Investors’ Chronicle: Keystone Law, Kingfisher, Trustpilot

BUY: Keystone Law (KEYS)

Keystone’s recruitment drive pays off in better income per principal, writes Julian Hofmann.

Keystone Law is one of those professional services companies with the potential to exist outside the economic cycle — when times are bad, people sue, when they are good there are deals for lawyers to ink.

The key constraint on its growth over the past 18 months has been the UK’s tight labour market, which affected the law firm’s ability to recruit new talent. The company’s return to first-half revenue growth — revenue per law principal was up 12 per cent to £104,000 — is also a sign that the hiring blockage that had held back its growth is starting to ease.

For instance, the company engaged 25 new starters, out of 42 offers made during the half — its best total for two years. New lawyers mean the company can take on a greater caseload, and it currently has 415 principals working for it. The extra headcount, plus existing lawyers taking on more available work and price increases, was the main reason that operational gearing helped to turbocharge profits, with pre-tax profits well ahead of equivalent revenue growth at 29 per cent.  

Peel Hunt analysts said in a note: “Legal rates tend to be resilient over time. On the downside, Keystone does not comment on hours billed or average billing rates, hence an understanding of some of the key performance indicators normal to a legal business is not available to investors.”

The broker also reckons that the new lawyer recruitment, currently 12 per cent of the total workforce, needs to improve to 15 per cent fully to offset leavers and maintain numbers. The self-employment status of many solicitors contributes to higher levels of turnover.

Certainly, the company seems to have a spring in its step — a confidence reflected in the 12.5p special dividend that was paid out to shareholders in these results — although even management noted that the second half may see some headwinds for the UK economy. The business model is simple and cash generative and under the right conditions can generate operational gearing, although this is limited by the caseload it can carry. Peel Hunt forecasts earnings per share of 24.9p for 2024, giving a price/earnings ratio of 19. This leaves just enough room for a further re-rating if it can deliver on billings across a wide spread of legal specialists.

SELL: Kingfisher (KGF)

The home improvement retailer gave investors a lot of bad news and not nearly enough good news, writes Mitchell Labiak.

Kingfisher saw its profits slashed by a third at the half-year mark, blaming bad weather and inflation. The home improvement retailer said the numbers were “slightly ahead of expectations” but cut its full-year pre-tax profit forecast from £634mn to £590mn as it anticipates tougher trading conditions going forward. The shares sank as the market registered its disapproval.

The profit slump was despite a 1 per cent bump in revenue, a sign of how increased costs from wage inflation and energy bills have hit the company. And the sales increase turns into a 1 per cent fall when you factor in currency fluctuations. Meanwhile, there was no growth in its 3.80p per share dividend, which remains covered by earnings multiple times.

To improve this bleak picture, Kingfisher hopes to grow its online presence and cut costs. The company said ecommerce sales rose 7.1 per cent, driven by growth in the UK, Ireland and France. It wants a quarter of its sales to be online. During the period, that figure hit 16.8 per cent, up from 15.6 per cent last year.

“We will do this by offering our customers faster fulfilment of orders, greater convenience and broader product choice, leveraging our store assets, ecommerce marketplace and data-led propositions,” Kingfisher said. That sounds as though it will cost money, which may pose difficulties for Kingfisher’s “multiyear cost reduction programmes”.

The company plans to trim the fat by decreasing its net inventory by 2 per cent, optimising its supply chain, and “transitioning to a more agile and modular technology operating mode”. That sounds great, but investors might question whether the company will achieve these aims considering how badly something as simple as a rainy summer hit its performance. 

The company said its results suffered due to extreme heatwaves in Europe, combined with a rainy July in the UK. The retailer hopes that a return to “normal” conditions next year will improve matters. The implication is that customers are put off both by hot weather and wet weather — something worth taking on board if you accept the notion that we are likely to be subject to more extreme weather patterns in the future. 

Climate aside, the question marks around Kingfisher’s short-term performance and longer-term prospects make it hard for us to justify any change to our outlook on the stock, although the 36 per cent discount to net asset value and the prospective dividend yield will doubtless appeal to those with greater faith in the business. At this stage, however, we can’t be sure that inflationary pressures will dissipate to a significant degree through the remainder of 2023 and perhaps beyond.

HOLD: Trustpilot (TRST)

The review website is becoming more profitable but still commands a hefty valuation, writes Arthur Sants.

Depending on what metric we look at, there is an argument that review website Trustpilot is profitable. Its exact profitability can be debated, but what is undeniable is that it is moving in the right direction.

In the six months to June, adjusted cash profit (Ebitda) improved to $5.7mn (£4.6mn) from a loss of $5.4mn last year. However, this figure doesn’t consider the fact that it capitalises the sales commissions. Removing the impairment, amortisation and depreciation cost, it made an operating loss of $2mn, although that is still a big improvement from the $10mn loss last year.

The fact it recognises the revenue over the length of the contracts but gets paid upfront, means the company generates free cash flow in excess of its profits. The company swung to a free cash inflow of £6mn from an outflow of £13mn last year.

This improved cash flow and profitability ultimately stems from the 15 per cent increase in revenue. At the same time, it cut sales and marketing costs by $5.2mn to $23.8mn. This is all part of the push to create a more profitable business and the transition is ahead of schedule. Management is now confident in forecasting that full-year adjusted cash profit will be ahead of market expectations. It is still expecting mid-teens revenue growth.  

FactSet consensus expects cash profit to rise to $10.4mn and free cash flow to increase to $10.5mn in 2024. Trustpilot’s market cap is currently over 40 times that, which is expensive. The argument is it will benefit from operational leverage as the business grows. At least, that’s what new chief executive Adrian Blair will be hoping for. We stick to hold.