Edmond Jackson's Stockwatch: AGA a stock to accumulate

Despite a 60% jump in interim operating profit from cooker manufacturer AGA Rangemaster, its FTSE SmallCap shares have slipped 5p to about 150p, in context of the 2014 trend declining from 188p.

This follows a strong rally from 71p to 173p in 2013, which was dramatic in a five-year chart context and another example of a stock soaring in 2013 only to consolidate in 2014.

This is especially true of "quality cyclicals" where the dilemma is: does this represent a buying opportunity or do drops define a top in a five-year bull market? Consider how equities and the housing market have benefited from loose monetary policy; will the boost expire or have a longer-lasting effect?

AGA's normalised pre-tax profit and earnings per share are forecast to rebound sharply (see table) as cooker sales benefit from a strong UK housing market - also with affluent families upgrading kitchens.

Group revenue growth is essential, however, in the longer run, after a flat trend in the last five years. New product sales need to outstrip the decline in traditional cast iron cookers. The shares trade on nearly 60 times 2013 earnings although the multiple drops to about 12 for 2014 and below 10 for 2015, if forecasts are realistic.

Clearly a lot must happen in the second half after a £2.0 million pension charge and £700,000 finance charges meant a £300,000 interim pre-tax loss.

Housing market effect

As I have recently noted with regard to Barratt Developments, there is opinion that the UK is placed for a firm housing market to 2018, notwithstanding volatility in London. If this scenario applies then it would enable AGA to further capitalise on new products as part of a turnaround.

I also initially drew attention to this share at 62p in November 2012 because international expansion (e.g. China) may enhance long-term takeover prospects, AGA being an iconic brand.

Interim group revenue edged up just 3.3% albeit by 9.7% in the UK which accounted for 63% of 2013 revenue (the last available geographic breakdown) against 22% for continental Europe, 13% the US and 3% rest-of-world.

New products are said to be doing well with over 60% of first-half orders involving either the electricity-run Total Control launched in May 2011 or Dual Control in July 2013. It will be especially worth watching progress of the AGA City60 priced at £4,995 in the hope of significantly widening the customer base.

These designs are helping change perceptions of AGA away from oil-guzzling, cast iron range cookers, where sales of Rayburn and Stanley continue to decline although updated products have been introduced lately.

Mind the cost of it all: the table shows how capital expenditure per share has again ramped up, close to earnings per share, with Company REFS citing a modest return on capital of 8%. The published statements don't elucidate any capex cycle although it seems fair to expect relatively heavy capex continuing - which may eventually provide logic to integrate with a larger industrial group than remain a stand-alone plc.

While the UK is progressing well, with share of the range cooker market increased over 50%, the French market (AGA's largest for export) has seen a sales decline which is not yet quantified.

The interim results did not detail US sales either beyond citing AGA Marvel and Fired Earth (tiles) doing well but Grange (furniture/cabinets) suffering. Management says that despite re-organisations, the US and Irish businesses have seen sales fall and profits yet to recover.

So quite a lot has depended on a robust UK market - i.e. loose monetary policy and continued polarisation of wealth in society. A lurking question is whether a Labour majority government from 2015 would jolt confidence in the housing market and hike top rates of tax.

Another aspect to watch is first sales in China this autumn after a two-year effort to obtain accreditations. The Chinese market will generate small sales initially, but could ramp up longer term as wealthy Chinese seek the best for their homes.

Uncertainties

Overall, markets are said to "have picked up but remain inconsistent and variable. Uncertainties around mortgage availability and interest rates are a contributing factor. Even so, the willingness of consumers choosing to spend money on kitchen appliances has increased in the UK and in North America".

Not surprisingly therefore, investors are unwilling to chase the forward price/earnings multiple higher than 12 when forecasts assume plenty.

Yet the chief executive and finance director believe in value, having just bought shares at 157p - 6,410 and 3,846 respectively, taking their holdings to 247,696 and 171,843. Clearly they are confident the turnaround has further upside.

Net debt has reduced to £2.4 million from £6.0 million year-on-year, amid better cash generation; but mind how the pension situation is playing out: its interim finance charge rose from £1.8 million to £2.0 million and while its assets have risen by £10.4 million since the start of the year (despite £19.4 million payments), a fall in discount rates has meant a £21.3 million rise in liabilities hence the deficit to £46.7 million.

This compares with a market cap of £104 million currently. It is interesting how the stockmarket used to fret over pension deficits a couple of years or so ago, then rising sentiment brushed this aside. Issues remain though.

There is no dividend yield, payments being projected to resume in 2015. With the shares at a premium to net assets (of £109.5 million net assets, £64.1 million comprises goodwill and £24.9 million intangibles), it puts a lot of emphasis on earnings.

Overall, AGA Rangemaster remains a share to accumulate, I incline to say "when the market takes a hit" like it could this autumn as the Ukraine crisis deepens and borrowing to buy equities has reached record levels - along with share prices - in the US. It also shows how stocks have soared while neglecting certain risks.

For more information see agarangemaster.com

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.