Broker tips: French Connection, Hasgrove, De La Rue

4th Oct 2010 13:09

Reasons to buy fashion retailer French Connection are piling up, according to FinnCap.The stock appears cheap on the basis of asset backing, on a price/earnings (P/E) ratio once cash is stripped out and also on a discounted cash flow (DCF) basis, the broker maintained. "Indeed, it is not expensive in a sector context when valued on a traditional P/E basis," FinnCap's David Stoddart notes, though the dividend yield is "sub-par and on our modelling is likely to remain so for some time," Stoddart adds."Nevertheless, the better-than-expected interims suggest the recovery is gaining traction," the broker observes, and on the back of this it has bumped up its full year earnings forecasts and price target.The forecast for pre-tax profit in fiscal 2011 is bumped up by 57% to £5.1m, while the dividend forecast has been doubled to 1.0p."FY10 [fiscal 2010] year-end net cash was £35.7m and we expect this year to close with only slightly less. When one adjusts for this, the ex-cash PE is 4.6x in FY11 falling to 3.9x in FY12. That hardly captures the recovery potential," Stoddart maintains."To be fair, there are reasons to assume that recovery potential is limited. The business has shrunk in both scope and scale. We have reflected this in our DCF calculations which assume that the business stagnates after five years following a modest recovery in the next two years. Nevertheless, we generate a (rounded) valuation of 90p," the broker said. Looking at the asset situation, the net asset value per share is set to fall to 68p this year from 74p at the end of fiscal 2010, but "if one adjusts asset value to discount any value from fixtures and fittings but to reflect the potential profit in inventory, one derives a value of 80p for FY11 and 85p in FY12," Stoddart calculates. The latter figure - 85p - is FinnCap's new target price for the stock, a substantial revision to the previous target of 60p.Interim results from digital marketing and corporate communications specialist Hasgrove were in line with expectations and revealed good growth, despite the evaporation of public sector work, KBC Peel Hunt said.The broker is nevertheless shaving 5% off its full year profit forecasts to reflect unpredictability in the timing of projects and the investment being made in the reseller channel for Odyssey, Hasgrove's intranet software business.Even with full year adjusted profit before tax (PBT) is now projected to be a little lower than previous expectations at £3.9m, that still points to growth of 69% in the second half of the year. "We expect compound EPS [earnings per share] growth between 2008 and 2012 to be c22%," Peel Hunt analyst Malcolm Morgan said.With the company's commitment to pay earn-out fees related to acquisitions soon to come to close Hasgrove has pledged to be more generous with its dividend payments. The new policy could see it paying up to half of its earnings out in the form of dividends.Peel Hunt is looking for a ten-fold increase in the dividend from 0.5p presently to 5.0p for 2012. "This will cost Hasgrove £1.1m a year. Despite the rise in this cost, we still anticipate the company will be debt-free before the end of 2013," Morgan said.The broker has set a target price of 85p which, based on projected earnings for 2011, would still only trade on a price/earnings ratio of 6.4, while if the dividend rises feed through as Peel Hunt predicts the stock would be yielding 10.3% in 2012.Troubled bank note printer De La Rue is still on Panmure Gordon's sell list, and the broker has cut its price target to reflect reputational damage the company has suffered from the revelation that some of its employees had been deliberately falsifying paper specification test certificates for bank notes."We have little confidence in current forecasts given the nature of recent problems and the potential implications of the fraud discovered in July. While the indicated impact on the current year is considerable, we believe the risk remains firmly on the downside given the ongoing ramifications of a loss of reputation in what are highly sensitive currency markets," Panmure Gordon said.The broker cut its price target for the stock from 605p to 529p, saying the company had suffered "unquantifiable damage" to its reputation, the full extent of which could take a considerable time to emerge.In previous economic downturns the contract visibility of De La Rue would have made it a favourite defensive stock, but with numerous contracts due for renewal over the next 12 months the broker is waiting to see how customers will react; Panmure Gordon's guess is that De La Rue will be obliged to swallow smaller margins.Over the medium term there is a risk that the company could lose its lucrative Indian contracts."With increased investment in banknote paper production capacity, India - a considerable customer for the group - could be largely self-sufficient by 2013. This potential loss of business could leave both a difficult hole to fill, a geared impact on the bottom line, and a risk to our future dividend assumptions," the broker gloomily suggested.