Buy Lees Foods (LEE) at 153.5p

Says The AIM & PLUS Newsletter

THE BUSINESS

AIM quoted minnow Lees Foods is the parent company of two Scottish confectionary manufacturers, Lees of Scotland and the Waverley Bakery. Joining the junior market in June 2005 at 200p per share the company has made steady progress since its IPO, despite having dealt with the administration of a subsidiary, rocketing food price inflation and the economic downturn in the past few years. Shares in Lees have slipped back slightly despite the company having just released a very positive set of results for the 2009 financial year and as such we see this as an ideal entry point.

Lees of Scotland, founded in 1931, specialises in making teacakes, meringues, cakes and other types of confectionary. The company is probably best known for its Lees Snowballs - chocolate covered marshmallow based treats - with over 50 million being sold in the UK every year, as well as its famous macaroon bar.

The Waverley Bakery, which just last year celebrated its centenary and was bought by Lees in 2003, specialises in the manufacture of ice cream cones and wafers, which are sold under the Carousel and Carousel Continental brands. Based just outside Glasgow, the firm targets its products at the retail, premium retail and catering markets.

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CURRENT TRADING

The 2009 financial year was very positive for Lees, with both operating divisions posting record levels of sales and profits. The group as a whole saw revenues from continuing operations up by 13% to £18.2 million, with pre-tax profits before exceptional items rising from £379,000 to £843,000. We also note the positive sales momentum over the year, with sales in the second half of the year up by 5.5% over the first. The numbers were driven by a number of new product categories in the UK retail market, along with new export customers in Kuwait, France, the US and Australia. Diluted earnings from continuing operations were up from 10.55p to 17.9p and as a result the directors were confident enough to hike the dividend for the year by 7.5% to 7.2p per share.

The company also put in an excellent cash flow performance, with the net inflow from operations almost doubling to £908,510. The net cash position rose from £44,000 to £375,000 (the net cash position constituted £2.08 million of cash less a £1.7 million bank overdraft.). This was due to the operating cash inflow and as £375,000 of debt was paid back during the year. Net interest payments were covered a very comfortable 24.3 times by operating profits. Encouragingly, the group reported that the positive trading had continued into 2010, with sales in the first quarter of the year slightly ahead of the first three months of 2009. It added that, while organic growth is the main focus of the business, complementary acquisitions will be considered.

OPPORTUNITIES & RISKS

Like all food producers Lees faces a significant threat from rises in the price of the raw materials used in its manufacturing processes. This was particularly evident in the 2007 and 2008 financial years when soaring prices of many soft commodities hit the bottom line as the firm was unable to pass on the increases to customers. Lees' main ingredients include chocolate, eggs, coconut, jam and sugar (which is subject to regulation by the Evil Empire - aka the European Union). To increase pricing certainty the firm enters into forward agreements to a certain extent.

Another significant threat to the business is the highly competitive trading environment. Not only are there countless substitute products to the firm's offerings, Lees is up against competition from significantly larger competitors such as United Biscuits, which owns the McVities brand and Burton's, which is well known for its Jammie Dodgers and Wagon Wheels. While the Lees brand name is well known, particularly in Scotland, the firm faces the challenge of maintaining trading in the face of its rivals' huge marketing budget.

ASSESSMENT

On the house broker's forecasts, which see earnings growing by around 32% this year, the shares currently trade on an undemanding price earnings ratio of just 8 times. Considering the comfortable debt position, progress made in the export markets and opportunities for further growth we consider that to be good value. The historic price to operating cash flow multiple of just over 4 times also looks undemanding.

Assuming that the 2009 dividend is maintained then the shares also offer a healthy yield of 4.7%. However, considering the growth forecast for 2010, historic earnings coverage of 2.5 times and operating cash flow coverage of 5.4 times we would not be surprised to see further increases in the dividend in the coming years. BUY.

Key Data
Epic: LEE
Market: AIM
Spread: 152p - 155p (1.9%)

The AIM & PLUS Newsletter, launched in 1995, covers shares listed on the Alternative Investment Market (AIM) and the PLUS Markets trading facility. Twice winner of the prestigious AIM Best Research Award, every month The AIM & PLUS Newsletter brings you two meticulously researched tips as well as investment ideas, analysis and expert comment on a wide range of companies from these vibrant markets, and is edited by current PLUS Journalist of the Year Richard Gill. To gain access click HERE.