How to profit from company turnarounds

The 1990s weren’t kind to Apple

The Board of Apple Computer wasn’t certain whether Steve Jobs was the right man to lead the company when it appointed him as interim CEO in 1997. But it had to take the chance. The situation was desperate.

The 1990s had been a dreadful decade for Apple. Sales had dropped sharply, market share kept shrinking and the company went through a string of CEOs with no visible results. Of course, the rest is history.

An investment in Apple at the moment of Jobs’ return would have paid out about 15,000% since. But it’s all well and good to say that now. How can we spot a successful turnaround in real time?

Today, I want to show you how I spot a company with the potential to transform its own fortunes. And later on, I want to show you a company which is in the middle of a turnaround of its own right now.

The four elements of a successful turnaround

It’s very hard for an organisation to change from within. There are a lot of entrenched habits and interests to overcome. In my experience, successful turnarounds tend to have the following four characteristics:

1. New management. A fresh pair of eyes and a different approach are necessary when it comes to making change happen.

2. A good underlying business. Hopefully, there is a corporate gem waiting to be discovered after the problems have been resolved.

3. A clear strategy. Ideally, the new plan will include targets so we can measure the progress being made.

4. A following wind. It’s a lot easier executing a turn-round if trading is picking up anyway. Management see a quicker pay-back from their strategy – you don’t get the dispiriting sense of running hard just to stand still.

Can Stadium Group transform its fortunes?

Stadium Group (LN: SDM) is a provider of electronic products. It’s fair to say, however, that making good profits in contract manufacturing isn’t easy. This has been reflected in lacklustre returns for Stadium’s long-term shareholders.

Back in 1998, the shares hit 200p, but over the last decade, they’ve traded in a sideways range between 30p and 80p. We’ve also had three dividend cuts over this period. It’s been a tough share to make money from.

But Stadium’s prospects could improve in the near future. I’ve always been tempted by companies carrying out a self-help programme which brings the promise of improved performance. How does Stadium fit my four criteria?

The management has a crucial role to play in a turnaround operation. Very few can hope to emulate Steve Jobs’ success at Apple, of course. But all restructuring involves leadership and vision. At Stadium, ex-operations director, Charlie Peppiatt, was appointed chief executive on 1 June 2013. So we can tick point 1.

Point 2, the quality of the core business, is a bit trickier. About 80% of Stadium’s sales come from its electronic manufacturing services (EMS) contract division.

Stadium is mainly an assembler, who adds limited value to the product. It will always be a low-margin operation and in recent years, it’s struggled to make a meaningful profit. So the strategy is to improve EMS within its limitations and look for growth in the other legs of the business.

CEO Charlie Peppiatt is seeing through a modernisation of the EMS operation. This has involved consolidating UK facilities onto a single site in Hartlepool. In the Far East, Stadium had an old-fashioned approach, with a Hong Kong head office separate from its factory on the mainland.

This regional HQ has been closed and upgraded management now works out of the single manufacturing site in China. Freeing up surplus property assets has reduced costs. It’s also made the business leaner and more competitive by raising capacity utilisation. Peppiatt now describes EMS as “match-fit”.

If Stadium manages to turn the corner in EMS, the group will have been stabilised. But it’s hard to see this division earning more than a low single-digit profit margin. Better growth prospects lie in the power and industrial graphics technologies (IGT) divisions, which also make much higher margins.

It’s chasing higher margins

The strength of Stadium’s business lies in its power and IGT divisions. Management now needs to develop a clear strategy to optimise results for these two branches.

Stadium Power had a tricky year in 2013 due to a major customer delaying orders, but this year looks much better. Stadium is improving the quality of its sales force by investing in field engineers. Focusing on the technology content and new products should reinforce the pickup in sales. Profit margins here are over 20%.

The third Stadium business, IGT, was acquired in 2012. Further progress is expected from IGT’s niche in touch screens and control panels. The management is clearly happy with IGT, and we should expect further acquisitions along similar lines.

Growth in these two divisions and more acquisitions will help to reduce dependence on the EMS arm. But Mr Peppiatt feels that the newly modernised EMS branch can help the group by cross-selling the other products.

It has a blue chip customer list, most of which is unaware of the full range that Stadium can offer. A more integrated approach to selling and product design should help raise performance further.

The balance sheet is in reasonable shape. The management also thinks there’s scope to improve working capital ratios. Borrowing facilities are in place for the bolt-on acquisitions management is looking to make. The strategy is reasonably clear and talking to the management, there is a good sense of what’s expected. So, I’m happy point 3 is covered.

As for the fourth point, I think it’s fair to say the economy is picking up, which bodes well for Stadium’s restructuring project.

When I’m looking for new ideas I normally go for out-and-out growth stocks. But this looks like a decent restructuring story which has scope to raise its game under new management.

The shares have run up from last year’s lows, but at 68p, broker N+1 Singer has them on a 2014 price/earnings (p/e) ratio of 9.7. This falls to 8.1 times the 2015 earnings forecast and there is an expected yield of 3%. If it can deliver on Charlie Peppiatt’s plan, then Stadium is definitely worth a look.


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