The Faraj List of Exploding Stock Part 4.05

Buy Amstrad at 141.5p
Says Tom Winnifrith of t1ps.com
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A lot of people don't like Alan Sugar the man behind Amstrad. In his TV show "The Apprentice" he appears rather unpleasant and there was an incident a few years ago when he tried to take this company private at far too low a level. As it happens I loathe the guy. I once spent an evening with him in the Directors box at his beloved Spurs and having chatted to him at length about results due the next morning from the club, wrote the back page story on the numbers for the Evening Standard. Sugar was furious and suggested that I did not understand balance sheets. So as it happens I dislike Mr Sugar even more than I dislike "The Spuds." The fact that he endorses the party led by the war criminal Blair is yet another negative point. But that is all irrelevant, Sugar is a good businessmen and has created a good company in Amstrad. The fact that he is such a piece of work means the stock does not have the rating it merits. Either Amstrad will be re-rated or, I would think, Sugar will take it private.

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For the year ended 30th June 2005 the consolidated balance sheet shows that the company had cash of 40.4 pounds million, worth 49.45p per share, bringing total net assets to 41 million pounds. The cash underpins the share price, and means that the actual business trades on a PE of just 6.3, falling to 5.3 in 2007. That rating is too low, even for a company associated with Alan Sugar. I would have thought that the business should trade on a forward PE closer to 9. This year won't be great but on forecasts for the year to June 30th 2007 ( a year which starts in just 7 months time) that gives an implied share price of 200p. Moreover, although Amstrad made a tiny loss in 2002 it is pretty consistently profitable and maintains a good level of dividend cover and with its enormous cash pile it can deliver real dividend growth. And given that Alan "You're Fired" Sugar holds 28.4% of Amstrad, the dividend is unlikely to be cut. I assume a payout of 7.3p this year and 8.3p in the year to June 2007 which puts the stock on a current year yield of 5.1% rising to 5.8%. Another reason to buy the stock. And the third reason is that Sugar may well enjoy sticking two fingers up to the City and taking Amstrad private if the rating does not improve. The limit buying price is 155p and my one year target is 200p.

Amstrad - The Business
The main revenue generating product for Amstrad is its digital satellite boxes. In total the group offers a choice of seven boxes, which enables BSkyB digital television to be received. As digital TV has been expanding people have been buying more set top boxes to sit in front of the television watching re-runs of Eastenders, Coronation Street, or The Office, so it is not wholly surprising that the satellite boxes have been selling strongly given the public's love of television. During the last financial year to 30th June 2005, it was the DRX500i box that performed strongly, providing access to all Sky Italia digital satellite programmes, where there was a strong demand from the Italian distributor. It is anticipated that there will continue to be strong demand for the personal video recorder and HDTV over the next couple of years and beyond, but not at the same level as the past year, due to demand slowing down, and pricing pressure from other competitor's models. On 19th September Amstrad announced a new deal with BSkyB to develop and supply a new PVR set top box, which is anticipated to sell large volumes in the financial year to 30th June 2007.



In 2000 Amstrad launched the e-m@iler, which I could never for the life of me see taking off, and, sure enough it has struggled. The e-m@ailer, which is operated by Amstrad's 89.8% owned subsidiary Amserve, is a personal communication device that offers communication in the same way as a normal telephone, but also has e-mail, internet, txt messages, fax messages, answering machine, as well as video calls. The company generates revenues from the ongoing use of the e-m@iler, primarily through e-mail, which does go some way to providing stability and a certain predictability of earnings. In the year to 30th June 2005 the annualised revenue received from the product amounted to 7.3 million pounds, over two times the level of sales of the unit in the year, which were just 61,000, sold at around 50 pounds a pop. In total there have been 429,000 e-m@ilers sold and registered since it was launched back in 2000.

More recently, on 20th September, the company launched a new product for the health care market - a new target market for Amstrad - launching the Integra face care system, which will be sold online through its website. Integra, which is a wholly owned subsidiary of Amstrad, is a face care system designed to reduce the appearance of lines and wrinkles. The product will be sold directly online, aided by users of the product recommending people to order Integra through the arrogantly named Sir Alan Sugar Enterprise Scheme . SASES, developed and owned by Amstrad, works through individuals becoming members of the enterprise scheme through purchasing Integra, and then being given the opportunity to earn income for themselves by selling the product to other people. Clearly this could work in a similar way to Ann Summers parties, albeit not quite so exciting, where people can view the Integra product for themselves, and then go away, buy it, and become a SASES member if they so choose.

Amstrad also has an international arm, located in Hong Kong, which serves as a factory liaison and a quality control operation for the UK business. The international division sells consumer products such as audio equipment, such as vertical loading CD players, to the worldwide market.

Management
Amstrad is chaired by Sir Alan Sugar, who is living proof that you can leave school at 16 with next to no qualifications and still become highly successful in business. In fact I am increasingly convinced that a University degree is an impediment to entrepreneurial flair rather than an aid to it. That will no doubt greatly encourage those who failed to last the course like Luke Heron and Zak Mir. Sugar founded Amstrad aged 21 in 1968, and has been at the helm ever since, and currently holds 23 million shares in Amstrad, 28.4% of the equity. Also on the board is his son, Simon Sugar, who holds 540,170 shares, 0.66% of the equity. All the remaining directors have shareholdings in the company, although none of any notable size.

Valuation and Forecast
What has really disappointed the city and caused Amstrad to be lowly is the statement in its results stating that "although we anticipate a good performance in the current financial year, shareholders should not expect the same level of result as we have reported for the year to 30 June 2005". In the year to 30th June 2005 Amstrad reported pre-tax profits of 19.1 million pounds on sales of 102.5 million pounds, giving earnings per share of 16.9p. For the current year I am expecting the company to report sales of close to 90 million pounds, with a pre-tax profit of 16.4 million pounds, worth 13.8p per share in earnings. As the company has already indicated, "the subsequent financial year looks positive and we are excited by the potential of the new orders and new range of products which should underpin prospects for future financial years". I am therefore expecting a strong uplift in sales for the 2007 financial year to 95 million pounds, with pre-tax profits rising 19.5% to 19.6 million pounds, giving earnings of 16.8p per share. If the company hits my forecasts then it will be trading on a current PE of 10.3, falling to 8.5 for 2007. But ...that assumes that the company's cash pile sits in the bank earning sod all in interest. Sugar is too smart to do this.

With over 40 million pounds of cash in the bank, the company has the backing to pay a healthy dividend, and I would certainly hope for an increase to 7.3p per share for the current year, rising to 8.3p per share. There is no reason with that cash that it has why the company could not pay a larger dividend, or indeed pay a special dividend, or buy back its shares for cancellation to improve earnings. If the company does pay the dividend that I expect, then it offers a yield of 5.1%, rising to 5.8% for 2007.

In terms of valuing Amstrad, I do not regard a valuation of nine times June 2007 earnings as outrageous. One could put it another way and say one is valuing the business (ex-cash) at less than 10 times the average earnings and earnings forecast for 2004-2007. If one adds onto this relatively modest rating (which gives a valuation of 151.5p per share) the cash pile one arrives at a target price for the entire company of 200p per share.

Conclusion
Amstrad is a well run entity. It has attractive growth prospects over the medium term. It has stacks of cash and pays an attractive dividend. As a fully listed stock it can be stuck in your ISA and it should be. I am not promising a stellar reward but if it achieves my target price and pays my projected dividend then the total one year return will be just under 50%. I do not regard that as a disgrace. Ignore the hostility of some to Sugar, for their hostility is based on judgements about the man and not his abilities. Amstrad is a buy at 141.5p.

Key Data

EPIC: AMT
Price: 140 - 143p
Market : Main Market

Tom Winnifrith edits www.t1ps.com. Past performance is no indication of future success but, 1 in 6 of his tips over the past 5 years have gained 100% or more. 1 in 3 have gained 50% or more. The average gain per tip is 46%. To sign up click here.