Riding an earnings upgrade cycle
Shares in Aim-traded Getech (GTC: 61p), a geoscience company specialising in the provision of data, studies and services to the oil, gas and mining exploration sectors, have surged by a third since I initiated coverage a couple of months ago at 45p ('Exploit a share price break-out', 10 Feb 2015) and look well on course to hit my initial target price of 67p. That target price is now likely to prove too conservative in light of yet another multi-year award with a major national oil company under which Getech is contracted to provide basin evaluation services
This contract is for a three-year period with the client having the option to extend for a further two years. Getech is one of three companies contracted to provide basin evaluation services and it is anticipated that the client will offer several basin evaluation packages per year to these three companies through a tender process, and that the value of each package will, if won by Getech, "significantly affect the company's results". This news is highly supportive of the board's decision to continue to build its range of consultancy projects, but also to focus on a number of key clients which, individually, could be material to Getech's trading. In the second half of last year, the company announced two similar contracts including a $5m (£3.3m) contract with Angolan National Oil Company, Sonangol, the largest in Getech's history.
Analysts are holding fire on issuing any upgrades, but analyst Eric Burns at house broker WH Ireland notes that "assuming Getech receives its fair share of work under the agreement, there are clearly upward implications as the year progresses". For the current fiscal year to end-July 2015, Mr Burns predicts Getech will report full-year pre-tax profit of £2.3m on revenue of £9.3m to produce EPS of 5.9p, rising to pre-tax profit of £3m on revenue of £12m the year after. On that basis, expect EPS of 6.9p. These forecasts already include hefty upgrades following the acquisition of ERCL, a Henley-based company employing 26 consultants operating in the specialist upstream oil and gas sector (ercl.com), a deal I commented on just three weeks ago ('Buy-outs and bumper profits', 25 Mar 2015). But frankly those estimates could be blown out of the water if Getech lands its share of contracts in the tender, making Getech a pretty rare find in the oil and gas industry: a company that is clearly in an earnings upgrade cycle and one buoyed by growing interest in its product suite from national oil companies and from data sales in the US.
In the circumstances, it's hardly surprising that investors are warming to the investment case. In fact, the share price took out the 55p resistance level on the chart yesterday to issue both a point-and-figure and swing buy signal. It looks the real deal and points at the very least to a run up to the pre-oil price slump highs of around 71p dating back to last September. So rated on a lowly 7.5 times fiscal 2016 earnings estimates net of my calculation of pro-forma cash (9p a share), it's my firm view that Getech shares continue to rate a strong buy on a bid-offer spread of 59p-61p ahead of likely upgrades as the year progresses. In fact, I have upgraded my target price to 80p, or the equivalent of 10 times cash-adjusted earnings forecasts.
Blue-sky profits
Shares in small-cap UK defence company Cohort (CHRT: 280p) are now in blue-sky territory having rallied by a third since I advised buying them at 215p ('Blue-sky buy', 6 Oct 2014). True, they have yet to hit my six-month target price of 300p, but I feel it's only a matter of time given the company will be announcing another bumper set of financial results in little over two months' time.
I am not the only one thinking this way as analyst Roger Johnston at Edison Investment Research, who initiated coverage on the company in mid-January, has a sum-of-the-parts fair valuation of 310p a share, or the equivalent to 15 times 2015 calendar-year earnings estimates, a 10 per cent premium to UK defence peers. Analyst Chris Dyett at broker Investec has a slightly higher sum-of-the-parts fair valuation of 325p a share. Peter Ashworth at Charles Stanley Stockbrokers has a 300p a share earnings multiple-based target price supported by "the scope for profitable growth in the medium term as well as the visibility of the forward order book".
Such a rating is fully warranted in my view: underpinned by a record order book of £146m at last October's half-year end, and with the benefit of a strong order intake in the second half to the end of April 2015 and some shrewd-looking acquisitions last year, profit estimates look well underpinned. In fact, having already factored in an 18 per cent rise in pre-tax profit to £9.8m for the fiscal year to April 2015, based on a third rise in revenue to £96.2m, Mr Johnston predicts that order cover at the start of this year covered 50 per cent of his forecasts for the 2016 fiscal year. On that basis, expect revenue to rise by 12 per cent to £106m to drive up both pre-tax profit and EPS by 16 per cent to £11.4m and 21.5p, respectively.
Furthermore, with net funds forecast to rise from £6.7m last October to £8.5m at the end of this month, or the equivalent of 21p a share, the company is well funded to make further earnings-enhancing bolt-on acquisitions as chairman Nick Prest noted at the time of the half-year results. As and when these complimentary deals are done, expect further upgrades to the aforementioned profit estimates. It's worth flagging up too that the double-digit profit growth is also being driven by major contract wins, details of which I outlined when I last updated the investment case ('Armed for success', 23 Oct 2014), so there is an organic growth story here, too.
In turn, this robust growth profile is enabling Cohort's board to maintain a progressive dividend policy that has seen the payout double since 2010. Having hiked the payout by 14 per cent at the interim stage, the board are predicted to raise the dividend per share by almost 17 per cent to 4.9p at the time of the full-year results in June. And with profits on an upwards trajectory, expect a further increase in the payout to 5.5p a share in fiscal 2016. On this basis, the prospective dividend yield is 2 per cent with the payout almost four times covered. The forward PE ratio is 13 for fiscal 2016.
Clearly, there are some risks to consider, the most obvious being potential for a slowdown in UK defence spending in the aftermath of the forthcoming general election, which could impact some of Cohort's short-cycle business activities. That said, going into the election with an order book at record levels, and the full benefits of contract wins and last year's acquisitions clearly coming through, I feel that the next trading update will be pretty positive when the company announces its full-year results. Offering a further 8 per cent upside to my target price of 300p, the shares remain a buy on a bid-offer spread of 272p to 280p.
Spudding profitable gains
Shares in Aim-traded Faroe Petroleum (FPM: 86.5p), an independent oil and gas company primarily focused on exploration and production (E&P) opportunities in Norway and the UK, gushed up to within pennies of my 94p target price last week before succumbing to profit-taking. I initiated coverage when the price was 75.5p ('A slick operator', 6 Feb 2015) and subsequently reiterated the advice at 79.5p ('Buyouts and bumper profits', 25 Mar 2015). Of course, some investors will be more than happy to bank a 20 per cent gain within a couple of months especially in light of a volatile oil price environment conducive to trading holdings for short-term profits.
But there has been some positive news to justify the share price gains, too. Firstly, the company has just announced that the Skirne East exploration well 25/6-5S has been drilled to a total depth of 2,366 metres below sea level and revealed a preliminary resource estimate in the range of 3m to 10m barrels of oil equivalent (boe) gross (0.6m to 2m boe net to Faroe, which has a 20 per cent interest). The Skirne East discovery is located in the Norwegian North Sea on the northern part of the Utsira High approximately five kilometres from the Total-operated producing Skirne field.
There is scope for more positive exploration news too as Faroe's chief executive, Graham Stewart, notes that in the coming months drilling starts on the first of two follow-up wells at the significant Pil discovery (Faroe has a 25 per cent interest) on the Blink and Boomerang prospects in the Norwegian North Sea, and also the Bister prospect to follow up on the company's recent significant Snilehorn discovery located close to the producing Njord field infrastructure.
The bottom line is that this ongoing drilling campaign, which benefits from lucrative tax breaks from the Norwegian government, is in the price for free. That's because Faroe's risked production is valued by analysts at about 70p a share and the company also has net cash on its balance sheet worth 27p a share. That leaves a free carry on Faroe's risked development assets of 36p a share. So, with the shares trading on a 35 per cent discount to the core risked valuation of 134p a share, I feel there could be further share price upside if Faroe hits pay dirt in its forthcoming drilling campaign especially as the oil price appears to be in the process of forming a base formation. I am willing to bet on that possibility and a return to the 100p price level too which is my new target price. On a bid-offer spread of 86p to 86.5p, I rate Faroe shares a buy.
Gama shares hit turbulence
The Aim-traded shares of privately owned private jet operator Gama Aviation (GMAA: 255p), formerly Hangar 8, have proved volatile since I advised buying at 225p last year ('Ready for take-off', 12 May 2014). Having ascended to an all-time high of 375p ('Wired up for gains', 11 Nov 2014), I updated the investment case following the merger of Gama with Hangar 8 when the price was 330p and placed a target price of 400p ('Platforms for growth', 16 Dec 2014). The shares subsequently hit a new high of 381p at the end of last year and clearly some investors were happy with the return as this proved another turning point. In fact, the subsequent profit taking has been so severe that Gama's share price is now below the level institutions acquired holdings at in a placing which raised £14.2m at 280p for the company at the time of the merger.
Despite the weak share price performance since the turn of the year, the good news is that the company has reported trading in line with estimates from house broker Cantor Fitzgerald. Analyst Robin Byde still predicts the merged group's underlying cash profit will increase by around half to $20.9m (£14.3m) this year based on a low teens double-digit rise in revenue to $324m. The fact that the merged group is performing in line with those forecasts is important because Hangar 8's own pre-merger results showed a subdued performance in the final six months of 2014.
However, this needs to be put into some perspective as Hangar 8's performance in that period mainly reflects significant downtime for heavy maintenance on multiple aircraft, albeit this was planned, which had the double effect of reducing charter capacity and increasing the cost base on certain contracts while substitute aircraft had to be used. Clearly, this issue was temporary and so was the additional executive management time dedicated to the merger discussions in the final two months of 2014. Admittedly, the appearance of a near £2m doubtful debt in Hangar 8's accounts was wholly unexpected, and took me by surprise, and will have contributed to the harsh reaction to those half-year results.
However, I still feel that investors are failing to recognise that trading across the enlarged group in the current financial year (to the end of December 2015) has actually been strong. The Gama part of the business accounts for two-thirds of both revenue and cash profit so it is the much larger part of an enterprise which has around 150 aircraft under management, operating from 44 different locations in 15 countries including a strong presence in North America, Europe, Africa, the Middle East and Asia.
And there is clearly value in the shares as Gama Aviation's current market value of £110m is little more than the combined value attributed to the Gama part of the business (£90m) at the time of the merger, and the £14.3m of new funds raised for the merged company in that placing. In other words, investors are attributing little value at all to the Hangar 8 part of the business despite the fact this company had a standalone market value of £31m pre-merger. On an earnings basis, Gama's shares are now being rated on just 11 times likely post-tax earnings for calendar 2015, or a hefty 27 per cent below the support services average. That's harsh and if you followed my previous advice I would hold onto the shares for their recovery potential. Expect a pre-close trading update in the summer ahead of half-year results in September. Hold.
■ Simon Thompson's 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 stockpicking'
