UK Edition
Normally we would be covering Questor’s Income Portfolio this week but we will interrupt the usual sequence because a severe fall in the shares of one of our Inheritance Tax Portfolio’s star performers may have given readers cause for anxiety.
Shares in Gamma Communications stand 22pc below where they were just before the company announced its interim results on Sept 7.
So steep a decline will inevitably prompt fears that something fundamental has gone wrong with the investment case, but before we rush to judgment it’s worth pointing out a couple of things about the share price as it stands now after this recent fall.
First, the shares are only back to a level they first reached in April, which reflects just how much they had risen since then. Second, the slump at the beginning of this month did not prevent Gamma from being the second best performer in our IHT Portfolio since its inception, as we reported in our round-up last week.
“Before [this month’s] correction, we felt the stock had climbed too high, too fast,” said analysts at Numis, the stockbroker, after the publication of the interims.
This illustrates a reliable stock market rule: the more a share price has got ahead of itself, the less it takes to knock it back down. Those half-year results that prompted the share price fall, far from containing some grave news about the company’s trading, involved little more than “niggles”, again in Numis’s words.
Among those niggles we could mention what amounts to a “plateauing” in gross profits in Gamma’s business in Britain and a 7pc decline in sales in Europe relative to the second half of the previous financial year.
Set against these apparently bad signs are the facts that growth prospects are now much greater in Europe than in the UK because take-up of “cloud-based” services has so far been slower on the Continent, especially in Germany and Spain, and that the revenue lost in Europe was low-margin, generated by “traditional” services. “Investors should not be concerned about this,” Numis said.
There was not much to cause alarm in the interim report’s headline numbers: first-half sales rose by 23pc to £217m compared with the same period last year, while pre-tax profits were 24pc higher at £32.4m (or 32pc higher on an “adjusted” basis). Adjusted earnings per share, the figure usually used to calculate the price-to-earnings ratio, were 32pc higher at 30.6p and the interim dividend was raised by 13pc to 4.4p. The firm said its dividend had increased by between 10pc and 15pc every year since it joined Aim in 2014.
Gamma described trading in the second half so far as “healthy” and said it was “optimistic” about its growth prospects. The board said it expected current market forecasts for sales and adjusted earnings per share to be met. Broadly speaking we might therefore expect about 60p in earnings per share, which at the current share price equates to a p/e ratio of 30 – hardly cheap, but not crazy either for a fast-growing business.
Numis concluded: “We continue to believe that Gamma must be a core holding for investors. The company has a long track record of under-promising and over-delivering, more than once a year, and, more importantly, the Covid-19 crisis has accelerated people’s move to the cloud, which is a strong positive for Gamma’s prospects.
“The company must now persuade investors that its businesses in Europe will generate significant value by riding the ‘cloud penetration wave’ for numerous years to come.”
One reason for companies to shift to cloud-based telephony both here and abroad is the impending switch-off of the traditional analogue telephone system in favour of routing everything, even simple phone calls, over the internet. The switch-off is due here in 2025 and according to BT various countries, including Germany, are ahead of us.
Gamma estimated that three million analogue lines used by micro-businesses in Britain would need to be migrated – quite an opportunity for the company. Questor would expect the deadline to prompt many firms to start thinking about the switch now and not wait for 2025.
This is just one more reason not to sell the shares. Hold.
Questor says: hold
Ticker: GAMA
Share price at close: £18.30
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