Stockwatch: A share to buy amid political chaos

Does AIM-listed Sanderson deserve a better rating for growth? Software and IT groups are prone to be rated as cyclicals according to trends in technology replacement; but shifts in the landscape can offer longer-term growth opportunities. Adoption of mobile and e-commerce by retailers is one such example as these firms strive for financial progress in a tough consumer environment; and Sanderson is well-positioned.

This small but nimble company has developed "multi-channel retail" as a growth prospect additional to serving manufacturers, such that accounts for the year to end-September 2014 show 59% of group revenue and 57% of profit derived from multi-channel retail. A forward price/earnings (PE) multiple of 14, easing to 13, plus a dividend yield of about 3% is undemanding assuming the UK economy does not stall.

Stock has traded sideways for 15 months

The five-year chart has shown very good progress from a mid-20p range to 76p by early 2014. But as many stocks benefited from loose monetary policy then consolidated, Sanderson has traded sideways in a 60p to 75p range for the last 15 months.

However, the rally originates from post the financial crisis: I drew attention at 10p in August 2009 when curiously the directors' wives were piling in. If only for the interests of matrimonial harmony, the risk/reward profile had to be favourable; and indeed the five-year table shows a healthy financial profile with majority earnings converted into cash, supporting both investment and a progressive dividend policy. Just over half of earnings are recurring which mitigates the risk of IT cycles; and the end-September 2014 balance sheet had £6.2 million cash providing scope for further acquisitions.

A 22 April, pre-close trading update for the six months to end-March has cited revenue and profit growing by just over 10%. That implies very good progress in multi-channel retail considering the manufacturing side is quite flat; although its order intake improved during the period and sales prospects for the second half-year are said to be good.

Like-for-like comparisons at the interims should be more helpful to discern progress, as there have been acquisitions such as Proteus on 5 December, a warehouse management solutions business with nearly £2 million revenue in its year to end-September (albeit a £3,000 pre-tax loss). This, therefore, will have enhanced revenue and possibly group sales order intake, cited up from £4.3 million to £4.9 million. However, the group's existing customers are said to be "particularly active."

Reflecting wider uncertainties I discussed in my last macro piece, "the general economic environment continues to show signs of improvement, though sales cycles continue to be protracted." This mild caution has kept the stock in check - if anything it has slipped a penny from 65p since the update - which is to the advantage of patient investors playing retail's shift to mobile/e-commerce marketing.

"Cloud" business acquisition: a key strategic step

The October 2013 acquisition of One iota for a maximum £5.4 million, helped by a £3.5 million placing at 55p a share, introduced a proprietary "cloud-based" technology platform - capability that tends to be critical for software solutions in online commerce. Retailers such as Littlewoods and SuperDry are involved and the company made £195,000 pre-tax profit on £660,000 revenue in its year to end-January 2013; despite modest financials however the company looked a good fit hence scope to leverage sales. Last November's prelims cited One iota achieving its largest-ever order in September 2014, valued at over £400,000. There had previously been a smaller e-commerce related buy in August 2013, of Catan Marketing, albeit for just £0.6 million maximum outlay - providing e-commerce solutions under the Priam name to over 30 retailers.

Longer-term takeover potential

At 64p a share this is a circa £35 million business, 21.6% owned by its chairman (who acquired substantial equity at market lows). While it is possible the stake eventually gets placed with institutions, his exacting best long-term value would involve a premium for control in a takeover - thereby acting as a motivator towards such an outcome. Sanderson is anyway a long-term bid target for another IT group looking to develop capability in multi-channel retail and e-commerce. Any software group lacking a weighting in this area is liable to be at strategic disadvantage.

Intrinsic value does therefore imply upside

Having made this strategic move as a nimble smaller firm, Sanderson deserves more goodwill in its rating - but the image of "small AIM stock" prevails, hence the ongoing consolidation in stock price. In due course however it will bump up against the likely reality of medium-term good results from multi-channel retail, making the stock attractive as a tuck-away, especially to mitigate inheritance tax where many AIM stocks involve a high risk of a fall in capital value.

Negative net tangible assets may deter some conservative investors: the end-September 2014 balance sheet had £28.5 million intangibles in context of £25.8 million net assets. This is to be expected of an intellectual property type business however, and where the group's principal assets are its 190 personnel. There is no debt to compromise operating profit: £160,000 finance expenses related mainly to interest on a £4.8 million pension fund deficit.

In the short term, the biggest risk is likely a hung parliament with strong SNP influence, stymieing business confidence to invest in software replacements. However, the trend to mobile/e-commerce looks plenty firm to recoup any setback, making Sanderson one of the shares to be eyeing if political chaos does ensue.

For more information see www.sanderson.com/