Interactive Investor

Stockwatch: This share looks too cheap

9th February 2016 12:02

Edmond Jackson from interactive investor

Is there value in electronics distributor Premier Farnell, given the sale of just one division is fetching 40% of the group's near-£400 million market value? Or, is the de-rating prescient of a wider downturn ahead, with electronics distribution a significant indicator of the business cycle?

It was expected to happen, but the US sale of Akron Brass, an Ohio-based fire-fighting equipment business for US $224 million (£155 million) in cash, represented nearly nine times operating profit.

On those "attractive" terms, Premier's management can pursue "significant opportunities to improve the group's operational and financial performance", with a view to restoring profits growth in the financial year to 1 February 2017.

As global economic indicators waver, the stockmarket is cautious to assume this scenario given a down-dip for Premier's latest financial year, and with the board yet to confirm the extent of a dividend cut.

If a recession beckons, then this kind of stock can become a value trap - but if wider sentiment is overly bearish and fails to recognise the positive benefits of cheaper oil for economic demand, then it can recover in 2016. There are both technical and fundamental reasons why.

Chart assumes 'saucer' profile

The "saucer" is a technical pattern that, according to principle, indicates a stock's price is low and the downward trend has come to a close.

In practice, I would not assume economic life accords with deterministic patterns - there is always a risk of force majeure taking over - but charts can be interesting to assess probabilities, especially when you consider fundamentals also.

Premier's one-year chart largely accords with the theory, i.e. a sharp drop and "saucer" about three-quarters complete. Strict technicians might prefer more evidence of that, but it's certainly worth watching.

Valued lower than major rival

The one-year chart for £930 million peer Electrocomponents shows far less de-rating, mainly due to a sharp recovery from 172p to 237p. That followed an early October trading update which affirmed that its largest business area, continental Europe, is doing well with 13% revenue growth.

Premier is more exposed to difficult markets in North AmericaHowever, North America slipped 3% and Asia Pacific was flat. In its last financial year, Electrocomponents' revenue profile was 35% continental Europe, 29% UK and 24% North America, while Premier's was 46% Americas, 30% UK and 25% Europe and Asia Pacific.

Premier's last trading statement on 17 December cited a 6.9% revenue drop in the Americas for its third quarter, offset by 14.9% growth in Asia Pacific and with Europe off just 0.5%. Group revenue edged up 0.5%, or 2.1% annualised.

So, while Premier is more exposed to difficult markets in North America, and this likely explains much of the valuation differential, it's not altogether a bad story.

Weighing valuations

What's perturbing in a macro sense is the extent of drop happening in the Americas (excluding Brazil) despite a 13.6% advance in sales for the Akron Brass fire-fighting equipment business being sold.

It exemplifies why stockmarkets are so edgy, after years of exceptional monetary stimulus in the US have apparently had little effect on its industrial base. And South America has its own problems, with low commodity prices and dollar-denominated debts.

Only a worsening economic situation can explain why Premier trades on such a low 12-month PEBut, weighing the valuations, only a worsening economic situation can explain why Premier trades on a 12-month forward price/earnings (PE) multiple of about nine times with its stock currently about 102p. A prospective yield of near 6% is covered nearly twice by forecast earnings, and there's strong cash flow backing.

By comparison, at 208p, Electrocomponents is on a PE near 16 times, yielding about 5.5% and covered just over once by forecast earnings.

It will be interesting to see what Electrocomponents has to say in a trading update due this Wednesday, but, even allowing for some differences in the businesses, that's some valuation contrast. The Premier forecasts are recent, so should significantly factor in earnings due to be lost from the disposal which was first mooted last year.

Balance sheets offer explanation

Both these groups have made acquisitions i.e. have accumulated goodwill and intangibles. Premier's end-August 2015 balance sheet shows they represented 105% of £81.7 million net assets.

At that point there were £59 million short-term financial liabilities and £229.4 million longer-term, hence Premier's recent gearing in the order of 335% versus 45% for Electrocomponents.

It would be encouraging to see directors back Premier's improving underlying potential with share purchasesHowever, Premier's interim income statement showed net finance costs clipping barely 20% off operating profit, and the latest £155 million disposal will radically improve the balance sheet. So the market appears to be overlooking this, or could not anyway anticipate the sale proceeds when the stock was de-rating.

A cash injection will improve Premier's risk profile and dividend security, in terms of circa 6.0p per share forecast for the full-year, which is consistent with a 40% cut in the interim dividend. Such a payout ought now to be supporting the stock, unless economies lurch lower.

'Buy' case improved

I drew attention at 105p in September during the early stage of what now appears a "saucer", with the stock testing 92p amid January's sell-off.

The Akron Brass deal deserves noting in this context, given the substantial proceeds. It would be more encouraging to see the directors back their claims as to Premier's improving underlying potential with share purchases - now they should be free of any restrictions around the disposal, although they may still apply with prelims only six weeks away.

One is quite reminded of Home Retail Group, where the market's caution as to its trading outlook has led to a buyer - Sainsbury's - exploiting aspects of underlying value. Premier shares may remain pressured if markets continue to sell off, but if a deflationary scenario applies then it becomes more of a target for rivals seeking growth.

For more information see their website.

Premier Farnell - financial summaryConsensus estimates
Year ended 1 Feb2011201220132014201520162017
      13 months 
Turnover (£ million)991973952968960  
IFRS3 pre-tax profit (£m)93.31056974.869.1  
Normalised pre-tax profit (£m)93.388.274.7777458.164.3
IFRS3 earnings/share (p)1820.913.213.912.8  
Normalised earnings/share (p)1815.814.814.514.110.911.4
Earnings per share growth (%)68.4-12.4-6.4-1.8-2.5-22.94.6
Price/earnings multiple (x)    7.29.48.9
Cash flow/share (p)15.618.42012.913.3  
Capex/share (p)5.3663.75.8  
Dividend per share (p)9.610.410.410.410.466
Yield (%)    10.35.95.9
Covered by earnings (x)1.91.51.41.41.41.81.9
Net tangible assets per share (p)-5.61.80.93.7-2.8  
Source: Company REFS

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