Park Group — Investing for faster growth

Given the acceleration in higher-margin card billings late in the FY19 year, management estimates the additional profit deferral for the year at c £0.5m. The impacts of IFRS 15 are explained in detail in our post-interim results update and although there is some deferral of income recognition compared with the old accounting standard, there is no impact on cash flow or the profit that is ultimately reported. The re-stated historical financial statements previously provided by the group show an average annual IFRS 15 pre-tax profit deferral over the four years to end-FY18 of c £0.4m, or c 3%.

Reflecting the underlying trading performance, despite the additional profit deferral and an additional c £0.5m of costs relating to investment in the new strategic business plan (c £0.3m in H119), management expects profit before tax and exceptional items will only be marginally below market consensus (revenues of £112m and PBT of £12.9m) for FY19.

Reported FY19 profits will also be affected by an exceptional non-cash impairment charge of c £1.25m. This is related to the group’s previously announced decision to move the majority of its core operations to new offices in Liverpool city centre (fulfilment and redemption activities will remain at the current site, along with separated hamper production) from the existing site at Valley Road, Birkenhead. The move is intended to provide the core activities with access to a wider talent pool, benefiting from an existing hub of like-minded fintech businesses in central Liverpool. Management anticipates the additional premises costs will fairly quickly be mitigated by productivity improvements and that the potential sale or subletting of vacated space in Birkenhead should also accelerate the pay-back period. The lease has been signed and the move is expected to take place in late summer 2019.

Park anticipates the trends experienced in the FY19 year that ended 31 March will continue in FY20, with good growth in the Corporate business, partially offset in the Consumer business by a slower Christmas savings market. In the latter, Park began taking customer orders late in 2018 for Christmas 2019, and will by now have a reasonable sense of Christmas savings activity for the year. As well as a challenging retail environment, the slowdown highlights some of the more structural issues that the strategic business plan aims to address. Strategic investment cost (net of the initial benefits) is expected to be c £2.0m in FY20, which will result in lower profitability in the current year but this is expected to increase growth and earnings thereafter. The FY20 investment costs include the impact of running two sites as the group transitions the core activities to the new offices, as well as additional technology and marketing investment.

Park reports good progress through the initial steps of the strategic business plan, which aims to enhance how the group works with consumers, businesses and retailers, and will give more details with the FY19 full-year results announcement in June.

Continuing senior hires include a new chief transformation officer, a human resources director and an interim head of marketing. Towards the goal of becoming an organisation anchored on digital products and processes, a new enterprise resource planning system has been selected and is expected to provide scalability, resilience and efficiency.

We welcome the announcement that the non-executive chairman, Laura Carstensen, has agreed to continue in her role for another three years from June 2019. She has significant experience of the group, having been appointed to the board as a non-executive director in September 2013 and becoming non-executive chairman in June 2016. As chairman she has helped steer the group through a period of significant management renewal and change, including the appointment of Ian O’Doherty as CEO in January 2018, Tim Clancy as CFO in August 2018 and a number of other senior executives. The new management team set out its strategic plans for the group in December 2018.

Taking account of management guidance in the trading statement, we have slightly reduced our forecasts for FY19 PBT and revenues before the exceptional write-down by c 3%, to £12.5m (from £12.8m) and £111.2m (from £114.3m), respectively. The revenue reduction substantially relates to the product mix changes discussed above rather than customer activity or billings. The small reduction in forecast billings (less than 1%) reflects a revised assumption of flat billings in the Consumer business rather than slight growth.

Our revised FY20 forecast captures the negative impact of the additional costs related to implementing the strategic business plan but little to none of the benefits expected by management on a medium-term basis. To better reflect this, we will extend our forecasting period with the annual results in June.

We have made no changes to our forecast DPS growth, with a good level of dividend cover maintained despite the reduction in forecast EPS.

Our approach to valuing Park is to consider a potential absolute valuation, based on a modified DCF analysis, alongside a relative value based on a comparison with a selected group of listed stocks that are engaged in activities that provide some overlap with Park. We would not go so far as to call this a peer group comparison because no such listed group exists. Park’s competitor employee benefits and service providers are either private companies or relatively small parts of larger groups, complicating any attempt at a relative valuation approach. Our last published fair value, based on the simple average of these two measures points, was 87p per share.

Our modified DCF valuation has been based on fairly consistent assumptions for an extended period. It is a modified DCF in the sense that we include the interest earned by Park on segregated customer cash balances (but not on the group cash balance), as this is an integral part of the returns the company generates. The customer cash is excluded from the overall valuation and the voucher provisions balance as this will eventually flow out in settlement of vouchers that have been issued but not yet redeemed. Beyond the forecast period (currently up to end-FY20) we have grown free cash flow at 5% per year until year 10, enhanced by an assumed normalisation of interest rates to 3% from FY21. The terminal cash flow has valued at 10x and we have applied a discount rate of 10%. Given the impact of the strategic investment costs on our FY20 forecast, an unchanged DCF assumption set would see the DCF value per share reduce from 90p to 77p, but this would not capture any of the accelerated medium-term growth that management is targeting. By assuming two stages of growth, at 10% per year for four years after the forecast period, before reverting to 5%, the DCF value would again be 90p. We will review the DCF value when extending our forecast period after the full-year results in June.

Our relative value comparison recognises the lack of direct comparators to Park. In incentive and rewards products, Sodexo and Edenred are both much larger and more international than Park, and the overlap with Sodexo is limited; Sodexo Benefits and Rewards Services is only a minor part of Sodexo Group. We therefore extend the comparator group to include payments service providers and companies engaged in UK home collected credit services (HCC), directed at a customer group with some demographic/socioeconomic overlap between the traditional customer bases of Park’s Christmas prepayments business (c 50% of Park). We recognise that the read-across is somewhat limited and note the difference between the savings nature of Park’s Christmas prepayments business and the lending nature of HCC. Given Park has no credit risk and we believe it has less regulatory risk, we would expect a higher valuation.

In our last-published fair value of 87p, we made the judgement that c 14x calendar year 2019 earnings would represent a reasonable valuation objective. Given the drag of strategic investment cost on our FY19 forecast earnings, the same 14x multiple would imply a value of 70p, but this would take no account of the benefits that management targets from the investment. We believe a successful implementation of management’s plans, leading to faster growth, increasing scale and a greater focus on digital payments services, has the potential to lift both earnings and valuation over time. On this basis, the 17.4x CY19e multiple implied by our last published fair value of 87p does not appear unreasonable, and we will review this with the full year results.