The company published a record set of half year results a few months back, so operationally there is a fair tailwind behind the business. However, I was waiting for a technical buy signal to indicate that the consolidation period since the shares hit their March all-time high had come to an end. That was clearly flagged yesterday when the company’s share price burst through the previous glass ceiling around the 250p mark, making this look like a major break-out in my book.
Furthermore, with Renew’s shares only modestly above the 20-day moving average (at 238p), and the rising 200-day moving average now around 213p, then the price is not overly stretched above these important rising trend lines. Other technical indicators are positive too: the moving average convergence divergence indicator (MACD) is positive and above its signal line having given a clear buy signal a week ago; and the 14-day relative strength indicator (RSI) is not yet too overbought as a reading of 70 is still well below the level at the time of the previous share price peak in March. In any case, the shares can continue to make new record highs for some time yet even with the 14-day RSI at this elevated level.
Importantly, the fundamental case is highly supportive of the investment case. In fact, following a number of upgrades this year on the back of both strong trading and earnings enhancing acquisitions, the latest of which was announced last week, analyst Nick Spoliar at brokerage W.H. Ireland now expects the company to report full-year revenues of £440m in the 12 months to end September 2014, up from £350m in the prior year. If achieved this will drive up pre-tax profits from £10.7m to £15.3m to propel EPS up a third to 19.5p and underpin a rise in the payout from 3.6p to 4.6p a share. On this basis, the shares are priced on a modest 12.5 times prospective earnings and offer a forward dividend yield of 1.8 per cent.
But with the full benefits of last week’s acquisition of Leigh-on-Sea based Forefront Group, an engineering services group focused on the gas infrastructure market, to be seen in the next fiscal year then analysts are predicting a hefty ramp up in earnings in the forthcoming 12 months.
A smart acquisition
Renew is paying £14.8m in cash for Forefront, a business focused on the replacement of gas mains and other critical services for National Grid and Southern Gas Networks in London and the South East. The deal is being part funded by a £12m loan from HSBC and the balance of the consideration is being financed from Renew’s own cash holdings.
The gas infrastructure market is highly regulated and revenues are derived from the 30 year gas mains replacement programme which involves the replacement of iron gas mains pipes with polyurethane mains. Forefront specialises in both low and medium pressure outlets up to 48" diameter, deals with emergency gas leaks and has a specialised under pressure drilling capability. The company also provides a complete reinstatement service and operates its own material recycling facility. It is one of only three companies approved to carry out under pressure drilling on larger diameter line mains for National Grid and Southern Gas Networks.
It looks a well timed purchase because although Forefront reported operating profit of £1.7m on turnover of £26.9m in the 2013 fiscal year, it only managed to break even in the year to March 2014 as workflow was reduced prior to the commencement of a new framework for National Grid. However, with that agreement now in place, and contracts with Southern Gas Networks in place too, revenue and margins have now returned to their previous levels. Moreover, established framework agreements should mean that Forefront will deliver both growth and earnings accretive to Renew's engineering services’ division current operating margin.
To put this into some perspective, in the half year to end March 2014, Renew’s engineering services’ division reported operating profit of £7.8m on turnover of £169m (accounting for three quarters of group revenue and 90 per cent of profits), producing a margin of 4.6 per cent. Analysts at W.H. Ireland believe the Forefront acquisition could produce operating profit of £1.5m on revenues of £26m in Renew’s 2014/15 financial year and so prompting another hefty earnings upgrade. The broking house now predicts Renew will report revenues of £485m in the 12 months to end September 2015, pre-tax profits of £19.4m and EPS of 24.4p.
In other words, if these forecasts prove correct, then Renew is on course to deliver 25 per cent EPS growth next fiscal year to follow on from the 33 per cent growth predicted in the financial year to September 2014. In the circumstances, it’s hardly surprising that the company’s share price is breaking out. A forward PE ratio of 10.5 seems very modest for a company with a PEG ratio well below 0.5.
Sensibly structured acquisitions
Importantly, Renew has been able to structure acquisitions in the most favourable way for its shareholders given that it was in a healthy net cash position at the half year-end in March 2014 – net funds had risen from £1.8m to £3.9m in the six month period after adjusting for finance leases. This meant that it was well placed to capitalise on the growth opportunities in the UK infrastructure engineering services market by tapping debt markets to make earnings enhancing acquisitions.
Indeed, at the end of April the company acquired Clarke Telecom, an engineering services business focused in the wireless telecoms infrastructure market, for a cash consideration of £17m. The acquisition has been funded from Renew’s cash resources and a four-year term loan of £12m provided by HSBC.
Oldham-based Clarke focuses on providing engineering services across all aspects of wireless telecoms infrastructure delivery including site acquisition and design, construction, installation and site optimisation. Clarke also carries out site maintenance and decommissioning. The business has relationships with all of the UK's cellular network operators and major network equipment manufacturers.
The wireless telecoms infrastructure market is currently experiencing growth as demand for mobile internet access and communications is outstripping the capacity of existing mobile network infrastructure alongside the introduction of 4G services. This is resulting in a growing need for network operators to add new infrastructure, upgrade existing networks and decommission redundant assets, providing Clarke with a range of excellent growth opportunities.
And it’s a profitable niche to be operating in too: in the year ended 31 October 2013, Clarke reported turnover of £32.9m and normalised operating profit of £2.3m. For the year ended 31 October 2014, Renew’s board expects Clarke to grow its turnover by approximately 5 per cent and to maintain its normalised operating profit margin, implying an operating profit of around £2.4m.
Or put it another way, the operating profit contribution from both Clarke Telecom and Forefront could easily be well over £4.2m in Renew’s fiscal year ending September 2015. This substantially underpins the £4.1m of extra pre-tax profit analyst Nick Spoliar is predicting the company will earn in the 12-month period.
And because Renew had low yielding cash balances of £8.1m at the end of March on its balance sheet, and has been able to fund the £31.8m combined consideration for the two aforementioned acquisitions through a £24m four-year term loan from HSBC, then the company had no need to dilute shareholders’ interests by issuing equity to fund the deals. This explains why Renew’s EPS are set to explode upwards again in the 2015 fiscal year as the company’s shareholders capture the vast majority of the profit contribution from the Forefront and Clarke Telecom acquisitions.
Both acquisitions look sound business to me especially since longer-term growth opportunities in UK engineering services infrastructure are well underpinned by the London Strategic Replacement programme that is just getting under way. This is set to deliver around £500m of investment in gas mains replacement over the next five to 10 years according to analysts.
Target price
In my view, a fairer valuation for Renew’s equity is at least 330p a share, or the equivalent of 13.5 times 2015 earnings estimates. W.H. Ireland is even more bullish, having upgraded its house target price from 335p to 360p following last week’s Forefront acquisition.
There is a progressive dividend policy to appeal to income investors too. Based on another hike in the payout to 5.1p a share in the 2015 fiscal year, the prospective dividend yield is 2 per cent with the payout covered more than four times over.
So with attractions for both income and growth investors on offer, I expect Renew’s share price break-out to prove to be the real deal. Offering 28 per cent potential upside to my 330p target price, I rate the shares a strong buy on a bid-offer spread of 255p to 258p. Please note the company is due to release a pre-close trading update in early October ahead of its full-year results on 25 November 2014. The time frame to hit my price objective is six months.
■ 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'
