical for the sector. However,
this is not a major drawback for a great growth share,
especially for one at a relatively early growth phase.
Currently for Debtmatters it is much more profitable to
invest in the expansion of the business rather than re-distribute
cash as dividends to shareholders.
The prospective PER is
surprisingly low for such a high rate of growth in earnings.
Moreover, the PEG (as mentioned above) is
exceptionally attractive at 0.12, as evidenced by the almost
full black moons against the market and the sector.
The forecast
growth rate in EPS (earnings per share)
of 191% for FY 2007 is still very high although lower in
relation to the past. It is three months since Debtmatters’ financial
year began, so the 118% forecast growth rate in EPS is
a blend of the consensus forecast of 191% for FY 2007 and
42.3% for FY 2008.
Now,
take a look at the individual brokers' forecasts. In this
instance, there are four, which is impressive for company
of Debtmatters’ small size.
Charles
Stanley’s and Daniel Stewart’s EPS forecasts
are consistent at just over 23 pence for FY 2007 and around
33 pence for FY 2008. The brokers clearly like the stock
with two buy ratings and one strong buy (plus one is still
embargoed).
Next,
check past increases in EPS in the large
panel of historic figures: 2005 - 3600%, 2006 - 623%, 2007
(forecast) - 191% and 2008 (forecast) – 42.3%. Although
the forecast growth for EPS is projected
to fall to 42.3% in FY 2008 this is still attractive and
well above the prospective PER of 14.5.
In addition one should expect the growth rate to ease given
that the company started from a very low base of earnings
in 2004.
Also,
check the OUTLOOK statement. In April the
company said that it expected results for the year ended
31st March to be ‘ahead of market expectations’.
This followed a statement at the AGM in
February when the company expected the full year results
to be at the upper end of analysts expectations.
Operating
margins have risen strongly as the company has taken advantage
of increased scale and operational efficiencies. Between
2004 and 2005 the operating margin rose from 4.05% to 23.6%
and in the year to March 2006 the pre-tax profit margin rose
from 21% to 36%.
The rocketing
turnover primarily as a result of the dramatic increase in IVA revenues
(£1.73 million in the
year to March 2005 compared with £7.79 million in 2006)
coupled with the very strong growth in margins is behind the
dramatic increase in profitability which is forecast to rise
from £2.8 million in 2006 to £8.3 million in
the year to March 2007.
Not unnaturally,
the brokers expect growth to taper off over the next couple
of years. However, the earnings enhancing acquisition of
Loanmakers (refer below to NEWSFLOW) for
which according to house broker Charles Stanley the company
is paying seven times earnings (before interest and tax)
should give a further boost to organic growth and profits
and possibly lead to broker upgrades.
As the
black moons indicate, both return on capital employed (ROCE)
and margins are excellent. The five year historic results
panel shows clearly that margins, in particular, have been
growing at a very attractive rate.
This is
a very healthy sign and is almost certainly an ongoing feature
as turnover is increasing by leaps and bounds. In fact one
of the most striking features of the Debtmatters REFS page
is the predominance of black moons in the growth statistics
panel, especially for the PEG, EPS growth
rate, ROCE and operating margin.
Now look
at the GEARING, COVER panel.
Gearing is high at 208%. However, borrowings are only £0.53
million and interest cover is a healthy 12 times. Cash
flow per share is also negative. Here, one has to take
into account both the company’s early stage of development
and the nature of its business model. It can take up to
a year to recover the outlay on an IVA (i.e.
advertising, set up costs and administration).
Debtmatters
has grown so rapidly that most of the 4,500 IVA cases
on its books are yet to earn it a positive return, in particular
from recurring revenues (monitoring fees). Reassuringly,
its larger competitor Debt Free Direct, which is about 12
months ahead in terms of its stage of development, has seen
net cash from trading turn positive due to significant monitoring
fees from its 5,500 cases.
Now looking
at the value statistics panel. Debtmatters is not an asset
situation, so one should not be overly concerned with PBV (price-to-book-value)
or PTBV (price-to-tangible-book-value).
The PCF (price-to-cash-flow)
is also negative and as discussed above reflects the cash
outflow associated with the setting up of IVAs as one would
expect with a company at this stage of its development.
By
contrast Loanmakers is strongly cash positive which will
reduce Debtmatters working capital requirements. Also, as
discussed above cash flow per share, which is negative, should
start to turn positive within the next 12 months.
As indicated
by the white moon, a PSR (price-to sales
ratio) of 53 is extremely high. High PSRs often
accompany the high margins of companies with a very successful
selling formula.
With a
growth share of this caliber and the rate at which Debtmatters’
turnover is rocketing this should plummet over the next year
to a much more comfortable level.
Next,
look at the panel of historic figures and, in particular,
at turnover and turnover per share.
The growth
in both is strong and consistent. The excellent and growing
operating margin figures have already been checked and ROCE and ROE (return
on equity) are also consistently well above average, suggesting
a degree of competitive advantage and an extremely lucrative
and profitable business model.
The accounts
look very clean given that there is no difference between
FRS3 EPS (the statutory reported earnings figure) and normalised EPS (adjusted
to reflect the underlying business eliminating one-off exceptional
items).
A normal
tax rate of circa 30% projected for FY 2007 and 2008 is also
reassuring. Creative accounting is unlikely to have been
at work.
Capex (capital expenditure)
is low because Debtmatters is a ‘people’s
business’, which means that once the company turns
cash positive a smaller proportion of available cash should
be absorbed in future years. In the case of Debtmatters
future cash generation by FY 2008 should be very healthy,
leaving a substantial balance of 'owners’ earnings'
each year.
The next
point of interest is SHARE CAPITAL, HOLDINGS and DEALINGS.
As can readily be seen, Gerry Ratcliffe, the CEO is the dominant
shareholder with 62.5% of the shares.
No share
transactions are showing for any directors over the last
six months. Only if there is heavy cluster selling, should
alarm bells ring.
A final
look at NEWSFLOW shows that the company
has just completed a major acquisition of Loanmakers for
an initial
£10 million, a complementary business and FSA registered
master broker handling secured loans. With the placing of
six million shares at 330 pence and a share price of 373
pence the market clearly likes the look of the deal at a
cost of seven times earnings (before interest and tax).
The KEY
DATES panel tells you that the AGM was due at the
end of July 2006. There could well be another bullish statement
then which should provide a further boost to market sentiment.
All
in all, one can conclude that after allowing for its early
stage of development and the nature of its business Debtmatters
meets many of the criteria specified for growth stocks within
the Zulu Principle, particularly in relation to the growth
statistics and is therefore a strong candidate for one’s
portfolio pre-supposing that one is comfortable with the
company’s
business model which is yet to turn cash positive (refer above).
The
next step is to obtain the Annual and Interim Reports,
brokers' circulars and press cuttings before coming to
a final decision.
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