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Begbies Traynor (BEG:AIM)

Insolvency specialist and property services company Begbies Traynor (BEG:AIM) derives two thirds of its revenue from activities which are counter-cyclical, which means that in any future slowdown or even recession the business will see rising demand for its insolvency services.

The company’s shares therefore provide a compelling hedge against future economic difficulties as well as good earnings expansion in the current low growth environment.

That isn’t to say the business needs a recession to perform well as the results for the six months to 31 October amply demonstrated.

Revenue rose 21% aided by acquisitions, but organic growth was still an impressive 10%, while profits surged 29%, helped by improving operating margins, which reached 13.2% (2018: 12.6%) as central costs were reduced as a percentage of revenues.

It is worth noting that businesses can also come under pressure as the economy starts to recover from a difficult period as they risk failing due to cash flow constraints. Therefore Begbies is attractive as an investment in both an economic downturn and upturn.

Chairman Ric Traynor sees increasing activity in the year ahead as the insolvency market continues its recovery. In the 12 months to 30 September volumes expanded by 7% to 16,857 cases nationwide.

This level is still some way off the peak seen in the financial crisis which saw annual insolvency cases peak at close to 25,000.

In anticipation of a growing workload the company has increased its capacity by recruiting additional fee-earners, taking the number of employees working in the insolvency division to 412 from 364 last year.

In October the firm purchased Alexander Lawson Jacobs which brings a team of 24 directors and employees focused on London and the South East.

Typically the firm earns revenue based on hours worked with the fees paid from asset realisations which are approved by creditors. On average each case can last from two to three years.

The company’s other division generates revenues from providing property advisory and consultancy services.

Begbies is the UK’s largest insolvency practitioner by volume with around 8% market share, serving the small and medium sized business community while the big four accountancy firms tend to handle the bigger insolvencies.

The insolvency marketplace is fragmented leaving scope for Begbies to grow by buying up smaller competitors. The business throws off strong free cash flows equivalent to around 10% of revenue.

It had a £2.3m net debt at 31 October 2019. A £25m revolving credit facility and a £5m acquisition facility provides the company with enough firepower to make selective acquisitions.

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Centrica (CNA)

Whether the latest strategic change of direction at British Gas owner Centrica (CNA) is yet another false dawn or a genuine reset onto a more profitable path, the shares are so beaten up that the risk/reward ratio here is attractive.

There are early signs that greater retail customer focus is having a positive impact on market share.

For instance a net 20% of households switched to British Gas in November as it offered one of the most competitive tariffs on comparison website Compare the Market.

Peter Earl, head of energy commented: ‘British Gas has put its foot on the gas in November, accounting for more than a third of all switches on our platform.’

The company is exiting oil and gas production as well as its interest in nuclear generation and is expected to provide net proceeds of around £2.7bn, most of which will be used to reduce the firm’s £3.37bn of debts.

Centrica is targeting £1bn of annualised efficiencies over the 2019 to 2022 period, a third higher than its prior target. It estimates these savings will cost £1.25bn to deliver.

If the new initiatives work they will result in a rough £20 saving for customers on dual fuel contracts, in real terms, propelling the firm into the top quartile cost position compared with the competition.

The firm has identified three fundamental trends which are reshaping the energy landscape today and its strategy is founded on an analysis of these changes.

The energy system is becoming more decentralised as renewable technologies are deployed on a smaller scale. At the same time customers have more choice about how they obtain their energy and the services they require, all aided by technology which puts the customer in control.

Positioning its services at the value-for-money end of the price spectrum should maximize the firm’s strong brand awareness and plays into the company’s strengths.

Centrica is the largest gas supplier and installer of boilers in the UK and has the widest range of on-demand services through its Local Heroes platform.

From an investment perspective, the most important consideration is that the market is sceptical on management achieving and keeping the cost savings announced, leaving room to surprise on the upside.

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Hotel Chocolat (HOTC:AIM) 

Premium British chocolatier Hotel Chocolat’s (HOTC:AIM) enviable record of beating earnings forecasts has been rewarded with a rich equity rating, yet the growth story is just getting started.

This cash generative chocolate brand’s product range is going from strength to strength and it plans to take a bite out of huge US and Japanese markets.

Guided by co-founder and CEO Angus Thirlwell, the leading UK premium chocolate brand sells products online and through locations in the UK and abroad.

It has a flagship UK restaurant in London and a cacao estate and hotel in Saint Lucia. A vertically integrated business, Hotel Chocolat grows its own cocoa and owns (and enforces) its own intellectual property too.

Risk factors include the fact that the bulk of its cocoa comes from a single supplier.

Hotel Chocolat’s stores – ‘a doorway into instant escapist happiness’ according to Thirlwell – are flourishing. Consumers are drawn in by relentless product innovation and experiences including Chocolate ‘lock-in’ tastings.

Like-for-like store growth accelerated in the first six months of 2019 following the launch of an in-home hot chocolate system and a loyalty scheme. And forthcoming launch ‘Biscuit of the Gods’ – where it is aiming to offer the ‘best chocolate biscuit on the planet’ – could boost sales momentum.

Hotel Chocolat is delivering tasty growth in the digital channel, as well as in the wholesale business, where it sells through Next (NXT), John Lewis and Amazon.

While being a near-term drag on group-level earnings, overseas developments are among the key upside catalysts to watch in 2020.

The gifting markets in the US and Japan are huge, roughly five and 3.8 times bigger than the UK respectively, while the brand’s ‘More Cacao Less Sugar’ mantra is already resonating in Tokyo and New York.

Having also formed a new joint venture in Scandinavia, Hotel Chocolat is exploring the potential for wholesale tie-ups in the US.

Furthermore, the gifting seasons are different in Japan, where Valentine’s Day and White Day in February and March generate a sales peak similar to Christmas in the UK.

For the year to June 2020, Peel Hunt forecasts £15m adjusted pre-tax profit (2019: £14.1m), rising to £16.3m in 2021.

We consider Hotel Chocolat one of those rare businesses with the right ingredients to keep growing thanks to geographical expansion opportunities. The shares have done well since it joined the market in 2016 and we see that trend continuing.

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IG Design (IGR:AIM)

You’d be crackers to ignore this global growth winner. Investors willing to pay up for a quality long-term consolidation story with global earnings momentum should snap up IG Design (IGR:AIM).

Despite having already delivered stellar returns for shareholders, we believe there is more to come as the company leverages long-standing ties with the world’s top retailers.

IG Design makes and supplies products that help people celebrate life’s special occasions. Its hugely diverse range spans gift packaging and greetings cards, stationery, creative play products and design-led giftware.

It is growing with the likes of Walmart, the world’s largest retailer, and Target in the US. It also has agreements with names such as Tesco (TSCO), Action, Dollar Tree and Lidl.

Successful licensing deals are in place for key brands including Peppa Pig, Toy Story and Frozen and these offer additional earnings upside for IG Design, whose UK business is taking a lead in developing more environmentally-friendly products such as fully recyclable Christmas crackers.

Results for the six months to 30 September showed a double digit profit gain amid impressive showings in the UK, Europe and US, where IG Design is geared into the buoyant consumer.

Following the acquisition of Impact Innovations, the US now speaks for 60% of group revenue. Sales and profits in the country are growing like topsy and it recently inked a deal with one of the largest retailers – it isn’t allowed to disclose the name for commercial reasons – for the supply of all-year-round themed and seasonal impulse gifting products to over 1,500 stores.

IG Design is primed for long-term organic growth as it expands with new and existing retail customers.

Risks to consider include cost pressures and competition, although this company has scale and manufacturing advantages over peers. Possible disposable income declines could also reduce gifting spend in key markets.

A new printing press in Memphis will reduce costs, increase gift-wrap production capacity and help the company mitigate the impact of tariffs.

Cash-generative IG Design also offers investors a progressive dividend, one forecast to rise from 8.5p to 10.54p in the year to March 2020 ahead of 12.61p and 13.71p in the 2021 and 2022 financial years respectively.

Chief executive Paul Fineman – whose personal stake in IG Design is now worth £15.7m – is likely to pursue further acquisitions, supported by the company’s strong balance sheet, to drive incremental growth.

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Kainos (KNOS)

A desire to go digital is one thing that unites organisations both large and small. From ordering a pint in a pub via a phone app to calculating a tax return, plus a million more things, this is a multi-year transition that will separate winners from losers.

Among those thriving from this structural growth trend is Belfast-based Kainos (KNOS) which helps large organisations transition their processes and operations into the 21st Century digital world.

Kainos is one of the key IT expertise suppliers to UK Government departments, often writing bespoke tools and software services for the Cabinet Office, Home Office, Driver & Vehicle Licencing Agency (DVLA), Department for Transport, Land Registry and others.

The company is also one of 35 global accredited installation providers for Workday, the $37bn US human resources and financial planning software platform. Kainos provides implementation and testing for users of Workday enterprise management tools.

It also runs Evolve, an NHS IT system including things like electronic medical records that help streamline the service delivered to patients.

One of the real attractions of Kainos is this multi-paced, segmented model. It means as growth temporarily slows in one part of the business, the slack can be picked up elsewhere.

This has been illustrated over the past couple of years. While Evolve has been muddling along due to years of austerity cuts biting into NHS budgets and investment spending, other parts of the business have been progressing at a blistering pace.

In the year to 31 March 2019 its digital services drove revenue growth, up 69% to £132.6m, with momentum in both Workday implementation and on UK Government digital transformation despite parliamentary deadlock over Brexit concerns.

If politicians are to be believed we are on the cusp of some of the largest healthcare and public sector digital services investment ever. That’s really exciting for Kainos and could unleash huge opportunities that could make current earnings forecasts look far too cautious.

The high price-to-earnings multiple will worry some investors but we believe the premium is justified by Kainos’ high-quality track record and impressive cash dynamics. It has £42m on the books with no debt making the balance sheet as bulletproof as they come.

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Lloyds Banking

The political situation in the UK is clearer than it has been for some time and the stage looks set for Lloyds’ (LLOY) steady approach to win favour with the market.

The shares are cheap. According to consensus forecasts the shares trade at parity with book value and Shore Capital’s estimates imply a price-to-earnings ratio for 2020 of 8.1.

With the PPI issue largely in the rear view mirror Lloyds can get on with doing the basics of banking well and rewarding shareholders with generous returns.

The company’s recovery from the financial crisis has been built on getting back to the old ‘boring’ retail banking model.

It funds a good chunk of its (almost exclusively UK) operations from customer deposits, secured through savings and current accounts, and offers mortgages, personal loans and credit cards.

The company has also strengthened governance of risk, by establishing a management structure which can hold the board to account and making bonuses dependent on long-term rather than short-term outcomes.

This model is helping deliver strong profitability and cash generation, underpinning a key attraction of the stock, namely its dividend.

Before the credit crunch banks were widely bought for income and Lloyds is renewing its credentials in this area. Since dividends were resumed in 2015, the company has grown its annual payout from 0.75p to more than 3p per share.

With the PPI provisions behind it – the deadline for claims having elapsed in August 2019 – the company could now be able to increase its generosity to shareholders. This might even involve resuming the share buybacks it suspended in September as well as continuing to deliver material growth in the dividend.

Like its rivals Lloyds comfortably cleared the latest Bank of England stress tests and it looks to have plenty of headroom to absorb the requirement to increase its capital buffer to deal with distressed economic conditions.

Greater levels of political certainty and increased Government spend could help give the UK economy a boost in 2020 and there is even a chance the Bank of England might use the current window of opportunity to raise interest rates (thereby benefiting the banks) to give it greater flexibility to deal with any future downturns.

The next obvious catalyst for the shares will come with full-year results on 20 February with the focus likely to be on the level of shareholder returns and the near-term outlook.

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Luceco (LUCE)

Some of the best investment opportunities are found when fundamentally good companies temporarily come a cropper. This is exactly the case with Luceco (LUCE), which continues to enjoy strong orders and has the scope to repair profit margins from the high single digits of today to the mid-teens of the past.

Having sorted out the disastrous stock and currency mis-management problems of a couple of years ago, Luceco has the opportunity to transform itself and its share price through 2020 and beyond.

There is scope for significant profit margin recovery to around 12% by 2021, improve free cash flow and possibly make value-adding acquisitions.

The Telford-based business supplies a large collection of electrical and wiring products to both retail and wholesale providers, covering industries such as commercial construction, residential housebuilding and housing maintenance.

Perhaps best known for its relatively new LED business (started from scratch just five years ago), many investors fail to recognise its much larger and more profitable wiring accessories operation, trading as BG, which supplies to the likes of B&Q and Travis Perkins (TPK).

This part of the business runs on high-teens margins and produces roughly 75% of operating profit. This is a regulated and defensive market with 50%-odd recurring revenues providing safety solutions to large landlords in both new build and repair, maintenance and improvement.

No-one wants to run the risk of electrocuting tenants when they plug the iron or kettle into the mains, for example.

Luceco’s wiring accessories business is still largely UK-based making international expansion an exciting opportunity.

Now that LED start-up costs have been largely sunk, free cash flow should really race ahead. For example, it threw off roughly £18m of free cash flow between 2014 and 2018. By contrast, analysts forecast £18m free cash flow in 2020 alone. This will allow Luceco to both deleverage the balance sheet and begin making bolt-on acquisitions to power growth.

Luceco is expected to have around £30m of net debt at the end of 2019, but that is forecast to be slashed to less than £5m by the end of 2021, giving the company up to £80m of acquisition firepower.

The stock is inexpensive in price-to-earnings terms, trading on just 12.6 times 2020 earnings forecasts of 9.2p.

With significant profit growth potential from both operational improvements, underlying expansion and acquisitions, we believe Luceco shares have significant re-rating potential.

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Redrow (RDW) 

Improved prospects for the housebuilding sector driven by more clarity on Brexit means it is time to buy Redrow (RDW) which has quality earnings and a strong cash position.

The landslide victory for the Conservatives in the 12 December General Election has created a measure of political certainty, in the short-term at least, which should be supportive to the housing market. This should allow housebuilders to increase asking prices, thus mitigating a rise in build costs.

The robust dynamics behind residential property, namely a lack of supply to meet demand, remain in place and mortgages remain cheap.

The Tories have made some positive noises about supporting the sector, including finding a new way to support home ownership once the current Help to Buy scheme expires in 2023.

And, although it was not in the party’s manifesto, prime minister Boris Johnson has previously discussed cuts to stamp duty which could provide a further boost to transactions.

Redrow’s focus on building premium quality homes means it is more exposed to the higher end of the market but also should help it steer clear of the build issues and poor customer service which have affected some of its peer group, notably Persimmon (PSN).

The company is also well aligned with the higher levels of investor and consumer focus on sustainability, with commitments to source 90% of its products locally and ensure 100% of its timber is responsibly sourced.

And unlike some of its rivals, who are taking their foot firmly off the accelerator, Redrow is still looking to grow, opening up its Thames Valley division in 2019 and with plans to open new outlets in 2020.

Its price-to-book value of 1.4 times is lower than the peer group average of 1.7, making the shares particularly attractive from a valuation perspective. 

The company offers generous dividends; based on consensus estimates the shares offer a dividend yield of 6.2% underpinned by strong cash generation and the net cash which is piling up on the balance sheet.

The next catalyst for the share price is likely to be the results for the six months to 31 December published on 5 February 2020 which may offer some commentary on the prospects for the key spring selling season.

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Schroders (SDR)

With assets under management of £444bn, Schroders (SDR) is one of the few UK financial firms able to stand shoulder-to-shoulder with its international peers.

While the UK accounts more than a third of assets under management, two thirds of operating revenue comes from outside the UK making it a truly diversified global business.

In terms of products, equities account for 37% of the total followed by multi-asset investments at 25% and fixed income at 18%.

Admittedly this means that Schroders has suffered net outflows from equities this year, along with the rest of the asset management industry, but these have been balanced by inflows into fixed income, multi-asset products and private assets.

Also the firm’s investment returns have been particularly strong this year, generating £35bn uplift in assets under management in the first half.

As well as its traditional asset management business, Schroders recently partnered with Lloyds (LLOY) to form a wealth management company after being awarded £80bn of the £109bn in pension assets that the bank pulled from its former partner Standard Life Aberdeen (SLA). It is also reaching out to younger investors with its MoneyLens service.

Success isn’t assured, however. Some observers have questioned how effectively Schroders Personal Wealth will be able to compete given that the bigger industry players have many more advisers and are unlikely to allow it to carve out a meaningful slice of the lucrative personal wealth management market.

Schroders Personal Wealth launched with 300 Lloyds advisers, while some of its bigger rivals have up to 10 times that number, although it plans to increase headcount substantially.

In a sign of confidence, earlier this year fund manager Nick Train doubled his holding in Schroders from 5% to 10% making him the second largest shareholder after the founding family.

The holding is a bet on Schroders cracking the US market, where it is ‘not well represented’ according to Train, through distribution deals. Of its assets under management, just 15% are owned by clients domiciled in the US compared with 41% owned by clients based in the UK.

‘Most of the trillion-dollar asset managers are in the US because of the scale of the domestic savings pool. How are they (Schroders) going to get to a trillion dollars? It has probably got something to do with the US,’ says Train.

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Wizz Air (WIZZ)

An outstanding growth stock leaving its rivals trailing, Wizz Air (WIZZ) is structurally better placed than its peers to exploit the rise in air travel.

A low-cost airline focused on connecting travellers from Central and Eastern Europe (CEE) with the rest of the continent, Wizz has carved a niche as the biggest airline in the region.

It provides relatively low cost travel to people from CEE countries whose rising income means they can now afford to go on holiday and see more of the world.

Wizz has a clear focus in this regard with its chief executive Jozsef Varadi calling for a ban on business class, and deriding plans of rival EasyJet (EZJ) to launch package holidays as ‘paying a premium for nothing’.

By targeting countries with high GDP growth, Wizz has grown earnings faster than its peers.

In 2020 the firm is forecast to grow revenue by 21.8% and earnings before interest, tax, depreciation and amortisation (EBITDA) by 98.7%.

In comparison, main rivals Ryanair (RYA) and EasyJet are projected to grow revenue by 12.1% and 7.6% respectively, with EBITDA growing at -2.8% and 17%.

Wizz has done a better job than rivals in generating ancillary revenue, i.e. extras once a passenger has booked their flight.

Ancillary revenue makes up 43% of its revenue, compared to 26% from Ryanair and 19.5% from EasyJet, and is important for airlines because it is stable income – prices of extras don’t change whereas passenger fares fluctuate.

The company is also known as something of an innovator in the airline industry, with latest chatter suggesting it could a launch a ‘Netflix-style subscription’ next year, where passengers pay a monthly fee for an unlimited number of flights.

One area to which Wizz may be more exposed than some of its rivals is fluctuating fuel costs, set to be a big challenge for airlines next year.

Fuel prices are forecast to go up by around $26 a tonne in 2020. To mitigate that Wizz has hedged 77% of its fuel for next year capped at $692 per tonne, and 43% in 2021 at $661 per tonne.

But EasyJet for example has hedged 68% at a lower price of $655 per tonne for the year to 30 September 2020, and 45% for 2021 again at a lower cost of $643 per tonne.

The airline industry is a tough one to crack. Wizz is no different to others in being affected by fuel costs, staffing issues and volatile fare income, particularly if the economic picture is sluggish.

But this is an airline much better placed than others with a stronger structural growth trajectory ahead.

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