The Quarto Group Good visibility into H2 Interim results Media As in FY14, Quarto s FY15 results will be heavily H2-weighted. The strong order book means that we maintain our FY15 forecast for a 10% increase in normalised PBT, despite the slightly higher H1 loss than the prior year. The group is making strong progress in children s publishing and in foreign language sales, and is also proactive in addressing opportunities offered by digital channels. The balance sheet continues to strengthen, giving flexibility for complementary acquisitions, like that of co-edition publisher Ivy Press. The valuation is starting to reflect Quarto s progress and opportunity, but remains at a sizeable discount to the market and sector. 13 August 2015 Price 235p Market cap 46m US$1.56/ Net debt ($m) at 30 June 2015 81.0 Shares in issue 19.7m Free float 27% Code QRT Year end Revenue ($m) PBT* ($m) EPS* (c) 12/13 176.3 9.6 37.7 7.9 9.7 3.4 12/14 172.6 12.1 44.8 8.3 8.2 3.5 12/15e 177.0 13.3 47.6 8.3 7.7 3.5 12/16e 184.3 14.4 51.6 8.3 7.1 3.5 Note: *PBT and EPS are normalised, excluding intangible amortisation, exceptional items and share-based payments. DPS (p) P/E (x) Yield (%) Primary exchange Secondary exchange Share price performance LSE N/A Building on strengths The benefits of the restructuring in FY13 have given the group a stronger and more coherent position in its markets, and the continuing investment in content creation underpins our confidence in the forecast top-line growth. Underlying markets are still difficult, but this is the new normal and Quarto has been on the front foot in orientating its offer to the areas where it sees the best opportunities, particularly in high-quality illustrated children s books and in foreign language sales. While its titles are not natural candidates for ebooks, the group is using digital opportunities to improve discoverability with its new group-wide consumer-facing web portal. www.quartoknows.com brings together all the imprint websites, blogs and social media, as well as offering an ecommerce facility. Group in improving shape for CFO transition With Quarto s refinancing early in 2015 and continuing progress on reducing net debt (despite continuing investment in building intellectual property reserves), retiring CFO Mick Mousley leaves after 28 years with it having positive momentum. His successor, Michael Connole, starts on 1 September. Q115 s successful acquisition and integration of Ivy Press (for 1.3m plus 0.2m debt) shows that the group now has the financial flexibility to take advantage of suitable opportunities. Valuation: Discount remains substantial An improved recent share price performance has narrowed the discount that Quarto has long suffered against its global publishing peers, yet the discrepancy remains substantial. Given the dominance of the larger publishing houses in trade markets, smaller publishers are valued by the market at levels well below larger peers. However, Quarto still sits at an unjustified discount to the smaller quoted global sector, which trades on 9.3x current year P/E and 5.0x FY15 EV/EBITDA. % 1m 3m 12m Abs 11.9 19.9 55.1 Rel (local) 11.8 25.4 50.9 52-week high/low 235p 140.5p Business description Quarto is the leading global illustrated book publishing and distribution group. Founded in 1976, it has five complementary businesses: Quarto International Co-editions, Quarto Publishing USA, Quarto Publishing UK, Quarto Hong Kong and Books & Gifts Direct (Australia and New Zealand). Next event Q3 IMS Oct/Nov 2015 Analysts Fiona Orford-Williams +44 (0)20 3077 5739 Jane Anscombe +44 (0)20 3077 5740 media@edisongroup.com Edison profile page The Quarto Group is a research client of Edison Investment Research Limited
Swings and roundabouts Quarto s progress in H115 has been hampered by later ordering patterns and specific external distribution issues in the US, as well as currency on translation of operating profits from Books & Gifts Direct. However, FY14 also had a heavier H2 weighting than had traditionally been the case and our full-year revenue projection is consistent with this trading pattern. The interim statement also refers specifically to robust order books and good visibility within the publishing companies. Exhibit 1: Interim results summary $000s H115 H114 Change % Quarto Publishing Group USA 27,234 26,957 +1 Quarto Publishing Group UK 7,582 7,624-1 Quarto International Co-Editions Group 15,106 12,645 19 Books & Gifts Direct, ANZ 8,875 11,814-25 Quarto HK 7,417 6,526 14 Revenue 66,214 65,566 1 Quarto Publishing Group USA 1,812 2,049-12 Quarto Publishing Group UK 293 219 34 Quarto International Co-Editions Group (1,110) (788) N/A Books & Gifts Direct, ANZ 413 585-29 Quarto HK 799 622 28 Corporate expenses (1,984) (2,079) -5 Normalised operating profit 223 608-63 Net interest (1,322) (1,638) -19 Normalised PBT (1,100) (1,030) 7 Source: Quarto accounts, Edison Investment Research Quarto International Co-editions top line will have benefited from the Ivy Press acquisition and it is already outstripping the original performance expectations on purchase. Operational profitability for the division will be helped by the co-location of some imprints to one base in Brighton. Performance in Quarto Publishing USA was held back by the strike at the West Coast ports, but we would expect this to be recouped in H2. The group is working with more customers on a direct basis, which improves visibility and gives the opportunity to be more proactive on leverage, particularly in selling new product categories, such as children s or gifts and stationery. The current craze for adult colouring books has also played to Quarto s strengths. The UK business, Quarto Publishing UK, is adapting to being a UK-based global publisher of illustrated books, rather than simply a UK publisher. The children s list remains a key focus. The Australia/New Zealand business, Books & Gifts Direct, is benefiting from last year s reorganisation, which is driving operating efficiency, despite difficult local economic conditions. However, with the group reporting in US dollars, there will be an impact on translation. The print broking and buying office, Quarto Hong Kong, is performing in line with expectations. 2015 continuing investment In H115, revenue from children s publishing was $9.2m 14% of group total revenues (11%). Across the group, investment in pre-publication costs at $17.6m was 13% down on the prior year, but H114 had an element of catch-up, particularly so far as investment in children s product was concerned. Foreign rights built to 11% of H115 revenues (H114: 8%), with plenty of further expansionary opportunities beyond the traditional old Europe markets. Comfortable debt covenants The banking arrangements agreed earlier in 2015 had principal covenants broadly unchanged, with an interest margin improved by 15bp: The Quarto Group 13 August 2015 2
total debt <3x EBITDA. FY15e: 1.72x. adjusted operating profit >3x net interest payable; FY15e: 5.29x; and cash flow >1.2x debt service. FY14: 2.97x. There is clearly plenty of headroom and debt is no longer constraining operational efficiency. As with Ivy Press, there is sufficient flexibility for modest acquisitions when it is clear that they will deliver shareholder value. The group is inherently cash-generative and the dividend continues to provide shareholders with a premium yield. Valuation remains at notable discount Despite the stronger performance of late, the share price remains at a considerable discount to other publishers (albeit that they are mostly much larger), to the market and is backed by the published asset value of 152p. Although the overall global publishing sector is currently trading at multiples of 14.5x FY15 P/E and 6.8x EV/EBITDA, the smaller international publishers are at around 9.3x current year P/E and 5.0x EV/EBITDA. Quarto is trading on a discount of 17% and 26% respectively to these latter peers. The Quarto Group 13 August 2015 3
Exhibit 2: Financial summary Year-end 31 December US$000s 2013 2014 2015e 2016e Accounting basis IFRS IFRS IFRS IFRS PROFIT & LOSS Revenue 176,318 172,644 177,000 184,250 Cost of sales (111,807) (117,437) (120,360) (125,290) Gross profit 64,511 55,207 56,640 58,960 EBITDA 33,317 34,832 36,100 37,325 Operating profit (before GW and except) 31,943 33,726 34,900 36,075 Amortisation of intangibles (434) (503) (500) (500) Exceptionals (3,405) 566 (500) 0 Amortisation of pre-production costs (17,899) (18,333) (18,500) (18,750) Operating profit 10,205 15,456 15,400 16,825 Net interest (4,443) (3,257) (3,100) (2,925) Profit before tax (norm) 9,601 12,136 13,300 14,400 Profit before tax IFRS 5,762 12,199 12,300 13,900 Tax (1,416) (2,980) (3,658) (3,960) Adjustment to tax for normalised earnings (1,013) (16) 0 0 Minority charge (412) (310) (270) (270) Profit after tax (norm.) 6,760 8,830 9,372 10,170 Profit after tax (FRS3) 3,934 8,909 8,372 9,670 Average number of shares outstanding (m) 19.7 19.7 19.7 19.7 EPS - normalised fully diluted (c) 37.7 44.8 47.6 51.6 EPS - IFRS (c) 20.0 45.2 42.5 49.1 Dividend per share (p) 7.9 8.3 8.3 8.3 EBITDA margin (%) 19% 20% 20% 20% Operating margin (before GW and except) (%) 18% 20% 20% 20% BALANCE SHEET Fixed assets 104,557 102,416 104,575 104,825 Intangible assets 42,358 42,025 42,275 42,525 Tangible assets 5,978 2,857 3,300 3,300 Investment in associates 56,221 57,534 59,000 59,000 Current assets 99,103 101,073 98,174 100,562 Intangible assets: pre-publication costs 0 0 0 0 Stocks 19,181 23,347 22,739 23,434 Debtors 56,043 54,616 55,434 57,128 Cash 23,879 23,110 20,000 20,000 Current liabilities (70,485) (144,919) (67,777) (65,170) Creditors (53,882) (55,769) (57,723) (60,088) Short-term borrowings (16,603) (89,150) (10,054) (5,082) Long-term liabilities (83,229) (6,875) (75,100) (73,100) Long-term borrowings (78,291) 0 (70,000) (68,000) Other long-term liabilities (4,938) (6,875) (5,100) (5,100) Net assets 49,946 51,695 59,871 67,117 CASH FLOW Operating cash flow 47,914 45,340 49,370 50,000 Net interest (4,701) (3,482) (3,268) (3,093) Tax (2,087) (759) (3,150) (3,734) Capex (28,805) (33,018) (33,000) (33,000) Acquisitions/disposals 1,057 (2,008) (1,350) (675) Financing 14 0 0 0 Dividends (2,427) (2,567) (2,610) (2,548) Other (382) 2,189 (6) 22 Net cash flow 10,583 5,695 5,986 6,973 Opening net debt/(cash) 80,978 71,015 66,040 60,054 HP finance leases initiated 0 0 0 0 Loans acquired with acquisitions 0 0 0 0 Translation differences (620) (720) 0 0 Closing net debt/(cash) 71,015 66,040 60,054 53,082 Source: Company accounts, Edison Investment Research The Quarto Group 13 August 2015 4
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