Investment Column: Hold on to high-quality ARM Holdings
Provident Financial; Games Workshop
Wednesday 28 July 2010
Our view: Hold
Share price: 339.9p (-12.2p)
ARM's microchips power such a huge array of products that, though you may not recognise the company, you have probably tapped or touched your way through some zippy handheld or laptop that's driven by a chip designed or based upon the Cambridge-based group's technology.
ARM already commands the mobile phone market and is widely expected to make rapid strides as the youthful tablet computer market matures in the coming years.
Apple's iPad, which, incidentally, is believed to draw upon ARM intellectual property, is only the tip of the iceberg, with analysts anticipating a surge in the demand for tablets.
On Goldman Sachs's numbers, for example, though tablets are likely to make up only 5 to 10 per cent of the PC market in 2011-12, they may well end up commanding as much as 40 per cent within a 10-year period. Given ARM's track record and expertise, you don't need to be a mega-brained chip designer to recognise the potential for higher earnings at the company as a result of these developments. And a cursory glance at yesterday's forecast-beating results should further confirm the company's strengths.
So, is it time to buy? On a long-term view, the answer is fairly straightforward: yes, yes, yes. On a short- to medium-term view, however, we're more cautious. Our concern is down to the valuation, with ARM trading on a very fancy-looking multiple of 47.9 times Investec's forecasts for 2011.
Technology companies often trade at what would be considered inflated multiples in other sectors, but even given that fact, ARM's rating seems toppish. That said, we wouldn't sell. This is a fundamentally strong company with great prospects. While we worry that the stock may fall prey to profit-taking in coming months, we're equally confident that any dip in its share price will be temporary. So, buy if it shows any weakness, and keep holding in the meantime.
Our view: Avoid
Share price: 821p (-61.5p)
Ever since the coalition Government announced plans to take a very big axe to public spending budgets just after coming into power, this column has been nervous about the prospects of those companies that count the state among their biggest clients. But the collateral damage is likely to spread much wider.
Yesterday, announcing first-half numbers, the sub-prime lender Provident Financial said that it is "tempered by cautious customer behaviour", and that there is "uncertainty over the direction of the employment market". It is concerned about "the potential for unemployment to increase as a result of the Government's fiscal austerity programme". In other words "we're worried". There were some upbeat points. Peter Crook, its chief executive, said he was comfortable with full-year profit forecasts, helped particularly by the Vanquis Bank division, which saw profits jump by 82 per cent. The Government's pledge to lift those earning less than £10,000 out of income tax bands (over time) is also helpful for a business like Provident.
On a valuation basis, the dividend yield of 7.2 per cent is first class, and the multiple of 11.8 times this year's forecast earnings is undemanding. But with between 40 and 50 per cent of Provident's customers in regular receipt of benefits, which in the case of welfare and housing payments are set to see an especially sharp blade, we cannot back the group. Avoid.
Our view: Buy
Share price: 432.5p (+27.5p)
It has been an action-packed two years for Games Workshop, the maker of tabletop fantasy war games and miniatures. Faced with a recession, the maker of Warhammer ditched its dividend in 2008, cut costs, reduced capital spend and froze staff pay.
The share price of the company, which has 382 Games Workshop Hobby stores globally and also sells its products in nearly 4,000 independent toy retailers worldwide, tumbled to as low as 246.95p in early January.
But yesterday Games Workshop showed these battles are behind it by more than doubling pre-tax profits to £16.1m for the year to 30 May, boosted by a sharp jump in its gross margins.
Furthermore, cash generation improved markedly to leave it with net funds of £17.1m at the year end. These factors helped Games Workshop to reinstate its dividend with a 25p payment. While its shares trade on a forecast 2011 multiple of 12.3, ahead of the retail sector, it is a niche player and its miniatures have proved they are well-equipped for any economic battles. We sat back and held in January but the results give us confidence to buy again.
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