One can rave about companies and their management when earnings are growing quickly, and criticise when earnings growth is slow or low. More important is context: how the company performed given cyclical or structural market conditions.
It is a good sign when companies can maintain a high Return on Equity (ROE), or lift it, in challenging markets. That says the executive team is capable of driving performance in good and bad markets. And that the company can exploit a competitive advantage.
Take Royal Wolf Holdings as an example. It sells and hires out portable containers to companies in the resource, construction, logistics, retail and manufacturing industries. Ranging up to 40ft, the shipping containers are used mostly as portable buildings and storage.
That’s a tough market. A slowing resource sector, manufacturing weakness, and lethargy in logistics could have crimped demand for Royal Wolf containers. But the small-cap company impressed with its latest full-year profit result and its operational and strategic progress.
To recap, Royal Wolf listed on ASX through a $91.5 million Initial Public Offering in 2011, in an awful market for floats. Its $1.83 issued shares have barely missed a beat, peaking at $3.82 this year and confirming the company as one of the best small industrial floats in recent years.
Now at $3.49, Royal Wolf is trading on a Price Earnings (PE) multiple of 16 times FY16 earnings, according to consensus broking forecasts – a slight premium to the broader sharemarket, although hardly excessive for a well-performing company with good-quality earnings and plenty of organic and acquisition opportunities.
The momentum was reflected in record revenue of $175.7 million for FY14, up almost 18 per cent on a year earlier. Underlying earnings (EBITDA) of $46.7 million were 12 per cent up over the year, and after-tax net profit rose 8 per cent to $15.9 million.
I rate Royal Wolf on a few fronts. As mentioned, it has consistently grown earnings in challenging markets, unlike some companies that only grow strongly when there are favourable market conditions. Royal Wolf is clearly well managed.
Second, return on Equity (ROE) rose from 13.6 per cent to 15.2 per cent in the latest full-year result – solid, rather than spectacular. Rising ROE is a good sign, for it means the company is working each dollar of shareholder funds harder, usually leading to a higher intrinsic value for the company, and ultimately a higher share price.
Net gearing (net debt / equity) of 73 per cent in FY13 is too high. But it stems from Royal Wolf investing heavily in its fleet, and debt should fall in the next few years. Interest cover of seven times should rise, meaning the company can comfortably service debt, and it recently refinanced its bank-debt facilities. Operating cashflow should improve as capital expenditure falls in coming years.
Third, Royal Wolf has recurring income from container rental. Although selling and renting out shipping containers looks like a basic, low-margin business, the product is being used in various ways, and more business and individuals are renting them. There is also a good spread of clients, industries and geographies.
For example, Royal Wolf supplied 150 prisoner-accommodation units to the Victorian Department of Justice last financial year. It also delivered eight transportable camps to mining projects, some of which could have elaborate fit-outs for kitchens, toilets and even gyms.
From 44 products at IPO, it now offers 103, with more on the way. Royal Wolf containers are even being used for “pop-up” retail outlets, and I have read stories of some people converting them into small, caravan-like homes because proper houses are too dear.
Royal Wolf is also lifting the proportion of rental sales in overall revenue – a long-held strategy that should lead to higher profit margins and provide greater earnings visibility. It’s not hard to see more businesses renting containers for extra off-site storage as urbanisation makes inner-city space more expensive and harder to access.
I wrote last month for The Bull that urbanisation and city congestion would become a tailwind for space providers such as National Storage REIT. Royal Wolf is not a pure play on that trend, but its portable accommodation and storage offerings will surely benefit as more companies recognise the flexibility of fitting out low-cost shipping containers, and storing more goods off-site in cheaper locations.
Credit Suisse lifted its 12-month share-price target for Royal Wolf from $3.40 to $3.90 after the full-year result in August. It wrote: “Measured against a consistent track record, demonstrable ability to increase penetration of its product set, favourable margin trends and likelihood in our view of at least a couple more years averaging double-digit growth, we do not regard (the) valuation as unreasonable.”
From its current price, Royal Wolf would provide a capital gain of about 12 per cent and an expected 3-4 per cent dividend yield, partially franked from FY15, if Credit Suisse is correct.
Royal Wolf looks like a solid small-cap stock for Self-Managed Superannuation Funds that recognise the benefits of holding companies that can perform in good and bad markets. After rallying in the last few months, Royal Wolf is due for a share-price pause or slight pullback. That could provide a cheaper entry point for long-term portfolio investors.
– Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at August 15, 2014.
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