SIF Portfolio: Should I put on a show with Avesco?

Small cap audio visual presentation group Avesco has risen by nearly 150% over the last year. It might have made an appearance in the SIF portfolio before now, were it not for the group’s small size.

However, the shares have surged higher since 1 September, when Avesco said profits were likely to be “comfortably ahead” of expectations this year. This has pushed Avesco’s market cap up to £53m, above my screen’s £50m threshold.

Despite these gains, the shares still look attractively valued to me. Avesco has been trading well and Stockopedia’s computers are keen, too. Avesco has a StockRank of 99.

What’s the story?

Avesco has four main operating companies. These provide audio-visual services and equipment for live events, corporate presentations and broadcasters. The main source of both revenue and profit is the Creative Technology or CT division. This provides audio-visual solutions and technical staging for major events all over the world, such as Wimbledon, the Olympics and major music tours.

The big screens, clever lighting and computer-generated effects you see used on live television and stage sets may well be provided by Avesco’s CT division. This is an area where I’d imagine long-term growth potential is strong. The scale and complexity of this kind of thing seems to increase every year.

CT generated 80% of revenue and virtually all of the group’s profit last year. This may cause you to wonder whether Avesco’s other businesses are pulling their weight or merely dragging down the group’s return on capital.

In at least one case, the answer is that it’s a drag -- and it’s going. You might expect Fountain Studios at Wembley -- which hosts the X Factor among other primetime glories -- to be a profitable business. But Fountain made a trading loss of £0.1m in 2015 and only broken even in 2014.

Avesco rightly decided that this business was generating an unacceptably low return on capital, especially when compared to the freehold value of the land and buildings it owned on the site. The good news for shareholders is that these assets were sold for £16m earlier this year, generating £13m of cash and a profit of £6m. The cash was used to reduce debt and Fountain Studios Wembley is now due to close early in 2017. Although I feel sympathy for the employees affected by this closure, this looks like a sensible decision.

Avesco’s two other businesses are Presteigne Broadcast Hire and mclcreate. Presteigne provides hire equipment to broadcasters, while mclcreate provides full service solutions for exhibitions and other such events. Trading has been poor at both firms but Avesco is -- for now at least -- redoubling its efforts to attract new clients and improve profitability.

Value: A sea of green?

As Paul Scott commented in his report on 2 September, the StockReport for Avesco is a sea of green:

This translates into an outstanding ValueRank of 95:

However, all is not quite as it seems. These trailing figures appear to include the benefit of the £16m sale of Avesco’s Fountain Studios site, which was included in the group’s interim results. This is clearly an exceptional item that’s big enough to distort the figures.

To get a clearer picture, I’ve stripped this out to calculate underlying trailing figures:

• P/E: 15.2
• P/FCF: 6.9
• Earnings yield: 11.6%

These figures aren’t quite so outstanding, but they’re still very attractive, in my view. Note how strong free cash flow has been over the last year.

I’m also encouraged by the asset backing on offer here. Avesco reported net assets of 230p per share in its interim results. That gives a price/book value of 1.2, which suggests that the group’s assets could provide some downside protection during periods of weaker trading.

Finally, Avesco’s trailing dividend yield of 2.7% is respectable for a small cap. The payout has grown by an average of 22% over the last five years and the interim dividend rose by 25% this year. Given the group’s strong balance sheet, what’s not to like?

A display of quality

Avesco’s QualityRank of 87 is less likely to have been distorted by the one-off gain from the Fountain Studios disposal. The main highlights here are the group’s high Piotroski F-Score and the profitability of its assets. This shows up both in terms of gross profit and free cash flow:

The one question mark here is Avesco’s return on capital employed, which has averaged just 1.35% over the last five years. Looking at the StockReport, the group’s historic profitability has been quite inconsistent:

However, the growth of Avesco’s CT business and the sale of Fountain Studios gives me confidence that future returns will be more consistent.

This should be made easier by Avesco’s balance sheet, which looks very strong following the Fountain Studios sale. Cash from the sale was used to reduce long-term debt from £14.8m to £9.5m, and lift the group’s cash balance from £12.7m to £22.7m. As a result of these changes, net debt fell from £17.5m in October 2015 to £3.3m at the end of March.

Judging from the number of high profile events at which it works, Avesco has a fairly strong reputation in its key markets. The increasing scale and sophistication of the technology involved in such work suggests to me that the biggest players will be able to take market share from smaller competitors over the next few years. I’d expect Avesco should be a net beneficiary of such changes.

Rising momentum

Avesco has a MomentumRank of 95. The stars seem to have aligned for the firm recently, and there’s nothing to dislike here:

Avesco shares are performing well and earnings guidance for the year ending 30 September has risen by a whopping 49% since January.

Although this partly the result of the Fountain Studios sale, this isn’t the only reason. Note the series of smaller upgrades since May. Further gains are expected next year, suggesting that analysts covering the firm believe underlying earnings growth will remain strong.

Avesco shares trade on 11 times 2016 forecast earnings. With less than three weeks until the end of the firm’s financial year, these forecasts should be pretty reliable. Current guidance for next year is for earnings of about 27p per share, which equates to a P/E of 10.

Avesco offers a modest valuation, rising dividend, strong asset backing and almost no debt. This stock looks very good value to me and will shortly become the smallest company to join the SIF portfolio.

As always, my comments are my opinion only. Please DYOR -- and if you’ve bought, sold or rejected Avesco, then let me know what you think in the comments below.