UK Edition
Questor: buy Dignity – the market is overstating the threat to earnings from competitors
Suggestions that Dignity, the funeral services firm, is in poor health look wide of the mark to this column.
A share price plunge late last year could therefore provide patient, contrarian investors with an opportunity to take a stake in the second biggest operator in a field where (regrettably) demand looks guaranteed.
On the face of it, November’s third-quarter trading update was perfectly respectable. The company turned a 1pc increase in deaths into a 6pc rise in sales and a 5pc improvement in underlying operating profit. Mike McCollum, the chief executive, also left full-year profits guidance for 2017 unchanged.
However, his guarded comments about rising price competition from new entrants in what remains an unregulated industry upset the market and drove the shares sharply lower. Dignity is calling for regulation to ensure that rivals meet minimum standards and to oversee funeral plan sales campaigns. But the firm is also helping itself by focusing on quality of service and launching new, more cost-effective packages to appeal to more pricesensitive customers.
The firm’s plentiful free cashflow should help it to bolster its competitive position via such initiatives, and also fund further acquisitions to take share in what remains a fragmented market.
A recovery is therefore perfectly possible and, assuming normal mortality rates, the company still looks capable of generating consistent profit and dividend growth.
A forward yield of 1.4pc may not tempt income seekers, although the firm has increased its annual dividend from 9.9p to 23.59p via an unbroken run of increases that dates back to 2006. In addition, the price-to-earnings ratio of 14.4 may underestimate Dignity’s long-term earnings potential.
Questor says: buy
Ticker: DTY
Share price at close: £18.33
Update: Connect
Connect continues to confound doubters who feel its dividend is too good to be true, and December’s disposal of the books division offers further support to Questor’s view that the payment, which equates to an 8.8pc yield, is well underpinned.
Earnings cover may look thinner than ideal but cashflow from this wellrun parcels, freight, newspaper and magazine distributor remains robust.
The sale of Connect Books for up to £11.6m, which does require regulatory clearance, will enable the company to further cut its £82.1m of net debt. Less debt means lower interest payments and lower interest payments mean both less risk and more cash, with which dividends can be funded.
Questor says: hold
Ticker: CNCT
Share price at close: 113.4p
Update: Next
No one should get too worried by guidance alongside Next’s seasonal trading update from its chief executive, Lord Wolfson, that the retailer will make smaller profits in the years to January 2018 and January 2019, making for three straight annual declines if the forecast is borne out.
Improved momentum in full price sales for the fourth quarter, buoyed by a particularly strong online offering, shows that Next is more than capable of holding its own in the digital world.
Any company that makes £700m a year must be doing something right and such profits mean that Next remains capable of paying a healthy dividend, topped up with share buy-backs.
The prospective 3.3pc yield, assuming an unchanged 158p-per-share ordinary dividend, looks dependable and the company’s online capabilities, thanks to the prowess of the Next Directory catalogue business, may be underestimated by a forward p/e of barely 12 for the year to January 2019.
The company’s superior brand, better online offering, healthier balance sheet (owing to lower lease liabilities on its store estate) and focus on full-price sales all compare favourably with rival Debenhams, whose disappointing Christmas trading statement received a rough response last week.
The retail environment is undeniably tough but Next has the brand, skills and financial strength that should enable it to adapt.
Questor says: hold
Ticker: NXT
Share price at close: £49.32
Russ Mould is investment director at AJ Bell, the stockbroker