Until recently the City put a high value on firms with efficiently geared balance sheets. But since the credit crunch struck, indebted firms are hugely unpopular with fund managers. So is this fear warranted, and if not can we make money from any mispricings? The answer is yes, depending on your risk appetite. To me, the fear of banks seems justified, since no one knows where the next blow will come from. But what’s important for investors when analysing other indebted firms is their interest cover, predictability of earnings, quality of management and loan maturity. If these look reasonable, yet the share price has tanked, then there may be a good buying opportunity – as long as you can accept greater volatility.
Vantis (Aim:VTS), rated a BUY by Landsbanki
Take Vantis. It provides accountancy (50% of sales), consultancy (30%) and business recovery (20%) services to wealthy individuals and small and medium-sized businesses (SMEs) and is now the UK’s 13th-largest player in its sector. Last week it reported upbeat first half results that met City estimates.
Turnover was up 11% (5% on a like-for-like basis) to £46.9m, with robust operating profit margins (16.4%) and adjusted earnings per share of 7.5p. Growth is being driven by successfully executed acquisitions and the ongoing trend for SMEs to pay for advice from experts such as Vantis. Moreover, the ‘big four’ accountants tend to focus on larger global clients and so are not usually direct competitors.
For the year to April 2008, house broker Landsbanki expects sales and underlying earnings per share of £98.8m and 19.3p respectively, rising to £107.3m and 21.9p in 2009. Chairman Paul Gourmand said the group is continuing to “perform in line with expectations” and that its core units “are trading well and are better positioned to withstand a more challenging economic environment” as its services help firms deal with bankruptcy and debt problems.
Given this reassuring guidance, and the firm’s defensive qualities, why have the shares dived more than 50% from 261p in March? The major worry is Vantis’s £37.9m debt pile. Yet it renegotiated its entire funding back in May 2007, agreeing a new £44m credit-line that should be sufficient for future growth. And interest payments are covered a manageable 4.2 times – above the three times stipulated in its banking covenants.
The City’s other concern is Vantis’s poor recent cash-flow generation. If SMEs start to feel the pinch, then growth could stall and the group mayeven incur bad debt write-offs as stretching debtor levels (£60.8m) need to be cut to industry norms.
But while Vantis’s gearing needs to be watched, I don’t think it is yet a problem, especially as the company employs hoards of smart turnaround experts, who should be ideally placed to improve cash management. With the shares on a 2008 p/e multiple of less than seven, the City’s skittishness looks over the top. Landsbanki has a target price of 240p.
Recommendation: high-risk BUY at 126p (market cap £64m)
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments