2 days ago
Look through the noise and this brickmaker is set for brisk growth
Questor is The Telegraph's stock-picking column, helping you decode the markets and offering insights on where to invest.
An extended period of high inflation, restrictive monetary policy and disappointing GDP growth has left investor confidence in UK-focused firms at a low ebb.
In Questor's view, this equates to a significant long-term buying opportunity. After all, weak market sentiment means the valuations of UK-focused companies are exceptionally low and provide scope for substantial upward reratings – and with the UK economy's performance already showing signs of improvement, stronger operating conditions could equate to a brisk rate of growth in company profits over the coming years.
Indeed, the UK economy expanded by 0.7pc in the first quarter of the year. Although the Bank of England expects growth to fall to just 0.1pc in the second quarter, 100 basis points of interest rate cuts and further monetary policy easing are set to have a positive impact on long-term GDP growth. When coupled with a forecast fall in inflation to 2pc over the medium term, the outlook for UK-focused firms such as Michelmersh is encouraging.
The brick manufacturer, which generates 95pc of its revenue in the UK, recently released a trading update stating it is on track to meet financial expectations for the full year. It is forecast to deliver a 16pc rise in earnings, followed by further growth of 12pc next year, as it seeks to pass higher costs onto its customers.
The firm should be a major beneficiary of a period of modest inflation following what is widely expected to be a temporary spike. Not only could a slower pace of price rises put less pressure on the company's profit margins, it should equate to higher demand for new homes – and the bricks they require – as falling interest rates make property purchases more affordable.
In the meantime, Michelmersh's financial position suggests it is well placed to overcome potential economic challenges as monetary policy changes take time to have their desired effect. Its net cash position, for example, amounts to £3.7m, while net interest costs were covered over 38 times by operating profits in its latest financial year.
Despite the prospect of double-digit earnings growth, the stock currently trades on a price-to-earnings ratio of just 13.8. This suggests it offers a wide margin of safety and scope for further capital growth after rising by 33pc since being added to our Aim portfolio in January 2018. In doing so, it has outperformed the FTSE Aim All-Share index by 62 percentage points.
Alongside the potential for capital gains, the company offers income investing appeal. It currently yields 4.1pc from a dividend that was covered a healthy 1.8 times by earnings last year. This suggests it can afford to pass a substantial part of future profit growth onto investors in the form of higher payouts.
Clearly, Michelmersh is a cyclical company. Its share price, and financial prospects, could fluctuate to a relatively great extent based on the economy's performance. While inflation remains elevated, interest rates are still high and GDP growth could yet plummet in the second quarter, the long-term outlook for the UK economy is becoming increasingly upbeat.
Therefore, we remain optimistic about the stock's future prospects. Its solid financial position, modest valuation and strong earnings growth forecasts mean that it continues to offer a favourable risk/reward opportunity.
Questor says: buy
Ticker: MBH
Share price at close: £1.13
Update: FD Technologies
Another of our Aim portfolio holdings, FD Technologies, recently announced that its board has agreed to the terms of a prospective acquisition by TA Associates. Subject to shareholder approval, investors in the software company will receive £24.50 in cash for each share held.
Given that FD Technologies' share price currently trades little more than 1pc below that figure, it will now exit the portfolio. It has produced a 46pc capital loss since being added in June 2018, which compares with a 31pc decline for the FTSE Aim All-Share index over the same period.
Questor says: sell
Ticker: FDP
Share price at close: £24.20
Update: Gamma Communications
Finally, telecoms company Gamma Communications recently moved to the main market. As a result, it is no longer eligible for inclusion in our Aim portfolio and will now be removed. Since being added in January 2018, it has produced an 86pc capital gain. This is 115 percentage points ahead of the FTSE Aim All-Share index's return.
