Do robust interims from international provider of vending equipment Photo-Me International (PHTM) position it well for 2018?
Capitalised at over £700 million, yet still in the FTSE SmallCap index, Photo-Me’s five-year chart shows a re-rating from 63p to 150p in 2013, with the QE-driven shift into risk assets. It then traded sideways for three years in a 120-175p range, as the market awaited evidence that a diversification strategy can work.
In the second half of 2017, the chart broke out of this range and ran up ahead of this week’s results, helping explain a 10p drop to 177p after the statement implied a full-year to 31 January outcome “in line with expectations” rather than any upgrade.
Previously, in response to a strong AGM statement on 25 October, Canaccord Genuity (a joint broker to Photo-Me) upgraded its current-year profit outlook slightly with a ‘buy’ stance, and independent broker N+1 Singer also followed through with a ‘buy’ rating on 21 November.
Moderate yet robust growth profile
While some profit-taking looks expected in a chart context, to be ultra-fussy on fundamentals, management cited at the AGM 11.2% like-for-like revenue growth for the first five months which now turns out at 10.5% for six months, as if a slowing in October.
Yet, that’s a narrow snapshot and at constant currency the six months’ revenue growth rate is 7.8%, still good. Pre-tax profit is up 6.1%, or 3.1% at constant currency, earnings per share (EPS) by 9.6% to 6.40p and the interim dividend by 20% to 3.71p. The cash flow statement shows £34.8 million net cash generated from operations, down 1.2% at £43.8 million, with £15.6 million spent on investment and £11.6 million on dividends – that’s robust, despite inherent vagaries within a cash flow profile.
The diversification story has kept shifting in recent years in an effort to source new growth, as digital photography has undermined traditional photo-booths which most people associate with Photo-Me.
I recall over 15 years ago, management introduced digital photo printing kiosks to bolster growth; more recently there was excitement over the introduction of ID cards in Japan; yet now it’s the expansion of laundry services – machines in car parks, and also launderettes -especially in Continental Europe, that’s presented as the chief growth driver.
While unexciting, such services are useful. For large items such as duvets, it is not easy to clean domestically, and, like ID/passport needs, they should not be exposed like discretionary spending to a consumer downturn.
Management concedes that if governments were to adopt centralised image capture or accept self-made photographs for document applications, this could hit revenues/profits, but says it has developed new systems securely linking its booths to government repositories. With banks looking to extend their service reach, the group has showcased new products and won an award to provide retail banking via the photobooth network.
International profile partly mitigates UK risk
Consumer-driven UK small caps are exposed to wage/inflation pressures and credit appetite easing, but segmental analysis (note 3 to the accounts) implies 18.5% of external revenues derive from Asia, 54.1% from Continental Europe and 27.4% from the UK and Ireland.
This diversifies revenue risk, helped by the European Central Bank’s cumulative monetary stimulus aiding the Continent’s recovery, although ECB bond-buying will halve next January. Thus, Continental Europe is presently the driver for Photo-Me’s main business areas of ID technology/services, laundry and printing kiosks.
Mind an uncertainty regarding UK domiciled businesses operating in the EU, even for those like Photo-Me that have been established there for many years – 6 of 7 directors are European and only the non-executive chairman is British – given it remains to be seen what will be terms of trade when Britain leaves in March 2019.
Brexit may, however, lead to positive outcomes such as replacing EU burgundy passports with the British navy blue version, which for practical purposes would have to happen at airport checks. Strengthened immigration regulations may also raise demand for Photo-Me’s secure ID products.
Laundry is seen as the primary growth driver via increased capacity and acquisitions, towards a medium-term objective for 6,000 units (owned and sold, via a manufacturing partner in Poland) by end-2020. It’s even replaced photo ID cards in Japan in terms of growth expectations, from a low base of just six launderettes open.
The implication is that Japan’s photo ID opportunity is proving more hope than substance, as high competition seeks to capitalise on the government’s medium-term objective to make it compulsory.
Cash flow/yield: more attractive than earnings valuation
The outlook statement implies meeting forecasts for high single-digit annual earnings growth, at least in the current financial year, giving a 12-month forward price/earnings (PE) ratio in the high teens. On a PE valuation basis, dividing by the projected earnings growth rate derives an expensive PEG ratio towards 3 times, although the table shows annual average historic PE multiples up to 27.4, with 2017 averaging 19.5 at the low end of the range.
Most likely, investors are respecting relatively stronger cash flow per share figures which, despite being half-absorbed nowadays by capital expenditure, support dividend growth.
Thus, despite the shares’ being at the top of their three-year range, their prospective yield is usefully about 5%. The interim statement shows £39.9 million operational cash flow enabling £18.7 million to be applied rolling out the laundries concept and buying launderette shops in Europe. There’s also £11.6 million to distribute as dividends.
At end-October the company had £63.1 million cash and total debt of £17.9 million, so although cash generation looks tempered lately, the board should be able to make progressive dividend payments. The second half year is set to benefit from enhanced profitability as manpower is taken out of the retail operations.
Otherwise, the balance sheet profile is strong albeit no real prop for the shares. Goodwill/intangibles constitute 21.4% of £128 million net assets equivalent to 31.4p per share, at least improving on 27.3p as of last April. Strength of cash position means the ratio of current assets to current liabilities is 1.44. In the event of a consumer slowdown the balance sheet doesn’t present a risk; which is relevant to dividend security.
Photo-Me International year ended 30 Apr Consensus estimates 2013 2014 2015 2016 2017 2018 2019 Turnover (£ million) 196 187 177 184 215 IFRS3 pre-tax profit (£m) 24.3 30.1 38.5 40.1 48.0 Normalised pre-tax profit (£m) 21.6 30.3 31.5 39.9 47.2 50.9 54.5 Operating margin (%) 10.7 16.0 17.6 21.3 21.8 IFRS3 earnings/share (p) 4.8 5.7 7.4 7.7 9.3 Normalised earnings/share (p) 4.1 5.8 5.6 7.7 9.1 9.8 10.4 Earnings per share growth (%) 4.4 42.2 3.3 37.9 17.8 8.3 6.1 Price/earnings multiple (x) 19.5 18.1 17.0 Price/earnings to growth (x) 1.1 2.2 2.8 Historic annual average P/E (x) 22.2 27.4 26.0 23.0 19.5 Cash flow/share (p) 10.8 9.7 10.8 11.0 13.1 Capex/share (p) 4.2 5.5 4.8 6.1 10.8 Dividend per share (p) 2.5 3.0 3.8 4.9 5.9 8.4 9.0 Dividend yield (%) 3.3 4.7 5.1 Covered by earnings (x) 0.7 1.9 1.0 1.6 1.1 1.2 1.2 Net tangible assets per share (p) 21.7 23.5 23.3 27.0 27.3 Source: Company REFS
25%+ total shareholder return over past two years
I originally drew attention at 155p in November 2015, arguing that the risk/reward profile was attractive given sound cash generation, a 6% yield with 10% annual dividend increase targeted for the next three years, and diversification starting to pay off.
The story has admittedly varied, “laundry” doesn’t exactly grab attention and concepts such as car-wash (in France) appear to have been wiped out. Sentiment has been prone to swing according to greed/fear, and what changes in governments’ ID policies could bring.
Yet a relatively high-quality dividend – due to proven cash flow credentials, geographic and services’ diversity – should continue to support the stock. Sellers are probably frustrated the growth story isn’t more focused and exciting, but Photo-Me should continue to reward long-term investors overall. Buy on any further weakness.
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.