One area I always focus on is risk and reward. I often hear people say that they wouldn’t buy certain shares because they are just too risky. That’s fine, but before deciding to discard an opportunity, it is important to understand the potential rewards being offered. This is a firm that falls into the higher-risk category. But this volatility need not be a problem, as long as the potential returns more than compensate – which, in this case, they do.
Tip of the week: Torex Retail (Aim TRX: 59p), tipped as a strong BUY by Arbuthnot
Over the past two years, Torex has acquired 15 companies costing nearly £350m and has transformed itself into a leading global “one-stop” provider of services to retailers. Although many investors have baulked at the break-neck speed of the purchases, the timing of these deals appears to have been astute. As you will probably remember, in the run up to 2000 many retailers installed new Y2K compliant software. These systems now need replacing. This software upgrade cycle has already started in the US, which is the largest retail IT market in the world.
Torex is the seventh-largest software vendor in the $6.6bn global market, with more than 6,500 customers, including Tesco, Shell, Argos, Matalan, Monsoon, Phones 4u, Virgin Trains and Benetton. It is also the clear leader in its sector within Europe, with a 26% share.
The firm’s integrated software spans all facets of a retailer’s operations. In the UK alone, its products help deal with more than 25 million transactions a week – that’s over 45% of all UK store sales by value.
Equally impressive was the company’s organic growth of 15% in 2005 (with operating profit margins of 16%), which substantially outperformed the overall industry growth rate of around 9%. Having achieved critical mass, the strategic focus has now switched from acquisitions to organic expansion.
So why have Torex’s shares tanked over the past year? Because the number and size of the company’s acquisitions has spooked investors: these have pushed up debt levels (to around £150m) and increased the perceived risk associated with integrating all these deals. But this Icarus-like dive has been significantly overdone, since forecast interest cover for 2006 is still a healthy 5.5, while the firm’s purchases have all been in complementary businesses, which reduces any potential integration risks.
The City is predicting 2006 sales and earnings per share (EPS) of £297m and 8.5p respectively, rising to £327m and 9.9p in 2007. This leaves the stock trading on rock-bottom p/e multiples of seven and six for the next two years, which for a high-tech business appears far too cheap.
At the recent July trading update, Torex’s management reiterated its “confidence in achieving these full-year expectations”. Arbuthnot has a 120p price target, and I would also recommend buying the shares as part of a well-diversified portfolio.
Finally, over the past two years, three directors have bought stock at between 73p and 112p.
Recommendation: BUY at 60p (market cap £221m)
Paul Hill’s personal portfolio has gone up by 483% over the last five years. To find out more about his own specialist share-tipping service, ‘Precision Guided Investments’, click on the link below: