The Vita Group (VTG) share price increased 22% to a high of $0.95, and then closed at $0.90 after the release of excellent full-year results on Friday.
The result was well above my expectations, with the company benefiting from an optimised portfolio focusing on Telstra retail stores and business centres.
The good news is that after adjusting my forecasts, the stock is still very cheap. I am maintaining my Buy recommendation with the view that the market will continue to re-rate the stock as it digests the company’s outlook and large discount to valuation. My $0.95 valuation has now increased to $1.30, and the stock is on a 2015 price-earnings (PE) multiple of 8.5, and dividend yield of 7%.
The key numbers include revenue of $450 million ( 4%), underlying net profit of $10.3 million ( 66%), and underlying EBITDA of $27 million ( 18%). A final dividend of 2.75 cents was announced, combining to a very healthy 4.64 cents full-year fully franked dividend – a payout ratio of 65%.
There are two key one-offs to be aware of in the result. The first is the $19.3 million goodwill write-down for NextByte (Apple) - announced at the half-year result. The second is a $6.5 million non-cash contribution to EBITDA from its superseded risk products that were sold prior to January 1. After this date Vita discontinued its proprietary warranty and swap products (ESP) to introduce Telstra’s portfolio of risk products.
I first highlighted the Vita Group opportunity on March 26 this year with the stock trading at $0.70. I also included Vita Group as one of my top five stocks to benefit from reporting season on July 23.
The rationale for the previous Buy recommendations included the unique combination of trading at a large discount to valuation, with high growth and high yield. Even though the price is now $0.90, this same combination is in place as we look towards the 2015 forecasts.
I also highlighted the potential for the company to address the large franking balance, which is now above half the market cap. Pleasingly, there was commentary that the company will announce further details on how it will unlock value from this franking balance towards the end of this year.
The company is very well positioned strategically. This has come about from a combination of three key factors. Firstly, by optimising its store portfolio towards the stronger Telstra branded stores, then positioning for Telstra business-to-business growth and also leveraging higher margin products – including those from the Camelon IT acquisition.
During the year an additional 12 Telstra points of presence were acquired to increase the total to 109. The mix included 10 retail stores and two business centres. There is a note in the accounts displaying that these achieved a full-year EBITDA of $10.8 million. This means the stores were acquired on a very cheap 1.2 times EBITDA multiple. With the company now generating high free cash flow, the prospect of further store acquisitions is a compelling value creation opportunity. There is expected to be at least another five stores acquired in 2015.
At the half-year result, management took their medicine and wrote off the remaining $19.3 million of goodwill from the NextByte (Apple) acquisition. Due to changes in the competitive landscape, the company correctly identified that it was not in shareholders’ interests to continue with expansion plans for NextByte. The performance from existing stores appears to have stabilised. Although there was a full-year loss of $1 million EBITDA, it did break even in the second half. With new Apple products to be released NextByte should be profitable in 2015.
Management correctly decided to prioritise capital to the core Telstra portfolio and on building its presence in the business channel where far greater growth opportunities exist. The end result is a big strategic tick for management.
On the topic of management, CEO Maxine Horne and her team also deserve praise for their initiatives in developing their staff. The improvements in productivity display evidence that the investment in employees is paying off.
For years the company has had to spend significant capital and time in transitioning the business away from the poorly performing Fone Zone and One Zero stores. With this process largely complete, there is far greater freedom in deciding where to invest its free cash flow, as well as rewarding shareholders by un-locking the huge franking balance.
The result is also testament to the quality of the strategic partnership with Telstra. Any detrimental change to this ongoing constructive relationship is the largest risk for Vita Group.
I maintain my Buy recommendation, with a $1.30 valuation and price target.
To see Vita Group's financial summary and forecasts, click here.