SIF Folio: UPGS could be a lockdown buy

The stock screen I use to select shares for my rules-based SIF Folio hasn’t provided any new stocks to buy for a month. That’s not unusual in itself. What is unusual is that for much of that period, only one stock has qualified for my screen – construction group Morgan Sindall, my favourite firm in a sector I generally avoid.

I’ve been running the SIF virtual folio for nearly five years and cannot remember such a dry spell. I’m not sure what this tells me about the outlook for the stock market, but I admit to being a bit nervous. However, my general policy is to avoid macro judgements and focus on stock picks.

Morgan Sindall is already in the portfolio, so I can’t buy it again. But after four weeks without new opportunities, my rules allow me to relax my valuation criteria slightly. The purpose of this provision is to try and make sure that I don’t miss out too much in major growth markets, when stock valuations tend to become elevated across the board.

Although there’s some risk to this approach, I’m a strong believer in the adage that it’s time in the market that counts, not timing the market. So I’m willing to keep buying if suitable candidates are available.

As it turns out, there is one stock that qualifies for the relaxed version of my screen and isn’t ruled out by existing holdings or diversification requirements:

Small cap Up Global Sourcing Holdings (LON: UPGS) owns a range of popular consumer  goods brands. Examples include Kleeneze, Salter, Beldray and Russell Hobbs – you can see a full list here.

These products are generally affordable everyday items. I’d hope that demand would be durable in all but the worst of recessions.

UPGS also benefits from owner management (CEO Simon Showman owns 22%). Although the stock got off to a shaky start after its 2017 flotation, it’s performed well since then:

UPGS (the UP stands for Ultimate Products) has become a popular stock with private investors and is also one of Ed Croft’s 2021 NAPS picks. The Stocko algorithms like UPGS, too. It currently boasts a StockRank of 98 and Super Stock status:

There is conceivably some overlap with existing SIF holding Bamp;M European Value Retail, which stocks a number of UPGS brands. But given that UPGS sells to 300 retailers in 38 countries, I don’t think this is a serious concern. 

On balance, UPGS is a company I’d consider adding to SIF. So let’s take a closer look.

Value: Fair

A ValueRank of 70 is the lowest of UPGS’s three factor scores. One reason for this might be the stock’s lofty price/book ratio of 7.8. However, this is that doesn’t concern me too much, as the shares score well on most of my other preferred value metrics:

• P/E: 15.4

• P/B: 7.8

• P/S: 0.9

• P/FCF: 6.9

• Dividend yield: 3.1%

• Earnings yield: 8.1%

Balance sheet: Although the group’s policy of outsourcing manufacturing means that it’s light on assets, the balance sheet looks fine to me. Net debt was around £7m at the end of July, which looks low risk against annual profits of £6.6m.

There’s a sizeable outstanding receivables balance of £18.5m, but UPGS says this is 97% covered by credit insurance. 

Cash flow: The stock’s trailing P/E of 15.4 is more than double the trailing price/free cash flow ratio of 6.9. I think it’s unlikely that a growing business would be able to achieve this consistently. When I see a discrepancy like this, I try to check it out to understand what might have happened.

In fairness, UPGS does seem to be fairly cash generative. Over the last six years shown on the StockReport, earnings per share and free cash flow per share have both totalled c.38p. This supports my assumption that last year’s cash influx was a one-off, presumably due to the impact of the spring lockdown in Europe.

A quick look at last year’s cash flow statement (y/e 31 July) confirms this. UPGS reported a £12.4m working capital inflow last year, due to a big reduction in inventories and receivables:

I’d expect at least some of this working capital adjustment to reverse during the next 12-18 months. 

On balance, I think UPGS looks soundly financed and reasonably valued, albeit not necessarily cheap.

Quality: super ROCE

Companies that generate high returns on capital with minimal leverage can deliver fantastic results for equity investors. I’m hoping that might be the case with UPGS. As we’ve seen already, leverage is low and cash generation is strong.

Zooming on the stock’s quality stats, we can see that ROCE is also very high, albeit somewhat variable:

These high returns are achieved despite fairly modest operating margins. This implies that UPGS has very low costs. That’s logical, given that the group outsources capital-intensive activities such as manufacturing and logistics.

UPGS appears to have many of the hallmarks of a quality business. But is it improving? One quick way to check this is by looking at the stock’s Piotroski F-Score. This fundamental health score monitors changes in measures such as profitability and cash generation. A high score indicates improving fundamental performance. That’s the case here:

I think that UPGS is a reasonably good quality business. The only caveat I’d add to this is that in my view, the company’s “value-focused consumer brands” (it’s own description) probably don’t have the brand equity of more upmarket rivals. In my view, UPGS’s success depends partly on its scale and distribution network. I wouldn’t want to pay a very high multiple for the shares.

Momentum: improving

This is the kicker. An unscheduled trading update in December revealed “continuing momentum” in UPGS’s order book. Sales to online and supermarket channels are said to be going particularly well. As a result, EBITDA guidance for the year was lifted. 

Earnings estimates: Brokers covering the stock have assessed this news and lifted earnings forecasts by around 15% for both FY21 and FY22.

Price momentum: UPGS shares have risen by nearly 40% since then, but the stock still looks quite reasonably valued to me. Broker forecasts put the stock on about 13 times forecast earnings, with an attractive dividend yield:

At this level I’d still be happy to run with UPGS. Strong price momentum and recent earnings upgrades support a high MomentumRank of 98. History tells us that stocks with strong momentum can outperform for extended periods. I think there could be further upside here.

My verdict

I can see plenty to like with UPGS and not too much to dislike at the moment. I’m going to add UPGS to the SIF folio and to my own holdings. As always, I’ll make the trades after this article has been published this week.

Disclosure: At the time of publication, Roland owned shares in Morgan Sindall Group and Bamp;M European Value Retail.

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