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The Quarto Group — Update 4 November 2016

The Quarto Group — Update 4 November 2016

The Quarto Group

Fiona Orford-Williams

Written by

Fiona Orford-Williams

Director, TMT

Quarto Group

Drawing ahead

Q3 trading update

Media

4 November 2016

Price

284.0p

Market cap

£58m

£1:US$1.25

Net debt ($m) at end September 2016

75.0

Shares in issue

20.4m

Free float

78.1%

Code

QRT

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

0.0

7.9

26.9

Rel (local)

2.9

5.2

20.0

52-week high/low

295.5p

207.0p

Business description

The Quarto Group is the leading global illustrated-book publisher and distribution group. It sells books across 45 countries and in 35 languages. Founded in 1976, Quarto employs over 400 people.

Next events

Y/E trading update

Jan 17

Analysts

Fiona Orford-Williams

+44 (0)20 3077 5739

Jane Anscombe

+44 (0)20 3077 5740

Quarto Group is a research client of Edison Investment Research Limited

Quarto’s Q3 trading update shows the group is on track to meet expectations and our FY16 and FY17 figures are unchanged. Group revenues were up 3.0% with publishing revenues up 4.6%, boosted by earlier acquisitions that are bedding in well. However, timing effects and tough comparatives were less flattering to the underlying revenue number. Unsurprisingly, Q4 is always the most important trading period. With earnings clearly on a rising trend and the debt level still receding, the rating remains at an unjustifiably sizeable discount to market and sector.

Year end

Revenue ($m)

PBT*
($m)

EPS*
(c)

DPS
(c)

P/E
(x)

Yield
(%)

12/14

171.3

11.9

44.1

13.7

8.0

3.9

12/15

182.2

14.1

49.5

14.5

7.2

4.1

12/16e

195.0

15.5

52.3

15.3

6.8

4.3

12/17e

212.5

17.1

57.4

15.8

6.2

4.5

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Growing focus on IP

Quarto continues to grow confidence in its proposition to increase earnings through leveraging its proprietary content across diverse channels. It increasingly sees itself as an IP business rather than simply as a publisher of books. The reconfigured management structure outlined at the recent investor day should give the group a better platform for expansion while allowing the individual imprints to develop without compromising their character. The children’s offer remains a key area of focus (22% of FY15 publishing revenues). Top-line growth across the group will allow for increasing efficiency across the supply chain and distribution, as well as facilitating margin expansion. The intention is to present financial results from FY17 by geography and by publishing/non-publishing, moving away from the publishing/ co-edition break down. The US accounts for around 46% of group revenues on a pro-forma basis, with the UK the next largest market, while core publishing represents 82%, the balance being the print broking and Australasian operations.

Debt pay down continues

Earnings growth and debt reduction are the central planks of the investment case. The net debt figure as at end September was $75m, down 6.7% from $80m a year earlier, with our year-end forecast remaining $64m, well within leverage, interest cover and cashflow covenants. This gives the group sufficient flexibility to supplement its portfolio with acquisitions that fit with the overall rationale.

Valuation: Low for a global publishing business

Quarto’s 2016e P/E is just 6.8x (EV/EBITDA 6.9x) and the stock carries a premium historic yield of 4.1%. This does not seem to adequately reflect its low-risk publishing business model, earnings and dividend progression, debt reduction and valuable backlist. The possibility of equity issuance to fund purchases may, though, limit full closure of the discount to other smaller publishing companies, which currently are trading on an 11.8x FY16e P/E.

Organic and acquisition growth strategy

The group’s growth strategy is predicated on a mix of organic and acquisitional growth, with a broad assumption that these two could contribute roughly equally to the overall top-line progress. While earlier obituaries to the printed book have proved wide of the mark, we are relatively cautious about how much help there will be from underlying growth in the book market. The experience has been that the global market for illustrated books has been much less volatile than for markets such as fiction or educational publishing and greatly less disrupted by digital distribution. The market for children’s books has also been comparatively strong. The latest release from the Association of American Publishers for the year to May 2016 showed that sales of paperback books were up 7.2%, while hardback books grew 17.4%; eBooks were down 18.2%.

Optimising organic progress

Quarto has a differentiated model from other publishers, with a concentration on generating IP that is realisable not just in the early days and months of a title’s release, but over an extended period. It therefore benefits from a backlist (of over 9,000 titles) that goes on selling, albeit with refreshes where necessary. Series of books, such as the ‘1001’ titles from group imprint Quintessence and the adult education books from Ivy Press, help particularly to stimulate earlier titles.

There were $89m of backlist sales in FY15, 61.4% of the total. This percentage has been falling over the last three years, (stable on an absolute level), but this reflects the top-line growth and the increase in development spend on IP. The group draws attention to its ‘Product Efficiency’ ratio, which it defines as the sales of new titles in any financial year divided by the IP development spend in the prior year. The target for this ratio is that it should be over 1.2x. In FY15 it was 1.34x.

Each of Quarto’s imprints has creative independence, but they can all benefit from the structures put in place at the group level particularly in terms of sales and marketing. This would also include expertise in fields such as foreign rights, different formats and languages as well as leveraging technical expertise in new distribution and dissemination channels. There are also benefits of scale in other practical areas such as print and freight purchase.

Acquisition rationale

At the investor day, Quarto outlined six types of acquisition opportunity:

■

Category enhancing: improves the group’s position and presence in a particular vertical. This is the largest group in terms of the number of potential opportunities

■

Additional expertise: adds capabilities or markets not covered by existing group imprints

■

Competitor ingestion: allows for synergistic benefits and/or adds channels to market

■

Step changers: larger targets, such as the purchase of becker&mayer (see our note of August 2016), which clearly changed the proposition in the US and children’s offers

■

Adjacencies: adding complementary subjects or markets or giving additional distribution

■

Distribution enhancing: giving access to specific channels (again these maybe at the larger end of the spectrum)

All are expected to have beneficial impact in terms of the people that they bring into the group, have good product and good process – although this latter could be enhanced by the inclusion in the larger group.

Exhibit 1: Financial summary

Year end 31 December

 

USD '000s

2014

2015

2016e

2017e

Accounting basis

 

 

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

 

 

 

 

 

 

Revenue

 

 

171,338

182,165

195,000

212,477

Cost of sales

(116,325)

(122,803)

(131,430)

(143,210)

Gross profit

 

 

55,013

59,362

63,570

69,268

EBITDA

 

 

17,025

18,395

19,674

21,204

Operating profit (before GW and except)

 

46,852

50,464

54,072

58,791

Amortisation of intangibles

 

 

(503)

(724)

(924)

(924)

Exceptionals

 

 

566

(445)

(200)

0

Amortisation of pre-production costs

 

 

(30,933)

(33,258)

(35,588)

(38,777)

Operating profit

 

 

15,982

16,037

17,360

19,090

Net interest

 

 

(3,977)

(3,098)

(3,008)

(2,904)

Profit before tax (norm)

 

 

11,942

14,108

15,476

17,110

Profit before tax IFRS

 

 

12,005

12,939

14,352

16,186

Tax

 

 

(2,922)

(3,685)

(4,055)

(4,620)

Adjustment to tax for normalised earnings

 

 

(16)

(645)

(231)

(236)

Minority charge

 

 

(310)

(388)

(375)

(388)

Profit after tax (norm.)

 

 

8,696

9,778

10,815

11,866

Profit after tax (FRS3)

 

 

8,773

8,866

9,922

11,178

 

 

 

 

 

 

 

Average number of shares outstanding (m)

 

 

19.7

19.7

20.7

20.7

EPS - normalised fully diluted (c)

 

 

44.1

49.5

52.3

57.4

EPS - IFRS (c)

 

 

44.5

45.0

50.4

56.8

Dividend per share (c)

13.7

14.5

15.3

15.8

 

 

 

 

 

 

 

EBITDA margin (%)

 

 

10%

10%

10%

10%

Operating margin (before GW and except) (%)

 

27%

28%

28%

28%

 

 

 

 

 

 

 

BALANCE SHEET

 

 

 

 

 

 

Fixed assets

 

 

102,416

104,433

124,948

124,774

Intangible assets

 

 

42,025

41,622

61,448

61,274

Tangible assets

 

 

2,857

3,368

4,500

4,500

Investment in associates

 

 

57,534

59,443

59,000

59,000

Current assets

 

 

99,702

108,369

114,180

124,173

Intangible assets: pre-publication costs

 

 

0

0

0

0

Stocks

 

 

24,851

26,147

27,989

30,498

Debtors

 

 

51,741

57,163

61,191

66,675

Cash

 

 

23,110

25,059

25,000

27,000

Current liabilities

 

 

(144,919)

(70,635)

(86,547)

(96,102)

Creditors

 

 

(55,769)

(65,635)

(70,935)

(78,036)

Short-term borrowings

 

 

(89,150)

(5,000)

(15,612)

(18,066)

Long-term liabilities

 

 

(6,875)

(87,127)

(78,100)

(70,100)

Long-term borrowings

 

 

0

(79,562)

(73,000)

(65,000)

Other long-term liabilities

 

 

(6,875)

(7,565)

(5,100)

(5,100)

Net assets

 

 

50,324

55,040

74,481

82,745

 

 

 

 

 

 

 

CASH FLOW

 

 

 

 

 

 

Operating cash flow

 

 

47,529

52,941

53,030

53,800

Net interest

 

 

(3,310)

(2,749)

(3,176)

(3,072)

Tax

 

 

(759)

(1,981)

(3,777)

(4,196)

Capex

 

 

(33,018)

(36,882)

(36,000)

(36,000)

Acquisitions/disposals

 

 

(2,008)

(1,614)

(11,329)

0

Financing

 

 

0

0

0

0

Dividends

 

 

(2,739)

(2,346)

(2,857)

(3,004)

Other

 

 

0

0

0

19

Net cash flow

 

 

5,695

7,369

(4,109)

7,546

Opening net debt/(cash)

 

 

71,015

66,040

59,503

63,612

HP finance leases initiated

 

 

0

0

0

0

Loans acquired with acquisitions

 

 

0

0

0

0

Translation differences

 

 

(720)

(832)

0

0

Closing net debt/(cash)

 

 

66,040

59,503

63,612

56,066

Source: Company accounts, Edison Investment Research

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt, Sydney and Wellington. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2016 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Quarto Group and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. 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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt, Sydney and Wellington. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2016 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Quarto Group and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2016. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Orexo — Update 4 November 2016

Orexo

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