It was therefore with interest that I noted that Oliver Scott, non-executive director of KBC Advanced Technologies (KBC: 80p), is a founding partner of and holds a beneficial interest in Kestrel Partners, the investment manager of Kestrel Opportunities. He is also a shareholder in Kestrel Opportunities. That's significant because ahead of KBC's pre-close trading update in mid-July, Kestrel acquired 300,000 shares in no fewer than four transactions to raise its stake to 7.15m shares, or 12.1 per cent of the company's issued share capital. It is fair to assume that Kestrel was given the green light by KBC insider, Mr Scott.
Major Shareholders in KBC Advanced Technologies
| Shareholder | Shareholding | Percentage of issued share capital |
| AXA Investment Managers SA | 8,806,000 | 14.98 |
| Kestrel Opportunities | 7,152,510 | 12.10 |
| Henderson Global Investors | 5,311,740 | 9.03 |
| BlackRock Investment Management (UK) | 2,119,341 | 3.78 |
A few weeks later KBC announced in a pre-close trading update that "contract awards for the first half were £32.5m, significantly ahead of the £17m achieved in the same period in 2012, and our forward order book remains strong". Moreover, with the strong sales momentum seen during the second half being maintained the company was trading bang in line with the board's guidance to house broker Cenkos Securities. Analysts there predict the company's pre-tax profits will increase by 27 per cent from £5.5m to £7m this year on revenues of £63.9m, before rising again to £8m on turnover of £67.1m in 2014. On that basis, expect full-year EPS of 7.3p and 8.3p in 2014.
Profit growth could be even greater because KBC, a consultancy and software provider to the global hydrocarbon processing industry, has been showing very encouraging signs of entering an earnings upgrade cycle. I dedicated a whole chapter to this subject matter in my new book, Stock Picking for Profit, and with good reason. Namely, if you can catch the companies early enough, then the share price gains can be substantial.
With this in mind, some of the key areas I look for in potential recovery plays are: a business emerging from a restructuring with a much slimmer fixed cost base, and so offers potential for a greater proportion of future revenue to drop straight down to the bottom line; and a return to revenue growth to build on the higher operational gearing. On both counts, KBC is showing the rights signs.
Contract wins
For example, the company announced a major contract at the end of last year with EP Petroecuador (EPP), the integrated state national oil company of Ecuador. KBC is working with EPP, both directly and through a major subcontractor, to improve its core work processes and support systems, as well as develop the technical capability of the workforce. The contract is worth $100m (£64.5m) over a period of four years, a significant sum given KBC generated annual revenues of £63m last year.
Not surprisingly, the contract underpins a large amount of the aforementioned forecast revenues for both this year and next. It also means that there is scope for earnings upgrades if KBC is able to win enough new contracts from other companies. And this is exactly what is happening as KBC won a $16m, seven-year contract for the provision of Multiflash™ software, maintenance and support services to a large oil and gas services company, in early May.
The contract is an extension to a previous royalty agreement between the client and Infochem, a company that KBC acquired 15 months ago, and will enable the integration of Multiflash™ within all of the client's production software applications, which are used by the majority of oil and gas companies worldwide.
Restructuring benefits profit recovery
It's worth noting, too, that part of the sharp increase in profits this year will be down to the fact that the business endured a painful profit slide in 2012. In that period, KBC was forced to raise £1.3m from institutional investors and axe the dividend due to working capital pressures; encountered delays in the renewal of a Latin American contract, which held back revenues at the company's high-margin software business; and put in place a restructuring programme that led to staff cuts. The reorganisation should slash the annual cost base by around £900,000, which accounts for almost two-thirds of the profit increase expected this year.
Moreover, KBC is also enjoying a profit uplift on higher-margin sales from these new contracts. In fact, KBC chairman Ian Godden highlighted a bumper number of contract awards at the annual meeting in May, a trend that has clearly continued given the upbeat pre-close trading update in mid-July ahead of half-year results on 19 September. Given the newsflow to date, it is only reasonable to expect a positive trading update next week when KBC reports its half-year results. And given that KBC only made pre-tax profits of £686,000 in the first half of last year on revenue of £27.5m, we are guaranteed a hefty increase in reported profits and a surge in operating margins.
There should also be positive news next week on the dividend, which Cenkos believes will be reinstated this year. The forecast is for a 1.6p a share payout. KBC can certainly afford it as the company ended last year with net cash of £13.3m, or 22.5p a share. Strip that out from the current share price of 78p, and in effect KBC's shares are being priced on eight times earnings estimates net of cash. The company's market value of £47m is a modest 50 per cent premium to book value of £31m.
Share price poised for another break-out
I have been biding my time waiting for the sideways move in KBC's shares to run its course following the bullish upmove following my advice to buy the shares at 69p in early May ('Fuelled for growth', 5 May 2013). Since then, they have been pressurising the 80p level, a resistance level dating back to July 2012. I fully expect this to give way when the half-year results are published next week, before an assault on the 91p high from February last year.
Needless to say, the combination of an imminent share price break-out, potential for earnings upgrades, contract wins, a likely reinstated dividend, and strong profit growth this year and next continues to make KBC a compelling investment opportunity. I rate the shares a strong buy on a bid-offer spread of 77p to 80p and have a one-month target price of 90p. It could prove conservative as analysts at Cenkos have a discounted cash-flow valuation of 100p-plus on the shares. Trading buy.
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