personal finance

IC — Keywords Studios, JD Wetherspoon, Staffline


Buy: Keywords Studios (KWS)

Shares in Keywords are still trading well below their highs of August last year, but we believe this presents a buying opportunity, writes Tom Dines.

Keywords Studios, the video games support group, once again demonstrated strong growth in the six months to June, with sales up 17.3 per cent on a like-for-like constant currency basis. The rate of growth more than doubled to 39.3 per cent once the contribution from its acquisitions was taken into account, but — presumably — concerns about the margin prompted some to pull back from the shares, sending them down by a tenth following the results announcement.

The group acquired four companies in the half, fewer than has historically been the case, which chief executive Andrew Day attributed to a lower number of opportunities in the market. However, he said it was keen to do more deals, particularly in the game development and marketing services sector. The group’s activity so far in the year pushed its net debt up to €9m (£7.9m), but Mr Day said he would be comfortable as long as borrowing stays below twice the adjusted cash profits, which came in at €25.8m for the first half.

The acquisitions have continued into the second half of the year, with the purchase of German-language voiceover studio TV Synchron announced alongside the results. Management said it is “actively reviewing” a number of attractive opportunities.

Growth requires investment, however, and the costs associated with recruiting and equipment have weighed on the group’s profitability, pushing the adjusted pre-tax profit margin down to 12 per cent from 14.6 per cent in the previous period. While management expects these to begin to unwind in the second half, margins are not expected to climb back up to around 15 per cent until 2020.

The group is benefiting from the growth in demand for game development, and the attendant trend towards outsourcing. This is only expected to grow in coming years with the launch of game streaming platforms, beginning with Google later this year, and next-generation consoles from both Sony and Microsoft expected to launch in 2020.

Broker Numis cut its profit forecasts following the announcement, and now expects adjusted pre-tax profits of €41.6m for the full year, with earnings per share of 45.1 cents, up from €37.9m and 41.7 cents in 2018.

Hold: JD Wetherspoon (JDW)

The pub group’s sales performance has steadily risen over the years, its shares have too, which are now trading at a near all-time high, writes Alex Janiaud.

“We’re not really focusing our major efforts on increasing profits in every year,” JD Wetherspoon chairman Tim Martin says, before adding that this is a medium to long-term aspiration rather than a consistent short-term goal.

The pub group’s like-for-like sales increased by nearly 7 per cent over its full-year, but rising costs chipped away at the pub group’s adjusted profits. These included booming wage expenditure and a 25 per cent uptick in finance costs, much of which pertained to fixed-interest swaps taken out “a few years ago” when the chairman had predicted the lifting of interest rates. Statutory pre-tax profits were helped by the fact that the comparative period saw higher exceptional property losses.

Mr Martin said that there were numerous reasons for Wetherspoon’s sales growth, likening this matrix to “a thousand components of a BMW”. These range from the length of tenure of pub staff and bonus systems to the design edge that he believes his pubs possess. Wetherspoon seeks to respond to a perceived consumer preference for character and individuality across its venues, in favour of pursuing the promotion of an all-inclusive brand. Low prices and the introduction of more food, which has recently included pizzas, have helped. The chairman speculated that recent UK regulations on fixed-odds betting terminals might have contributed to his company’s gains in fruit machines, where sales growth was 10.3 per cent.

Mr Martin characteristically used the majority of his foreword to the company’s results to lambast detractors of Britain’s decision to leave the EU. While Wetherspoon has experimented with substituting EU-produced drinks in favour of domestic products, including replacements for Jagermeister and brandy, Mr Martin said that these efforts are now on hold. “We don’t want to be horrid to European suppliers,” he adds. The decisions taken by prime minister Boris Johnson are likely to have a direct impact on the wallets of Wetherspoon regulars. If the UK leaves the EU without a deal and tariffs are reduced “in a meaningful way”, the group will seek to roll out price reductions.

Peel Hunt forecasts full-year 2020 pre-tax profits and earnings per share of £103.9m and 77.3p respectively, rising to £107.7m and 80.1p in 2021.

Sell: Staffline (STAF)

Challenging trading conditions that look set to persist don’t inspire much confidence about the full-year outlook, writes Nilushi Karunaratne.

Things just keep getting worse for Staffline. Swinging to a pre-tax loss in the first half of 2019, the recruitment and training group has been unable to escape the shadow of its delayed 2018 full-year results. The extended audit to investigate historical minimum wage compliance damaged customer perception, slowing new contract momentum and compounding the effects of “unprecedented” Brexit uncertainty.

Staffline specialises in providing flexible workers, but tightening labour markets have prompted customers to convert large proportions of their temporary workforce into permanent employment. With this trend expected to continue throughout 2019, the group has revised its guidance for full-year adjusted operating profit down from £23m-£28m to around £20m, having made £39.1m last year.

Revenue may have gone up, but growth was driven by acquisitions made last year. Excluding this impact, organic revenue declined by 12.4 per cent. Deferred payments on these acquisitions contributed to net debt more than doubling to £89.2m. But having gone cap in hand to investors in July, £37m in net proceeds from issuing new shares is expected to reduce the ratio of net debt to cash profits to two times by the year-end.

As the business mix increasingly leans towards the more seasonal recruitment division, earnings are expected to be heavily second-half weighted.

Berenberg anticipates adjusted cash profits of £23m and earnings per share of 22.1p for the full year, rising to £30m and 25.2p in 2020.

Chris Dillow: Expensive housing

New research at the Bank of England corroborates what many of us have suspected — that house prices are high because interest rates are low. “The rise in real house prices since 2000 can be explained almost entirely by lower interest rates,” conclude two Bank economists.

Common sense says this must be right. Like it or not, housing is an asset just like shares or bonds. And the price of an asset should be equal to the discounted value of future benefits from it — rent if you are a landlord, the rent you’ll save if you are an owner-occupier. Lower interest rates mean that by definition a lower discount rate applied to future rents, so they must raise the price of housing.

Simple.

Well, not quite. Exactly the same reasoning should apply to shares; lower interest rates raise the present value of future earnings and so should raise current share prices. But this hasn’t happened. Since the mid-1990s the All-Share index has risen only about as much as dividends: the dividend yield is much the same as it was in 1995. But house prices have risen much faster than rents: the rental yield has halved since the mid-1990s.

So why have falling interest rates benefited house prices so much more than equities?

It’s partly because houses were unusually cheap in the mid-1990s. But this doesn’t explain why rental yields have fallen relative to share prices since the early 2000s.

Instead, there are three other reasons for the difference.

One is that housing, but not equities, has benefited from the same demand that has helped reduce bond yields.

A second factor is credit availability. You can borrow four times your income to buy a house but not to buy a tracker fund. Leveraged investments are naturally more sensitive to falling interest rates than less leveraged ones.

I fear, though, that something else is going on. House prices seem to be pricing in the good news of lower rates (a lower discount rate) but not the bad.

If so, it is committing the error of which George Mason University’s Scott Sumner has warned us for years; it is reasoning from a price change, without asking why the price has changed.

All this leads to a simple inference. It is very possible that equities are cheap relative to housing. Which points to them outperforming house prices over the longer term.

Chris Dillow is an economics commentator for Investors Chronicle

The Financial Times and its journalism, including Investors Chronicle content, are subject to a self-regulation regime under the FT Editorial Code of Practice: FT.com/editorialcode



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