For instance, shares in Aim-traded Thalassa Holdings (THAL: 280p) have now more than doubled since I initiated coverage seven months ago ('Potential for seismic gains', 19 March 2013). I then reiterated the advice at the start of May when I noted that executive chairman and former banker Duncan Soukup had been on a massive buying spree when the price was 141p ('Small-cap stock picks', 1 May 2013), and again at 168p three months ago ('Expecting seismic gains', 1 August 2013). And following a bumper trading statement in September, I had no hesitation in reiterating the buy advice when the shares had surged through my 200p target price. In fact, I was so confident that I upgraded my target 50 per cent to 300p.
However, even that could prove conservative now and I am not the only one thinking this way. That's because as Thalassa has just raised £18.1m through an institutional placing of 7.24m shares at 250p each in order to provide funds to strengthen the company's balance sheet at a time when its level of order enquiry is at record levels. The new funds will provide the business with further capital to take on and fulfil new contracts.
Prospects for seismic profit growth
This looks a sensible move as Thalassa has been making significant progress in fulfilling its obligations under customer contracts. To recap, the company provides the energy industry with marine seismic equipment and, in particular, a technology called Portable Modular Source System (PMSS™). This equipment is installed on vessels to provide a seismic source to enable oil and gas exploration and production companies to perform life-of-field seismic studies or permanent reservoir monitoring.
Contracts won include one with SMG Ecuador, the Ecuador business of State Sevmorgeo Company, the Russian geological sea survey company, which earned the company $6.7m (£4.2m), or almost half of Thalassa's revenues in 2012, in the first half of this year. The second phase of that contract, relating to surveys that started last month and continues until April, is worth between $4m and $5.4m.
The future pipeline of work is very promising too. In fact, based on order enquiries and tenders submitted, Thalassa now has over $100m of work in the bid pipeline for delivery in 2014-15, up from only $38m at the same stage last year. Included in the order book is a major contract with Statoil ASA (NO: STL), potentially worth $65m over eight years, to provide seismic acquisition services for reservoir monitoring of the Snorre and Grane oilfields in the Norwegian sector of the North Sea. Statoil has also purchased a bespoke dual portable modular source system (D-PMSS™), which Thalassa will maintain and operate throughout the duration of the contract. Delivery of the system was completed last month and the contract value was $19.8m (£13.2m).
Moreover, I understand that Thalassa board is "becoming increasingly optimistic in the company's ability to convert a record level of enquiries into increased revenue in 2014 and beyond". This also means that analysts have massively raised earnings estimates for this year and next, but also explains why the company has just raised £18m of new capital to support the working capital required to fulfil these new contracts. It's easy to see why the institutions were happy to pay 250p a share.
Expect strong earnings growth
For the current financial year to end-December, oil analyst John Cummins at brokerage WH Ireland now expects Thalassa to more than double revenues from $14m last year to $30.6m. In addition he expects gross margins to rise from 23 per cent to 26 per cent. On this basis, pre-tax profits are expected to treble to $3.6m. Factoring in the extra shares in issue following a placing of 4.5m shares at 120p in April, adjusted EPS rises by a third to 20.1¢ (or 13p a share), up from the 10¢ reported in 2012. True, the placing last week will dilute those earnings forecasts slightly, but what it will do is increase the scope for Thalassa to take on even more contracts.
Prior to the latest fundraising, and assuming that only a quarter of the tender pipeline will be converted into firm contracts, Mr Cummins expects 2014 revenues to rise to $36.5m to deliver pre-tax profit forecasts to $5m. However, that's taking a very conservative assumption on the pipeline and, in my opinion, there is ample scope for more profit upgrades as further potential contracts in the pipeline are closed.
It's well worth noting that the company had a low-yielding cash pile of $16.8m (£10.6m) at the end of June, so on a pro-forma basis the current cash pile of £28.7m equates to 120p a share based on 24m shares currently in issue after deducting the 1.08m shares held in Treasury. Or put it another way, strip out this large cash pile from Thalassa's market value of £70m, and a business that conservatively is forecast to post profits of $5m net year is being rated on a prospective multiple of 16 times 2014 forecasts net of the cash pile.
For a company that is set to treble profits this year, and conservatively raise them by almost 40 per cent in 2014, and potentially more if more contracts are won as seems highly likely, that is hardly an exacting valuation. Moreover, the risk to earnings remains skewed to the upside, given the conservative assumptions for the conversion of the bid pipeline into contract wins. Clearly, the institutions buying equity at 250p a share are thinking the same way.
Mr Soukup certainly is as he notes that his company is finally reaping the benefits of its early recognition of a previously untapped growth area in the marine geophysical market and which industry experts estimate has potential to grow to $20bn over the next 30 years. I would agree.
Target prices
So having upgraded my target price from 200p to 300p, I am now raising the bar once again to 350p. If achieved this would give Thalassa a market capitalisation of £84m. I have sound reason for doing so as, based on the company conservatively growing revenues to $41.6m in 2015, this would produce pre-tax profits of $6.1m (£3.8m). Factor in 24m shares in issues post the recent share placing, and a 15 per cent tax charge, then the company is forecast to generate net profits of $5.2m, or 21.7c a share. At current exchange rates this gives EPS of around 14p. So once you strip out the 120p cash pile from my 350p target price, this means net of cash the shares would be trading on about 16 times 2015 earnings if my upgraded target price is hit.
For a company growing so quickly that is a fair price to pay for the shares. Offering a further 25 per cent share price upside, I rate Thalassa shares a strong buy on a bid offer spread of 275p to 280p.
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