Investment View: You should go for a firm that has its head in the cloud

This company is a crucial cog in the digital economy’s wheels and benefits from the growth of outsourcing too


Our view: BUY

Price: 846.5p (-7.5p) 

Telecity shares have been as hot as Scotch Bonnet chilli peppers for so long it comes as quite a surprise to see them consorting with polar bears.

I suppose it’s fair to say that the interim results reported by the data warehousing outfit (it provides secure servers and the like), at the end of July, didn’t exactly thrill.

But its well-heeled directors will hardly have been calling their private bankers with instructions to buy up property in the South of France in  anticipation of some extended holidays.

Au contraire. The headlines tell their own story: revenues increased by 16 per cent, earnings before one-offs and financing costs by 18 per cent.

Debt is on the rise, but is still at the lower end of the company’s target, and the borrowing is being used to invest in new capacity, and there is a ready market for what Telecity is selling. Shareholders also saw a 40 per cent rise in the interim dividend.

So what’s the issue? Well, the UK division was notably slow, and the results were shy of some analysts’ expectations. 

It is likely that the shares had reached a natural ceiling prior to the release of the numbers and that a lot of people felt the time was right to cash in, including at least one big institution. The results being slightly disappointing by Telecity’s standards could have served as the catalyst for this.

Given the way that the shares have performed, cashing in was quite understandable. Even after their recent weakness, the stock is still four times the level it was bouncing around at four and a half years ago.

But with the shares at a more modest level than their all-time high (over a tenner), is it time to dip your toes back in these waters? I think so.

The term “data warehousing” might not get the blood pumping but Telecity is a crucial cog in the digital economy’s wheels, and also benefits from the popularity of outsourcing, the growth of cloud computing, and the rise in internet-based transactions generally.

In this country it has facilities in London and Manchester but it is also active across Europe ranging as far as Turkey. You could argue that it is the gateway to the internet in this part of the world and bid rumours periodically do the rounds of the City’s dealing rooms, although there hasn’t been anything of real  substance for a while.

However, even with an uncertain economic outlook plaguing large swathes of this part of the world, it looks poised to do well on a medium- to long-term horizon.

What may have fuelled the weakness at the interim stage was that sales growth in the UK was torpid at best. This suffered largely as a result of  the company having a lack of capacity.

 That has been addressed and Telecity says it has seen improvements since then.

So we might expect to see a better story at the full-year stage. If Telecity can exceed analaysts’ expectations, and some of them have clipped their forecasts a bit, that would be the catalyst for the shares to bounce back very strongly.

Some have expressed concerns about rivals opening up new capacity of their own, resulting in pressure on prices and margins, but this doesn’t yet appear to have been a problem for the company.

It is something worth keeping a careful eye on, but Telecity does have a strong position in the market and should be able to cope.

The shares now trade on a multiple of 22.7 times this year’s forecast earnings, falling to 19 times next year, with the prospective yield set to rise from 1.1 per cent to 1.4 per cent. That doesn’t look at all stretched to my mind.

The multiple might be high compared to UK companies generally, but with Telecity’s growth potential it could be argued that it is actually starting to look quite modest.

I think there is a strong case for getting back aboard this train. Even if the shares take a while to find momentum, there is no reason to think they will suffer from any protracted weakness.

Most of the analysts who follow the stock remain confident, and to my mind the long-term prospects of this industry are very good. Buy.

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