Gamble of the week: high-growth retail support business

published 29 August 2008

As you're no doubt aware, most high-street stores are on their knees. Even the likes of Marks & Spencer, Starbucks, Dixons and B&Q are suffering as tighter credit conditions force consumers to cut back. However, there is one vital differentiator between the retail winners and losers: online sales. According to CapGemini, the internet now accounts for about one pound in every seven spent in Britain, while globally e-commerce is set to grow by an average of 16% a year until 2011.

SDI Group (Aim:SDIG)

One business that looks well-placed to benefit is SDI, the UK's fifth-largest automated materials handling (MH) group. It designs, builds and supports flexible warehouse systems used by the likes of Asda, Nike and Primark to run their web-fulfilment operations. Recently though, some large retailers have decided to defer their supply-chain investments until the worst of the credit crunch is over.

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Unsurprisingly, this temporary slowdown in orders has spooked SDI's investors, who have dumped their stakes, driving the shares down more than 80% in the past year. Yet all is not lost and here's why.

First, this hiatus will not last forever. I believe we'll start to see a return to more normal ordering patterns in early 2009. Retailers are increasingly sourcing their merchandise from around the world to secure cheap supplies and offer a wider choice, adding to the pressure for flexible, faster and more efficient MH systems. Next, to improve profitability, distribution costs must also be reduced, thus making it even more crucial to introduce these solutions, which typically cut expenses by 30%.

Last, SDI's rating looks far too cheap for such a high-growth business. Even after a "challenging" first half, broking house Cenkos still expects turnover to come in at £75m for the 16-month period ending March 2009, with the firm being profitable in the second half. On this basis, I could see SDI's 2010 turnover and underlying earnings per share hitting £65m and 4p respectively, putting the stock on a forward earnings multiple of below three. The balance sheet also looks solid, with £4.4m of net cash (or 4.1p per share) as at May.

As always, nothing is risk-free. The main concerns are greater competition from larger rivals and the impact of a prolonged recession. That said, five directors and 24 staff clearly feel confident in the company's prospects, together purchasing six million shares (5.5% of the equity) at 11p each on 1 August.

Recommendation: SPECULATIVE BUY at 11.25p (market cap. £12m)

Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.