The key take for me is that the strategy of adopting a cash preservation mode in what are still very difficult market conditions has paid dividends, quite literally, as the business turned cashflow positive. In fact, around €4.4m (£3.7m) net cash was generated from operating activities in 2013.
Revenues rose by over half to €71.4m in the 12-month period to produce operating profits of €6.6m as PV Crystalox successfully traded surplus silicon and doubled wafer shipments on the prior year to around 211MW. In part, this reflects the board’s decision to expand the customer base, so although the business was operating at only a fifth of its maximum 750MW capacity, sales volumes were double production levels as PV Crystalox was able to supply customers from inventory. That can be seen on the company’s balance sheet with year-end inventories of €13m almost two thirds less than at the start of last year.
Sensibly, having entered into long-term agreements when wafer prices were much higher, PV Crystalox’s management team has renegotiated pricing with the company's wafering subcontractor and polysilicon suppliers. The weakening of the Japanese Yen helped in renegotiating lower costs with its wafering sub-contractor in Japan. The company has also reached agreement with most of its long-term customers that were tied into contracts to buy wafers at prices considerably in excess of current market levels. Discussions are currently ongoing though to conclude settlements with the administrators of two long-term contract customers that have gone bust, and with one other long-term contract customer so that wafer shipments can resume. Sales to customers at premiums to spot wafer prices accounted for around a third of PV Crystalox’s wafer shipment volumes last year.
Importantly, PV Crystalox has been developing new customer relationships to broaden its client base and to better position the business to take advantage of any medium-term market upturn. In the UK, where the company’s ingot and block production facilities are located, a quality improvement programme has led to higher efficiency wafers that command a higher premium price.
The PV market is expected to grow by over a third this year, but excess capacity and anti-competitive pricing by Asian rivals has meant that pressure on pricing will remain a theme. However, the company’s cost base has been much reduced and the exit from the loss-making plant at Bitterfeld, Germany has clearly helped stop cash burn. Headcount has been massively reduced too and the company now employs less than a third of the staff it did at the end of 2012.
So with the company no longer burning cash it was able to return €36.3m of its cash pile to shareholders at the end of last year. Factoring in the exit from the Bitterfeld business, the cash pile ended 2013 at €39.2m or the equivalent of 20p a share. Book value of 30p a share was little changed on 2012, after factoring in the cash returns. This means the shares are trading 10 per cent below net asset value and net cash accounts for 75 per cent of the current share price. Or put it another way, strip out the £32m cash pile from PV Crystalox’s market capitalisation of £43m, and in effect the business is being valued at only £11m.
That seems a low price to pay for a company operating at only 20 per cent of capacity and with scope to ramp up output as and when market conditions prevail. The valuation also fails to reflect the fact that PV Crystalox is no longer burning cash and an easing in the tight pricing environment is not an unrealistic possibility.
That’s because the US government has launched another anti-dumping and anti-subsidy investigation into Chinese solar products imported into the country. The decision by US International Trade Commission follows a petition at the end of 2013 in which it claimed that existing anti-dumping levies, averaging 31 per cent, were being circumvented by China's manufacturers who are exploiting a loophole by using cells from Taiwan and elsewhere for their modules. A preliminary determination of any countervailing and antidumping duties could come as early as June. Ultimately, any reduction in anti-competitive supply coming onto the market can only be positive on industry pricing to rebalance supply with rapidly increasing demand.
In fact, according to the European Photovoltaic Industry Association (EPIA), global PV installations grew 35 per cent in 2013 driven by demand from China and Japan. These two leading markets accounted for 49 per cent of installations as the market continued its transition from a European-dominated environment to a global market. Growth in Japan has been stimulated by the generous incentive programme that started 18 months ago whereby Japan's feed in tariff in fiscal 2013 was set at 37.8 Yen (US$0.38)/kWhr for the next two decades, more than twice the tariffs on offer in China and Germany.
So, although PV Crystalox shares are up a third in the past six weeks, I still see scope for them to shine even brighter in the coming year as supply and rapidly rising demand start to balance out. Trading on a bid-offer spread of 25p to 25.75p, I continue to rate the shares a medium-term buy. I have a fair value estimate of 35p a share.
Contract wins to drive earnings upgrade cycle
Full-year results from Aim-traded Thalassa (THAL: 270p) hit my expectations too and I have no reason at all to change my positive stance on the company. To recap, Thalassa provides 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.
It is proving not only popular, but highly profitable too: in the 12 months to end December 2013, Thalassa’s revenues more than doubled to $30.6m (£18.4m) and with the benefit of a three percentage point hike in operating margins to 13.7 per cent, operating profits surged from $1.5m to $4.2m, bang in line with upgraded analyst estimates.
A major contract win with Statoil ASA (STL:NYQ - $27.46), the Norwegian energy giant, underpinned the revenue and profit surge. The agreement is worth $85m (£51.9m) over a nine-year period with Thalassa providing long-term seismic acquisition services for permanent reservoir monitoring of the Snorre and Grane oil fields in the Norwegian sector of the North Sea. Other contract wins last year include one with SMG Ecuador, the Ecuador business of State Sevmorgeo Company, the Russian geological sea survey company.
Since the financial year-end, the company has also won a contract with Nasdaq-quoted SAExploration (SAEX:NMQ - $9.93) to provide shallow water source handling and deployment services for seismic acquisition projects in the North Prudhoe Bay, Alaska. Mobilisation is anticipated to start in three months time and the survey will last until mid-October. Thalassa will assist SAExploration, an established operator on the North Slope, Alaska, in developing a shallow water source handling and deployment system with the aim of increasing productivity during the short summer weather window. The total contract value for services provided will be around $4m (£2.4m).
In total, Thalassa now has $142m worth of potential orders in the pipeline including tenders submitted. That’s over 50 per cent higher than at the same stage last year. The company is also well funded to execute these orders, having raised £22.6m through institutional placing of shares at 250p last October, and 120p in April, to strengthen the company's balance sheet and provide the working capital needed to service a record order book and to undertake new work. The funds raised have also enabled Thalassa to carry out a $10m capital expenditure programme this year to refurbish two compressors acquired, upgrade some of its existing systems, build a mini-PMSS™ system in advance of undertaking work in the high resolution 3D sector.
So given the favourable backdrop of a strong order pipeline and new contract wins, it’s a very realistic possibility that conservative analyst earnings estimates could be surpassed. That’s because WH Ireland has only factored in that a quarter of the tender pipeline will be converted into firm contracts this year and next. On this basis, current year revenues are predicted to rise by around 20 per cent to $36.5m and deliver pre-tax profits of $5m and EPS of 16.9¢. The respective forecasts for 2015 are turnover of $41.6m, pre-tax profits of $6.1m and EPS of 20.7¢. Please note that the EPS figures have been adjusted to reflect the greater number of shares in issue post the aforementioned placings.
But with the company still in a strong earnings upgrade cycle, I still believe the shares are undervalued even though they have more than doubled since I initiated coverage a year ago at 138p (‘Potential for seismic gains’, 19 March 2013). That’s because Thalassa’s cash pile ended last year at $32.2m (£19.4m) and, even after factoring in capital spending plans, is expected to end this year at around $28.5m, or 70p a share. Strip this sum out of the current share price, and the shares are being rated on a cash adjusted multiple of 15.9 times low-ball earnings estimates for 2015. But that multiple drops very sharply if we assume that a more realistic $45m of contract wins come through from the $142 pipeline for completion in 2015, as I anticipate, against current forecasts of $30m embedded in WH Ireland’s numbers above. Assuming a gross margin of 28 per cent, this would imply 2015 EPS of 34¢, or 21p a share. That looks a feasible outcome and one that should provide ample further share price upside. Indeed, on this basis, the cash adjusted multiple is only 9.5 times earnings.
In the circumstances, I have no hesitation repeating my previous buy recommendation with Thalassa shares trading on a bid-offer spread of 268p to 270p. I am maintaining a price target of 350p, well below WH Ireland’s target price of 400p, but I believe the risk remains to the upside.
Please note that I have written another column today: Time to sell. I am currently working my way through a very large number of announcements from companies on my watchlist including: LMS Capital (LMS), BP Marsh Partners (BPM), Eros (NYSE: EROS), First Property (FPO), and Pure Wafer (PUR). I will also be updating my recommendations on Moss Bros (MOSB), IQE (IQE) and GLI Finance (GLI) after these three companies report financial results on Wednesday, 26 March.
