Clean up with this Aim stalwart

Johnson Service Group (JSG) launders linen for hotels and restaurants, and counts Whitbread’s (WTB) Premier Inn as its largest customer. It also rents out staff uniforms, processing more than 1mn garments every week. It’s not glamorous work, but it does it well, retaining impressive numbers of customers each year.

In the decade before the pandemic hit, JSG consistently grew its profits, and its share price increased tenfold as a result. But Covid-19 changed everything. The group’s core hospitality client base was shut down overnight and it fell into the red. Then, just as tourists and diners ventured out again, Russia invaded Ukraine, electricity bills shot up and wages started to climb. 

In 2019, energy costs represented 6.2 per cent of JSG’s total revenue. By 2023, this figure had risen to 10 per cent. Labour costs peaked slightly earlier, representing 47 per cent of revenue in 2022, up from 43 per cent in 2019. These pressures have weighed on operating margins which, as of last year, remained more than 4 percentage points below their pre-Covid peak. 

Fresh start

Four years after the initial shock, however, JSG seems to have turned a corner. In May, it published an “updated positive energy outlook”, which noted that costs had been trending downwards since the end of 2023. Management revised its adjusted operating profit forecasts in response, boosting estimates for 2024, 2025 and 2026 by £3mn, £7mn and £9mn, respectively.

The company is able to make these predictions because it forward fixes its energy pricing on a “little and often” basis. Between 2021 and 2023, this policy allowed it to save £15.4mn on gas and electricity. It’s a riskier strategy when prices are falling, and could drag on margins in the short term, but the visibility is extremely valuable. 

There are other reasons to feel optimistic too. Demand has been picking up in the hotel, restaurant and catering (HORECA) business, and divisional sales are now 50 per cent higher than they were in 2019. Some of this is down to pricing – management has been pushing through double-digit hikes in response to inflation – but volume also plays a part. 

A higher workload is clearly good for the top line, but it also benefits the bottom line as it increases productivity. Much like Rentokil Initial (RTO) and International Distribution Services (IDS), JSG’s business model relies on route density, with vans whizzing around different venues to deliver and pick up linen. Volumes are also becoming more predictable, according to management, which further aids efficiency. 

The company is now confident that it can achieve an adjusted operating margin of at least 14 per cent by 2026. The analyst consensus figure previously sat at just 12.4 per cent. 

JSG’s second, smaller division – workwear – is something of a worry. While sales are ticking upwards, this is the result of price hikes rather than improving demand. Meanwhile, operating profits have been edging downwards since 2020. Customer retention is strong at 91 per cent, and management has noted increased activity among prospective customers, but this has yet to be reflected in the numbers. 

As we discuss in our recent feature on investors’ biggest mistakes, it can be dangerous to ignore underperforming divisions, even if the main arm is thriving (workwear generates 30 per cent of total sales and 37 per cent of profits). In the case of JSG, however, the positives appear to outweigh the negatives. Organic sales across the group are expected to keep growing strongly, albeit at a less rapid rate than in the aftermath of Covid, and margins are widening as a result of internal efficiencies and external factors. 

Share price kickers

The market has been taking note of these positive trends. Analysts at both HSBC and Peel Hunt upgraded JSG to a buy this year and the shares have risen by 56 per cent in the past 12 months. This begs the question of whether we are featuring it in this section too late in the day.

JSG is an awkward company to assess from a valuation perspective as it doesn’t have any direct rivals on the London Stock Exchange. Comparing a UK-focused, Aim-traded mid-cap to something like Rentokil or equipment giant Ashtead (AHT) is of very limited use.

Its closest peer is actually French laundry group Elis (FR:ELIS), which owns JSG’s main UK and Ireland rival, Berendsen. Based on its predicted earnings for 2024, Elis trades on a price/earnings (PE) ratio of 11 times, while JSG attracts a multiple of roughly 15 times. It is important to note, however, that JSG’s growth trajectory has been far more impressive than Elis’s and, when growth is factored into the equation, the London group starts to look more attractive.

JSG’s PEG ratio – which is calculated by taking its PE ratio and dividing by its growth rate – is around 1 times, compared with Elis’s 1.4 times, according to FactSet figures.

The UK laundry group could also benefit from some share price kickers. Analysts at HSBC note a “clear” correlation between margin and valuation, based on JSG’s own history and other companies in the textile rental sector. As JSG becomes increasingly profitable, therefore, it could attract a higher multiple. HSBC added that there could be further upside to margins after 2026, when the group’s new hospitality site in Crawley is due to break even for the first time. 

Also important is the fact that JSG’s balance sheet is in increasingly good nick. Its medium to long term target is for net debt/Ebitda to sit between one and 1.5 times. As of December 2023, however, leverage was just 0.77 times and analysts expect it to fall further this year. Peel Hunt said this gives the group “significant headroom to allocate capital for dividends, acquisitions and buybacks as the free cash flow generation de-levers the business”.

Acquisitions could certainly be on the cards. JSG has bought 14 companies for a total of £225mn since 2012, most recently Celtic Linen. Increased automation could also be an option, as part of a strategy to increase efficiency. However, returning cash to shareholders is likely to have a more immediate impact on the shares, with Peel Hunt estimating that – in the absence of M&A – future share buybacks could increase earnings per share by 6-11 per cent every year by the end of 2027. 

Chief executive Peter Egan may well have other plans. On top of this, the past four years have made it painfully clear that nothing can be taken for granted. JSG is a cyclical business that is highly exposed to energy costs and consumer trends. However, management actions combined with a more favourable backdrop are driving shares higher and – for now at least – they show no signs of slowing down.