Quality…at a price

I can’t pretend to understand the science behind what small-cap Bioventix (LSE: BVXP) does in much detail, apart from saying that it develops and supplies antibodies for use in the diagnosis of conditions such as heart disease, cancer and drug abuse. What I can tell you is that it’s a first-class business, generating absolutely huge operating margins and returns on capital employed — the latter being just the sort of thing one of the UK’s most successful fund managers looks for. Based on its half-year report issued at the end of March, I shouldn’t think there’ll be much to worry about when the Farnham-based firm reveals its latest full-year numbers on 21 October.

Back in March, the company revealed 24% rises in both revenue and pre-tax profit (to £4.4m and £3.2m respectively). Its balance sheet remained strong with a closing cash balance of £5.5m. While far from being an income play, an interim dividend of 30p per share was also declared — 20% higher than at this time last year; not bad for an organisation with just 15 employees.  

Pretty much the only issue with Bioventix at the current time is the price of its stock. At a little less than 33 times earnings, the market is already expecting a lot. Should markets head southwards over the next month or so as a result of Brexit jitters, I’ll be in the queue to pick up a slice of this quality small-cap. 

Buy the dip?

Another growth stock that’s likely to be flying well under the radars of most retail investors is audio-visual specialist Midwich (LSE: MIDW). Its services include providing huge LED screens for a variety of clients and events. 

Trading over the first half of 2019 was encouraging, with this month’s interim results revealing a 19.2% rise in revenue to £314.8m and a 6.2% rise in adjusted pre-tax profit to £13.7m. 

In addition to this, there was a 5.4% increase to the interim dividend and news that acquisitions in the previous financial year were bedding in nicely. Indeed, these purchases, combined with three others over the first half of 2019, have helped to increase gross margin and open new markets for the company. 

In terms of share price performance, however, Midwich hasn’t exactly set the market on fire. Indeed, it’s been rather volatile over 2019, rising as high as 633p back in April only to fall back to the 500p mark over the summer.

That said, this company’s value is still well over double what it was five years ago. What’s more, the recent dip in form leaves the shares looking reasonably valued at 16 times earnings, especially when it’s considered that Midwich achieves consistently great returns on capital and is expected to yield 3.1% in the current year (with the payout covered twice by profit). The fact that it has operations in Europe and Asia Pacific as well as across the UK and Ireland should give it some degree of protection from any Brexit fallout. 

Again, like Bioventix, I’ll be sorely tempted to open a position if Midwich drops a bit more over the next few weeks/months. It’s on the watchlist for now.

And Midwich Group (LSE: MIDW) is a good example, despite a lack of progress with the share price since my previous article about the firm in January. The firm operates as a specialist audio and visual (AV) distributor to the trade market in the UK, Ireland, Continental Europe and the Asia Pacific region. I like its strong position in the UK and the acquisitive and organic growth strategy that is helping the firm expand abroad.

A strong position in its markets

Midwich distributes stuff for around 400 “vendors”, which includes some “blue-chip” organisations. Think of things such as large format displays, projectors, digital signage and professional audio. In some cases, the firm is “the sole or largest in-country distributor for a number of its vendors in their respective product sets.”

The directors reckon the company’s cosy position in its markets has arisen because of its technical expertise, ”extensive” product knowledge and “strong” customer service. Such things haven’t occurred overnight but have been “built up over a number of years.” Meanwhile, the company serves around 17,000 customers, most of which are “professional AV integrators and IT resellers” serving the corporate, education, retail, residential and hospitality sectors. 

In today’s trading statement, the company said that in the six months to 30 June it traded well, with revenue growing both organically and via contributions from recent acquisitions. The firm saw revenue growth from all its trading geographies but Continental Europe and the Asia Pacific region performed “particularly well.”  Overall gross profit margins were up a bit too.

Ongoing geographic expansion

Midwich acquired four businesses in the period, which have given the firm a toehold in Italy, Switzerland and Norway as well as “strengthening” its capabilities in the audio and lighting segments. Meanwhile, cash generation in the first half came in “slightly ahead” of the directors’ expectations. 

City analysts following the firm have pencilled in earnings increases for the current year to December and for 2020 averaging around 12% per year, which strikes me as a decent rate of growth. Meanwhile, with the share price close to 565p as I write, the forward-looking price-to-earnings ratio for 2020 hovers between 16 and 17, and the anticipated dividend yield is about 3%.

I admit that this isn’t a bargain valuation, but the firm is profitable, growing its earnings and has a vibrant strategy for further expansion. We’ll get more colour regarding trading in the first six months of the year in the half-year report, which is due on 10 September. With a bit of luck, the company will also update its outlook statement at that time.

The firm operates as a specialist Audio Visual (AV) and document solutions distributor to the trade markets and has been around since 1979. But it only arrived on the stock market as a public company during May 2016, which is a big tick on my list. I like investing in firms that are new to the stock market because, at the time of their Initial Public Offering (IPO), they’re often well financed with a war chest of cash to pursue their growth ambitions. The directors are often incentivised and the company can be at its entrepreneurial best. Indeed, the first decade or so as a listed company can prove to be a time of fast growth and rapid share-price appreciation for many.

A record of growth

Midwich has a record of rising annual revenue and normalised earnings, which earns another tick on my list. Then there’s the return-on-capital figure running close to 36%, which gets another tick for quality. The firm pays a decent dividend and it’s been rising every year – yet another tick. And the share price has eased back from the highs it achieved in the autumn, which earns another on my list. Meanwhile, City analysts have pencilled in decent double-digit percentage increases in earnings for this year and next. You’ve guessed it, another tick!

But I’m adding a few question marks too. For example, I’m not keen on the low, single-digit operating margin, but I’m prepared to accept it given the firm’s business in distribution. I don’t much like the level of borrowings the company is carrying, which is running close to twice the figure for annual operating profit. And I’m wary about the inherent cyclicality that must reside in the business. If the sector the firm serves has a downturn, falling earnings could make the debt troublesome.

Acquisitions delivering

However, as well as being cyclical, Midwich is growing fast, driven by its vibrant acquisition programme and via organic means. Indeed, today’s year-end trading update is positive. We learn, for example, that trading momentum continued in the second half of the year, “with encouraging growth seen across all of the Group’s divisions.” On top of that, “all of the acquisitions made in 2017 performed either in line with or ahead of the Board’s expectations.” Revenue is 20% up on the prior year, and adjusted profit before tax will likely come in “slightly ahead” of the directors’ previous expectations.

Group managing director Stephen Fenby said in the report that there was “strong” organic performance from the firm’s existing businesses and he’s pleased with how the integration of the three businesses acquired in 2018 is going. So far in 2019, Midwich has already acquired another company called MobilePro in Switzerland, which “further expands the Group’s geographical reach.” Fenby explained that Midwich plans to explore cross-selling opportunities in its existing businesses and to evaluate its pipeline of potential acquisitions “both in the Group’s existing markets and in new territories.” Things seem to be going well, and I reckon researching the share now could be a good use of your time. 

While in the near term they may be correct, in the long run, the stock’s valuation suggests that it may offer excellent value for money. At a time when a number of shares, including one stock that released results on Tuesday, appear overvalued, ITV’s share price could have long-term investment potential.

High price

An example of a stock which may be overvalued at the present time is Midwich (LSE: MIDW). The specialist audio visual distributor reported positive interim results on Tuesday which showed a rise in revenue of 25%. Adjusted earnings increased by 23% on a per share basis to 12.09p, with the company’s overall performance being strong. It was able to generate double-digit revenue and profit growth in all territories, while investment in new geographies and the development of specialist broadcast, lighting and audio segments boosted its financial performance.

Looking ahead, the company is expected to report a rise in earnings of 15% in the current year, followed by further growth of 8% next year. While this is an upbeat outlook which suggests that the stock is performing well, the investment potential of the company appears to be limited. It trades on a price-to-earnings (P/E) ratio of 27, which indicates that it lacks a margin of safety at the present time.

Low valuation

In contrast, the ITV share price appears to be dirt-cheap after its recent decline. It has a P/E ratio of around 11, which indicates that it offers scope to trade at a much higher level than at present. In the short run, the company’s financial outlook may appear to be downbeat, with earnings set to decline by over 3% in the course of the next two years. But with it having a dominant position in the television advertising market, the long-term growth prospects for the stock remain bright.

As a cyclical company, periods of disappointing financial performance are not unusual for ITV. In fact, they provide long-term investors with the opportunity to buy the stock at a low price, with improving earnings performance often being a good time to sell after making a profit.

While it may take a number of years for the stock to return to previous highs, it seems to have the right strategy and a sound management team through which to deliver improved performance. As such, and at a time when a number of FTSE 100 shares are trading on high valuations, now could be the right time to buy the company for the long run. While it may disappoint in the near term, its potential to deliver high total returns in the coming years still seems to be significant.

UK inflation is currently about 3%. Today I’m looking at two small-cap dividend stocks whose payouts have risen by at least double this amount.

A mixed picture

International recruitment firm Empresaria Group (LSE: EMR) issued its 2017 results this morning. Sales rose by 32% to £357.1m last year, but much of this reflected pass-through wages of temporary workers. A more meaningful measure is net fee income, which rose by 18% to £69.4m.

According to the firm, net fee income has now risen for 18 consecutive quarters. Profits have also risen steadily in recent years. It said today that its adjusted pre-tax profit rose by 20% to £11m last year. However, the recruiter’s statutory pre-tax profit only rose by 3% to £8.1m.

As investors, I believe we need to understand the difference between the adjusted and statutory figures. But having taken a closer look, I’m satisfied that the adjusting items are either genuine exceptional costs or non-cash charges that can safely be ignored.

15% dividend growth

The good news for shareholders is that the firm’s dividend has been increased by 15% to 1.32p per share for 2017. Although this payout only gives a yield of 1.5%, the Crawley-based firm’s dividend has risen by an average of 26% per year since 2011.

Today’s dividend increase was ahead of consensus forecasts, so expectations for the year might also be increased. As things stand, the shares trade on a 2018 forecast P/E of 7.6 with a prospective yield of at least 1.5%. Although low P/E ratings are the norm in the recruitment sector, I believe this stock might offer reasonable value at this level.

A better choice?

Shares of Midwich Group (LSE: MIDW) have risen by 135% since the group’s flotation in 2016. This company is a distributor of audio-visual equipment and document management solutions to trade customers.

The group has around 13,000 direct customers as well as relationships with 330 vendors, who resell the products to their own customers. About 60% of sales come from the UK, with the rest coming from continental Europe and Australasia.

A year of rapid growth

Yesterday’s full-year results show that 2017 was another strong year of growth. Sales rose by 27.5% to £471.9m, while adjusted pre-tax profit climbed 35.7% to £24.3m.

The dividend was increased by 36% on a like-for-like basis to 13.8p, giving the stock a yield of 2.5%.

Companies with rapid dividend growth tend to have lower yields than those with slow-growing payouts. Over time, I expect Midwich to follow this pattern too, offering a higher yield with lower growth.

2018 is expected to be another year of strong growth, with analysts pencilling in earnings per share growth of almost 50% and dividend growth of around 10%.

The stock trades on a forecast P/E of 21, so a lot of growth is already in the price. But if you’re keen on this sector and believe Midwich can continue to expand, these shares could be a good buy at current levels.

Over the past 12 months, shares in the company have smashed the broader market, returning 146% as the business has gone from strength to strength. And today the firm revealed that this growth momentum has continued with management now expecting to report revenue for 2017 of approximately £470m, representing growth of around 28% year-on-year. As well as growing revenues by nearly a third, the group has managed to do so while “continuing to improve gross margins in line with the board’s expectations.“

Beating expectations 

As a result of this performance, the group “now anticipates reporting adjusted profit before tax for 2017 comfortably ahead of its previous expectations.” 

City analysts had been expecting earnings per share growth of 78% year-on-year before today’s news. It now looks as if this target will be exceeded, which means that the shares, trading at a forward P/E of 22.5 (based on old forecasts) look exceptionally cheap. Specifically, Midwich’s PEG ratio is around 0.3. A PEG ratio of less than one signals that the shares offer growth at a reasonable price. 

What’s more, it looks as if Midwich’s growth will continue into 2018. The company made a number of acquisitions in 2017 to help this, the full benefit of which should be seen this year. MD Stephen Fenby noted in today’s press release that “through 2018, management will continue to explore cross-selling opportunities in the current portfolio while also evaluating the healthy pipeline of potential acquisitions.” So it looks as if there are more deals on the horizon. 

Analysts have earnings per share growth of 14% pencilled in for 2018, but this could turn out to be a conservative estimate if Midwich continues to expand at its current rate. 

Alongside Midwich, I also like the look of Rolls-Royce Holding (LSE: RR). 

Growth target by 2020

Shares in Rolls have struggled over the past year as the company has got stuck into its turnaround plan. On the face of it, the stock isn’t that cheap, which could put investors off. However, this is a growth story that will take time to unfold. 

Rolls is currently trading at a forward P/E of 27.2, which is painfully expensive when you take into account the group’s stagnating earnings. Nonetheless, management believes that by 2020, the firm will be producing £1bn of cash flow, and it’s here that the value is to be found. 

Rolls’ free cash flow last peaked at £781m in 2013 when the shares traded as high as 1,185p, a valuation of just under 26 times free cash flow per share. Cash flow of £1bn works out at 54p per share, which translates into a share price of 1,404 based on the previous multiple. Based on this target, investors could see a return of 64% over the next three years. 

That said, management has cautioned that it won’t be plain sailing to this target, that’s why I believe Midwich would make a perfect partner for Rolls in your portfolio if you’re looking for a growth duo. 

According to the firm’s press release on the matter, management is currently holding talks over a potential new buy in South America. However, due to the size of the purchase, the transaction would constitute a reverse takeover and as such the company’s shares have been suspended from trading. 

The group’s shares will remain suspended until a new admission document is published and after shareholders have approved the transaction – or the proposed deal is cancelled.

A big deal 

Unfortunately, as of yet, there are no further details on the transaction, but it looks as if this will be a transformational deal for the business. Earlier this month management praised a very active period for company development in the prior weeks and informed shareholders that “we have continued to assess multiple opportunities in the region.”

And unlike the majority of other small oil & gas explorers, Echo is cash rich. The company ended the six-month period to June 30 with £25.5m of cash on the balance sheet after acquiring two exploration blocks in Bolivia. 

Charting a course for success 

Going forward, as with all oil minnows, Echo’s success depends on management’s ability to select the best quality assets and bring production on-stream efficiently and under budget. 

The new management team led by CEO Fiona MacAulay and chairman James Parsons seems highly motivated, and management is certainly not wasting any time expanding the group’s asset base. If the firm continues on this track, I believe that there’s a high chance investors could be well rewarded over the long term. That being said, while Echo could be a multi-bagger, as with all early-stage oil and gas companies, the risks of failure are high. 

A safer buy? 

Echo is a high-risk, high-reward play. If you’re looking for a lower-risk opportunity which still has the potential for outsized gains, the Midwich Group (LSE: MIDW) might be a better buy. 

Midwich is a specialist audio visual, professional video, film, broadcast, lighting and document solutions distributor. A relative newcomer to the public markets, the firm has quickly made a name for itself. Over the past year, the stock is up more than 100%. 

It looks as if these gains could be just the start of the company’s growth. City analysts have pencilled in earnings per share growth of 15% for 2017 and 9% for 2018. If Midwich hits these targets, the company will have more than doubled pre-tax profit in just under two years. 

To help boost growth, management is reinvesting cash generated from operations into acquisitions, a strategy that’s already paying dividends and should continue to yield results. Recent acquisitions have been incorporated into the group with no issues and are already producing results —  a sign that management knows what it’s doing when it comes to deal-making, which bodes well for future expansion plans. 

The company, which distributes audio visual and document solutions to trade, advised that revenues shot 34% higher during January-June to £211.6m. As a consequence adjusted pre-tax profits improved 32% to £10.3m.

Stephen Fenby, chief executive, commented: “The group has performed strongly in the first six months of the year across all geographies with robust organic growth and contributions from recent acquisitions Holdan and Earpro.” He highlighted strong growth in large format displays, in particular, as well as Midwich’s progress in the developing specialist broadcast and audio segments.

Fenby added: “The strong performance reported in the first half year coupled with indications of positive sales momentum and strong contributions from recent acquisitions gives the Board confidence in reporting results for the full year in line with our expectations, which were upgraded at the time of [July’s] trading statement.”

With Midwich also reporting robust cash generation, the firm elected to lift the interim dividend 36% year-on-year to 4.17p per share.

In splendid shape

Investors should be cheered by the massive headway Midwich is making across all regions — the company saw sales increase by double-digit rates in all its territories, led by Germany and Australasia where turnover grew 47% and 44% — as well as impressive, M&A action.

The firm noted that recent buyouts have “performed ahead of expectations.” And the company’s robust balance sheet should keep the position-enhancing acquisitions coming — the firm snapped up audio visual and lighting products distributor Gebroeders van Domburg just last week for a minimum of €2.1m.

So it comes as little surprise that City analysts expect profits to rise 14% in 2017, with an extra 7% advance marked in for next year. As a consequence, Midwich deals on a forward P/E rating of 20 times, very decent value in my opinion given the terrific headway it is making across the globe, not to mention the potential for forecast upgrades further down the line.

In rude health

Renishaw (LSE: RSW) has been no stranger to stratospheric share price gains in recent times either. The healthcare engineer has seen its market value almost double since the bells rang in New Year’s Day, and I fully expect the share price to remain on an upward trajectory.

The Gloucestershire company reported record revenues of £536.8m in the first half of 2017, up 26% year-on-year, with sales growing across all healthcare segments. And Renishaw is investing heavily in its marketing and distribution facilities across the globe to keep sales on an upward bent — it forked out £42.6m in capex in the year to June 2017 alone.

The City expects Renishaw to print a further 10% earnings rise in fiscal 2018, resulting in a toppy-looking prospective P/E rating of 33.8 times. Still, I reckon the firm’s ambitious growth strategy, not to mention the huge sales potential of its ever-expanding markets, makes the business worthy of this premium.

One example is Morses Club (LSE: MCL). This is a small-cap financial stock which floated in 2016 with the backing of fund manager Neil Woodford, whose funds own 8% of the stock.

It operates in the sub-prime credit market as a doorstep lender — or a Home Collect Credit provider, as the company prefers to describe it. Some investors may be unhappy about putting their money into this sector, but this appears to be a well-run business with several attractions for shareholders.

Growth + cash

The firm’s net loan book rose by 7.7% to £61.2m last year, as customer numbers rose by 9% to 216,000. This increase in lending was mirrored by a 7.7% increase in pre-tax profit, which rose to £11.2m.

In its first year as a public company, Morses declared dividends totalling 6.4p per share, giving a trailing yield of 5.2%. The majority of this payout was backed by underlying free cash flow of £7.1m, although not quite all of it.

The big risk for investors in this type of business is that the bad debt levels will rise, leaving the lender with big losses. The company’s impairment rate was 16.8% last year, measured as a percentage of credit issued. This was a slight increase from 15.4% during the previous year.

Based on these metrics, bad debt doesn’t seem to be a particular problem at the moment. Neil Woodford certainly doesn’t appear to think so. He’s gone public with his view that the UK economy is likely to remain stable and that domestic stocks offer opportunities for investors.

If Mr Woodford is right, then I believe Morses Club could do well. Earnings per share are expected to rise by 40% this year. The stock looks cheap on a forecast P/E of 10.8, with a prospective yield of 5.6%.

A super ‘sleeper ‘?

You may not have heard of Midwich Group (LSE: MIDW). But if you work for a big company, you may be one of the firm’s customers. It sells electronic visual equipment such as projectors, big televisions and printers to corporate customers, including many blue-chip names.

This AIM-listed business only floated last year, but has a market cap of £262m and annual sales of nearly £400m. Adjusted pre-tax profit rose by 23% to £17.9m in 2016, while the group’s operating margin remained stable at 4%.

The main growth opportunity appears to be expansion overseas. As a distributor, Midwich doesn’t have large stockholdings or manufacturing costs. This means it can expand relatively cheaply, reducing the risk of entering new territories.

This strategy seems to be working well. Non-UK and Ireland sales now account for 33% of revenue and are growing fast. Sales rose by 39.3% in France last year, by 26% in Germany and by 42.8% in Australasia, for example.

City analysts appear to be confident that the firm’s strong performance will continue. Consensus earnings forecasts for 2017 have risen by 15% to 19.7p per share since last July. The stock now trades on a forecast P/E of 17 with a prospective yield of 3.5%. I believe further growth may be possible from this level.

Growth and balanced returns

The firm describes itself as a specialist audio, visual and document solutions distributor to the trade market, dealing in products such as large format displays, projectors, digital signage, printers and scanners. Investing in distributors that trade between product manufacturers and the companies selling things to end users always appeals to me. Distributors tend to ride the fortunes of entire industries, responding to demand without the costly cut-and-thrust of dealing with end users.

During 2016, around 65% of the firm’s operating profit came from the UK and Ireland, 21% from Germany, 8% from Australasia and 6% from France. It seems clear that the firm has plenty of room to expand further internationally, and it has moved fast since raising around £24m (net) with the recent initial public offering (IPO) of shares. During September, the company used part of the proceeds to acquire two companies, which underlines the company’s organic and acquisitive growth strategy.

The strategy seems to be working. Revenue is up 17.8% compared to a year ago, adjusted operating profit ballooned 22.2% and adjusted earnings per share notched up 19.5%. In a sign that Midwich plans to deliver balanced returns for investors, the directors declared a maiden dividend of 8.62p and committed to a progressive dividend policy.

At today’s share price of 335p, the forward price-to-earnings (P/E) rating runs at just over 16 for 2018 and the forward dividend yield is around 3.6%. City analysts following the firm expect earnings to cover the payout around 1.7 times.

Rolling out in the UK and the US

Petrol forecourt retailer Applegreen (APGN) describes itself as Ireland’s largest motorway service area operator and it also enjoys a leading position in the Irish petrol forecourt sector. Last year around 71% of gross profit came from Ireland, 27% from the UK and 2% from the USA. The firm is seeing brisk progress in rolling out its offering in Britain, and the potential for growth in America looks vast.

Today’s full-year results are encouraging, with revenue up 9% compared to a year ago, net profit shooting up by 43% and diluted earnings per share ratcheting up 27%. The directors revealed their confidence in the firm’s prospects by declaring a maiden dividend of 1.25 euro cents.

The firm has three strands to its plan for growing the estate of forecourt convenience retail outlets — a “low fuel prices, always” price promise, intended to drive footfall to the stores, a “better value always” tailored retail offer, and a strong food and beverage focus, aiming to offer premium products and service to the company’s customers. 

The appeal of Applegreen’s offering is enhanced by strategic partnerships with brands such as Burger King, Subway, Costa Coffee, Greggs, Lavazza, Chopstix, Freshii and 7-Eleven, and the company also has its own brands in aCafé and Bakewell café.   

At today’s share price around 417p, the forward P/E rating for 2018 is just over 15 and the dividend yield runs at just over 0.4%. City analysts following the firm expect earnings to cover the payout around 16 times, suggesting the directors are keeping funds back to progress opportunities to grow.