Investors’ Chronicle: Softcat, Bloomsbury, Whitbread

BUY: Softcat (SCT)

The IT company has seen no drop off in spending from its customers despite the wider economic malaise, writes Arthur Sants.

Softcat has posted strong full-year revenue growth. Management says it has seen “no evidence of weakening demand” because in a hybrid working world continued IT investment is essential.

Revenue growth was in the double digits across all three divisions. Hardware sales increased 43.4 per cent, while services jumped 31.2 per cent and software by 16.8 per cent. The hardware sales were driven by one big cloud computing contract. However, management said even if this was stripped out, growth would still have been in double digits.

Although revenue rose quickly, margins have slipped from last year. The size of the large cloud contract meant the buyer could negotiate down on price. This contributed to the gross margin falling 4.8 percentage points to a still solid 30.4 per cent. Meanwhile, the operating margin fell 2.6 percentage points to 12.6 per cent. Central costs were inflated through the period, with a rising wage bill reflecting a 14.3 per cent increase in staff numbers and growing pay rates, the latter point no doubt exacerbated by a tight labour market.

Cash conversion suffered from an upgrade of the finance system. The conversion ratio fell from 89.9 per cent to 76.2 per cent because of issues linked to the new system upgrade. However, management maintains the implementation was successful and the rate will normalise in the first half of next year. Although there is no immediate cause for concern, investors would be well advised to keep an eye on the level of receivables. It may just be timing issues, but if they increase much faster than revenue growth it could point towards liquidity issues within the customer base.

Despite growing costs, the top line growth is impressive, especially given the wider macro conditions. Chief executive Graeme Watt suggested continued investment in IT is partly due to the expansion of hybrid working arrangements, but also because of the imperative to reduce costs through technology investment. His thesis will be put to the test in the coming months. The good news is that the company has plenty of scope to grow market share even if wider demand for IT infrastructure products softens in the near-term. Softcat has added breadth and depth to its client base, while increasing gross profit per customer by 16.1 per cent and growing the overall catchment by 2.1 per cent.

Broker Numis likes that 35 per cent of Softcat’s cost base is sales commission. This means costs will fall linearly if the market were to turn. Numis is currently forecasting a forward PE of 20.8, which looks good value despite the wider tech sell-off — certainly better than the 34 times on which Softcat was trading at six months ago.

BUY: Bloomsbury Publishing (BMY)

It’s not entirely recession proof, but the publisher’s revenue mix provides resilience, writes Mark Robinson.

JK Rowling got a solitary mention in Bloomsbury Publishing’s half-year update. That might seem a little churlish given that sales of the Harry Potter series increased by 35 per cent during its 25th anniversary year. Harry Potter and The Philosopher’s Stone, the first instalment of the series, has been the second-bestselling children’s book of the year to date. That’s quite an achievement given that the novel was first published in 1997, but it’s understandable why Bloomsbury might want to bypass the culture wars.

And there was much to commend in the publisher’s half-year results. Organic revenue growth was 12 per cent to the good, with three strategic acquisitions contributing aggregate revenue of £14.8mn (2021: £4.4mn).

Progress was made across the board. Revenue at the non-consumer division grew by 24 per cent to £46.6mn, with academic and professional sales buoyed. It’s worth noting that sales for reference works tend to hold up reasonably well during economic downturns. They also afford more predictable margins.

Meanwhile, organic revenue growth from consumer sales increased by a fifth, with children’s trade publishing leading the way. The fact that sales to youngsters account for a sizeable proportion (some 41 per cent) of the group total is a major plus point as household budgets start to creak. Consumers tend to be price elastic where books are concerned, but that doesn’t apply to the same extent with children’s titles (anything to keep them happy).

The group continues to move beyond the printed word. Group chief executive, Nigel Newton, touted Bloomsbury Digital Resources as “the standout performer during the period, with 69 per cent revenue growth year on year and profit of £6.6mn, an increase of 134 per cent”. The development of digital channels promises to support margins over the long run, although it will necessitate further investment.

The balance sheet remains in good nick, even though there is an inherent drag in remittance from the sale of books due from distributors. Nonetheless, receivables as a proportion of sales were broadly the same as the 2021 half-year comparator.

The revenue mix at Bloomsbury should insulate it to an extent against any slump in discretionary spending, so a forward rating of 16 times Investec’s forecast earnings per share is not prohibitive. Newton thinks the resilience of the top line is partly because “reading offers a form of escapism and an ideal — and inexpensive — therapy for dealing with the stresses and strains of day-to-day life”. Perhaps a book voucher for Rowling might be in order?

HOLD: Whitbread (WTB)

While its brand equity and market position stand the company in good stead, rising costs are a headache, writes Christopher Akers.

The current headwinds crushing hospitality present opportunities as well as downsides and Whitbread is keen to take advantage. The Premier Inn owner said that “a declining independent sector” is boosting its own growth potential and has raised its long-term hotel room target in the UK and Ireland to 125,000.

Begbies Traynor partner Julie Palmer said this “could be the polite way of saying the smaller hotels Whitbread competes with are simply being overwhelmed by rising bills such as energy and labour and throwing in the towel”.

While this looks like good news for Whitbread’s long-term growth, it shouldn’t obscure the fact that the company has problems of its own. It expects £60mn of additional costs in financial year 2023, a figure which represents almost a fifth of this half’s profits, driven by labour, utilities and food and drink inflation. And while utilities have been fully hedged for next year, £20mn of further costs are forecast for 2024, with 70 per cent hedging in place.

But taken as a whole, these results represent progress. Profits outstripped pre-pandemic levels with pent-up demand, a net 487 new rooms in the UK opened in the half, better pricing, and a reduced pool of competitors all having an impact. Revenue per available room soared by a quarter against 2019 to £62 in the UK, while in Germany established hotel operations were profitable for the first time in the second quarter. And current trading is solid — for the seven weeks to October 20, total UK sales were almost a quarter up on the same period in 2019, and total accommodation sales grew by 37 per cent. Saying that, while hotel sales are performing well, it is the food and drink side of the business that is struggling, with sales not expected to return to pre-pandemic levels this year.

With a strong balance sheet — lease adjusted leverage fell to 2.8 times in the half — and solid brand equity Whitbread is well positioned in the market. A committed pipeline of 8,875 rooms is encouraging. As is the valuation — the shares trade on an undemanding 21 times forward earnings, according to consensus analyst forecasts from FactSet. This is below the five-year average of 37 times, and cheaper than hospitality peers such as Hilton World, which trades on 24 times, and Accor, which trades on 23 times.

Hermione Taylor: Feeling shrinkflated? Try quiet quitting

Sometimes, a colourful new economics term springs up that seems to capture the spirit of the times: we have “friendshoring”, “bond vigilantes”, “corporate zombies” and “economic nothing burgers” (glossary to follow). And now labour markets are evolving a post-Covid vocabulary of their own: employees today are grappling with “worker shrinkflation” and “quiet quitting”.

Shrinkflation in product markets is well known: customers pay the same price for a product, but its size gets smaller. It’s a particularly popular strategy for retailers at times of high inflation, allowing firms to protect their bottom lines without subjecting consumers to unpopular price hikes. And we may now be experiencing shrinkflation in labour markets, too.

Mark Humphery-Jenner, banking and finance professor at the University of New South Wales argues that workers are feeling shrinkflated. In the UK, average total pay has risen by 6 per cent — the strongest pay growth on record outside of the pandemic period. But in real terms, inflation-adjusted pay fell by 2.4 per cent over the year. Workers are offering the same amount of labour — but getting less for their efforts. 

On a national scale, this may be no bad thing: nominal pay is still rising — and fast enough to fuel the Bank of England’s concerns about domestic price pressures. On a macroeconomic level, policymakers may well welcome signs of the UK labour market cooling — even if this means further cuts in real pay.

But individual workers are likely to be less sanguine. Humphery-Jenner argues that for squeezed workers, the conclusion is obvious: if real wages are decreasing, the only way to maintain a sense of wellbeing is to work less. In practice, shrinkflated workers are unlikely to go above their job descriptions, and will have little enthusiasm for taking on additional tasks.

This all looks a lot like another labour markets buzzword: quiet quitting. Quiet quitters no longer strive for praise and promotions, choosing to do the bare minimum at work instead. A September Gallup poll prompted the conclusion that “at least half the US workforce is quiet quitting” when it found that half of US workers were “not engaged at work”. 

Quiet quitting may appear widespread, but not everyone is on board. As quiet quitters neither quit, nor neglect their job duties, commentators have pointed out that this phenomenon could actually be described as “doing your job”. Jonathan Lord, a lecturer in HR and employment law at the University of Salford, likens quiet quitting to “working to rule”, well established as a method of industrial action in the UK. 

New or not, quiet quitting still presents a challenge for the economy. A recession this winter looks overwhelmingly likely, threatening the UK’s already-sluggish labour productivity. Research from the IFS showed that UK productivity tumbled in the recession following the global financial crisis, while US labour productivity actually grew. The NBER found that these US gains were driven by employees working harder, rather than “laggards” being fired. Tackling quiet quitting could provide a welcome productivity boost for the UK this winter. 

Lord argues that although quiet quitting looks like working to rule, it requires a very different remedy. Working to rule is, after all, a form of collective action — usually over a well-defined dispute on pay or conditions. Quiet quitting, on the other hand, is a personal decision, tied to a worker’s individual circumstances. Lord describes quiet quitting as “a silent protest” and one that employers must solve by meeting the demands of each employee. A quick fix is unlikely: tackling widespread demotivation will not be an easy job.

Hermione Taylor is an economics writer for Investors’ Chronicle