Edmond Jackson's Stockwatch: St Ives could see further upside

If a latest British Chambers of Commerce survey is reasonably correct - that Britain's economy should exceed its pre-recession growth peak in the next few months as investment picks up - then firms geared to rising business optimism should benefit. One example is St Ives, a FTSE Small Cap-listed company re-positioning from print to marketing services, especially digital which is in vogue.

I initially drew attention in October 2012 as St Ives approached 90p a share when the share's derisory rating contrasted with strong results emerging. The price/earnings (P/E) multiple was only five and the prospective yield 7% covered over 2.5 times by earnings. "In short, the kind of share that looks primed to re-rate."

Of intrigue, the chart at the time represented a "saucer" that, according to chartist folklore, can also presage a rise. But it mainly appears the market was jaundiced about St Ives' exposure to book printing and operating results have quashed this poor sentiment. There may be a median level of demand for printed books instead of largely being replaced by digital. Near 200p a share currently, the P/E has doubled to about 11 times projected earnings and the prospective yield moderated to 3.7% - still useful - for fresh buyers.

A play on Britain's recovery

Last August I noted attractive prospects despite a re-rating above eight times earnings with the price at 165p, and St Ives' ongoing rise shows it perceived as a play on Britain's recovery - the main question being, how strong and durable will it prove? Latest forecasts speak of the fastest growing nation in the G7.

St Ives has slipped from a recent high of 204p to about 198p after latest results for the 26 weeks to end-January showed underlying group revenue up barely 2% to £164.8 million versus underlying pre-tax profit up 13% to £12.9 million with earnings per share also up 13% to 8.1p.

The table shows how profit/earnings advanced in the 2012/13 year despite a 2% slip in revenue, so at first sight the earnings trend looks as if it will hit peak margin. The details are more encouraging however: marketing services revenue rose 50% to £46.7 million, helped 13.9% by new client wins and 36.1% by acquisitions, such that its operating profit now represents 35% of the total with an objective to become over half of group operating profit by 2016.

While revenue on the print services side (books and marketing print) fell by 7.4% to £121.7 million, this reflected the October 2013 sale of a direct mail printing operation, otherwise revenue would have improved 2.4%. In book printing, "volumes are now stabilising and we continue to believe that digital and printed books will co-exist. Our investment in digital print production has allowed us to respond to changing consumer behaviour and meet the demand for quick response and short print-runs".

So recent headline figures are snapshots that don't properly reflect how the group is evolving. Possibly the trend towards digital marketing has its own momentum irrespective of the wider economy, as many businesses develop this capability. Also on St Ives' print side, a graphics business serving exhibitions and events "performed satisfactorily without the positive effect of the Olympics and Paralympics in the previous period. This business stands to benefit from continuing signs of confidence returning to the market for discretionary marketing spend".

Improving business investment

Sceptics have seen Britain's recovery as imbalanced towards house-price rises and consumer borrowing; yet business investment is now improving and forecasts for modest wage growth are starting to appear; meanwhile the Bank of England keeps reassuring against interest-rate rises in the short to medium term.

It is starting to look as if external events are the main risk, and it would need something severe. While St Ives more than doubling in value over 18 months may look as if prospects are priced in, it was never envisaged that Britain would recover so strongly or soon.

The interim cash flow statement also looks encouraging as a health check. Gross cash flow from operations rose 15.2% to £16.9 million, and £2.9 million proceeds from disposals facilitated £9.7 million investment. Despite dividend payouts rising from £4.8 million to £5.6 million, net cash at the period-end worked out at £12.6 million versus £8.7 million like-for-like, helping net debt reduce from £15.2 million to £12.4 million.

A week before these results came the acquisition of Realise Holdings, "one of the most respected digital marketing agencies in the UK" with a well-established client base across various sectors. It made £1.7 million operating profit on £9.7 million revenue in its year to end-September 2013 and St Ives is paying an initial £21.7 million mainly in cash, with a further £18.3 million according to the next 18 months' performance.

This may look a full price unless post-tax profit is trending well, but not if St Ives can combine clients and services to exact value. "With the acquisition of Realise, we are adding substantial depth to our digital offering and further enhancing the range of marketing services we can provide for our existing and prospective clients." Both sides in the deal therefore look motivated by a "2+2 = 5" rationale.

So while the P/E rating and yield now seem fair, on a two-year view the risk/reward profile favours further upside assuming economic recovery is not de-railed.

For more information see st-ives.co.uk.