We first called Vita Group (VTG) a "buy" at $0.70 on March 26 this year. The company exceeded our expectations for the full-year result, and has again exceeded our expectations for the first half guidance of 2014-15.
After the positive guidance today the company hit a high of $1.32, or an 89% gain since the initial recommendation.
Today the company stated it expects first half earnings before interest, tax, depreciation and amortisation (EBITDA) to be in the range of $23.7 million to $24.7 million. This includes a greater than expected $5.5 million from the group's proprietary Swap and Extended Warranty Product (ESP). The program has been retired from sale, but the group continues to service obligations to customers for the remaining life of contracts in force.
The number one driver of the exceptional results continues to be the Vita network of Telstra stores, with recent additional stores performing well, and an improved contribution from the small and medium business channel.
The recent Apple iPhone 6 launch has fueled a positive response for both the retail and business channels.
Moving forward there are a couple of key uncertainties that will likely drive the share price. Firstly, how long will the Apple iPhone 6 affect lasts. Secondly, the Vita run retail Telstra store is getting towards an average fourth year which we have previously assumed is the year where the high growth rates begin to stall. The final uncertainty is just how much impact the new Telstra business centers will have on Vita's overall operations.
One of the key reasons for our high conviction "buy" recommendation for Vita was the fact that its franking balance was half the market cap. Pleasingly the company has implemented a rational method of slowly releasing these franking credits to shareholders.
Vita Group has consistently traded on a price-earnings (P/E) ratio of around 10 times, with a fully franked yield of 6-7 percent. Considering the company is comfortably growing at rates of above 30 percent, these metrics have appeared significantly discounted.
Previously we view one of the reasons for this discount was the poorly performing Fone zone and One zero stores. Now the company has optimized its store portfolio away from these stores and towards Telstra.
Another reason for the discounted share price has likely being the perception around the Telstra relationship. We believe the concerns here have been overplayed for a couple of key reasons.
Firstly, all evidence would suggest the Vita run Telstra stores significantly outperform the Telstra operated retail stores. This may be due to the fact that Vita has had twenty years to refine its techniques and has far greater flexibility than Telstra in how the stores are run.
Also if Telstra changes its mind and wants to bring the VIta stores in-house again they have to pay a market value to regain ownership. We don’t view this scenario as likely, especially whilst the Vita stores significantly outperform.
The difficulty in forecasting earnings from here is determining how the company will use the significant free operating cashflow generated.
History would suggest the opportunity to acquire further Telstra stores would be likely to pay off.
Although the visability around the likelihood of first half earnings strength continuing is low, our earnings upgrades increase the DCF valuation for the company to $1.40.
Those shareholders who followed our initial recommendation have done very well and are up nearly 90%. From here we do have some concerns - Firstly a significant amount of positive news has been factored in. Secondly we don’t believe the company can keep up the high growth rates given the company is averaging a fourth year average store life. Our view is that the Telstra stores under Vita ownership can grow earnings signficantly for the first four years but then tend to plateu. Also it is difficult to quantify how much future growth will come from VIta's exposure to Telstra's business centres.
Although CEO Maxine Horne deserves enormous credit for her efforts in recent times, we are downgrading our recommendation from "buy" to "hold" with an increased valuation from $1.30 to $1.40.
To see Vita Group's forecasts and financial summary, click here.