Moving Wellcom to a hold

Our valuation increases, but in light of a substantial increase in share price we're happy to hold it for now.

Wellcom is a provider of content creation, production and content management services, and delivered a strong half year result to the market. The company’s profit result and dividend were in line with our expectations and the business appears to be taking advantage of recent geographic expansions by bringing in strong growth in the UK and US business.

The interim dividend announced was 9 cents per share fully franked, with shares to commence trading on an ex-dividend basis on the March 2, 2016. This 9c dividend is a 6 per cent increase on the 8.5c dividend paid in the previous corresponding period (pcp).

This 9c dividend is in line with our expectations to the cent, showing that WLL’s future is stable and the financial position of the business is strong and predictable. We note that the dividend increase is smaller than the profit increase at the business, leading to a lower payout ratio of 65 per cent, down from 72 per cent in the pcp. This is a positive, as it underlines that WLL is generating the profits to both reinvest in growth of the business and pay out a strong income stream to shareholders.

Highlights and challenges

WLL is growing its revenue; with a 26 per cent lift on the PCP for the first half to $52.11m. This has translated to net profit after tax growth of $16.4 per cent to $5.39m, up from $4.63m in the pcp. The company has seen some earnings margin contraction, but remains in a strong balance sheet position with net cash of around $3m.

Most of the margin contraction was attributed to the company’s Australasia operations. This segment produced $28.598m in revenue and earnings of $6m, down slightly from $6.083m in the pcp. However, there were some one off costs including new business investments, an impact from the Dick Smith receivership and FX impacts. Overall, even with these impacts, the core Australasia division produced a solid result.

Perhaps most pleasing was the lift in the result from the UK. Segment revenue lifted 55 per cent to $9.773m and earnings increased fivefold from $0.21m in the pcp to $1.37m this period. Staff numbers in the UK were significantly increased as the division begins to contribute meaningful earnings, and ramp up for further growth.

Finally, the US segment has been a strong source of outperformance in recent periods for WLL, and this period was no different. Segment revenue was higher by 54 per cent to $13.734m, from $8.94 recorded in the pcp. While margins were weaker, the contribution from acquisition of Dippin Sauce assisted in an earnings increase of 35 per cent to $2.13m.

Key take-away and outlook

This was a strong result from WLL. The company is delivering on expectations, and is very healthy in terms of balance sheet position and cash flow management. We remain confident in the company’s ability to deliver increased dividends through continued earnings growth.

That said, WLL management have delivered some cautionary words in their financial report, suggesting that market activity and moderating consumer spending will provide some top line challenges to the business.

It is worth noting that both Masters and Dick Smith are WLL clients, and the issues seen at these retail businesses will impact WLL. The impact is unlikely to be material, as WLL has a well-diversified client base, but there is nonetheless risk involved. To exhibit this customer diversification, here is a slide showing some of WLL’s client base, taken from the results presentation:

During the half, new business was won with Telstra, Coles, NBC, Fairfax, BASF, NBC Universal, Michael Kors, Tesco, and Audi just to name a few. Our view remains that the company is well placed to absorb the potential impact from businesses that are encountering issues such as Masters and Dick Smith.

Given WLL’s newfound geographic strength, I believe that the company has a stronger capability to service multinational clients and win further work across geographies. This strategy could become key to growth in coming years.

WLL has maintained full year guidance of around 10 per cent growth in earnings per share. With the company having achieved growth of 16 per cent in the first half, this guidance seems conservative. However, if market conditions are deteriorating slightly, then conservative guidance, a healthy balance sheet and strong cash position will be assets to the company.

I am pleased that WLL delivered once again. The company has established a strong track record now, and this makes us comfortable retaining it in the Income First model portfolio. However, with the price having lifted substantially in recent months, we change our recommendation from buy to hold, with an updated valuation of $4.63.

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