Is the world heading into a second recession, or just going through a soft patch? Nobody knows for sure. Yet given that there’s a US presidential election in 2012 (hence the US government has every incentive to stimulate the economy by any means necessary), and that the global economy is set to grow by 4.3% this year and 4.4% the next (according to the International Monetary Fund), I’m still in the ‘glass half-full’ camp. This is important, because as long as one accepts the near-term volatility, there are bargains to be had.
Take Premier Farnell, a distributor of niche electrical components. It stores around 400,000 items and has access to another four million parts via its extensive supplier base. Most of its orders are dispatched in low volume and at short notice to its two-million-odd customers. This makes it a bellwether of what’s happening in the wider economy.
The firm’s shares fell 20% in July as business slowed in May and June, due to falling demand in Europe and North America. Also, some customers bought extra stock following the Japanese earthquake. The resulting inventory glut is taking longer to shift than expected. However, if there is a pick-up in the second half, Premier should rapidly return to its target growth rate of 6%-8% a year. This may already be happening. “We have achieved stability and things are looking stronger in July,” says chief executive Harriet Green. This claim is backed up by the firm’s own forward-looking indicator of new customer numbers, which shows a constant rate across the first and second quarters.
Yet even if the soft-patch continues a bit longer, Premier’s self-help measures should keep the ball rolling. Green stressed that gross margins should stay flat due to cost-cutting. For example, Premier plans to put a freeze on hiring, slow spending on new projects and gain more savings from its internet arm (53% of sales). Thus the overall impact on profit should be modest and enable the company to maintain its tasty dividend (it’s on a 5% yield).
Premier Farnell (LSE: PFL), rated a BUY by Collins Stewart
Prospects are bright too. Premier’s addressable markets are set to grow at high single-digit rates for the foreseeable future. Moreover, its tried-and-tested model has already weathered the 2008/2009 storm. Its strategy is to focus on targeting design engineers in niches that make the greatest use of electronic gadgetry (such as biometrics, medical devices, and optoelectronics), alongside expanding in new territories – notably into India, China and eastern Europe, where the company has won market share.
The City expects 2011 turnover and earnings per share of £1.0bn and 19.4p respectively, rising to £1.1bn and 21.7p in 2012. The stock trades on p/e ratios of 9.7 for this year and 8.7 for the next. I value the group on an operating profit multiple of ten. Adjusting for the £35m pension deficit, preference shares of £71m and £166m net debt, this gives an intrinsic worth of around 230p a share.
What are the possible pitfalls? Premier depends on the health of the economy and so would undoubtedly be hit if there was another slump. It is also exposed to currency fluctuations, tough competition and has limited visibility in light of its 24-hour ordering patterns. Yet with strong barriers to entry, these risks are more than baked into the moribund price. The directors seem to agree: five of them have topped up their holdings over the past two months. Collins Stewart has a target price of 300p. Interim results are due on 8 September.
Rating: BUY at 186p (market cap £690m)