International distribution and outsourcing group Bunzl (LSE: BNZL) has a record of producing steady returns for investors. Indeed, according to data provided by Morningstar, over the past 15 years, the stock has produced an average annual return of 11.7%, outperforming the wider market by about 2% per annum over the same period.
The company has accomplished these returns through a combination of organic growth and bolt-on acquisitions. According to its annual results for the year ended 31 December 2017, the firm spent £616m acquiring 15 businesses during the period (apparently one of its busiest years ever for deals), which helped produce reported revenue growth of 16% year-on-year. On a constant currency basis, revenue grew at only 10% and adjusted earnings per share rose 7%.
Looking at these figures, you could be forgiven for thinking all of Bunzl’s growth for the period came from acquisitions, and the underlying business is struggling. However, that is not the case. Organic revenue growth for the year to the end of December was 4.3%, “the highest level since 2006” according to management. Unfortunately, the company’s operating profit margin contracted by 20 basis points due to “the impact of the significant additional business won in North America” for the year, but this is a small price to pay for the revenue growth achieved.
Going forward, management expects to continue on its current trajectory of reinvesting earnings back into operations to drive organic and bolt-on growth in what it believes is a fragmented distribution market.
Too expensive?
Despite Bunzl’s bright outlook, I’m concerned about its investment potential. Right now the shares trade at a forward P/E of 16.2, which is high for a low-margin distribution business. The wider market is trading at a forward P/E of 13.9.
It seems to me that investors are placing a huge growth premium on Bunzl, which is fine as long as it can continue to live up to expectations, but if the business stumbles, the shares could tumble.
With this being the case, I’m much more positive on the outlook for smaller peer Wincanton (LSE: WIN). This company may not have the growth record of Bunzl, but its valuation is much more appropriate. The shares currently trade at a forward P/E of 7.3, making it one of the cheapest stocks around.
That being said, analysts are much more cautious on the growth outlook for this company. Compared to Bunzl, the City expects Wincanton to grow earnings per share at between 1% and 4% for the next two years. This lower growth rate does deserve a lower valuation, although I would say a multiple of around 10 times earnings is more appropriate, not 7.3, which is around half the market average. And as well as this depressed valuation, the shares also support a market-beating dividend yield of 4.7%. With the payout covered nearly three times by earnings per share, it looks to me as if this payout is here to stay for the foreseeable future.
The other thing to consider with Wincanton is the firm’s debt. This is around £44m and shareholder equity is -£134m, a troubling figure, although over the past five years management has been working hard to improve the balance sheet and has cut net debt by more than 70% since 2012.
