Stock in Focus: Will Woodford woes provide Paypoint buying opportunity?

The troubles affecting Neil Woodford were hard to ignore last week. And although I don’t think this is the place to comment on Mr Woodford’s situation, I have been cross-referencing my portfolio with the Woodford Equity Income fund.

I’m interested to see whether any forced selling by the fund manager could create an opportunity for me to top up my own holdings at attractive prices.

As far as I can see, I only own two stocks that feature in the Equity Income fund. One of these is newly-promoted FTSE 250 payment processor PayPoint (LON:PAY). This stock doesn’t feature in the SIF Folio I run here at Stockopedia, but is a part of my main (personal) income-focused portfolio.

As it turns out, PayPoint also comes very close to qualifying for my Stock in Focus screen. So in this piece I’m going to take a brief look at the attractions (and risks) of this high-yield favourite.

The UK’s biggest retail network?

PayPoint operates a network of payment terminals in convenience stores and corner shops. Its network was originally setup to allow customers to make cash payments for utility bills and mobile top ups. But as demand for cash bill payments has fallen, the company has started to evolve.

The firm’s terminals are now able to provide a fully-featured point-of-sale system for small retailers. The latest PayPoint EPoS system replaces a conventional till, providing support for card payments, a cash drawer, inventory management, reporting and even ordering stock from selected wholesalers. Other services for customers include cash withdrawals and the Collect+ parcel service, which is run by PayPoint.

In the UK, the group’s network now includes 28,000 stores. I estimate this as being more than half the addressable market, when supermarkets are stripped out:

PayPoint is keen to point out that its network is larger than the Post Office, and larger than any UK bank or supermarket. Apparently, 99.5% of the UK’s urban population lives within one mile of a PayPoint retailer. In rural areas, 98.5% of people live within five miles of a retailer. The company also has a network of c.18,500 sites in Romania, where cash remains much more dominant.

My view is that such broad market penetration is likely to remain a valuable asset, if combined with good management and technical innovation.

Interestingly, long-time CEO Dominic Taylor has recently stood down. His replacement, Patrick Headon, has only been in the job for just over two months, but has a varied CV including senior European roles at eBay and Diageo. It’s too soon to see what changes (if any) Mr Headon plans to make. But after 21 years with the same chief executive, I believe this transition is worth watching.

Almost a SIF stock…

Here’s how PAY stock looks when I run it through Stocko’s checklist tool (a very useful way to understand more about screening results):

As you can see, PayPoint appears to fail two of my screening tests.

PEG Ratio: The fail here is real. Earnings per share growth was 3% last year and is expected to be similar in 2019/20. Although the pace is expected to improve in 2020/21, the stock’s mid-teens price/earnings ratio means that the PEG ratio (price/earning dividend by eps growth) is still too high. I’ve circled the P/E and PEG ratios in the image below:

Sales Growth: The other numbers I’ve highlighted in the image above are the firm’s reported revenue for last year, and the forecast figures for FY20 and FY21. These appear to suggest that revenue is expected to fall by 42% this year.

Happily, this isn’t true. Although both numbers are correct, the £211.6m figure represents statutory revenue, while the £122.2m figure is PayPoint’s measure of net revenue. Essentially, this measure removes mobile top-ups, SIM cards and related commission payments to retailers where PayPoint is the principal.

As far as I understand, this refers to locations where PayPoint has contracted with retailers (agents) to sell these products. This is distinct from situations where PayPoint is the agent — i.e. where mobile phone networks have contracted with PayPoint to sell their SIM cards and top-ups.

Essentially, my reading of this is that the net revenue figure excludes pass-through revenue. I’m comfortable with this.

Although PayPoint’s net revenue fell from £119.6m to £116.6m last year, consensus forecasts suggest an increase to £122.2m in FY20. Based on this measure, sales are expected to return to growth this year, so the shares would probably pass my screening test for this metric.

A high-quality income stock?

So far, we’ve established that PayPoint is very slow growing and that the stock is not obviously cheap. So what do I like these shares?

The short answer to this is that I believe it’s a high quality business. Profit margins and returns on capital are exceptionally high. Cash generation is very strong, and we’ve already seen that the company enjoys a very wide reach in its chosen market.

Here’s how Stockopedia ranks the shares:

And here’s why the quality score is so high:

As you can see, return on capital employed has averaged more than 90% over the last three years. Also note that these operating margins use statutory revenue. Using the net revenue measure, operating margin last year was actually 46%.

Cash generation is consistently good and is backed by a debt-free balance sheet. Dividends are generous. Although the picture is blurred slightly by special dividend payments of £25m per year (36.7p per share), scheduled to continue until December 2021, I believe the yield should be sustainable at at least 6%.

The right time to buy?

Recent RNS filings show that Woodford funds have indeed been selling PayPoint stock. In fact, Woodford Investment Management’s large holding has fallen from 20.05% in October 2018 to just 10.98% today. About 4% of this was transferred to another manager, rather than sold, so in total Mr Woodford has sold just over 5% of PAY stock so far.

The effect on the share price has been minimal. In fact, Mr Woodford has actually been able to sell into a rising market:

The stock’s strong performance is reflected in its Stockopedia momentum score of 97/100:

There’s nothing to dislike here, in my opinion. But I can’t help but feel that after such a strong run, PayPoint’s slow earnings growth may soon start to exert a gravitational pull on the share price.

The stock’s High Flyer classification also seems to suggest that this could be a risk, if the firm disappoints in any way.

My verdict: PayPoint’s slow earnings growth suggests this stock is unlikely to qualify for my SIF screen anytime soon. Looking at the bigger picture, I think the main risk for investors is that the transition to being a service provider for retailers still a work in progress.

Despite this, I remain a happy holder. Indeed, I’d like to buy a few more of these shares, but after such rapid gains I’m not going to rush in. History suggests the shares could retreat at some point:

If they do, then I will consider buying more.

As always, I’d love to know what you think about this stock, which has been a very successful long-term investment for many shareholders.

Disclosure: Roland owns shares in PayPoint.

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