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BUY: AG Barr (BAG)
The drinks group delivered a 40 per cent margin, with the business making progress across its portfolio, writes Christopher Akers.
AG Barr posted its best revenue and profit figures since 2019 as it recorded strong growth across its core brand portfolio. The producer of Irn-Bru rebounded from a pandemic-hit 2021 and reinstated the dividend.
All three of the company’s core brands — Irn-Bru, Rubicon, and Funkin — saw sales rise against both the 2021 and 2020 (pre-Covid) financial years. Taking the latter as a more reasonable basis for comparative performance, Irn-Bru sales were up by 6 per cent, Rubicon by a quarter, and Funkin by 92 per cent.
AG Barr has been keen to further expand into the energy category of soft drinks. Alongside the existing Irn-Bru energy drink, Rubicon Raw was launched in the year which management said is “aimed at the growing number of consumers entering the energy category who are looking for a more natural, juice-based energy proposition”. This strategy seems to be paying off.
In relative growth terms, consumer cocktail brand Funkin was the company’s standout in the year. It delivered revenue of £37mn and a margin of 39.8 per cent, driven by the reopening (and restocking) of hospitality venues and a robust take home performance.
Chief executive Roger White said that much of the sales growth story was to do with trading channels reopening after the comparatives were hit by restrictions on hospitality and out of home business, but that progress also reflected “investment in marketing activity and innovation activity in the year”.
But despite this spend and the wider cost pressures facing the business, the company managed to grow the operating margin. This was up by 83 basis points to 15.6 per cent, a solid result.
Importantly, the company isn’t resting on its laurels. It took a 61.8 per cent stake in MOMA Foods Limited in the year, which sells oat milk, porridge, muesli, and granola. White said the purchase was due to management’s belief in the “high-growth” nature of plant-based milk, but reiterated it would be a small part of the overall business moving forwards.
Investec analysts said that “the shares are some way below historical (pre-Covid) levels, as are the valuation multiples.” Indeed, the shares are trading on a consensus 18 times forward earnings, nicely below the five-year average of 21 times. The company delivered a strong set of results, and its brand equity and pricing strategy are allowing it to stand strong in the face of inflationary pressures.
HOLD: Team17 (TM17)
Working from home has disrupted development, meaning a number of games have had delayed releases, writes Arthur Sants.
Of all companies, you would expect games developers to be some of the best at dealing with the challenges of working from home. However, at Team17 the “Teamsters” — an affectionate term for their employees — are struggling to maintain productivity.
The pandemic provided increased demand for gaming and that can be seen in the 9 per cent increase in revenue to £90.5mn and an 11 per cent jump in adjusted cash profit (Ebitda) to £35.8mn. A concern, though, is that operating cash conversion dropped eight percentage points to 101 per cent.
The fall in cash conversion is in part because of a rise in receivables by £509,000 — this was a large reversal from a fall of £4.9mn last year. This reversal was presumably because of “remote working and disrupted supply lines” — six titles have had delayed releases. The conversion figure would have fallen even further were it not for a £5mn provision that pushed up the trade and other payables by 41 per cent to £24.3mn.
Management also expects higher wage inflation to increase group costs next year by £1.7mn. This is in addition to the ongoing conflict in Ukraine hitting group revenues by about £4mn and adjusted profits by about £2.5mn. Due to these concerns broker Peel Hunt sees a potential 10 per cent cut to cash profit.
NewZoo has forecast the global gaming market to grow at a CAGR of 7 per cent until 2024. This will be a factor in the FactSet broker consensus still guiding for EPS to rise to 23.7p in 2022, giving a forward PE ratio of 24.
Game developer TinyBuild currently isn’t suffering from the same development issues and is trading at a slightly more affordable multiple. TinyBuild also has 80 per cent of its revenue from its own IP compared with just 22 per cent at Team17.
HOLD: Michelmersh Brick (MBH)
The brick maker has hedged 90 per cent of its expected energy needs, writes Michael Fahy.
Market conditions remain broadly positive for Michelmersh Brick, given that demand for bricks and pavers continues to outstrip supply, supported by a strong housing market.
A “buoyant” construction sector underpinned a double-digit rise in revenue last year, although supply chain and raw material cost increases meant gross margins weakened slightly to (a still healthy) 40.7 per cent.
Elevated inflation risks mean Michelmersh is operating “in a more challenging environment”, chair Martin Warner said, but importantly for a business which uses as much gas as it does, its energy costs for the current year are largely covered. It has hedged over 90 per cent of its expected needs this year and has other contracts running into 2024.
Net cash excluding leases increased by £6.9mn to £7.7mn despite higher capital spending — it built a new road at Telford and bought more land next to its Michelmersh brick works, both of which increased the amount of mineral deposits available to it. It also increased kiln drying capacity at its Carlton site and agreed a new £20mn bank facility to provide “capacity for further strategic investments” and acquisitions.
Michelmersh’s share price has dropped by about 12 per cent since the start of the year. Competitors have suffered similar declines due to fears over soaring gas prices.
These declines ignore the “strong fundamentals” underpinning both Michelmersh and the wider brick industry, analyst Tess Starmer at Canaccord Genuity said in a note. Stocks are at multiyear lows, giving producers the ability to pass on price increases.
The broker has a forward earnings target of 9p per share for Michelmersh, with its shares currently trading at 13-times this level. This is only slightly below its five-year average and in line with peers. Given that cost pressures seem unlikely to ease, we maintain our hold recommendation.
Chris Dillow: Investing for bequests
Many of us want to leave money for your children or grandchildren, which poses the question: how should this affect your investment strategy? The answer, I’m afraid, is: it depends.
If you are investing for your descendants you should not invest more in growth stocks. What matters is total long-term returns. And growth stocks do not necessarily offer more of these.
Granted, they have outperformed in more recent years, but this is very likely because of the trend decline in bond yields which might well have now stopped.
In fact, if you are reviewing and rebalancing your portfolio regularly, there is no difference between long-term investors wanting to leave bequests and shorter-term ones. For both, your time horizon is in effect as long as the time to your next rebalancing.
Whether you want to leave a bequest or not should not affect your stock selection. That depends upon whether and in what respects the market is informationally inefficient and where (if anywhere) cheap stocks are — which is a question independent of your attitude to bequests.
Most obviously, if you want to leave a bequest you must spend less than you would if, like me, you are happy to let your wealth dwindle in retirement. This is even more true if you want to make some lifetime gifts to your descendants in an attempt to reduce inheritance tax liabilities.
If you are determined to leave all your current wealth then you need frugal spending habits and a conservative asset allocation strategy because there is a non-trivial chance that equities will lose money in real terms even over a long period: this chance is around 5 per cent over 20 years based on historic volatilities, and higher if we factor in the possibility that past risks aren’t necessarily a reliable guide to future ones.
Less strong bequest motives, however, give us much more flexibility. Wanting to leave one but being relaxed about how much means that you are in effect sharing risk: the pain of losses is split between you and your children and grandchildren. And if you are pooling risk you can afford to take more of it. Which should embolden you to hold more equities.
There is, however, a complication here: how do we handle the retirement risk zone? This zone is the years just before and just after our retirement. During these years a big fall in share prices is a bigger problem than it would be if it came earlier or later. If you’re young, a crash isn’t a big deal as you have less money invested and can save more or work longer to recoup your wealth. And if you’re very old it’s not such a problem because — to put it bluntly — you’ve not long enough left to spend your money anyway. If, however, you are in between these positions, stock market losses are nasty.
How exposed we are to this risk zone varies from person to person. If you are retiring on a big final salary pension, your spending plans aren’t so sensitive to stock market wealth. If instead you have a defined contribution pension, you are exposed.
There is, though, a solution to this.
While we are in the retirement risk zone we should have a cautious asset allocation strategy with lots of safe assets, not least of these being cash. As we get older, though, and escape this zone, we can afford to be more adventurous. If you don’t want to leave a bequest and have enough to live on anyway, this doesn’t matter much. If, however, you do want to leave a bequest then — if you have enough to live on — you can afford to focus more upon increasing prospective returns and so hold more equities in order to leave your descendants even more.
The point here is simple but important. Whereas some financial advice is true for everyone (such as be wary of expensive actively managed funds and don’t trade much), other advice is not. The question of how your exposure to equities should change over your lifetime depends upon idiosyncratic facts such as your exposure to the retirement risk zone; your holdings of safe assets; or the strength of your bequest motive. We cannot generalise.
Chris Dillow is an economics commentator for Investors’ Chronicle
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