SHARES

Aussie tech and communications stock provides great value

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This week's Hot Stock is courtesy of Roger Montgomery, chairman and CIO of Montgomery Investment Management.

Vita Group (ASX:VTG)

Key statistics:

Closing share price 20-9-16: $5.200

52-week high: $5.470

52-week low: $1.600

Most recent dividend: 8.21c

Annual dividend yield: 2.69%

Franking: 100%

Imagine being able to buy a business for just two times its EBITDA (Earnings before interest, tax, depreciation and amortization) of say $250,000 and then, in just a few years, annually earn what you paid for the business? And imagine being able to repeat the process 100 times or more.

They're the metrics we were confronted with when we started to investigate a company called Vita Group, which we ultimately invested in at a price of about $2.70.

Vita Group is a chain of Telstra stores and Telstra Business Centres commenced over 20-years ago under the stewardship of Maxine Horne, a genuine human Eveready battery and a woman that has wowed everyone she meets. She is that rare combination of entrepreneur, business analyst and mentor that staff aspire to be.

The businesses we love the most are those that can sustain high rates of return on equity. They tend to be businesses in which inhere competitive advantages - unassailable moats around the business. Vita Group's competitive advantage is its staff and culture of achievement. If you are hired to work at Vita Group, within hours Maxine will know whether you are cut out for the job. There is nowhere to hide.

Double digit life-for like sales are the result of staff productivity improvements. If a store is on the bottom 10% of sales, a swat team of sales experts are deployed to see if improvements can be made. If improvements are made, the incumbent staff have a new hurdle to achieve and if they don't they are let go. If the "swat" team cannot extract improvements, the store itself is replaced with another from which growth can be extracted.

We are confident of double digit like-for-like EBITDA's for at least two years just from productivity improvements management have identified. Last year's underlying EBITDA was $62m and consensus analysts have $71m forecast for 2017 but there's a visible $5.7m to be added in 2017 just from most-recently acquired stores. Therefore the market is only anticipating 5% organic growth from $67m to $71m. And as brokers take Maxine around to meet more investors (now that the company has been included in the ASX300) we believe these organic growth numbers will be upgraded.

On top of the organic growth many analysts have believed Telstra would limit the company to 100 retail stores. But at the full year results announcement the company emerged with 103 stores as Telstra divested and allocated more stores to Vita Group. Telstra has another circa 30 stores to divest and VTG could pick up more. It is also believed that of the 150 Telstra licencees running 160 stores, Telstra wants to reduce the number of licencees it deals with to 50. That means Vita Group could be in the box seat to extract improving EBITDA growth from a much larger number of stores than originally anticipated.

We have upgraded our valuation of VTG on the basis of a stronger outlook for EBITDA per Telstra retail store and more stores.

Roger Montgomery is the chairman and CIO of Montgomery Investment Management.

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Roger Montgomery is founder, chairman and chief investment officer of Montgomery Investment Management. Following a successful career as an analyst and public company chairman, Roger published the first edition of his stock market guide, Value.able, in 2010, becoming an Australian best seller in just 16 weeks. He holds a Bachelor of Commerce and is a senior fellow of the Financial Institute of Australasia.
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