Sinnerschrader Offers High Yield Plus Growth

Sinnerschrader is a micro-cap German listed company with huge potential to see a substantial stock price appreciation in the next few years. The transition from high street retail towards e-commerce is still ongoing and represents a key secular growth area in the economy and, interactive agencies like Sinnerschrader look set to benefit. Ebay $EBAY buying interactive agency GSI Commerce can be seen as an affirmation of how good prospects look for this industry. It is an interesting stock to do an equity research report on because it offers a blend of strong growth plus high cash generation, with a very strong balance sheet. There is even a high dividend yield too!

Sinnerschrader is an Exciting Growth Stock

The company is one of the top 10 interactive agencies in Germany and currently receives 89% of its revenues from ‘interactive marketing’. This involves developing and marketing internet based activities for a range of companies. In the past, Sinnerschrader has been highly dependent on a few large customers, however this risk is being reduced following the strategy of pursuing growth in new customers. I will discuss this again later. The other two segments are ‘interactive media’ which involves buying online ads for their clients and ‘interactive commerce’ whereby Sinnerschrader develops online shops for its clients.

The important thing to understand with this type of business is that it is relationship based. This carries risks- the staff could walk away with some clients- but also offers great reward as once a client is onboard the opportunity for a recurring ‘annuity’ type income stream is very strong. Indeed, the good news is that Sinnerschrader is aggressively pursuing new customer acquisitions which should lead to increased cash flows in time.

Growth Strategy

Not only are existing markets looking strong, but I believe the opportunity for future growth from areas like mobile applications is very good. Increasingly, the convergence between telecommunications and internet usage is being manifest in the growth of smart phone usage. Email and social networking are the ‘killer app’ for the internet and smart phones are capable of supplanting computers in this aspect. All of which, will mean increased demand for agencies that can integrate clients online offerings towards mobile. In addition, if mobiles are going to be the next payment device than there is an obvious synergy in companies marketing themselves to the customer via mobiles.

Sinnerschrader Results Statement and Stock Evaluation

The company gave its Q3 results on the 14th of July and they can be read here. I was pleased to see that Sinnerschrader is chasing growth, albeit at the detriment of reducing initial margins. With the new emphasis on growth, analyst estimates for revenue growth for this year are 25% to E30m with further revenue growth of 17% for next year. Ebitda for the next three years is forecast at E3.5m, E4.6m and E5.5m respectively. Now considering that the Enterprise Value of Sinnerschrader (stock price of E2.35) is E20.1m than on an EV/Ebitda basis this stock is far too cheap. Similarly, despite the working capital requirements necessary to fund the growth in the business, analysts have Sinnerschrader generating nearly 7% of its Enterprise Value in Free Cash Flow. Again, this is far too cheap for a company set to grow EPS by around 30% pa for the next two years.

Sinnerschrader trades on a forecast forward (Aug 2012) PE ratio of 10.7x and forecast dividend yields of  4.2% and 7.5% for 2011 and 2012 respectively.  I think this is too cheap.

General Mills Offers Defensive Growth Prospects

General Mills $GIS is an interesting defensive stock that appears attractive because it offers a few key plus points. I’ve listed a few of them in bullet form below

• Defensive end markets of food and yogurt
• Good exposure to lowering commodity prices
• Strong dividend yield currently around 3%

So is General Mills an attractive stock to buy?

General Mills is ubiquitous name in the US Households through its cereal brands, healthy snacks, ready-made meals (Pillsbury etc), Haagen-Dazs ice cream and Yogurt (Yoplait) offerings. The last of which is growing quicker than the other products and, accordingly, the co is busying acquiring the international business of Yoplait. Next year will be about General Mills increasing pricing in order to benefit from the retention of market share that they fought for (via promotions, discounts etc) in previous years. However, the co is predicting that media spending will track sales growth so the management are unlikely to generate any operating efficiencies there.

This type of stock will always appeal to fund managers and investors because it provides good income and helps balance risk in a long only portfolio. I like the potential for future margin expansion coming from exposure to commodity prices coupled with its defensive nature. Indeed, over the last five years General Mills has grown operating profit every year (CAGR of 7% over the period) and EPS every year (CAGR of 12% over the period).

General Mills Q4 and Full Year Results

General Mills recently gave results and they were pretty good, however the outlook was weaker than the company had previously forecast. The good news is that the market had largely priced this in because the main cause is commodity price inflation. All of which suggests that if these prices continue to moderate-in line with the tightening attempts in many emerging markets-that General Mills could see some ‘upside surprise’ to gross margins. I’ve outlined historical cost inflation and gross margins for General Mills below

General Mills Estimates(%)	2007	2008	2009	2010	2011	2012
Input Cost Inflation	4	7	9	-3	4	10 to 11
Gross Margins	35.9	35.1	36.4	39.7	39.4	Lower

It is easy to see the inverse relationship between gross margins and input cost pressures. Moreover, this year’s cost inflation push is even more pervasive because commodities are up across the board and from relatively weaker comparables. In fact, the company is predicting lower gross margins as well as a low adjusted EPS growth of only 5% for next year.

Delving deeper into the results reveals that US retail sales were down 2% but international sales (constant currency) were up 16% respectively. This should provide little succour to shareholders because US retail sales still make up over 76% of segmental operating profits but international is only 10.7%. US retail sales were down but this is largely due to less price discounting and promotions. Accordingly, overall, full year operating margins expanded from 15.1% in 2010 to 16.6% in 2011.

General Mills Evaluation

Listening to the conference call, the management are predicting a tough time in 2012 and, gross margins are seen as being lower. Similarly, the forecast adjusted EPS growth of 5% (261c from 248c) is not particularly attractive. However, I think the co could beat this guidance with lower commodity costs; however, my concerns are with the stock’s evaluation and sales growth.

At $37.26 General Mills has a market cap of $23.81bn and an EV of $30.17bn which, in my opinion, is a bit rich for a company which has generated $878m in free cash flow. In addition, the co is forecasting $670m in capital spending next year against $649m in 2011. Given that EPS is predicted to rise by 5% only, then this suggests that next year’s free cash flow generation could be similar to this year’s. A forward PE of (37.26/2.61)=14.3x and FCF/EV of around 3.2% is not particularly exciting for a company with low single digit sales and EPS growth.

In addition, the free cash flow barely covers the dividend which suggests that long term dividend growth will be tough for General Mills. I think there are better ways to play a correction in commodity prices. The bulk of General Mills products are hardly high growth so whilst it is a fine investment for investment managers looking to park cash in a defensive manner, it will not attract GARP focused investors. I took a pass.

Sonosite is a High Grow Healthcare Play

Sonosite $SONO is a leading player within a high growth niche area of healthcare. The company specialises in hand carried ultrasound systems and, is the leading player in the US in this area. SONO is competing with some very big companies like GE , Philips and Siemens but it has demonstrated the capability to lead this market. As such, this stock is a genuine takeover candidate for these companies or a larger company like Mindray.

Sonosite are involved in miniaturising and simplifying ultrasound for Point of Care (PoC) medicine. The company was spun out of a larger US company in 1998 and until now has established over sixty thousands installed users. The company's solutions are sometimes described as 'portable ultrasound' but this description does not allude to some of the growth drivers for Sonosite. Before going into them, it is useful to see how Sonosite is performing right now.

Sonosite SONO Q4 Results

Turning to the recent Q4 results

• Q4 Revenues of $89.3m vs. $83.7m estimates
• Including Non-Recurring Charges EPS was 41c vs. 36c estimates

Guidance

• Full Year Revenues of $310-325m vs. $312m estimates
• Full Year gross margins stable at around 71%
• Operational expenses of $184-186m
• Tax rate of 34%
• Analyst are forecasting EPS of $1.20 for 2011

Listening to the conference call the management are seeing a 50/50 split between international and US sales in 2011. International growth is seen as stable but low growth in Western Europe, however the emerging market and BRIC economies are seen as faster growing. A combination of organic revenue growth, new product launches in the second half and growing contribution from the Visual Sonics acquisition will increase the top line by 13-18% according to Sonosite.

One interesting aspect of this growth is that it will be more back end loaded, so investors can expect a 40/60 split of revenues in the two halves, with revenues in Q2 and Q3 being higher than in previous years. Margins are likely to stay stable because Sonosite is in-what the company sees as- the first of a three year sales cycle. Typically this means that sales costs, R & D and promotional activity are higher in the first year. After which, operating margins will expand in the next couple of years.

Sonosite estimates that it either held or gained market share in its major markets and the management do not appear to be planning any acquisitions for 2011.


Sonosite Growth Prospects

The growing usage of portable ultrasound for emergency procedures (where portability is an issue) is one area of growth as is increasing usage for certain medical procedures. In particular, advances in portable ultrasound technology are seen as creating a market for the machines to be used in procedures that would otherwise be covered by computed tomography (CT) or magnetic resonance imaging (MRI).

For example, patients who need on going antibiotics or chemotherapy will have a Peripherally Inserted Central Catheter (PICC) placed in them and, portable ultrasound is ideal for helping the nurse visually see how the instrument should be placed. Similarly, nurses use the machines to guide them in injecting anesthetics near peripheral nerves prior to surgery. For this type of hospital usage, Sonosite claims to be the clear leader with GE its main competitor.

Another growing usage is for detection of breast cancer, as ultrasound gives very high

Sonosite also cites Mindray as being a competitor in some of its markets and, they could be potentially an acquirer because Sonosite and GE have already settled a law suit. Furthermore, Sonosite should be attractive to the likes of Philips or Siemens who could immediately gain scale in the US by buying SONO.


Sonosite Evaluation

The stock trades at a share price of $36.94 which gives it a market cap of $498m and an Enterprise Value of $497m which makes it a small cap growth play. Analyst estimates are for EPS of $1.20 and $1.64 for 2011 and 2012 respectively. This hardly makes the stock cheap on a PE basis.  However, net income is only one side of the story, because SONO have been booking losses via buying back convertible debt. Furthermore, Sonosite is a highly cash generative business.

Given the numbers in the guidance above, it is entirely feasible that, for 2011, Sonosite will record $225m in gross margin and 40.4m in operating income. Assuming losses on debt repurchases similar to 2010 would give pre-tax profits of $29m and $19.1m in net income. Given traditional operating cash flow conversion, Sonosite could generate $33.5m in operating cash flow and around $31m in free cash flow (FCF).  This equates to a foward FCF/EV yield of  6.2% based on a current price of $36.94

This looks too cheap, so I bought some with a $45 price target.

Source:

iData Report, "U.S. Market for Ultrasound Equipment 2010"

UPS Delivered Simple

With UPS, sometimes less is more. Analysts and investors spend an awful lot of time analysing the minutiae of every aspect of a company's performance, when quite often, the primary driver of the stock price is actually something quite prosaic.

I think this is the case with UPS. UPS delivers packages worldwide. More economic growth, more packages, it is as simple as that. Naturally, there are company specific issues but as an investor our job is to be able to define the key stock price drivers in a perspicacious way.

So what guides the UPS stock price?


UPS Revenue Growth and Global GDP

Simply put, UPS growth is dependent on the economy. I have carried out a linear regression analysis on UPS growth vs. OECD global growth. Here is the raw data for the last eight years

growth%	2003	2004	2005	2006	2007	2008	2009	2010	2011E	2012E
OECD	2.0	3.2	2.8	3.1	2.7	0.3	-3.4	2.8	2.3	2.8
UPS Rev	7.1	9.2	12.0	11.7	4.5	3.6	-12.0	9.4	8.0	9.0

Source: Earnings View, OECD

The UPS revenue figures have been adjusted for acquisitions. The last two years are estimates which are garnered from OECD forecasts and estimates from the analysis. For the record, the equation that came out was

UPS Rev=3.274*Global Growth+.153

The R^2 for this equation was 90% so it is quite accurate. Analysts are forecasting 7.6% and 7.1% revenue growth for 2011 and 2012 respectively. This suggests some 'surprise' upside, but investors would have to price in a risk premium for the chance of being wrong.

At the current price of $74 I would argue that UPS is fairly priced. The dividend is not great and their cash flow is not that much in excess of long bond yields. I see no reason to take on the extra risk for a return that is likely to match UPS' earnings growth.  However, if there is a dip and I'm confident about GDP growth than it might be worth another look.

NCC Group a Fast Growing IT Security Stock

NCC Group gave interim results last week and they were warmly received by the market. This is a UK based small cap IT company, but before international stock pickers turn away, I suggest taking a closer look. This stock offers a compelling proposition of offering a highly cash generative business model as well as strong secular growth prospects.

Before discussing the results, I want to outline the nature of the company.


A Secular Growth Stock

NCC core business is software escrow. In other words when a company buys some developmental software, it has to carry the risk that the developer could go bust or disappear. Holding the software code in escrow will help to mitigate this risk, because the company can always retrieve it. The defensive nature of this business was put to the test in 2008-10 and it passed with flying colors. NCC was not able to implement the Co's annual price increases, but with this result NCC confirmed that the price hikes are now back.

The second main division is Assurance, and this focuses on the high growth are of information security. NCC have been acquisitive in this area and has built revenues steadily over the years. NCC offers a range of services and cross sells them across the constituent parts. NGS secure sells security testing services. Site Confidence sells web performance and load testing services. SDLC is a UK based testing services provider.
Finally, US based iSEC Partners sells security testing mainly to the US.

The iSEC acquisition is expands NCC presence in the US, where NCC are seeking to also expand software escrow revenues.


NCC Interim Results

I liked these results. Some bullet points

• Closure of the under performing general IT consulting unit
• Group orders and renewals at £41m vs. £30.9m last year
• UK Escrow annual price increases re-implemented with 5% hike
• Assurance growing strongly due to acquisitions, but underlying profits still rising at 6%
• Margins reducing because Assurance (lower margin than Escrow) is becoming a larger share of sales
• High cash flow generation and the current ratio is falling

I think the closure of the general IT consulting unit has been due for some time. NCC reported that

 

The Group's withdrawal from the general IT Consultancy market resulted in a one off exceptional charge of £950,000, of which £450,000 is non cash related.  Total post tax losses from discontinued operations were £1.1m in the period compared to a profit of £182,000 in 2009

This means that the reported results contain losses of £1.1m from attributable profit which makes 3.1p of diluted EPS. The adjusted diluted cash EPS actually rose 24.6% from 12.2p to 15.2 with the trailing EPS at 32.4p giving a PE ratio of 640/32.4=19.7 times.

The disposal is good news because NCC can now focus on growth.

NCC Set for Growth

I've broken down half year historical numbers for Escrow and Assurance here. NCC year end is in May, all data in millions.

	Nov 2007	May 2008	Nov 2008	May 2009	Nov 2009	May 2010	Nov 2010
UK Escrow	7.8	7.9	7.9	8.7	8.5	9.4	9.2
Eur Escrow	.1	1	1.2	1.2	1.4	1.5	1.5
US Escrow	.5	.7	.8	1.2	1	1.2	1.1
Total Escrow	8.4	9.6	9.9	11.1	10.8	12.2	11.9
Assurance	5.8	7	7.7	18.1	11.3	19.5	21.1

Clearly, the acquisition led growth in Assurance is shifting revenues towards a lower margin division. Furthermore, it is interesting to note that non-UK escrow revenues have gone from 7.1% to 21.8% in the last two years. This is partly due to the inability during the recession to implement price rises and from the international expansion plan. Nevertheless, growth has been excellent and few IT companies can boast anything similar over the last few years.

Turning to segment profitability

  

	Nov 2007	May 2008	Nov 2008	May 2009	Nov 2009	May 2010	Nov 2010
Escrow Profit	4.6	5.6	5.5	6.2	6	7.3	6.7
Margin %	55	58.3	56	55.4	55.4	60.1	56.1
Assur Profit	.8	.9	1	2.6	1.3	2.7	2.4
Margin %	14	13	13	14.1	11.8	13.8	11.5
Total Margin %	38	39.1	36.9	29.8	31.6	32.2	27.6

The reduction in margin can be seen in, however, profits are growing strongly. Moreover, this has always been a highly cash generative business. Trailing free cash flow is 12.1m which puts it on a FCF Yield of 5.6% with strong growth due in the second half. Historically, the second half is stronger and NCC expects the same thing this year. 

Consensus forecasts are for £70.4m in revenues, EPS of 36.6p and pre tax profits of £17.2m with a market cap of £214.5m.  I think this stock is better priced at aroud 710-725p.

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Fastenal Set for Good Growth but What About the Evaluation?

Hardware wholesaler and retailer Fastenal gave results recently and, the market bid the stock down, they beat on revenues but earnings were slightly shy. For Q4 Fastenal reported revenues of $573.8m and EPS of 44c. Analysts forecasts were for $563m and 45cents respectively.

Before I get into more detail on Fastenal, I want to outline the Co’s main objectives as laid out in the ‘pathway to profit’. I do these write-ups to serve as a reference point for future research and I find this sort of benchmarking useful.

Fastenal Pathway to Profit

This is a set of strategic end points that was originally laid out in 2007, but it has seen adjustment due to the effects of the recession.

1.  to continue growing our business at a similar rate with the new outside sales investment model
2. to grow the sales of our average store to $125 thousand per month in the five year period from 2007 to 2012
3. to enhance the profitability of the overall business by capturing the natural expense leverage that has historically occurred in our existing stores as their sales grow, and
4. to improve the performance of our business due to the more efficient use of working capital (primarily inventory) as our average sales volume per store increases
5. 85% of earnings in operating cash flow

As a consequence of the recession the Co reduced the growth of new store openings and headcount additions. Furthermore in 2010, Fastenal pushed out the $125k a store target until 2014 but announced that it was possible to hit the profit objectives (23% operating margin) anyway, thanks to cost cutting.

Scorecard on the Pathway to Profit

Firstly, I want to outline how Fastenal is now increasing the share of sales force outside the store…

	Q1 2007	Q3 2008	Q4 2009	Q1 2010	Q2 2010	Q3 2010	Q4 2010
Store Personnel	6383	8280	7007	7004	7118	7450	7611
Non-Store Sales	616	599	597	594	591	639	712
Percentage	8.8	6.7	7.9	7.5	7.7	7.9	8.6

 source: Fastenal, Earnings View

Secondly, as discussed earlier the aim of sales of $125k per month per store has been pushed out by two years but, they think they can hit the 23% operating margin target early.

Thirdly, the development of leveraging up on sales has been held back by the recession. I want to highlight the percentage of pre-tax profits generated by stores with sales of over $100k a month.

Stores Selling over $100k per month	2008	2009	2010
Percentage of Stores	20.7	12.7	19.1
Percentage of Pre-Tax Profits	53.3	48.8	52

 source: Fastenal, Earnings View

Again, there is a return in the numbers but they are still not back to 2008

Fourth, looking at working capital as a percentage of sales tells a similar story.

	2008	2009	2010
Accounts Receivable	244940	214169	270133
Inventories	564247	508405	557369
Working Capital	809187	722574	827502
WC/Sales %	34.6	37.4	36.5

source: Fastenal, Earnings View 

In essence, Fastenal have been held back from achieving the ‘pathway to profit’ objectives but look set to get there in future.

Fastenal End Demand is a Combination of Industrial and Residential Construction

In these results, Fastenal has benefited most strongly from a cyclical recovery in industrial production and less so from ongoing demand from maintenance. However, commercial residential construction customers (which usually represent 20-25% of their business) are still in a funk, despite the recorded growth. I would guess that this growth is coming of a very low base and, until the US housing market recovers, it will not come back in a meaningful way.

Fastenal Revenue Growth

On the conference call, Fastenal argued that

‘think it's a reasonable target. Some of the puts and takes would be if you look at the historical patterns, we normally touch start our January at or above where our October daily average was, which puts us in the 20% range in January. If you start out there, even if it slowed down a little bit, you should be able to hit the 15% to 20% for the year. Right now, we do not predict that it will be slowing down. So we're pretty confident in the 15% to 20% sales range at this point.’

Looking at the October number for stores opened for more than two years, it is 18.8% growth. Considering that most analysts have 2011 GDP growth to be similar to 2010, they could hit this again in 2011. Moreover, they are opening 150-200 new stores in 2011. Assuming $10k per month for 175 stores over the year gives another 21m or about .9% to 2010 revenues. Adding these two numbers together gives 19.7% for the year.

On top of that, 2010 saw very weak housing starts data. I think this will continue into 2011 as there remains a substantial amount of shadow inventory. However, the market has stabilised and I think there could be stronger activity in the second half. In addition, increasing employment and discretionary spending should aid Fastenal. I think they could achieve 16% revenue growth next year. I’ve shaved off 2% points to reflect on the slowing in the rate of growth of industrial investment spending.


Fastenal Evaluation

This would give $2.62bn in sales, which could give $2.20 in EPS or $324m in net earnings. If operating cash flow is again around 85% this gives $275m in operating cash flow, if capex is around $70m (new stores etc) this gives $205m in free cash flow.

I would want to buy it at a forward FCF/EV of around 4% which would give it a share price of $35. I find myself in a curious position of thinking forecasts are too light but that the company is overvalued. Frankly, I don't buy the analysts forecasts of 20% growth for next five years. Fastenal maybe recovering, but we are not going back to a housing boom anytime soon.