Stockwatch: A Recovery Play And Takeover Target

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By Edmond Jackson from interactive investor

Persistent director buying implies long-term value at this well-known firm, argues our shares analyst.

Have shares in £260 million price comparison website (LSE:GOCO) finally bottomed out? Four non-executive directors appear to think so, buying nearly £44,000 worth of stock at around 65p once the company was out of its closed period ahead of its 28 February full-year results.

Since a flotation price of 60p in November 2016, when the group demerged from insurer Esure, the chart flags "return to go" during a game of snakes and ladders, where 139p was hit in the middle of last year.

This last weekend it appeared the chart was flagging a "double bottom" bullish reversal pattern, with 65p tested as it was last December – i.e. two consecutive troughs roughly equal, with a moderate peak of 76p in-between.

Source: Tradingview Past performance is not a guide to future performance

I drew attention last December at around 70p as "a speculative buy at best" given questions about organic growth in context of the stock's sub-3 per cent yield. Yet it merited attention because "the company's margin and cash flow attractions could tempt private equity if the stock continues its fall.

"We've already seen Bain Capital exploit stock market disillusion at the extent of competition in insurance, to buy Esure for £1.2 billion – a 37 per cent premium to market price," I wrote. A case could, therefore, be made to average into the stock, and five insiders including the CEO and CFO had bought a total £137,500 worth around the 80p mark.

A downgrade and balance sheet issues behind latest drop?

Renewed share price weakness may relate to 2019 earnings per share (EPS) apparently downgraded – whether or not by guidance – from around 9p to 7.6p, albeit still an undemanding price/earnings (PE) multiple of just over 8 times, which prices in plenty of caution.

Dilemmas for support are a sub-3 per cent dividend yield - despite a very respectable 40 per cent hike in net cash generated from operations to £35.5 million – and negative net assets of £12 million.

The balance sheet deficit doesn't just follow from £35.1 million goodwill and £18.8 million intangibles, but also total debt up from £63.8 million to £79.4 million and post-flotation cash, down from £24.5 million to £11.9 million, as acquisitions get funded.

Near-term debt in particular is up from £9.7 million to £34.7 million (and net finance costs by 39 per cent to £3.2 million) thus investment - both organic and by way of acquisitions - needs to prove value-accretive, in spite of the debt. With price comparison activity lately, compromised by lower insurance premiums, it therefore gets speculative as to how this strategy will bear out.

Yet it should not be overlooked how, despite some cute attempts to show "normalised" profits, GoCompare's operating margin is in a range of 24.7 per cent to 28.8 per cent - so, if the stock market remains grumpy, a trade buyer will have it. Group Forecasts

year ended 31 Dec 2013 2014 2015 2016 2017 2018 2019
Turnover (£ million) 110 113 119 142 149 153
IFRS3 pre-tax profit (£m) 25.5 25.8 23.3 21.6 30.7 33.8
Normalised pre-tax profit (£m) 25.6 25.8 23.1 29.6 38.7 35.0
Operating margin (%) 22.9 22.6 19.3 21.0 22.1 24.6
IFRS3 earnings/share (p) 4.7 4.9 4.6 3.8 5.8 6.5
Normalised earnings/share (p) 4.7 4.9 4.6 5.7 6.5 7.8 7.6
Earnings/share growth (%) 3.2 -6.4 23.9 14.0 20.0 -2.6
Price/earnings multiple (x) 7.9 8.2
Annual average historic P/E (x) 14.2 16.6 19.4 12.4
Cash flow/share (p) 4.6 4.7 4.5 6.7 6.4
Capex/share (p) 0.6 0.6
Dividends per share (p) 1.6 1.8
Covered by earnings (x) 4.9 4.9
Yield (%) 2.6 2.9
Net tangible assets per share (p) -14.9 -9.1 -15.8

Company REFS Past performance is not a guide to future performance

Do the 2018 annual results add grist?

I'd been concerned about a potential crisis for revenue growth, the July 2018 interims showing a flat level of £75.8 million, only achieved by £3.7 million contributed from the acquisition of MyVoucherCodes, one of the UK's largest such websites, for £36.5 million that January.

In June came the £10 million acquisition of Energylinx, an energy comparison/switching specialist. GoCompare doesn't provide like-for-like revenue numbers at prelims; it's not until you scroll down below a 2.3 per cent advance to £152.6 million in the highlights, to segmental details, that you see the core business of price comparison revenues is down 3.3 per cent to £144.4 million, despite Energylinx contributing in the second half of 2018.

Net performance in this core business was bolstered, however, by a 25.3 per cent cut in distribution costs, hence trading profit up 10.9 per cent to £67 million. A higher conversion rate of customer interactions to policies also helped its operating margin from 40.5 per cent to 46.4 per cent. The newly-acquired "Rewards" (vouchers) side contributed £8.2 million revenue and £2.8 million of adjusted operating profit.

So, the market is understandably wary about how GoCompare's growth model is being propped with acquisitions, for which transaction costs are lumped together with goodwill amortisation – and share-based awards also – to proclaim adjusted operating profit up 22.2 per cent to £44 million. That said, do not lose sight of how basic operating profit is up 14.2 per cent to £37.7 million, pretty good for a business valued at £260 million at the current share price of 62p.

Adding back amortisation of acquired intangible assets (modern accounting rules require) is fair enough to get a true sense of profit, and I suppose a “look-through” view of profitability would exclude transaction, restructuring and other corporate costs also fees in relation to listing, but it’s overlooking the reality of costs, how the business achieves all this.

What else are share-based payments, if not a cost to owners? I would deduct only regular amortisation and the one-off flotation cost, all others are genuine costs. The market appears to concur, adding a further discount for annoyance about it all.

Even so, I'd respect price comparison as an online service here to stay. Having used GoCompare to get a better deal on my home insurance last December, I'll do so again now that my car insurer has slapped me with a hefty renewal. It doesn't seem to me like this annual farce prompting online searches for better prices is likely to end soon.

"Second half weighting" may also be hurting sentiment

The outlook statement projects "another year of modest revenue growth" on the core business, although this doesn't apply organically. The "operating segments" section in the latest final results shows that talk of "performance to be skewed towards H2" may have been interpreted as a mild warning, said to be "reflecting our business initiatives and the market backdrop".

Quite as I noted last week regarding Beeks Financial Cloud Group (LSE:BKS), hit by declared investment (though in a bull market, prices typically rise in response), GoCompare is investing organically in "Weflip", an automated energy switching service launched last October - £10 million is applied towards marketing it from the core business's cash generation.

"Our ambitions are to scale Weflip to transform the group into a higher margin business. Weflip will benefit from higher customer retention, recurring revenue and multi-year customer lifetime value," says GoCompare. Potentially this could refresh organic growth.

Four non-executive directors buy modestly

Once the results were declared, on 28 February one director bought £9,872 worth of stock at 65.8p, then another invested £5,000 at 65.8p. On 1 March, a third bought £15,000 worth at 64.4p and a fourth £13,800 at 65.4p.

It's modest buying, but notable because non-executive directors don't have an agenda to prop up substantive existing holdings like executives can, although they are expected to own some extent of equity.

It all adds up to GoCompare looking modestly priced despite a seeming lack of catalysts to re-rate its stock near–term. Takeover interest could resurface anytime, too: in November 2017, the board rejected a £460 million offer at 110p a share from the owner of property portal Zoopla, then a modest premium to the circa 100p market price. And again, last summer, private equity vultures were said to be circling. Accumulate.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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