S P E C I A L S I T U AT I O N S
the country, a 15% market share reflects the fragmented nature of this market. The work it performs is nevertheless safety-critical, non-discretionary and generally delivered under multi-year contracts of varying lengths, a fact reflected in the firm’s £372m multi-year order book. Further, customers, which include local governments and housing authorities, usually agree to inflationlinked pricing. Whilst the growth potential for the underlying market is limited, we nonetheless see revenue gains arising as Sureserve takes more of the available market. In a highly regulated area such as this, failures can be catastrophic, which should play to the firm’s reputation as a large, high-quality operation. Recent investment in the bidding team has reportedly already driven an improvement in the conversion ratio of bids to wins from one in three to one in two. A fragmented market also offers scope for non-organic growth, an opportunity that was flagged in the recent interims. Overall, EBITA margins at the division have grown strongly via a combination of revenue growth, a richer mix of projects, and efficiency improvements. However, our investment case does not rely on additional margin expansion. Instead, the crux of it is the valuation of just 10.3 times September 2022 earnings, alongside a 7.0% free cash flow yield and 2.6% dividend yield. This is compelling on an absolute basis, given the high levels of earnings visibility (around 99% for FY21, 56% for FY22 and 26% for FY23), the scope for growth from acquisitions, and a potential recovery in the Energy Services business. By comparison, its nearest listed peer, Marlowe, trades on about 29 times 2022 earnings, albeit it has adopted a different strategy based on “buy and build”. Even so, successful M&A execution from Sureserve will make it harder to justify the valuation gap. The balance sheet is also strong, with net cash of £9.7m reported at the
interim stage in March 2021. This should build towards a year-end position of closer to £12m, rising to £18m by the end of FY22. At these levels, special dividends should be on the cards in the absence of suitable M&A.
Studio Retail – scaling sales Studio Retail (formerly Findel) is a digital value retailer with an integrated financial services proposition. We believe that it operates in something of a retail sweet spot and therefore view its target of £1bn in annual revenue, from around three million customers, as conservative. Historically, the operational picture has been clouded by the sheer number of businesses within the group, encompassing healthcare, door-todoor product sales, a dedicated online sports retailer and even education. However, management have disposed of all of these, leaving the firm as a pure-play online retailer generating over 90% of sales via its “digital department store”. The rest come from a small base of customers who still submit orders via the phone or by post. Interestingly, the company still uses catalogues as part of its overall marketing mix, where it deems them to be more cost effective than online advertising. Although there is stiff competition from “digital first” retailers (e.g. Amazon, Shop Direct and N Brown), traditional value retailers (Primark, B&M, ASDA/ George and Argos) and credit providers (Argos, Next, Shop Direct and N Brown), none of them quite captures its home market in the same way as Studio Retail. Around 2.5million active customers buy from it via the internet and are offered cash payment terms, or a range of credit options, which are taken up by about 60% of them. In common with other online retailers, the closure of physical stores as COVID-19 raged helped to drive record sales and profits for the group in FY21, with revenues up by 45% and profit before tax by 75%. Arguably more important still has been the 36% expansion of the overall customer base,
with around 15% of that coming from the firm’s more loyal credit customers over the last year. We hope that this will lay the foundations for several years of further growth. The company has nonetheless been in something of a no-man’s land over the last 18 months, when it comes to an earnings consensus. This is down to several factors. Firstly, it was under offer (at 161p) for a period from the Frasers Group, which still retains a 27% stake. Next, a strategic review was being finalised which culminated in the eventual sale of its education business. And thirdly, the initial shock of the pandemic resulted in analysts pulling forecasts. At the time of writing, the shares trade on 7.4 times March 2022 earnings. This is based on conservative forecasts which imply around a 10% decline in revenue in FY22 versus FY21. Our view is that the channel shifts that have occurred in the wake of the pandemic will prove more permanent, and the group will benefit from a material increase in customers recruited during the past year. That makes the current rating seem deeply depressed when set against the average 12-month forward price to earnings (P/E) ratio for the wider FTSE All Share retail peer group of 17.4 (excluding loss making firms) and the equivalent multiple of 25 for FTSE AIM retailers. Although we acknowledge that the firm’s financial services exposure will hold back the rating, we see several positives. These include, a streamlined operating structure combined with balance sheet net cash (excluding the securitisation facility used to enable the credit product), a resumption of market forecasts and, more recently, a reduction in the Frasers Group stake from 36% to nearer 27%, with any additional sell down likely to be good for free float and therefore the share price. As such, we think that the discount, at the time of writing, of around 50% can no longer be justified. ● Summer 2021 — 23
