Introduction & History
In the recent re-screening of the Compound Income Scores portfolio I mentioned that I was pretty biased against one of the stocks selected, given its share price has gone sideways for years. The stock concerned was RM which for example traded at 177p back in January 2005 which compares with today's price of 165p so very much a flat liner. To be fair though the broader stock market hasn't been much better, although they note they have underperformed the FTSE Small Cap Ex IT index in total return terms in the Directors Long Term Incentives section of the report and accounts. It has also been anything but a smooth ride for shareholders over the last ten years as you can see from the chart below the price has ranged between a high of around 230p and a low of around 60p during that time.
Along the way shareholders also had to suffer a dividend cut over a couple of years starting in 2011 from 7.13p down to 2.61p. From there is has grown back to 4p in 2014 and is forecast to grow quite strongly back to 5.5p in the year to November 2016. So some good growth is forecast and if they achieve that level of dividend next year then it will be on a yield of 3.3%. On the earnings front these are forecast to grow more modestly to 16p which would leave it on just over 10x (or more like 9x if you factor in some of the cash they have) which is quite a cheap rating and would cover the suggested dividend nearly 3x, thereby offering some reassurance on the security and sustainability of said dividend. To be fair it is also worth pointing out that they paid a special dividend of 16p in 2013 presumably after some disposals given they have been restructuring the business. So given the current cash on the balance sheet (see next section) then I guess another special is always possible but I wouldn't bank on it.
Talking of security lets take a quick look at the balance sheet which at the interim stage boasted Net cash of £43.1m and at that time they said that they expected the 2015 year-end cash position was likely to be ahead of current market expectations so presumably that means higher again but lets run with the £43m for now. Against that this one does have a pension deficit of £30 million or £24 million net of deferred tax also at the interim stage. Another triennial review of this is due which may lead to an increase but they do have a remaining £3.3m set aside in an escrow account which can be used to buy insurance and reduce liabilities (see annual report page 8 for details of this). The group has also been quite cash generative with £19.1m cash generated from operations last year for example (Source: Annual Report).
If we treat the current deficit as a debt / liability and net this off against the cash this would leave say £13m net cash which compares to a market cap. of £136m so would give an adjusted enterprise value of £123m or £93m if you ignore the pension fund. Taking their adjusted operating margin of 8.7% at the interim stage and applying this to full year turnover forecasts of around £180 million gives an EBIT of £15.66 million for an earnings yield on the pension adjusted EV of 12.73% which is pretty attractive. Without adjusting for the pension deficit this would be nearer to 17% so presumably the market is discounting this one to a certain extent to allow for the pension fund. However they seem to have addressed this with a recovery plan and planned payments over a number of years plus the remaining escrow account. So maybe I'm being overly cautious on this and it is also notable that other smaller UK companies with big pension funds and deficits deficits have nevertheless attracted bids despite this, with AGA being one notable example recently. Maybe Pearson might like to mop this one up perhaps now they are seemingly tidying up to focus more on Education?
Description of Business
So what is RM today and what are the prospects? Well what it does is probably best summarised with this extract from the Report and accounts as follows:
The RM plc group of businesses creates and maintains an extensive range of innovative solutions and services - all designed or selected to meet the specific needs of educational users.
The RM group comprises the following divisions:
This division comprises two operating businesses:
TTS and SpaceKraft. TTS provides a wide range of
resources for use in schools and other educational
settings. TTS is a leading provider of physical resources
to UK schools, with over 14,000 product lines and an
established leadership position in Primary and Early Years
age groups. SpaceKraft is a leading provider of resources
and immersive environments to meet the specific
requirements of learners with Special Educational Needs.
RM Results Formerly known as Assessment and Data Services,
RM Results supplies government ministries, exam
boards and professional awarding organisations with
technology and expertise to improve efficiency, accuracy
and clarity in the assessment cycle, both in the UK and
internationally. This includes the systems required to
provide the ‘league tables’ for English schools.
RM Results is a business that provides products and
services that include secure, innovative systems for
creating high-stakes exams and tests, on screen testing,
on screen marking and the management and analysis
of educational data.
RM Education Formerly known as Education Technology,
the division provides technology-based software
and services, specifically designed for UK schools
and other educational establishments, across the
Outsourcing, support and implementation services,
including managed services, on site support,
telephone support and consultancy services.
Network software, tools and infrastructure services,
such as the Community Connect network and device
management tools and virtualisation.
Digital Platforms and Content
Access to curriculum resources and school management
solutions, including RM Integris school management
systems, RM Unify ‘launch pad to the cloud’, RM Books
e-book system, RM Easimaths and RM Easiteach.
Internet The provision of broadband and e-safety solutions.
The group has been restructuring over the last few years and has exited from some of its lower margin hardware and other operations. As such it is now much more focussed on software and services to the educational sector primarily in the UK and as a result costs have been cut and margins increased although this has been at the expense of turnover which has fallen by around £200m from £380 million in 2010 to the expected £180 million or so this year. That's fine though as dear old Warren Buffet said "turnover is vanity, profit is sanity."
At the interim stage they suggested that they expect revenue (turnover) growth to resume in 2016 with all three divisions expected to show growth by 2017. They also suggested maintained strong margins in the Results and Resources divisions where they seem to make mid teens operating margins and this represented 54% of turnover at the interims and 70% of adjusted operating profits. They also suggested increased margins from Education as it focusses more on software and services and this made just over 7% operating margin on £36m of turnover so maybe they could double profits from this division if they can achieve the same kind of margins here as in the other divisions. So things seem to be on a recovery track operationally so lets finish up now as I'm sure you are getting bored with this now too.
Summary & Conclusion
Here we have a small (£100m or so enterprise value) company which has had something of a chequered past but which seems to be on an improving track in terms of the quality of its remaining businesses and prospects after a period of restructuring. They have a strong cash rich balance sheet and strong cash flow generation, although this is offset to a certain extent by a pension deficit of around £30m which is sizeable but probably manageable for them as they have a funded deficit reduction plan in place. But it will be worth watching out for the forthcoming triennial review of this.
The group is expected to show modest turnover and earnings growth next year after strong earning growth on declining turnover in prior years. This has allowed them to rebuild dividends with some strong growth after a cut a few years ago but does leave the currently forecast dividend well covered by expected earnings.
This has all left it looking quite good value on just over 10x for 2016, or 9x adjusted for the cash, with a 3.3% yield and a double digits earnings yield although I note on Stockopedia it only scores 66 for value given the other metrics they take into account. On the Compound Income Scores it gets a higher value score of 88 as I only use earnings yield and dividend yield. Looking at it another way the EV/ Sales seems low at around 0.5 - 0.55x compared to the operating margins which seem to be heading towards 10% or more. This could argue for a fairer EV/ Sales of closer to 1x which suggests the shares could double or more in the medium term on this basis.
Furthermore looking at the rating of 10x and 3.3% yield, perhaps if they can continue to deliver improved returns and the market starts to recognise and reward this more fully then maybe it could move onto a more average rating of say 14x. With next years earnings forecast at 16p this would equate to a price target of 224p which wouldn't be far off the highs of recent years which I guess might then act as resistance. I also note when it re-rated back in 2013 it moved up from a 60p to 100p range to a new range between 120p and 180p which it has been stuck in since. If it can break out of this range then this could also suggest a move up into a new range extending up to perhaps 240p.
Aside from that it scores well on most of the other factors I look at although operational quality is a low score of 35 reflecting the historically lower profitability but this seems to be on an improving track now. Despite this the overall CIS is 96 and the Stockopedia QVM Stock Rank comes in at 97 with stronger scores for Quality (97) and momentum (85). Talking of momentum I note that the 12 month price momentum, whilst positive, only ranks at 42 in the CIS universe of stock while the earnings momentum is stronger at 76 after recent upgrades and suggests that the market perhaps shares some of my scepticism on this one - but therein maybe lies the opportunity? Some good institutional investors seem to agree as Schroders have a 21% stake, Aberforth the highly regarded value investors, have just over 16% and Artemis have just over 10%.
So on the fundamental and technical picture I could see a potential upside of between 35 and 45% or lets say 40% taking the average of the two which gives a target of around 230p at which level the earnings yield would still be a reasonable but perhaps fairer 9% or so. While my back of the envelope EV/ Sales calculations suggest that it could even potentially double in price if they can deliver higher turnover with increased margins.
So given that the MCIS Portfolio has been doing well and the Scores have been quite good at identifying some good performers that are not necessarily that palatable and having done this work on this one, I have treated myself to a few too. Please don't follow me blindly and do your own research as this one could obviously still disappoint if they don't deliver the expected improvement in turnover and margins. If it does then I think the chances of a re-rating are quite good, although it seems there is no immediate catalyst for that. If you do decide to buy it you have to accept a fairly wide spread but at least it has come back from its recent highs.