Enero Group (ASX:EGG) is an advertising agency that was re-birthed from the ashes of Photon Group about a decade ago. Under new chairman John Porter and the new management team led by Matthew Melhuish, the company has undergone a significant transformation in terms of both its earnings profile and balance sheet. The stock has experienced a substantial share market re-rating. The group has diversified geographically via acquisition, and is now operating in Australia, the U.K. and the U.S. It has also diversified its business model to now offer a completely integrated communications and advertising proposition. We expect to see further acquisitions fuelling earnings growth and continued share price re-rating, albeit not without some cyclical risk around its market segment.
One of the main reasons we specialise in small cap is the lack of market efficiency. Enero Group Ltd (ASX:EGG) is a perfect case in point. The company reported its full year results for the period ending June 30 2019. Its results were strong, but un-acknowledged by the market. The share price fell by 2.2% to $1.78. We took that opportunity to establish a position. The market reacted notably slowly, allowing us to earn a 30+% return. So why are we delighted with the results? A summary follows:
Net Revenue of $129.5 million, up 25%
Organic revenue growth rate of 14%
Operating EBITDA of $20.7 million, up 53%
Operating EBITDA margin 16%, up from 13%
EPS before significant items 14.2 cents, up 53%
Enero Group was an old-fashioned advertising agency called Photon Group. A decade ago, the company changed its name to Enero Group and more importantly, changed the management team. Current CEO Matthew Melhuish and current Chairman John Porter successfully turned the company around.
The company patiently made two acquisitions in the past 10 years. In 2016, Enero acquired a U.S.-based technology public relations agency called Eastwick Communication. The acquisition resulted in a large jump in EBITDA margin in FY19. EBITDA margin from the U.S. operation rose from 16% to 35% as the company is now pitching to larger clients from Eastwick. In 2018, Enero acquired another Australian creative technology agency, Orchard Marketing Pty Limited. This acquisition is expected to fuel revenue and earnings growth for Enero.
Besides strong growth drivers from acquisitions, we also like Enero’s balance sheet and revenue diversification. Both provide some protection to the company and us. The company has no net debt and achieves a free cash flow yield of 10%. This healthy balance sheet positions the company to acquire other companies in the future. Enero has a well-diversified customer base. The largest customer only accounts for 12% of the revenue. 54% of revenue is generated outside Australia. With the diversification benefit of operating in other countries, the company can withstand an economic downturn in Australia.
Finally, the company has an attractive valuation. When we bought the company, it had a PE of 12, which is slightly lower than peers, and an EV/EBITDA of 8. We believe it is undervalued and has been overlooked by the market. We are pleased that the market has now re-rated the company. We believe the re-rating will continue if the management team continues its good work.