I want to introduce you to a small company stock that’s in a great industry, making good money and looking very cheap. A stock overlooked by the market.
In fact, the stock I’m going to recommend looks like it could easily add 50% and still look undervalued!
Let me first explain a bit about the industry these guys are in.
Consumer debt
Consumer indebtedness in the UK is amongst the highest in the world. And now the banks are turning off the taps – scared about bad debts. Suddenly, many of the people that over-borrowed during the boom times are finding themselves unable to pay their debts.
Insolvency practitioners have never been busier. These guys help over-indebted consumers work out affordable repayment plans through Individual Voluntary Arrangements (IVAs). I’ll explain more about these below…
Individual Voluntary Arrangements (IVAs)
These arrangements were designed to find solutions for consumers unable to pay back unsecured debt. Things like credit cards, store cards and personal loans which saw an unprecedented boom over the last 10 years. The bust has only just begun – and insolvency practitioners are in demand.
The insolvency specialist negotiates with the lenders, offering a repayment plan in return for some debt forgiveness. The plan usually lasts for five years or less, the consumer escapes bankruptcy and the lender gets some money back.
I’m going to show you a company that generates nearly 90% of its revenues from IVAs. Profits more than doubled last year and it expects more of the same this year. Best of all, the company is excellent value…
Fairpoint, the IVA specialist
Fairpoint (LSE:FRP), has three divisions to its business, but by far the most important is the IVA division, which trades under the banners of Debt Free Direct and Clear Start.
The IVA market suffered a couple of years ago as a new fee-charging regime was introduced. This hit FRP’s revenue (down 19%) and the shares have never really quite recovered. Right now, the industry is consolidating (many players have left as it’s no longer profitable for them) leaving FRP a market leader, with 18% of all IVAs.
Basically, only the large fish have survived. FRP has been spending less on marketing, yet they’ve been picking up new clients (up 23%). Profits are growing and the company fundamentals are looking strong.
An industry in rapid growth
I did feel a pang of guilt as I read through their accounts which were out last week. Results for the year just finished, described excellent trading due to high unemployment, personal indebtedness and lack of credit available to individuals.
What’s more, company management are expecting more misery for 2010. They point out that the public sector is likely to suffer job losses this year. Together with rising interest rates and continued scarcity of new loans, individuals’ financial health will continue to suffer.
Let’s take a look at how this company turns such bad news into profitable business…..
The financials
Profit before tax came in at £6.1m. The company used this to halve its bank borrowings (now only £4.5m) and it has re-instated the dividend. The shares are currently on a yield of 3.6%, rising to 4.9% next year.
The market cap of £33m is way under the book value of its assets £45.5m.
Technically, a company trading below its book value, should be able to shut down, sell its assets (generating £45.5m in this case) and return the excess funds to shareholders. In reality, this isn’t quite as easy as it sounds. I mention it really just to highlight the fact that this company looks undervalued.
I suspect FRP is still suffering from the negative sentiment generated a couple of years back when IVA fees were restructured and revenues fell off. If you can see through this negativity, you’ll see that the business has now recovered and is looking robust.
With bank debts likely to be paid down by the end of this year, this company is looking safe too.
Directors have been buying shares. Matthew Peacock, the company chairman now owns nearly 25% of the company. This not only shows faith in the company, but it’s another indicator that the company is good value.
A diversification play
Diversification isn’t just about holding a lot of different companies in your portfolio. To get the most out of diversification, it’s a good idea to hold stocks that perform well in different types of environment.
As most stocks tend to do well as the economy booms, it’s worth having a company like FRP that benefits even when the economy falters. As consumer debt problems increase, this company’s profits increase.
Why FRP could still look cheap, even 50% higher than today.
FRP’s book value is £45.5m, yet the stock is capitalised at only £33m. So even if the stock price recovers by 50%, it’ll still leave it trading at only just above the value of its assets.
FRP is trading on a P/E of 8 times. A 50% increase in the share price will put them on a P/E of 12 times. For most companies a multiple of 12 times is generally considered cheap or fair value. But for a company enjoying growth (and falling costs) it’s too low.
The shares are trading at 77p; I would recommend buying at anywhere below 90p. It may take some time, but value will always out in the end.
• This article
was written by Bengt Saelensminde and was first published in the free daily investment email The Right Side
on 22 March 2010.