Importantly, the deal makes commercial sense, a point that Hangar 8 chief executive Dustin Dryden rightly points out: “Our clients, many with ultra-long range aircraft, require their premier suppliers to be truly international with the ability to supply a full range of private aviation services across the globe.”
The reverse takeover values Gama at £90m (using Hangar 8’s latest share price) and will be satisfied by issuing 27.3m new Hangar 8 shares to the vendors. The company plans to raise £14.2m net of expenses through a placing at 280p a share to pay off a debt facility and provide additional working capital. On completion, Gama shareholders will hold 60 per cent of the enlarged equity and the company, to be renamed Gama Aviation, will have a market capitalisation of £141m. As a stand-alone entity, Hangar 8 has a market value of £31m, so this represents a material change in the business from the one I recommended buying into seven months ago at 225p ('Ready for take-off', 12 May 2014). Subsequently, Hangar 8’s shares hit an all-time high of 375p (‘Wired up for gains’, 11 November 2014). So what are shareholders getting for their money?
Investing for growth
Gama’s strategy has been to replicate its profitable UK business model in new regions. International expansion started in 2008 and will be the major driver of growth: gross profit increased by 50 per cent between 2011 and 2013, reflecting the ongoing capital investment. To give you some idea of the profit potential from Gama, its mature UK business generated a gross profit margin of 24.3 per cent in the first half of 2014. By contrast, gross margins in the less mature US business were 7 per cent. Hangar 8’s own gross profit margins are around 16 per cent. So given the US business accounts for 30 per cent of Gama’s annual revenues of $183m (£117m) – Hangar 8 generated revenues of $105m in its last fiscal year – then if Gama’s margins can be improved then this will have a material impact on profits.
And that’s exactly what is forecast as 2014 is likely to prove an inflection point as Gama’s US business reaches scale with significant built-in, contracted growth for the year ahead and beyond. The enlarged group is also expected to benefit from Gama’s accumulated US tax losses of $13m, which will be available to offset future profits generated in the US. As a result analyst Robin Byde at brokerage Cantor Fitzgerald pencils in an effective tax rate of 15 per cent for the merged group. Moreover, there should be costs savings by stripping out duplicated overheads. Mr Byde has conservatively factored in $1m of annual savings.
Of course, the deal is subject to shareholder approval in the first week of January. But it’s easy to see why it will appeal to both parties. Mr Byde reckons the enlarged group will generate pro-forma cash profits of $14.6m (£8.1m) in calendar 2014 on revenues of $291m, but after factoring in the faster growth rate of the Gama business, Mr Byde expects revenues to ramp up to $334m in fiscal 2015, increasing to $383m in 2016. And with margins improving too, Cantor predict cash profits will increase by half to $21.7m in 2015 and to $24.9m the year after. Deduct from these figures a depreciation and amortisation charge of $1.7m and this translates into pre-tax profits of $20m in 2015, rising to $23.2m in 2016. Based on 43m shares in issue, and factoring in a tax charge of 15 per cent, expect EPS of 40¢, rising to 46¢ in 2016.
Clearly, the sterling:dollar exchange rate is material and Cantor have used a rate of £1:$1.60 in their calculations, slightly above the current cross rate. This seems sensible as I expect the normalisation of interest rate policy in the US to lead to further strengthening of the greenback, so if anything the currency risk to sterling denominated earnings is to the upside. On this basis, expect EPS of 24.8p in 2015, rising to 28.7p in 2016, which means that Hangar 8’s shares trade on a forward PE ratio of 13.7 – a 10 per cent discount to the FTSE All-share support services average rating - falling to a modest prospective PE ratio of 11.8 in calendar 2016.
Furthermore, after adjusting for Hangar 8’s net funds of £4.6m, and the proceeds of the £14.2m placing, the group will have an ungeared balance sheet and resources available for working capital and investment.
Assessing risk
Of course no investment is without risk, the most obvious being execution risk. There is a risk too that demand for private aviation services may not be as strong as industry forecasts, and specifically in the US where Gama has most exposure to an improving economy.
Analyst estimates are also predicated on the enlarged entity maintaining a high level of recurring revenue (around 80 per cent) which will provide the highly experienced board, and one boasting 225 years of industry experience, with confidence and visibility of future income to enable ongoing investment programmes. This will include a planned new strategic partnership in Asia in the first half of next year, new maintenance bases to be opened under Gama’s fractional ownership, and the addition of new aircraft under management in Europe.
However, after factoring in these risks, I still see the tie-up between the two companies as a sound strategic move and one where there should be upside to the equity. In fact, I believe that Cantor’s price target of 400p is very sensible, equating to a valuation of 14 times prospective earnings for 2016. For a business predicted to grow annual revenues by 15 per cent for the next three financial years, and lift EPS by a third from 24.8p in fiscal 2015 to 33.1p in fiscal 2017, a forward PE ratio in the order of 14 to 15 seems appropriate for calendar 2016. In the circumstances, I am happy to issue a buy recommendation on Hangar 8’s shares and have a target price of 400p.
Financed for bumper growth
Aim-traded shares in 1pm (OPM:59p) have pulled back to 10 per cent above my recommended buy-in price of 54p (‘Bargain shares for 2014’, 7 February 2014), even though the specialist provider of finance to small and medium-sized companies is experiencing high levels of demand from its customers. Over £6.8m of new business was written in the first half to end November 2014, up 36 per cent on the same period in 2013. This included a record £1.5m of new business written in October and takes 1pm’s combined asset finance and loan portfolio to £24.3m, up from £20.4m at the May year-end.
To fund this growth 1pm has raised £5.7m of debt finance since the summer and a further £3.8m from a share placing at 61p in October. Analysts expect the company to grow its loan book to £40m by 2016 and, as flagged in September’s final results (‘Funded for growth’, 23 September 2013), 1pm is investing heavily in sales, marketing and underwriting staff to support this anticipated growth over the next three to four years. The company is also investing in new IT systems and has recently moved to larger premises in Bath which will enable it to continue to expand the business and recruit additional staff.
Reflecting the £800,000 of additional costs to be incurred over the next few months, as previously flagged, analysts expect pre-tax profits will be flat at £1.3m in the financial year to end May 2015, based on a 28 per cent rise in revenues to £5.4m However, clearly underlying profit growth is strong once adjusting for the investments being made, and this positive trend is expected to continue: based on an increase in revenues to £8.9m in the year to end May 2016, inline with anticipated growth in the loan portfolio, analysts anticipate pre-tax profits of £2m, EPS of 4.4p and a dividend of 0.7p a share. The forecast is for a maiden dividend of 0.3p a share in the current fiscal year.
Importantly, 1pm operates in area where there is a supply-demand imbalance due to the unwillingness of the banking sector to provide adequate funding, something that is unlikely to change which underpins the business case. And with the shares trading on 12.5 times prospective earnings, the rating is attractive given the growth prospects.
The shares are also massively oversold with the 14-day relative strength indicator below 20, so both from a technical and fundamental perspective the risk looks skewed to the upside. My immediate target is the autumn high of 70p, and beyond that the June high of 89p. Medium-term buy.
Dressed for success
I feel the share price derating of clothing retailer Moss Bros (MOSB:79p) is way overdone. To recap, I have been a fan of the company for some time having first advised buying the shares at 39p (‘Dressed for success’, 20 February 2012). They subsequently hit my fair value price range of 120p to 130p (‘A chic performance’, 28 May 2014), a level from which they have fallen steadily for the past six months.
This is at odds with an update from the company that confirmed robust trading: like-for-like sales were up 7.8 per cent in the first 19 weeks of the second half; retail sales have benefited from new products and the launch of sub brands – Moss London, Moss 1851 and Moss Esquire; and the store refurbishment programme continues to boost sales. Since January, 14 stores have been refurbished as part of the ongoing refit programme which means 56 of Moss Bros’ 131 stores trade in the new format. Refurbished stores immediately deliver a sales increase of between 8 and 10 per cent in the first year, and outperformance in the second and third years too, so the investment makes commercial sense. And with Moss Bros generating annual cash profits of around £9.5m, the business has ample fire power to fund the ongoing programme: net cash of £20m is the equivalent of 20p a share.
Importantly, the board are “confident in the outlook for the full year” which points to another positive update in mid-January. Ahead of that analysts are predicting full-year pre-tax profits of £4.5m, EPS of 3.5p and a dividend of 5.5p. On this basis, the shares offer an attractive a prospective dividend yield of 7 per cent. A rating of 16 times cash adjusted earnings may seem full, but with non-cash depreciation and amortisation charges accounting for £5m of the company’s £9.5m cash profits, a more appropriate valuation measure is to adjust for cash on the balance sheet and compare Moss Bros’ enterprise value with its cash profits. On this basis, its equity is being valued on just six times cash profits. For a business that’s rewarding shareholders with a bumper dividend and one accounting for half those cash profits, such a rating is too low in my view.
For good measure, Moss Bros’ shares are now massively oversold – the 14-day relative strength indicator is in the mid 20s – and the price has retreated back to January’s important break-out point (76p), a level from which it then rallied strongly to that 126p high in May. From my lens, the risk is to the upside and I would be exploiting the weakness ahead of January’s trading update. Buy.
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