Having subsequently lifted my fair value target price to 100p when the price was 80p ('Buy the break-out', 6 September 2013), I was not disappointed by the reaction to a bumper set of half-year results in late September. In fact, I was so impressed by the figures that I again upgraded my earnings multiple driven target price to 116p when I last updated the investment case ('Value plays', 4 November 2013). A very favourable chart set-up and positive investor sentiment were also contributory factors in making that decision.
The price at the time was 92p, so if you followed that advice in the past five weeks you will have made a healthy 20 per cent gain. Moreover, with the share price hitting a high of 113p yesterday, we are now within pennies of my 116p target price being met. Importantly, the fundamentals also support the ongoing rerating.
Ride the earnings upgrade cycle
As I have pointed out previously, KBC has been showing clear signs of entering an earnings upgrade cycle as the recovery in the business gathers pace. For starters, the company has emerged 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. It also offers scope to return to revenue growth and to build on the higher operational gearing as a result of a lower fixed cost base.
KBC is certainly ticking the right boxes. 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 almost a third was derived from the higher-margin technology segment and the balance from consultancy work.
Contracts won included 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 (£9.8m), 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 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 to end June. Furthermore, a £84m pipeline of contract work is at an all-time high and includes £8m of contract wins since July. In turn, this prompted analysts to upgrade earnings estimates.
Still undervalued relative to peers
Post the interim results, house broker Cenkos Securities moved up their 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, KBC is expected to guide towards full-year EPS of 7.3p at the very minimum when the company releases a pre-close trading update in late January. Guidance for 2014 is likely to be strong too with Cenkos currently conservatively forecasting EPS of 8p based on a further rise in pre-tax profits to £8m on revenues of £67m.
So, with the shares being offered in the market at 110p, the 2014 forward PE ratio is still only 13.5 - a 10 per cent discount to the UK software and services sector average earnings multiple of 15 for sub-£100m market cap companies and a massive 25 per cent discount to the UK software sector as a whole.
Investors should also expect news of a reinstatement of the dividend in January's trading update. Cenkos currently forecast a 1.6p a share payout for 2013, implying a prospective yield of 1.5 per cent. KBC can certainly afford to be generous as the company had net cash of £5.15m, or 9p a share, at the end of June. Furthermore, this was after expensing research & development costs of £1.3m in the first half. Strip out that cash sum from the current share price of 110p, and KBC is modestly rated on 12.5 times earnings estimates for next year.
It's also well worth pointing out that there is realistically potential for further earnings upgrades on the back of additional contract wins, news of which would be seen as very positive by investors. In fact, analysts at Cenkos made this very point in their post results note when they noted: "The case for a rerating hinges on good fundamental growth prospects and the potential for further upgrades, driven by both end-market demand as well as an improving revenue mix and an operational gearing impact."
Clearly, Kestrel Partners, the investment manager of Kestrel Opportunities, remain pretty keen on the investment case as they acquired a total of 226,000 shares in three transactions in September and October to raise their stake to 12.48 per cent of the issued share capital. Oliver Scott, non-executive director of KBC, is a founding partner of Kestrel and holds a beneficial interest in Kestrel Opportunities. I am sure that Kestrel was given the green light by KBC insider, Mr Scott, before these transactions took place.
Upgraded target price
So with investor sentiment positive, and KBC set to issue what will only be an upbeat pre-close trading statement next month, I feel the current rerating has further to run even though the shares are riding an 11-year high. In fact, I believe that a rating of 15 times 2014 earnings estimates net of that cash pile is not an unrealistic valuation. On this basis, I have again upgraded my earnings multiple driven target price from 116p to 129p. Offering a further 17 per cent upside to my target price, the shares rate a buy on a bid offer spread of 109p to 110p. My time frame for this trade is two months.
Please note that I am awaiting financial results and pre-close trading statements from the following companies: WH Ireland (pre-close); Terrace Hill (final results); Aurora Russia (interim results). These announcements are due imminently and I will update my views at the time. In the meantime, I would run with your holdings in all these companies.
Finally, due to unprecedented demand, my new book, Stock Picking for Profit, has sold out and is being reprinted for delivery the week commencing Monday, 6 January 2014. As a special promotion to IC readers, the first 100 pre-orders for the book placed online with YPD Books and quoting offer code ICOFFER will receive complimentary postage and packaging. The book can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213. The book is only being sold through YPDBooks and no other source. It is priced at £14.99, plus £2.75 postage and packaging. Telephone orders will continue to incur the £2.75 charge.
MORE FROM SIMON THOMPSON ONLINE...
In the past fortnight, I have published articles on the following 23 companies or trading strategies:
■ Eros ('Conundrum to solve', 25 Nov 2013)
■ Amino Technologies ('Conundrums to solve', 25 Nov 2013)
■ Town Centre Securities ('Time to make friends up north', 25 Nov 2013)
■ Raven Russia ('Cash in on a Russian property play', 25 Nov 2013)
■ Sanderson ('An app investment', 26 Nov 2013)
■ Equity market strategy ('Betting on a Christmas rally', 26 Nov 2013)
■ Eurovestech ('Kalibrate to fuel Eurovestech', 27 Nov 2013)
■ Housebuilders trading strategy ('As safe as houses', 27 Nov 2013)
■ Bovis Homes ('Bovis poised for chart break-out', 28 Nov 2013)
■ Netcall ('Dial into cloud-based profits', 28 Nov 2013)
■ Mountview ('Profit from the London housing boom', 29 Nov 2013)
■ Daejan ('Bargain basement prime property', 29 Nov 2013)
■ PV Crystalox Solar ('Cash rich and undervalued', 2 Dec 2013)
■ Pilat Media Global ('Bumper upgrades for software maestro', 2 Dec 2013)
■ Housing market ('Allaying fears of housing myths', 3 Dec 2013)
■ Dragon Ukrainian Properties ('Ukrainian nigntmare tames the dragon', 4 Dec 2013)
■ Conygar ('A smart regional property play', 4 Dec 2013)
■ Sutton Harbour ('Small cap value plays', 5 Dec 2013)
■ Crystal Amber ('Small cap value plays', 5 Dec 2013)
■ API ('Small cap value plays', 5 Dec 2013)
■ Greenko ('Fair wind', 6 Dec 2013)
■ Bezant Resources ('High risk, high reward resource play', 9 Dec 2013)
■ Thorntons ('A rating too sweet?', 9 Dec 2013)
