And some of the re-ratings can be substantial. In fact, two of the shares in my 2012 portfolio – Telford Homes (TEF: 340p) and urban regeneration and strategic land specialist MJ Gleeson (GLE: 416p) have almost quadrupled in value in the past couple of years, albeit I banked profits too early. They were not isolated examples as shares in two of the companies from my 2013 portfolio, property group Terrace Hill (THG: 24p) and housebuilder and land specialist Inland Homes (INL: 48p) doubled in value last year.
All of these companies were classic value plays trading below the true worth of the value of their assets when I spotted their investment potential. But the re-ratings were also driven by better than expected earnings too. To find companies displaying both strong earnings growth potential, a modest forward PE ratio and a strong balance sheet is the nirvana for a stock-picker when the equity is trading on a discount to book value. It also explains why I maintain a watchlist of companies displaying exactly these characteristics, and patiently wait for the right moment to recommend buying into these investments, as and when the risk:reward ratio is most favourable.
A year ago, I spotted a real gem in Aim-traded Thalassa (THAL: 280p), a provider of marine seismic equipment and, in particular, a technology called Portable Modular Source System (PMSS™). Although you will have doubled your money on that investment if you followed my advice, I still remain very positive given there is a further 25 per cent upside to my 350p target price (‘Ride earnings upgrades’, 14 January 2014). In fact, the sideways movement in Thalassa’s share price this year presents an ideal buying opportunity ahead of what are likely to be very impressive full-year results at the end of next month.
I have also spotted another investment opportunity with clear potential to double in value in the next year, and potentially treble, and one where we can get in on the ground floor now. It is a stock market minnow, Aberdeen-based SeaEnergy (SEA: 29p). The company is a small cap energy services business valued at £16m, a discount to net asset value of £18m even though net cash on the balance sheet is around £5.6m, or almost a third of the market capitalisation.
Bargain basement acquisition
Formerly known as Ramco Energy, the company sold off its interest in SeaEnergy Renewables Limited to Repsol and EDPR for a total of £38m in June 2011, which strengthened its balance sheet and provided a source of funding for new ventures. Subsequently, SeaEnergy acquired R2S, a profitable, cash generative and growing business, around 18 months ago. The initial consideration was £5m with a further earn-out payment of £500,000 made in March last year and another of £4.6m due next month if R2S achieves cash profits in excess of £2.5m in the 12-month trading period to end February 2014.
That’s significant because I understand from analysts at Edison Investment Research, who attended an investor day held by the company a couple of months back, that R2S is on course to achieve revenues of £5m last year, up 150 per cent on the £2m reported in 2012, and is on track to report cash profits of at least £2.5m. In other words, for a total acquisition price of only £10.1m, SeaEnergy now owns a business that not only makes over £2.5m of cash profits, but is growing at one heck of a pace.
This stellar growth rate is likely to be maintained in the future because R2S's core service - Visual Asset Management - is proving popular. The VAM technology involves taking 360 degree spherical photographs of locations and then building up three-dimensional (3D) models. Data can then be embedded, indexed and managed. R2S initially provided these services to Police Forces and Courts across the UK, to model crime scenes and to index and manage associated evidential data. Fingerprints, footprints, DNA and other forensic evidence are all embedded within recorded scenes, whilst video footage, forensic photographs, 3D models, animations, plans, audio files and websites can be added and updated as a court case progresses. The meticulous and visual nature of R2S helps anyone connected with a case to be quickly and continuously informed without the need for direct access to the scene.
But it is the oil and gas sector where the real profit potential of the technology is taking off as VAM enables oil rig operators to keep a visual record of all key parts of an oil rig, monitor its condition and any changes to the fabric, with a view to carrying out the required maintenance. And the best part is that customers using the technology can tour their facilities from the comfort of their offices, so providing cost savings and reducing the need for costly trips out to the oil rigs.
Growth potential
R2S's core market is in the North Sea, where many oil & gas installations are reaching the ends of their design lives and the importance of maintaining asset integrity is increasing. The R2S service enables better and more cost effective management of this information, thereby allowing the safe extension of the productive lives of installations. Revenues are generated from both the "asset capture" project of initially setting up the 3D models and from ongoing software licensing fees charged to the operators of assets which have been captured.
Since entering the oil & gas sector market, R2S has developed a strong market presence, and is now finding that clients, who have successfully utilised the company’s service on UK installations, are looking to replicate the cost savings they have achieved on a global basis. As a result the company has set up an office in Houston, Texas, to target the Gulf of Mexico market. Chevron, BP and Nexen are amongst SeaEnergy’s dozen UK operators so the company has a blue chip client base. In terms of the income generated, of the £5m revenues earned in the latest 12 month trading period, a fifth came from software sales and the balance from data capture, therefore offering a recurring and growing revenue stream. And as SeaEnergy’s customers expand the number of rigs they are using the technology to monitor activity on, then expect the company’s revenues to increase further as penetration of this niche, but highly profitable market, grows.
I understand that overseas demand for the R2S is “high with current work underway in the Gulf of Mexico, about to commence in the UAE and potential projects as far afield as South Korea, China and Iraq”. In the circumstances, Edison’s prediction that SeaEnergy’s total revenues in 2014 will rise by 50 per cent to £7.4m and pre-tax profits will hit £1.8m to produce EPS of 3.1p are looking conservative to me. But even on this cautious basis the shares are trading on less than 10 times prospective earnings, a bargain basement valuation considering R2S could be now worth as much as SeaEnergy alone. That leaves the rest of the operations in the price for free.
True, the company is only expected to have hit break-even last year, but this implies a second half pre-tax profit of over £600,000 wiped out a loss in the first half of the same magnitude, thus confirming that there is decent earnings momentum building up. There are some other interesting businesses in SeaEnergy’s stable too.
Value in the rest of the business
The company has three other divisions: a consulting operation, a ship management business and marine services. The consulting business secured its first project last year, working with an international wind farm operator of European offshore wind farms, to develop and implement an approach for the inspection and maintenance of operating assets. Not only are there benefits for the client in reducing costs and maximising turbine efficiency, but there is an obvious cross over with R2S.
The ship management business is focused on operations and maintenance vessels to service offshore windfarms and oil and gas platforms. The current team is small so annual overheads overheads are not huge at around £300,000, but there is potential to generate a decent revenue stream from multi-ship contracts over the medium-term. The unit should also enable SeaEnergy’s marine service business in winning tenders for wind farm support operations vessels of the type designed by the company over the past three years, albeit the business has yet to win its first new-build tender.
True, none of these operations are major fee earners yet, but all have potential to be. Moreover, they are all in the price for free given the ramp up in the profits from R2S and the low valuation being placed on SeaEnergy’s equity.
Hidden value in the balance sheet
Interestingly, there is hidden value in SeaEnergy’s balance sheet. That’s because the company owns a 21.4 per cent stake in Aim-traded North Celtic Sea focussed, oil and gas exploration company Lansdowne Oil & Gas (LOGP: 18.6p), a company with a market value of £27m. This shareholding is in the books for £5.6m, or around its open market value.
The key here is that Lansdowne has a 20 per cent holding in the Barryroe licence, where Providence Resources (PVR: 228p) is the operator with an 80 per cent interest. The license area is located in 100 metre deep water in the North Celtic Sea Basin around 50 km off County Cork, Ireland. The field has 346m barrels of oil equivalent of recoverable 2C resources and will need substantial capital to develop, possibly as much as £1bn to reach first oil. That’s well beyond the means of the two companies. So advised by Rothschild investment bank, Providence Resources is seeking a farm-out deal on behalf of its partners.
Although terms of a farm-out deal have yet to be agreed, it’s only reasonable that both Landsdowne and Providence Resources would seek to have a carried interest to first oil and be fully reimbursed for their costs incurred to date in exchange for reducing their stakes in the Barryroe license. This could be significant as I understand that Landsdowne has invested around £12m to date, a sum equating to almost half its market value.
Moreover, if any farm-out deal does take place then expect shares in both Providence Resources and Lansdowne to re-rate with an obvious read through to SeaEnergy given its 21.4 per cent stake in Lansdowne. It would also offer the real prospect of SeaEnergy being able to sell off this legacy asset. And the best part is that this investment in Landsdowne is in the price for free. That’s because even if you only attributed a modest valuation of six times cash profits to R2S, or the equivalent £15m, then the subsidiary is worth almost as much as SeaEnergy itself. And remember SeaEnergy also has net cash of around £5.6m on its balance sheet prior to the earn-out payment of £4.6m due to the former owners of R2S.
Technical set-up
The chart set-up is also encouraging. Having drifted down on the lack of newsflow in recent months, SeaEnergy shares are trading well below their December high of 36p having come back to their 200-day moving average around 26p. There was always going to be some stiff resistance at the 36p level since this coincided with the March and July highs in 2012 which capped progress.
It’s worth noting though that the 14-day RSI is now in oversold territory, giving a reading well below 40. Interestingly, the share price is sitting on its 20-day moving average which has been falling during the recent drift, but a move above 29p would enable the price to cross this trend line and could signal that the downtrend is now over. For good measure, the moving average convergence divergence indicator, a trend-following momentum indicator also known as the MACD, has given a positive cross over, albeit the signal line is still below zero.
What’s also clear is that an improvement in investor sentiment could have quite a dramatic impact on SeaEnergy’s share price given the low valuation being attributed to the equity right now. Moreover, with the forthcoming final results set show that the company turned a first half pre-tax loss of £611,000 into a profit of the same magnitude to break-even in 2013, then we are guaranteed a good news story in April especially since profits at R2S have been surging.
Target price
In my opinion, fair value for the shares is closer to 60p, or double the current share price to reflect cash on the balance sheet, the increased value of R2S since its acquisition in 2012, the potential for significant value to be realised from SeaEnergy’s shareholding in Landsdowne Oil & Gas, and upside to current analyst earnings estimates if R2S continues to make the stellar progress as seems highly likely.
From a charting perspective, if SeaEnergy’s share price can break above 36p then there is no technical resistance at all until a band between 60p and 66p. Positive newsflow at the full-year results could just be the catalyst needed to spark a much overdue re-rating. So ahead of that announcement I have no hesitation recommending a buy on SeaEnergy’s shares on a bid offer spread of 27.5p to 29p. My initial target price is 60p on a 12 month basis.
