Every week, professional analyst Paul Hill picks his gamble, a riskier share for braver investors. This cleaning and hygiene products supplier may have had a bad year, but with a supportive bank and high-profile new clients in tow, its shares are looking somewhat oversold.
Gamble of the week: Zenith Hygiene (Aim:ZHG)
While ‘zenith’ means “the highest point (of achievement)”, in most shareholders’ experience Zenith Hygiene’s (ZHG) performance has been quite the opposite over the past year. After a series of profit warnings, the stock has fallen from 180p to around 25p. Formed in 1996, Zenith is the UK’s top independent manufacturer and supplier of cleaning and hygiene items to the food and hospitality industries, hotels, pubs and other leisure groups. The majority of its products are supplied under the Zenith brand.
So what has gone so badly wrong? Firstly, last summer’s World Cup hit underlying demand from restaurants; then there were delays in rolling out two major contracts then problems integrating two recent acquisitions, plus in March a failed takeover attempt by a private-equity house that ended with the resignation of the finance director (who has still to be replaced).
The final nail in the coffin came in June, after Zenith warned that it would make a loss for the full year. The culprits this time were one-off exceptional charges, cost overruns and the need to change the way the company accounts for customer rebates. This issue may even lead to a restatement of the prior year’s results. Not surprisingly, many shareholders have lost patience. But amid the doom and gloom, I believe that this is a sound business, and that the shares (while high-risk) are oversold. Let me explain.
Firstly, Zenith’s bankers (Royal Bank of Scotland) seem to be supportive through this tough period and have reconfirmed its current lending facilities of around £11m. Although tight, with net debt as at February 2007 of £8.12m, I think that via aggressive cost cutting and working capital management, this loan facility should be sufficient. Secondly, and most importantly, Zenith is still winning new blue-chip clients. In the first months of the financial year, it won prestigious customers, including Starbucks and Travelodge. Finally, although there are no up-to-date financial forecasts available, I reckon this type of enterprise – after a successful two-year turnaround – should be able to generate operating profit margins of at least 5% on turnover of about £40m. Assuming this was the case, EPS would be around 4.5p, which, using a 12-times earnings multiple and a 15% discount rate, would generate a fair value for the shares of over 40p. I’m not the only one thinking this. In June, Stanley Fink (of Man Group) topped up his holding to 5.25%, buying 288,217 shares at 23p. But bear in mind the risks – other worries include rising cost pressure from suppliers and competition from the likes of Bunzl and JohnsonDiversey.
Recommendation: high-risk turnaround play – Buy at 21p (market cap. £4.3m)
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments