Cube Midcap Report (26 July 2019) – RMV, VOD, CVSG, IMI

Cube Midcap Report (26 July 2019) – RMV, VOD, CVSG, IMI

Good morning, it’s Roland here with today’s Midcap Report.

The weather may be cooling off but it looks like another busy day for news. Here are the companies I’m planning to look at today:

Rightmove (RMV)

  • Share price: 522p (+2%)
  • Market cap: £4.7bn

Half-year results & acquisition

This property website needs little introduction. It is, by most measures, the most profitable company in the FTSE 100. Anyone who picked up £10,000 of shares in late July 2009 would have a holding worth £120,000 today, plus dividends.

Today’s half-year results confirm that this show is still on the road, with double-digit increases in revenue and profit:

Rightmove 1H19 headline figures

These figures indicate that Rightmove generated an underlying operating profit margin of 77.1% during the half year, which is consistent with the same period last year. Operating costs rose by £2.8m to £32.9m, due to salary increases and additional headcount. But I don’t see anything to be concerned by here.

Falling house sales

News headlines yesterday flagged up HMRC figures showing a 16.5% drop in home sales in June, compared to the same period last year. Will Rightmove be affected if this slowdown continues?

Turning to Rightmove’s operational metrics, I think there’s some early evidence that market conditions and the firm’s strategy may be changing.

The company reports a 4.6% drop in sales transactions for the year to date, compared to 2018. Completion times are said to be rising and Rightmove says the resulting cash flow delays have caused some “low-stock agents” to leave the industry.

Although average revenue per advertiser (ARPA) rose by £90 to £1,077 per month, membership numbers fell by 1% to 20,209. The company says this reflects “a 3% decline in low-stock agency branches offset by strong growth in New Homes development numbers”.

These numbers are reflected in segment revenues for the half year:

  • Agency (sale+rental): +5.5% to £104.8m
  • New Homes: +29% to £27.8m

Management expect this shift to continue during the second half of the year, with more low-stock branches shutting down and stable numbers of new home developments.

Given the extensive government subsidy for new housing through the Help to Buy scheme, I’d expect sales of pre-owned homes to slow before those of new homes. That’s what we seem to be seeing — recent results from housebuilders have not suggested a slowdown in sales.

For now, strong new home sales are supporting Rightmove’s revenue growth and listing numbers. However, this could change if we get a wider market slowdown, when housebuilders might slow production and cut their marketing budgets.

Rental growth + acquisition

Rightmove’s management aren’t blind to one of the biggest trends in housing — more people are renting.

Rightmove has advertised rental property for a long time, but more recently it’s introduced a Tenant Passport service that allows renters to upload information such as moving requirements, budget, employment details and income information. The idea is to pre-qualify tenants to cut admin for agents (and tenants) and make renting quicker and easier.

This product remains under development and was recently upgraded with the addition of tenant referencing capability. To enhance its services in this area, Rightmove has acquired Van Mildert Landlord and Tenant Protection Limited for £16m, plus deferred consideration up to a further £4m.

Van Mildert’s services include tenant referencing and rent guarantee insurance. According to today’s RNS, the firm reported revenue of £3.6m last year and pre-tax profit of £1.4m, with both up by 19%. So the acquisition looks like a reasonable price for a highly profitable business.

My view

Rightmove’s timing has been superb, profiting from an unprecedented post-crisis period of low interest rates, strong housing demand and the extension of internet usage through smartphones.

This business generated a return on capital employed of 800% and an operating margin of 74% last year. Given this extreme profitability, the stock’s forecast price/earnings ratio of 26 and 1.4% yield are arguably quite reasonable.

Shareholder returns are also enhanced by ongoing buybacks, which have reduced the share count by about 10% since 2013.

I think Rightmove’s market leadership position is unlikely to be threatened by rivals or market conditions, thanks to the network effects it enjoys. In my experience, it’s the only place most people look for property.

However, I don’t think Rightmove’s margins and growth are untouchable. In my view, both could weaken during a recession, pushing down profits.

Personally, I’d be looking for a lower price to buy this stock. But if I held, I’d be unlikely to sell.

Vodafone Group (VOD)

  • Share price: 143p (+8%)
  • Market cap: £38.1bn

Trading update & plan to create tower company

I’m diverting to look at FTSE 100 telco Vodafone because it’s unusual to see a £38bn company up by 8% in one day.

Two pieces of news today seem to have convinced the market that this large, asset-rich firm — which operates mobile and fixed networks all over Europe — may be undervalued and returning to growth.

Europe’s largest tower company

The main catalyst for today’s gains was probably the news that Vodafone plans to spin out its European tower infrastructure into a new company (TowerCo) by May 2020. This will be operated by a dedicated management team and monetised through a partial sale or IPO during the next 18 months.

This plan was trailed by CEO Nick Read when he took charge of the firm in 2018. But today we get to see the numbers. As a standalone business, Vodafone estimates that TowerCo could generate annual revenue of €1,700m and EBITDA of €900m. Annual capex requirements are estimated at €200m.

One broker has suggested that TowerCo could have an enterprise value of €8bn – €11bn. Proceeds from the monetisation of these assets will be used to reduce the group’s €27bn net debt.

Trading improving

The other highlight from today’s newsflow was a positive Q1 trading update, with “organic service revenue” down by just 0.2%. This compares to a fall of 0.7% in the previous quarter. This is a key metric for Vodafone and the company expects this gradual recovery to continue.

The company says its on track to achieve €400m of cost savings in Europe and reiterated full year guidance for adjusted EBITDA of €13.8-14.2 billion and free cash flow (pre-spectrum) at least €5.4 billion.

My view

Vodafone has been seriously unloved over the last 18 months, and recently cut its dividend to help reduce its debt burden.

VOD 5-year share price chart

Source: Google Finance

However, I think it’s been a mistake to write off this firm, which was always expected to face a period of consolidation after former CEO Vittorio Colao’s decade-long M&A spree.

Nick Read’s appointment as Mr Colao’s successor was public confirmation of this — Mr Read’s previous job was as chief financial officer. So he knew the firm’s finances and assets intimately. Presumably he wouldn’t have accepted the job if he hadn’t been confident he could could return the business to growth, cut costs and get rising debt levels under control.

We’re now starting to see the fruits of Mr Read’s labour. Although debt and capex commitments remain fairly onerous, in my view, this business remains highly cash generative.

My calculations suggest the group generated underlying free cash flow of about £3.4bn last year, giving the stock a price/free cash flow ratio of about 11. If the firm delivers on forecasts, I’d expect this figure to improve over the next couple of years, covering the current dividend and allowing for some debt reduction.

In my view, investors looking for big cap high yield stocks could do worse than consider Vodafone at current levels. The forecast yield of 6.6% looks affordable to me, and performance appears to be improving.

CVS Group (CVSG)

  • Share price: 905p (+2.5%)
  • Market cap: £640m

Trading update

After warning on profits in January, this veterinary services group seems to have made a remarkable recovery.

Today’s year-end trading update tells us that revenue for the year to 30 June rose by 24% to £406.5m. Stripping out acquisitions, the company says it achieved like-for-like revenue growth of 5.2%.

Gross margins improved in the small animal, equine and referrals businesses during the second half of the year. But gross margins for the group as a whole fell last year, from 79.6% to 76.2%. This is said to be due to an increase in farm work, where lower-margin pharmaceutical sales outweigh higher-margin vet fees.

Adjusted EBITDA (and presumably earnings) are expected to be in line with market expectations, which were upgraded at the end of June.

The company seems to have got a grip on its staff shortages, with vacancy rates down from a 2018 peak of 12.5% to 8.4%. However, this has required the firm to offer more attractive pay packages for vets and nurses. As a result, clinical salaries rose by 8% during the second half of 2018. No further increases — beyond inflation — are expected to be necessary.

My view

I can see that the vet market may offer opportunities for consolidation and acquisition-led growth. But I’m struggling to get excited by CVSG stock, especially at current levels.

The firm’s high gross margin does not seem to translate into an attractive operating margin or return on capital. Looking back over results for the last five years, the group’s operating margin appears to hover between 5% and 6%, while returns on capital have averaged about 10%.

Although cash generation has historically been quite good, heavy spending on acquisitions has resulted in a mounting debt pile. The group expects to report leverage of 2.08x EBITDA in its forthcoming results.

Earnings are only expected to grow by about 5% during the 2019/20 year. The dividend yield is negligible at 0.6%.

These metrics suggest to me that with the stock trading on 19 times forecast earnings, any good news is in the price. I respect management’s achievement in getting the business back on track, but I don’t see any compelling reason to buy at current levels.


  • Share price: 1,037p (unch)
  • Market cap: £2.8bn

Half-year results

I wanted to take a quick look at the latest numbers from FTSE 250 engineering company IMI because I see this as another quality industrial firm, in the same vein as Victrex, which I discussed yesterday.

IMI isn’t exactly a household name, but it generates sales of £1.9bn each year from making “highly engineered products that control the precise movement of fluids”. Customers come from all the industries you might expect, including the automotive, energy and construction sectors.

Like Victrex, IMI is seeing weaker demand in some industrial markets. However, the company’s results remain fairly stable, with revenue broadly flat at £910m during H1 and operating profit unchanged at £101m.

These figures support a trailing 12-month operating margin of 12.1% and a return on capital employed of 19%. This is consistent with performance in recent years and full-year expectations are unchanged.

My view

IMI lacks Victrex’s near-40% operating margin and its debt-free balance sheet. But IMI’s numbers suggest to me this it could also be an attractive buy during a market correction or recession.

The stock currently trades on about 14x earnings and offers a 4% dividend yield. It’s a watch list stock for me. But for investors with a benign view on the global economy, this might be worth considering.

That’s all for today, thanks for reading if you’ve made it this far!

I’ll be back on Tuesday next week, when we’re expecting another action-packed day of news.

Until then, I hope you have a great weekend.





Wordpress (4)
  • comment-avatar

    Great article as always Roland. Bit of a random question – the picture you’ve used for the article, of the white houses etc, where is that?!

  • comment-avatar

    “Personally, I’d be looking for a lower price to buy this stock. But if I held, I’d be unlikely to sell.”

    An inconsistency, surely?! If the first sentence is the correct, then the second displays the status quo bias.

    • comment-avatar

      Hi pj0077,

      Thanks for your comment! What I meant was that to buy a company like RMV, I’d be looking for an exceptional opportunity. A time when the shares had fallen temporarily out of favour for some reason.

      In this case, a good example might be during a housing market downturn, when the market might start to doubt RMV’s ability to maintain its profits.

      However, having bought at that level, I wouldn’t sell readily, whatever happened to the price.

      I don’t think I’m being inconsistent (but maybe I am!).


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