Even after the government cuts kick in, one thing austerity Britain will still always need to spend on is its schools. Paul Hill recommends this IT firm as a defensive education play.
In June, after the general election, the new UK education secretary, Michael Gove, tore up the Labour Party's flagship £55bn Building Schools for the Future (BSF) programme. This sent the share price of RM Group, the main player in the UK's £1.1bn IT education market, down to five-year lows.
But while the cancellation is bad news, all is not lost for RM. Most politicians acknowledge that in order to boost sustainable job creation, education is key. A skilled workforce is likely to invent more new technologies, file more patents and be better prepared to turn good ideas into real business opportunities. Given this need for top-flight schools and universities, I suspect Gove will resurrect many parts of the BSF scheme perhaps doing similar things at lower prices.
This already seems to be happening. On 20 September, RM said that trading was in line with expectations. Chief executive Terry Sweeney said that, over the summer, the group had "commissioned more new schools, processed more examination scripts, and shipped more classroom resources than ever before". RM "continues to see good sales momentum, with both new contracts and extensions to existing arrangements". Better still, the organisation is moving up the value chain away from standard hardware sales, towards higher-margin products and services under long-term relationships. Earlier in the year, it established a joint venture with Lego to supply state-of-the-art learning software.
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The City expects 2010 turnover and underlying earnings per share (EPS) of £369m and 15.7p, moving to £360m and 16.9p in 2011. That puts RM on miserly p/e ratios of 9.2 and 8.6, while paying a 4.2% dividend yield.
So what are the risks? The biggest worry is what happens after the October Spending Review. But I think educational spending is unlikely to be obliterated this would seriously handicap Britain's ability to create wealth in order to pay off the £1trn deficit. Then there is RM's £15.7m pension deficit to consider. But with a strong position in a strategically important sector, on top of lucrative opportunities abroad (presently 13% of turnover), the stock is a 'buy'. RM already has a nice foothold in the US, where the Barack Obama administration, through the American Recovery and Reinvestment Act, has allocated $83bn for educational spending. Preliminary results are out on 22nd November. I would value the stock on a nine times EBITA multiple, giving an intrinsic worth of around 180p a share.
Recommendation: BUY at 141p
Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments
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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.
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