BUY: Mears (MER)
The accommodation services provider had a record year in the face of questions about its services, writes Mitchell Labiak.
At first glance, it is easy to see why Mears’ share price rose 6 per cent on the morning of its results for the past calendar year. The accommodation services provider’s pre-tax profit more than doubled from £16.3mn to £34.9mn thanks to its £960mn record revenue — beyond consensus forecasts — offsetting a 9.46 per cent increase in the cost of sales.
However, those numbers need context. The company said the stellar figures were “underpinned by the increased volumes experienced within the Asylum Accommodation and Support Contract (AASC)”. It added that “except for AASC, revenues have been relatively consistent across the remaining contract estate, with a small reduction in our traditional repair activities”.
In other words, without the AASC, revenue would not have been as impressive. Mears says that it has so far received more than double the £120mn revenue it planned for from the contract as the government has become ever more dependent on Mears’ services due to an influx in asylum claims.
This is worth bearing in mind considering the chorus of criticism the company has received from charities and politicians who say that the accommodation and services provided by Mears for asylum seekers are subpar. While some of these criticisms date back a few years, the number of concerns raised last year as the living conditions of asylum seekers has become front-page news is worth investor consideration.
Mears has long defended itself against these claims, stating in its results that while the continued use of hotel accommodation is “not the preferred solution”, it is “working hard to increase the number of residential properties which we can use”. It adds that it is “unequivocally focused on being the leader in the UK in providing high-quality housing services to the public sector”.
What’s more, even with the criticism, Mears’ AASC revenue remains secured with the government giving no indication that it wants to renege on the contract with Mears to provide the services until 2029.
Gearing is also lower than it has been in recent years thanks to a bump in net cash, and this cash flow has helped increase dividends by 31 per cent on last year. These shareholder payments are covered by earnings 2.33 times and Mears said it would look to reduce this to two times earnings — a still conservative approach which underlines its confidence in future cash generation and suggests further dividend growth over the coming years. Shares are also well priced at nine times earnings.
As such, we reiterate our buy call, but note that the service Mears provides has been called into question.
HOLD: Card Factory (CARD)
New financial targets were outlined in the results, as the company looks to have rebounded well from the pandemic, writes Christopher Akers.
Card Factory shares were marked down by 7 per cent, despite sales at the greeting cards retailer outstripping pre-pandemic levels as customers returned to the company’s high street stores after a comparative period of closures. The market reaction came against a backdrop of a 70 per cent share price uplift over the past 12 months, however, helped by increases to guidance which included last week’s profit beating confirmation from management.
Stores are the company’s revenue driver and took 95 per cent of total sales in the year as high street footfall improved. Online sales fell by almost a fifth, year-on-year, as Royal Mail strikes took their toll but these were still up 86 per cent against pre-pandemic levels on a like-for-like basis. Post-year-end dealmaking, meanwhile, will support future revenues — a new franchise agreement with Liwa Trading Enterprises heralds market penetration in the Middle East, while the acquisition of SA Greetings gives a “foothold into [the] target South African market”.
The balance sheet looks more resilient after an operating cash conversion rate of 96 per cent in the year helped to cut net debt (excluding lease liabilities) by £17mn to £57.2mn. On the return of capital, however, investors must wait until at least the 2025 financial year for the resumption of dividend payments given that certain loan repayments must be completed first under the terms of the company’s financing facilities.
Investec analysts argued that the company “has recovered well from Covid with its strategic initiatives delivering better profitability”. As the board works towards targets of annual revenues of £650mn and a pre-tax profit margin of 14 per cent in financial year 2027, we think that is accurate. The shares trade at a consensus 10 times forward earnings, according to FactSet, slightly above the five-year average of nine times.
HOLD: Lords Trading Group (LORD)
An increased proportion of higher-margin products has joined the sales mix, writes Mark Robinson.
Lords Trading Group has been trading on Aim since mid 2021. A distributor of building, plumbing, heating and DIY products, the company is exposed to fluctuations in construction markets.
Despite lingering anxieties over whether successive interest rate hikes will have a cooling effect on industry activity, Lords has delivered pleasing numbers for 2022, sending the shares upward on results day.
Cash profits, excluding exceptional items and share-based payments, were 34.4 per cent to the good at £30mn, reflecting a 60-basis point increase in the underlying margin.
The general industry disruption brought about by the pandemic, specifically that linked to supply chains, convinced management that the company should increase the proportion of higher-margin products in the sales mix. So, while like-for-like revenue at the Plumbing and Heating division slipped by 9.1 per cent — the indirect result of semiconductor shortages — it still generated increased profit on improved margins.
Lords swung from a net cash position of £6.5mn at the end of 2021 to net debts of £19.4mn at the end of last year. That’s because £26.9mn was allocated towards acquisitions through the year, including the purchase of the freehold of George Lines’ Heathrow site for £6.3mn. Meanwhile, a planned increase in capital investment meant that the free cash flow conversion rate narrowed to 66.9 per cent from 89.1 per cent at the end of 2021.
The shares are valued at nine times consensus earnings, which compares favourably with peers such as Travis Perkins, although a price/earnings-to-growth multiple of 2.4 could indicate that the company’s growth prospects are adequately reflected in the share price. Admittedly, that conclusion is at odds with broker analysts covering this stock, but we remain circumspect, despite the impressive trading performance.
