And this is exactly what I think is happening in the shares of Greenko (GKO: 146p), the Indian developer, owner and operator of clean energy projects. It has proved a frustrating holding and one yet to make any meaningful progress towards my 200p-a-share fair value target, having originally advised buying the shares at 138.5p ('Buy signal flashing green', 18 Mar 2013).
However, that could all be about to change, as in recent weeks the price has been making headway, and on a bid offer spread of 142p to 146p, the March high of 152p is now within sight. Moreover, a breach of that level would signify a major chart break-out and open the way for a move towards my 200p target price. Importantly, there is very little overhead technical resistance above that March high until my 200p target price, so if a chart break does indeed occur out of the current trading range, it is likely to attract momentum buyers, too. There are several reasons to think this will happen.
For starters, I noted that both Prudential and M&G have acquired 1.4m shares in Greenko each in the past week to take their respective stakes upto 14.76 per cent and 14.35 per cent of the issued share capital. Having analysed the share transactions, it would appear that the first stake changed hands at 127.25p on 24 October and there were a number of other deals transacted around 130.25p a few days later. The subsequent rise in the price adds weight to the fact that a seller has been cleared out from the market and one that has most likely been holding back the price. On fundamentals, the case to invest remains as strong as it was when I first made the investment case.
Plugging into a green energy generation
To recap, my interest was sparked by a £100m investment in Greenko Mauritius by an affiliate of the government of Singapore Investment Corporation (SIC), one of the world's leading sovereign wealth funds. The shares are convertible on a one-for-one basis into ordinary shares in Greenko, subject to final adjustment between 1 July 2015 and 30 June 2017.
The funds are being used to ramp up the construction of the company's power portfolio and take advantage of the attractive power opportunities in India. Greenko is clearly making progress and has added six new run-of-river hydro projects totalling 425 megawatts (MW) to its active development pipeline. Two of these are additions to the existing hydro cluster in Himachal Pradesh and a further four projects will form a new regional cluster in Arunachal Pradesh, with site work expected to start late this year.
So, with the £100m new funding in place, Greenko is now targeting approximately 2,000MW of operating capacity in 2018, double the target for 2015. The aim is to increase the fully commissioned asset base from 244 MW in March 2013 to over 500 MW by March next year. At the end of September, the company had 412MW of installed capacity, but more than double that capacity including sites currently under construction, so is clearly making progress towards that 2,000MW target.
Greenko has also confirmed that the wind project at Balavenkatpuram is due to complete by the end of the monsoon season, and the site has been expanded to 200MW. This highlights the benefits of Greenko's policy of developing sites with incremental expansion opportunities. Moreover, it's the extra revenue and profit generated from the ramp-up in capacity that should drive the re-rating in the shares I have been predicting.
Strong earnings growth forecast
Following a pre-close trading update ahead of its half-year results on Monday, 2 December, analyst Adam Forsyth at broking house Arden Partners forecasts that Greenko's revenues will rise from €36m to €50m in the financial year to March 2014 to boost operating profits from €16.3m to €29.6m. Revenues and profits are forecast to increase to €91m and €60.5m the year after. On that basis, EPS rises from 5.4¢ in the 12 months to March 2013 to 15.4¢ in the 12 months to March 2015.
If Greenko can hit these targets over the next two financial years, then it is only reasonable to assume that the share price will start to reflect the upside that the SIC sees in the revenue-generating potential of the power generation assets.
Target prices
As I have noted previously, Mr Forsyth values Greenko at 245p a share and has pointed out that "there is considerable potential in the shares and the prospect of more project completions should drive newsflow in the remaining financial year". I completely agree, and priced on a bid-offer spread of 142p-146p, I continue to see significant medium-term upside in the shares and maintain my 200p target price. Buy.
Stakebuilding in KBC
Greenko was not the only company to have seen activity on its share registrar in the past week. I also noted that Kestrel Partners, the investment manager of Kestrel Opportunities, has just acquired another 75,000 shares at 89.55p to raise its stake to 7.38m shares in KBC Advanced Technologies (KBC: 92p), a consultancy and software provider to the global hydrocarbon processing industry. Kestrel now owns 12.48 per cent of the company's issued share capital. Oliver Scott, non-executive director of KBC, is a founding partner of Kestrel and holds a beneficial interest in Kestrel Opportunities. It is fair to assume that Kestrel was given the green light by KBC insider, Mr Scott, before the above transaction took place.
Clearly, Kestrel was impressed by October's bullish trading update from KBC. I had expected as much as ahead of that announcement I lifted my fair value target price on the shares to 100p ('Buy the break-out', 6 September 2013). Broker Cenkos Securities also have a discounted cash flow valuation of 100p-plus on the shares.
Moreover, having taken out the 80p resistance level post the release of the half-year results in October, the shares are now making an assault on the 91p high dating back to February last year. Beyond that the next resistance level is 100p. I have little reason to change my upbeat stance on the shares. The price action in the past few months also vindicates my decision to advise buying KBC shares at 69p six months ago ('Fuelled for growth', 5 May 2013). Importantly, the fundamentals also support further upside in the share price.
Ride the earnings upgrade cycle
As I have pointed out in my previous articles, KBC has been showing signs of entering an earnings upgrade cycle as the recovery in the business gathers pace. 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 ticking the right boxes.
In fact, buoyed by a raft of contract wins, revenues in the six months to end-June surged by 15 per cent to £31.7m, of which an eye-catching £9.6m was derived from the higher-margin technology segment and the balance from consultancy work.
Contracts won include five-year agreements with a Japanese refiner worth £1.8m, and a similar deal with a US refiner worth £1.8m. KBC also won a $16m (£10m), 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. These contract wins are in addition to the one with EP Petroecuador (EPP), the integrated state national oil company of Ecuador, worth $100m (£64.5m) over a period of four years. KBC is working with EPP to improve its core work processes and support systems, as well as develop the technical capability of the workforce.
So, with the benefit of a lower cost base, and rising margins on contracts won, operating margins quadrupled to 10 per cent in the first half. Furthermore, a £84m pipeline of contract work is an all-time high and includes £8m of contract wins since July. In turn, this prompted analysts to upgrade their earnings estimates last month.
Modest valuation
Post the interim results, house broker Cenkos Securities bumped up its full-year pre-tax profit estimate from £7m to £7.5m on revenues of £66m, up from £5.5m and £63m, respectively, in 2012. On this basis, expect full-year EPS of 7.3p. For 2014, the broking house is conservatively maintaining EPS of 8p based on a further rise in pre-tax profits to £8m on revenues of £67m.
So, with the shares currently trading at 92p, the 2014 forward PE ratio is only 11.5 - a massive discount to the UK software and services sector average earnings multiple of 15 for sub-£100m market cap companies.
Investors can also expect a reinstatement of the dividend when final results are released in March. Expect news of this front in a pre-close trading update in January. Cenkos forecasts a 1.6p a share payout, implying a prospective yield of 1.7 per cent. KBC can certainly afford it as the company had net cash of £5.15m, or 9p a share, at the end of June. Moreover, this was after expensing research & development costs of £1.3m in the first half. Strip that cash sum out from the current share price of 92p, and KBC is being modestly valued on 10 times earnings estimates for next year.
In my opinion, the potential for further earnings upgrades on the back of additional contract wins, news of a reinstated dividend, and strong profit growth this year and next makes KBC an attractive investment opportunity. I continue to rate the shares a buy on a bid-offer spread of 91p to 92p and have upgraded my earnings multiple driven target price from 100p to 116p.
True, expect some resistance around the 100p level, but given the momentum in the business I can see this resistance level being breached and the shares returning to the April 2002 high around 116p. My time frame for this trade is three months.
■ Finally, as a pre-Christmas offer exclusive to Investors Chronicle readers, all telephone orders placed with YPDBooks for my new book Stock Picking for Profit will receive complimentary postage and packaging. This offer is strictly for a limited period, is subject to stock availability and applies to only telephone orders placed until Friday, 15 November 2013.
Please note the book is only being sold through YPDBooks and no other source. Full details of the content of the book is available online at www.ypdbooks.com. If you would like to take advantage of this offer, please contact YPDBooks on 01904 431 213 and quote reference 'ICOFFER'. The book is priced at £14.99. Internet orders will continue to incur the normal postage and packaging cost of £2.75. I have also published an article outlining the content of the book: 'Secrets to successful stock picking'.
MORE FROM SIMON THOMPSON ONLINE....
In the past week I have published six other articles last week on the following six companies and portfolios:
■ First Property Group ('On rock solid foundations', 28 October 2013)
■ US Dog share portfolio ('Dog shares barking back', 28 October 2013)
■ Sanderson ('Running bumper profits', 29 October 2013)
■ IQE ('A conundrum to solve', 29 October 2013)
■ Netplay TV ('Strong buy signal', 31 October 2013)
■ Thalassa ('Cashed up for earnings upgrades', 4 November 2013)
