Independence: No, I don’t own DGC shares
Digicor provides and disseminates critical information to its customers for the efficient and effective management of their mobile assets—like vehicles and their cargo—for both logistical and security purposes utilizing technology. Basically, Digicor helps its clients save money on fuel and security by offering fleet tracking and coordination software and hardware. With the oil price sky-high, this is a booming industry whose growth is reflected by the recent 57% growth in profits of Digicor for the year ended 2006 as compared to the 2005 year. But, all of this is historical news and has long since been factored into the share price. The only question now left is whether or not DGC is still worth buying?
With a market cap of R758million it could well be called a mid cap, but its recent growth in earnings places it into the potential growth stock category, thus I will still attempt to value it.
Digicor started paying dividends a few years back (with its virgin 2c DPS in 2003) and since then its dividend growth has outstripped its earnings growth to the most recent 2006 DPS of 10c. But, the share price has also rocketed from a low of 15c in 2003 to a high of 390c on 6/09/2006. Hence the dividend yield has dropped from 8% at the closing price of the 2003 year of 25c (=2/25) to the present 2,7% of today (=10/375). Thus, although Digicor may once have fallen perfectly into the Small Cap category, the real question is do they still? How much growth can we still expect? Or have they reached the maturity of a healthy mid cap with appropriate growth and related investment returns.
Their PE ratio has grown from a very low 3.12 at the end of 2003 to the present day 11.8. So it is reasonable to expect that next years PE will be between 12 to 14…if the market factors in the time value of money as applied to earnings. Lets make it 12 to be conservative.
EPS for the year ended 30 June 2006 has been forecast at between 45% and 55% higher than last year equivalent EPS. It ended up being 57% higher. Last year 12 month EPS was 32.3 (HEPS = 31.9), so if the growth in the twelve months ended 30 June 2006 EPS carries through to the next twelve months year then the 2007 EPS can be forecast at 48cps (=32×150%). Given a conservative PE of 12 a forward one year price can be seen to be 576c (=12×48). This gives a return of 53,6% on an investment bought at 375c, excluding all dividends. So, it sounds like it would be an excellent investment.
As Digicor pays dividends it is also worth using the Dividend Growth Model, but the problem is two fold: it does not have constant growth and its Cost of Equity (which I calculate at 16,8%) is greater than its present growth rate of 30%. Thus, using a modified dividend yield I can assume that the future DY will pan out at about 2 to 2,5% (which the market will then factor in all future growth into this) and that next years dividend will be around 13 to 14cps. Let’s say its 13cps with a DY of 2,3%. Thus the forward price is around 565c (=13/0.023). This appears to back up the PE Model used above.
The question is will the 2006 growth rate continue into the 2007 year?
Looking at Digicor’s balance sheet it has a conservative D:E ratio of 0.31, an interest cover of negative 31.49 (i.e. it earned more interest than it paid), and a dividend cover of 3.23. A very healthy picture indeed for a growing firm.
Recently Digicor sold a wholly owned subsidary Digicor Fleet Management (Pty) Ltd to another 70% BEE empowered subsidiary, effectively disposing of a 30% interest in this company. This will help it secure BEE contracts, but it looses out on 30% of that income. This sounds to me like a zero-sum game that DGC has play in order to comply with the BEE codes and should be pretty much discarding in valuating DGC.
It also recently won a large contract from the eThekwini municipality, which is probably the product of the BEE deal mentioned above. Once again, too little information on the contract has been released to the public to factor this into this valuation.
So where to look for signs of growth?
Well, the profit margin has creeping up from a small 9.71% in 2003 to the healthy 19.84% in 2006. Turnover has also grown significantly in line with the margin growth. This all points to an increasing demand for its products and services and the resulting returns to it scale that it is experiencing from this expansion.
Added to this, in the long-term oil is a limiting factor in the world economy and is only going to get more expensive. So more and more firms are going to looking for ways to save and manage their fuel requirements efficiently. This makes Digicor perfectly placed, but will also attract competitors.
Due to all the above factors I believe that the 2006 growth will not be seen again, but that a more reasonable 30% growth in 2007 will occur with a gradual slow down from there onwards. The problem is that the Funds have started moving into DGC, thus squeezing the returns on its share (hence the dropping dividend yield and increasing PE ratio). There are a limited number of funds and a limited amount of funds. This means that the share may well have overextended itself in the long-term and as competitors wade into Digicor’s fragile market the DGC share price plateaus.
Over all, I feel that DGC is as safe as a large small cap can be and is a good buy—if properly timed—for the next 2 to 3 years, but I would not look beyond this. It is a growth stock in the process of maturing. Hence it is labelled with a conservative buy rating from www.smallcaps.co.za.