Driver Group - A Robust Proposition

I covered Driver Group (LSE:DRV) back in December when the shares were exchanging hands at 126p. I concluded the article by describing Driver as a medium term investment proposition and that the company is "relatively small, profitable company with strong cash generation, a track record of delivery and a confident outlook." The share price has since dropped down to 101p, which has been surprising to say the least. However, I reckon that Driver now offers investors an even better entry point, and the company remains undervalued amongst a sea of fairly valued and overvalued small cap companies. Driver currently has 27.13m shares in issue meaning that the company is now capitalised at £27.40m. The fundamentals remain strong and the downtrend looks set to cease.

This article is a follow-on from the below post. For full context and information, read this article first:

The technical position of the shares is the most likely reason for the price retracement from 120p+ to 101p now. The obvious point to note is that there was also going to be some level of profit taking around these levels as investors looked to secure substantial profits made during 2012 and 2013. Looking back at the chart, there was probably a combination of reasons for technical weakness. The long-term blue support line was broken through, followed by the formation of a bearish heads and shoulders formation (which looks to complete), followed by a break of the 200-day moving average, and then followed by a break of weak support at 111p (which was the H&S neckline). That's a pretty dismal technical breakdown, but it looks close to completion now, as the MACD and RSI are both heavily oversold, plus the share price is reaching down to enormous support at 100p. Overall, the technical position is now improving, in light of the recent downtrend, and a base is likely to be made around the current level.

The spread for Driver has improved with it currently only 2% (100p - 102p). Following on from Hargreave Hale increasing their stake in Driver in early December, there have been a couple of institutional movements with Baronsmead reducing its stake through its venture capital trusts marginally, to 18.9%. Artemis has increased their stake to 5.06%. Having watched the price movements of the company over the past few months, there haven't been a concerning number of large share trades, which suggests that the drop has largely been fuelled by retail investors taking profits or responding to the weakened technical picture.

Due to the nature of Driver's business and the lack of operational talking points, I appreciate that some part of this article will be very similar to that in the first article. The first part of the article will re-examine the company's financial results from December, and the second part will take a look at the trading statement released in late February. Both include important details that have to be considered when appraising Driver Group.

Starting with the 2013 full year results, I've re-written the headline points of importance below.
- Revenues of £37.2m (up £10.98m)
- Underlying pre-tax profit of £3.07m (vs. £1.75m)
- Exceptionals and share based payments of £482,000
- Reported pre-tax profit of £2.29m (vs. £1.20m)
- Reported post-tax profit of £2.21m (vs. £961k)
- Basic EPS of 8.3p
- Underlying EPS of 10.2p
- Dividend per share of 1.5p
- Net cash of £1.07m with cash generation from operations of £2.2m

Putting those figures back into context, the trailing PE ratio of Driver is of just 12 at the basic level, or 9.9 taking the underlying EPS figure. What figure is more useful? For that you have to look at the nature of the exceptionals/share based payments. There was £482k in share options so that does not reflect the underlying performance of the business, thus the underlying EPS figure is more appropriate, and for a company growing as quickly as Driver is, a PER of less than 10 is very good value.

However, you have to be careful when looking at EPS figures, and there are a few points to note. Companies almost always use the 'weighted number of shares in issue' over the period, to calculate EPS, and whilst that is perfectly fair, the reality is that the EPS will adjust next year if new shares have been issued. For that reason I prefer to use the actual number of shares in issue rather than the weighted average. Taking 27.13m as the actual number of current shares in issue, the 'true' underlying EPS falls to circa 9.9p so the company is trading on 10.2 times that multiple, which is still very low, especially in the current market climate.

The 1.5p dividend gives a yield of 1.49% which is not something to be particularly excited about, but it is covered more than 5 times over by non-underlying diluted EPS, so it is very secure. The net cash pile also isn't large, but with strong cash generation of £2.2m, it should continue to grow, and is likely to tend towards £2.5m towards the course of 2014. The final dividend (1p of the 1.5p) is due to be paid in early April, and to qualify; investors need to hold Driver shares on March 28th.

A slight negative was that the overall margin reduced by 1.7%, but positively, that was the result of investment in America and Asia. Non-current tangible assets total £2.27m with the balance in goodwill. Positively, current assets are 1.48x total liabilities so the balance sheet is very solid and there isn't much concern with regards to possible financial problems. There were net receivables of £3.81m, although this included £1.75m in prepayments and accrued income. Of the actual receivables, 71% are not overdue, and only 9% are more than 60 days overdue. The raw cash balance was £2.67m, with borrowings of £1.59m. Those borrowings should be wiped out over the next couple of years, and the cash balance should improve, and the majority of the borrowings are non-current anyway, thus they don't pose a problem. That should reduce the already low interest payments. No customer had more than 10% of the group revenue, and the revenue profile is actually very balanced so that is reassuring - a lot of small companies have their revenues skewed by large contracts.

The less numerical parts of the update were also strong. There was revenue growth across the board (the impact of the acquired Driver Trett was largely responsible), with the lowest percentage growth experienced in America at 20%, and the highest percentage growth seen in Asia Pacific at 203%. A concern investors may have is, "what percentage of that growth was acquisitive?" That's a very valid question because if most of the growth is from the acquired Driver Trett, then is Driver much of a growth prospect at all? Remarkably, around half the revenue growth was organically, and that bodes well going forward. In the medium term, Driver's focus was to continue to develop the oil & gas, and petrochemicals offerings. Driver also hoped to see the positive effects of investment in Asia and America filtering through. With utilisation rates in Asia at less than 50%, there is plenty of scope to increase revenues through the existing cost base, and that is the case in America as well. The catch is that if the growth is not forthcoming, the cost base can be deemed too high. Growth in 2014 was outlined as being possible through taking market share in America and Asia Pacific, continued good performance in Europe, and expansion in the Middle East.

Driver are looking to develop their oil & gas offering
The recent market share price decline was sparked by the trading statement released in late February, and I believe that was unjustified and actually down to the structure of the RNS - Driver outlined their performance, region by region. I've summarised the RNS as follows.
- Asia Pacific revenues and results better than expected. The management were "delighted by its performance to date and remain cautiously optimistic about its outlook"
- Middle East continued to perform well with momentum seen last year, carrying through early 2014. Expansion opportunities were seen and there is "good potential" for these to develop over the remainder of the year
- European business continues to perform as expected
- Africa impacted by a delay in 3 hospital projects by the South African government. Furthermore, a weak South African Rand has impacted margins as products are sourced from Europe
- American investment has helped win oil & gas relationships for business outside of America. American workloads remain subdued with the American H1 performance adversely affected. Driver are targeting a reduction in this expanded cost base in order to protect current year-end profit expectations for the region

It therefore reads as if most of H1 has been a mixed bag (bear in mind that Driver's H1 ends at the end of March). In reality, that is not the case. Overall, the group traded in line with management's expectations due to the encouraging performance in Europe and the Middle East plus growth in Asia Pacific. The fact of the matter is that these three regions contribute over 90% of the group's business now, compared to slightly below 90% at year-end. In particular, American revenues contribute very little relative to African revenues. That is important as it means that the vast majority of Driver's business is doing well, with the all important Middle East and Asia Pacific regions showing good performances. Thus the situation in Africa and America really does very little to detract from the overall investment proposition, and the recent market pullback is unjustified. The management commented upon "continued confidence" when reflecting on the results during the year to date.

The final part of evaluating Driver is to examine the broker forecasts. There is only one set of forecasts available in the market meaning they are open to being beaten/missed. 2014 estimates are for £3.2m in pre-tax profits, 8.70p in EPS and a dividend of 1.60p. 2015 estimates are for £4.00m in pre-tax profits, 11.37p in EPS and 1.70p in dividends. Looking solely at the 2014 estimates, that puts Driver on a modest PER of 11.6 and on a yield of 1.58%.

Those figures look odd to me as it implies a drop in profits, when the company have already stated that they have platforms to grow profits in each region. Taking £3.2m on pre-tax profits, taking away ~15% in tax (which was the last effective rate), and dividing by 8.7p, gives that there are apparently 31.26m shares in issue, which is not right. Therefore, the only sensible conclusion that I can come to is that there is either large possible dilution on the cards, or the broker is expecting exceptional costs to be incurred, which would lower the EPS. Taking a look through the accounts, there is dilution to be mindful of, with 3 million outstanding options all due to vest before November 2014. That will cause downward pressure on the EPS figures because they will almost certainly be exercised (as they have a low exercise price relative to the current price). Even so, that would only take the shares in issue up to approximately 30.13m, so there is still a discrepancy that I can't seem to get to fit. The dividend forecast also seems too conservative, in my opinion. If the company is chucking off over £2m per year, they can afford much more than a 0.1p dividend rise, even if some of those proceeds are used to pay back borrowings.

In cases like this, I am therefore far happier to construct a theoretical scenario and see what figures I get out. Assume that revenues this year grow by 10%, and administrative costs rise by 4% to cater for the opening of new offices (this probably can be largely mitigated by the initial office costs last year, but let's forget that for now). Revenues therefore rise to £40.96m, and assuming a 26% gross margin (which is up 0.9% on the last figure, which had a 1.7% drop), the cost of sales rise to £30.31m. Administrative expenditure tracks higher to £7.14m. That would combine to give an operational profit around £3.51m (which would be ~12% higher than in 2013). Assume an effective tax rate of 17% (to factor in the potential for a rise due to tax rate mixture changes), and the profit after tax comes out at £2.91m. Divide by the current number of shares in issue, and "true" underlying EPS comes out at 10.7p versus broker estimates for 8.7p. Factor in the 3m options, and the underlying EPS drops down to 9.7p, which is still comfortably above broker estimates. It's also important to recognise that any EPS figures would use the weighted number of shares in issue so the full year results will look 'artificially high'.

Those figures, in my opinion, are perfectly attainable especially since Driver has a track record for outperforming market expectations. The assumptions used are not unreasonable, but if you relax them slightly (i.e. use a 25% gross margin), the figures come out closer to broker estimates. That said, the issue with using a weighted number of shares in issue does prove that broker estimates look rather conservative.

Each percentage point of gross margin boosts profit by as much as £0.4m, so that is a key figure. If they can restore margin following the drop due to investment last year, then these is plenty of scope to materially outperform market expectations again this year. In any case, around 8.5p looks to be the base case for EPS this year, which puts the shares on a very undemanding rating. I do however believe that the dividend forecasts are too low, and I would expect north of 1.75p this year, on the back of a strong performance. Take into consideration that the 2013 performance was attained "whilst making key strategic investments". The forward PER assumes strong growth in 2015, which is attractive.

On that basis, Driver Group continues to look a robust proposition for investors, and for that reason I have doubled up the site's portfolio stake, thus reducing the average to 112.5p. The strengthening balance sheet should allow for strategic acquisitions to be an option over the course of 2014, and the company has noted that any that could help accelerate growth would be welcomed. In the interim, investors are faced with a company that is still growing organically in its core markets, has strong cash generation, and is priced on low valuation metrics. The technical weakness looks to be close to subsiding, and with the share price only marginally above the pivotal 100p support, the market looks to be offering investors a good opportunity. There is every chance that Driver will top expectations this year, as it has done so frequently in the past. I retain my Buy rating on Driver Group.

UPDATE (24/09/14) - In line with previously stated aims to trim down portfolio positions, I have reduced the Driver Group stake back to 'normal' levels with a single position of £5,000. However, 1.6p of dividends were accrued on this secondary position.

UPDATE (01/10/14) - In light of currency pressures of the South African Rand (ZAR) and strong sterling, I have moved the final slot in Driver to No Rating at 110p for pre-cautionary measures. Whilst the company may have performed well in H2, the broker estimates will have required a particularly strong performance generating 4.9p EPS. That is not impossible, but with options coming towards their exercise dates, it makes sense to be cautious in the current market climate. The portfolio price of 113.2p accounts for 1.6p in dividends on the core holding, plus 1.6p in dividends on the secondary slot, which was closed in September


  1. Very very good. Subscribed. DRV does look good at this level

  2. DRV still looks much better value than CSG at the moment. I hink the dicidend eatimate of 1.6p is very conservative as well. That wouls represent a poor yearly dividens increase compared to the rate of revenue growth!

    James R

  3. Thanks El1te,
    I can only assume that your revenue growth assumption will prove very conservative, given:
    - opening of Hong Kong office and expectation of rapid Asia growth
    - more than 50% growth in Middle East last year, with continued momentum into this year
    - opening of offices in UK, Germany and Australia
    - impact of strategy to win global clients

    1. Organic growth last year was 20% (so around £5.5m of revenue growth organically) and numerous offices were opened, as you say.

      10% revenue growth this year assumes that growth has actually slowed to £3.7m, which is fairly conservative in my opinion, but it's better to take the conservative scenario and then be surprised to the upside if that is the case. Growth in Asia should contribute materially to this years revenue growth.