Sanderson – low p/e, mammoth yield

Shares in software provider Sanderson have moved in a narrow range this year. But that belies what the managing director, David O’Byrne, calls a ‘step-change’ in the business following two acquisitions – one of them major – that have reoriented Sanderson away from the manufacturing sector and towards the multi-channel retailing market. With the impact of those two deals likely to be highly visible in the current year, the shares are starting to look cheap. If the house broker, Arden Partners, is right, they are selling at under 8.4 times likely earnings at the current 49.5p. They also pay a whopping yield – of 5.5 per cent.

The company produced its full-year figures last week (to end-September) and they marginally beat forecasts at £2.83 million. The manufacturing-related business had a tough first half but a better second half and the outlook for the current year is positive. Among the client industries, print and food are still investing strongly.

But it is the outlook for multi-channel retailing that intrigues. Two astute acquisitions, most notably RBS, mean three-quarters of turnover will now come from this area. With retailers increasingly keen to exploit the shift of spending away from the high street and into catalogue and internet shopping, they want software solutions that can address all areas.

Importantly, there is next to no customer overlap between Sanderson’s original businesses in this sector and the acquired businesses. There is also a managed service operation that will be rolled out across the whole group. The retail sector may not be at its most robust right now, but issues such as the new payment card industry regulations and chip and pin encourage more spending, whatever the economic fundamentals. Recent customer wins include Wyevale Garden Centres and Slater Menswear.

Why are the shares so cheap? The company’s operating margin of 19 per cent last year puts it at the top of its peer group – a reflection of the fact that it owns its intellectual property. With attractive opportunities for cross-selling as a result of the two acquisitions, margins should continue to be strong.

If there is one fly in the ointment it is the debt taken on to fund the RBS deal. Sanderson finished last year with net debt of £11.7 million. There is further £2 million of deferred consideration to be paid in the next year. But the business is highly cash generative and O’Byrne says the company can live with existing debt levels. Only another major deal would force the company to top up with more equity. That is not likely in the near future as the management concentrates on getting more out of what it already has.

Sanderson looks a very solid lock-away, especially for income-conscious investors.