This is why I meticulously go through the last 18 months’ interim reports, preliminary results statements and trading statements to work out the underlying trends and pinpoint key growth drivers in all the companies I analyse. This includes anticipating what company-specific newsflow is set to be released over the coming months, and estimating the likely implications for the share price based on a series of possible outcomes.
This is a very useful exercise to carry out, not to mention one that can be financially rewarding, especially for companies that have already slimmed down their cost base, or have scaled up the business. That's because modest increases in revenues can have a disproportionately large impact on profitability as operational gearing kicks in. As a result, it can pay big dividends to buy into these situations to ride the upgrade cycle at the earliest stage possible. But that’s only possible if you know what to look out for.
Director share dealing
One tell tale sign for me is when directors have been digging deep into their pockets to purchase shares in their own company in advance of pre-close trading updates. It’s the strongest signal you can possibly get that the insiders know that the risk to their investment is skewed heavily to the upside.
This is exactly what the directors of Aim-traded Hangar 8 (HGR8: 272p), one of Europe’s largest operators of privately owned jet aircraft, have been doing. In fact, chief executive Dustin Dryden splashed out £168,000 picking up 80,000 shares at 210p each in early May. He was not alone as non-executive director George Rolls followed suit and virtually doubled his holding by purchasing 50,000 shares at the same time. I noted these purchases when I initiated coverage on the company six weeks ago when the share price was 225p (‘Ready for take-off’, 12 May 2014). It proved the right call because the company has just issued an upbeat trading update for the year ended 30 June 2014 in which the board have revealed that cash profits will be ahead of their own expectations. Those director share deals were clearly well-timed as the company’s share price has shot up a further 7 per cent to 272p this week.
Analyse the business model
The earnings beat was no fluke either as a key part of my investment analysis is to appraise each company’s business model. If I don’t understand it, then I simply pass it over. But in the case of Hangar 8, it was clear to me that this was a business that was quite literally taking off.
To recap, the Oxford-based company makes its money by acting as an asset manager looking after the private jets of wealthy individuals. That in itself de-risks the investment because Hangar 8 doesn’t actually own the expensive planes itself. Instead, it charges a monthly management fee to the jet owners of up to £20,000 and takes a slice of the fee charged to third parties when the planes are chartered out. The company doesn’t even shoulder the burden of the direct costs such as crew, maintenance, jet fuel, landing and handling charges as these are passed onto the owners of the planes.
The key to this particular business model is to scale up the operation to a level whereby all Hangar 8’s fixed overheads are covered and the natural operational gearing effect can kick in. As I pointed out in mid-May, the company is well past that critical point which means additional charter contracts have an accentuated impact on profitability. When Hangar 8 floated in November 2010 it was managing 19 aircraft, but thanks to expansion and the astute acquisition of rival International Jet Club at the end of 2012, the company now has over 50 planes of which 30 are long range heavy aircraft.
In addition, by offering a more dedicated full-service management operation, Hangar 8 has targeted the growing intercontinental business air travel market where the highest growth rates are being seen. Operating from 17 bases across Europe, Middle East and Africa, the company offers customers 12 different types of aircraft ranging from the 4-seat Phenom 100 Jet to the 16-seat Embraer Lineage 1000. In fact, Hangar 8 now has 14 super heavy jets on its books that can fly up to 9,000 km without the need for refuelling.
The strategic move to target long haul is certainly paying off because Mr Dryden points out that “the improving economy is already feeding through into our market place with higher activity across our business streams”. He adds that the “outlook for our business is strong and we enter the year with confidence”.
Understand the financials
It also pays to analyse the quality of a company’s revenue streams to gauge how predictable they are. This has a major bearing on the rating investors are willing to pay for a slice of those earnings. In the case of Hangar 8, customers generally sign up for contracts of between one and five years, with obligations to buy a minimum number of flying hours a month. And it’s this certainty of income that underpins the business and improves the quality of the revenue stream. In fact, contracted revenue now accounts for 83 per cent of Hangar 8’s total.
Moreover, the increased scale of the business is generating significant benefits. That’s because as Hangar 8 grows its aircraft assets under management, the savings it can secure and pass onto clients increases too. And as I have alluded to previously, the company is operationally geared. To put this into some perspective, in the financial year to June 2013, Hangar 8 reported revenues of £23.6m and pre-tax profits of £1.93m. Ahead of this week’s earnings beat, analyst Caroline de La Soujeole at house broker Cantor Fitzgerald had been expecting fiscal 2014 revenues in the region of £29m and adjusted pre-tax profits of £2.5m to produce EPS of 21p. These estimates are now under review.
I also target companies where strong revenue growth is being converted into cashflow. Hangar 8 ticks the right boxes here too: the company’s cash profits surged by a third to £1.2m in the first half to end December 2013 and cash increased by £1m on an underlying basis after adjusting for balance sheet movements in relation to the acquisition. At the end of December, Hangar8 had net funds of £3m on its balance sheet, or the equivalent of 30p a share. It’s reasonable to expect a further hike in the cash pile as the company has beaten Cantor Fitzgerald’s cash profit estimate of £1.4m for the second half to end June 2014.
Furthermore, strip out net cash from Hangar 8’s market capitalisation of £26.2m, and this means that the company is only being valued on 11.5 times cash-adjusted earnings. There is a dividend too as the board intend to declare a maiden payout of 2.3p a share alongside the full-year results in October. In turn, small cap income funds will now be able to buy into this growth story which can only support the share price.
In the circumstances, it’s hardly surprising the shares have taken off. In fact, having hit my initial target price of 275p, they are trading around the March all-time high and are approaching blue sky territory. They are also making a smooth ascent to my fair value target of around 300p a share. Even at that altitude they would be priced on only 13 times cash adjusted earnings, a significant discount to the support services average of around 17 times earnings. I would not be surprised at all to see that target taken out too in due course. Trading on a bid offer spread of 267p to 272p, Hangar 8 shares rate a buy ahead of the full-year results in October and potentially more earnings upgrades if the momentum in the business is maintained.
■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'
