There are sound reasons to believe that Software Radio should be able to beat the house broker’s estimates too. That’s because a few months ago the US Coast Guard (USCG) published new regulations which require more commercial vessels operating in US territorial waters - such as fishing boats, tugs, and ferries - to install and operate a USCG-certified AIS transceiver by the end of April 2016. Some categories of vessels are required to install a Class A type transceiver and others an AIS Class B type device. AIS is an international maritime tracking and monitoring technology developed by the International Electrotechnical Commission (IEC) under the auspices of the International Maritime Organisation (IMO), and which has become the technology of choice to enhance maritime domain awareness across the world. In particular, the technology is used for vessel tracking; anti-collision; search and rescue; waterway, port and coast security; pollution monitoring; and fisheries management.
The key here is that failure by owners of vessels navigating through US waters to install these AIS transceivers will invalidate their insurance, so there are strong reasons to support Mr Tucker's expectations of an uptick in demand for his company’s USCG certified Class A and Class B transceivers from customers addressing the US commercial boat market. The USCG mandate covers between 12,000 to 17,000 boats, and with Software Radio selling its kit to distributors for $1,000 (£646.90) a pop, then even if the company only captures a small slice of this particular market then it could generate a significant amount of revenue in the current financial year.
Potential to ramp up revenues
It’s worth noting too that sales of Software Radio’s AIS ‘Aids to Navigation’ (AtoN) products trebled to £400,000 in the last financial year. AIS AtoN's are fitted to buoys that mark wrecks, rocks and navigation channels to guide shipping safely around hazards. Due to the nature of this market where the end user can range from an operator of a wind farm, a port, a waterway authority or a private marina, the quantity of opportunities is large and diverse with individual sales values ranging between £1,000 and £200,000.
It’s lucrative as average gross profit margins are in excess of 80 per cent, much higher than the company’s normal gross margin of around 50 per cent. Importantly, having developed its product offering over the past three and a half years, and invested in sales and marketing to educate the end market, Software Radio is now at an inflexion point where it not only has the best product in the market, but also has sales channels in place to exploit. Mr Tucker believes there is potential to generate “millions” in sales from this segment over the next 12 months or so. It wouldn’t be difficult as each unit is sold by Software Radio for around $2,000.
Even more lucrative could be the contract just landed for an initial order for the company’s Class A transceivers and GeoVS data management and viewing system that is worth US$290,000 (£190,000) from a national authority in the Middle East. The acquisition of GeoVS in October 2013 and subsequent investment in a series of professional maritime data-management and viewing products have enabled the company to provide customers with the capability to display, manipulate and manage the AIS data transmitted by its transceivers. The Middle Eastern country in question has been working towards implementing a project which will require up to 5,000 local vessels to fit an AIS transceiver over the next two years. Software Radio and its regional partner have worked closely with the national authority over a three year period to assist in the development of their maritime domain awareness plans. Potentially, if this initial contract is extended, as would be a sensible assumption to make, it could generate between $5m to $6m in revenues over the next couple of years, according to Mr Tucker.
Funded for growth
Clearly, if sales take off as forecast, then Software Radio will need to be able to fund the flood of new orders. Bearing this in mind, the company has inventories on its balance sheet with a book value of £5m, but a resale value of £15m once contracted to firm orders. In other words, cash generation from new sales is likely to be robust as stocks are converted into cash. That’s important because having tapped shareholders for £1.5m in a placing at 18p a share last July, and with cash of £2.1m on its balance sheet at the end of March 2015, excluding a £1m loan, then the company should be funded to meet its working capital needs without having to tap shareholders again.
Moreover, with gross margins of 50 per cent of sales, then in effect 50 per cent of incremental orders fall straight down to the bottom line given that administration costs are fixed at around £5m. Product development and capital expenditure is likely to be around £1.6m this year. Or put it another way, given that WH Ireland has not factored in any sales from Software Radio’s pipeline of over 40 large vessel monitoring project opportunities, of which a subset of 21 worth up to a potential £200m in revenue are sufficiently mature to be included in its validated sales pipeline, then if only one of these contracts converts into a firm order then the company’s sales and profits would soar. To put this into perspective, analyst Eric Burns at WH Ireland predicts that revenues of £12m in fiscal 2016 would generate pre-tax profits of £700,000, highlighting the high operational gearing of the business.
But that only tells part of the story as Software Radio generated cash profits of about £1.3m last year, before deducting a £120,000 non-cash depreciation charge and amortisation costs of about £1.5m. So if the company hits the £10m revenue forecast for the 12 months to end March 2016, then it would make cash profits of £1.9m, rising to cash profits of £2.7m if turnover were to hit £12m. In other words, with cash profits ramping up sharply, and stocks being converted into cash, then there is scope for the company to increase its cash pile significantly. Indeed, analysts predict net funds will rise from £1.1m to £1.7m by next March.
Target price
Having initiated coverage on Software Radio’s shares at 31.25p (‘On the radar’, 3 March 2015), and reiterated the advice when the shares were 32p ahead of yesterday’s results (‘Decision time’, 16 April 2015), I continue to rate them a speculative buy on a bid-offer spread of 28p to 29p and maintain a target price of 40p-43p, implying a value of the equity of £50m-£54m - a valuation that would be justified if the company can significantly ramp up its annualised revenues in the coming year, and beat analysts’ earnings estimates. Speculative buy.
On a growth trajectory
Shares in Aim-traded software company Sanderson (SND:69p), a specialist in multichannel retail and manufacturing markets in the UK, have been marking time since my last update (‘Tapping into e-commerce profits’, 4 March 2015), but yesterday’s interim results can only have reinforced the investment case. Having initiated coverage when the price was 33.5p ('A valuable stock check', 18 July 2011), I have no reason at all to change my positive stance.
The company increased underlying pre-tax profit by 13 per cent to £1.37m on revenue up 14 per cent to £9.1m in the latest six-month trading period, and with second-half trading well supported by an order book of £2.84m, up from £2.1m at the fiscal year-end, the company is well on course to grow full-year pre-tax profits by almost 15 per cent to £3.1m as analyst Michael Donnelly at Charles Stanley Stockbrokers predicts. On this basis, expect adjusted EPS of 4.7p, up from 4.4p in fiscal 2014, and a dividend of 1.9p a share at the very least. The interim payout was raised by 12.5 per cent to 0.9p a share, so the 1.9p a share full-year forecast only assumes a held final payout of 1p a share which seems far too conservative to me. In any case, this means the shares are priced on a reasonable 15 times forward earnings estimates and offer a 2.9 per cent prospective dividend yield.
To put the rating into perspective, small-cap software companies in the same universe, Tracsis (TRCS:440p) and Craneware (CRW:670p), are both rated on around 27 times fiscal 2015 earnings estimates. Moreover, Sanderson has a cash-rich balance sheet as net funds equate to 7p a share which means the cash adjusted forward PE ratio drops to only 13. The company’s prospective dividend yield is five times greater than the average for the FTSE Aim technology index too.
Solid business proposition and sound management team
Furthermore, the company has a tendency to be overly cautious in its outlook statement, albeit siding towards “optimistic”, which in the case of this latest set of results masks what is a very long list of sales prospects. Indeed, Sanderson’s multi-channel retail division has continued to gain a number of large orders from existing customers including JD Sports, Kingstown Associates, Healthspan and Superdry. Five new clients were signed up in the period too. Divisional revenue shot up by a quarter to just shy of £6m, or two thirds of the total, to drive up the unit’s operating profit by a fifth to £1m. The period end order book had risen by 50 per cent to £1.8m, leaving the business “well placed to achieve its increased trading targets for the financial year”.
True, the company’s manufacturing business put in a flat showing, reflecting some delays in orders from the food and drinks segment of the business. But the general manufacturing unit improved its trading performance and this trend has continued into the second half. The board now expect growth from this division for the full-year.
It’s worth noting too that Ian Newcombe, who has made a major contribution to the company’s strategy and who has personally driven the development of the multi-channel operations as managing director of that business, has been appointed as chief executive with immediate effect. It’s a logical step, as is the re-appointment of David Gutteridge as a non-executive director. He knows the company very well having been on the board until three years ago.
Ultimately, the investment case for Sanderson is all about the company’s ability to continue to develop a range of solutions to enable its customers to boost their sales and revenue while achieving additional savings, often within 12 months of implementation. Particular emphasis has been placed on businesses specialising in the UK food and drink processing sector, and more especially in the development of mobile commerce solutions which enable retailers to capitalise on the growth of smartphones and tablets, and exploit mobile as a sales channel integrated with existing business systems. The m-commerce part of the business is a hot space to be operating in. But with the shares rated on a modest 13 times cash adjusted earnings estimates, these growth prospects are simply not reflected in its current modest valuation.
Offering around 20 per cent upside to the top of my 80p to 85p fair value price range, I continue to rate the shares a buy on a bid-offer of 66p to 69p. Buy.
On the crest of another run
Shares in small-cap marketing communications company Creston (CRE:135p) have reacted positively to yesterday’s full-year results and have passed through my original target of 135p, a price level that was also achieved at the end of last year after I initiated coverage at 118p in the late autumn (‘Buy the break out’, 4 November 2014).
However, I still feel that a run up to the 150p level is on the cards as I noted when I last updated the investment case (‘On the acquisition trail’, 23 April 2015). If this target is achieved the rating would still only be 10.5 times conservative looking EPS estimates of 14p for the fiscal year to end March 2016 based on forecasts from brokerage N+1 Singer. For the fiscal year just ended, the company delivered 11 per cent EPS growth and diluted earnings of 13p a share beat analyst expectations by around 4 per cent. In turn, this supported an 8 per cent hike in the dividend to 4.2p a share. A further hike to 4.7p is predicted this year to give a prospective dividend yield of 3.5 per cent.
At the end of March the company had an £8.3m cash pile, since when the board have been deploying these funds wisely. In April, the company acquired a 51 per cent stake in How Splendid, a London-based digital design and development consultancy, a deal which I analysed in depth at the time (‘On the acquisition trail’, 23 April 2015), and has just announced another strategic investment alongside yesterday’s results: a 27 per cent stake in 18 Feet & Rising, a London based advertising agency.
Established in 2010, 18 Feet & Rising works with brands including Allianz, Cuprinol, Nando's, House of Fraser and ŠKODA, for which they created the world's first ad campaign to use eye-tracking technology. Half of the £1m cash consideration will be invested in the business to help accelerate its growth. In 2014, 18 Feet & Rising grew revenue by almost a quarter to £2.7m, so the business is being valued on a reasonable 0.7 times’ sales. This means that Creston has now deployed virtually all its net cash after the period end, but with annual operating cashflow of around £8.6m and credit lines of £35m in place, the company is well funded.
The bottom line is that with the company posting organic revenue growth for the first time in four years, and utilising its cash position wisely, then investors are likely to continue to warm to the strong investment case which I outlined when I initiated coverage at the end of last year.
Offering a further 11 per cent share price upside to my new target price of 150p, and underpinned by a 3.1 per cent historic dividend yield, I continue to rate Creston’s shares a buy on a bid-offer spread of 133p to 135p.
Tristel wipes to clean up
I only reassessed the investment case a week ago on Tristel (TSTL:92p), a maker of infection prevention, contamination control and hygiene products, but another update is warranted in light of a study by Cardiff University that has been published in American Journal of Infection Control. The academics concluded in their study that commercially available detergent wipes are inconsistent in their ability to remove spores of bacteria from hospital surfaces following a 10 second wipe.
This is a significant announcement and is highly supportive of Tristel's range of infection prevention products for hospitals that have been developed specifically to disinfect medical instruments, using a proprietary chlorine dioxide chemistry that is clinically proven to be effective against the most common bacteria, micro-bacteria, viruses and fungi as well as being effective at a sporicidal level. This chemistry has been applied to Tristel's range of surfaces products so that the same effectiveness can be achieved on hospital surfaces, the area that the Cardiff University study shows to be ineffectively cleaned when only detergent wipes are used.
Paul Swinney, chief executive of Tristel, points out: "There is a huge difference between our proven disinfectant chemistry, which is commonly used in the majority of UK hospitals to clean key medical instruments, and the simple detergent wipes that have been shown by this study to be inconsistent in killing superbugs such as MRSA or C. difficile.” Mr Swinney also adds that the study highlights the very issue that his company addresses every day in its engagement with hospitals, which is “the need to step up surface cleaning from regular detergents to a more powerful disinfectant that is effective against tackling some of the deadliest hospital acquired infections”.
In my opinion, this news can only be supportive of Tristel’s investment case (‘Hitting target prices’, 2 June 2015). So with the shares trading on 17 times cash adjusted earnings estimates, and underpinned by a 3 per cent prospective dividend yield, I feel a price move towards the 110p target of research firm Equity Development is quite possible especially if the company delivers yet more earnings upgrades.
On a bid-offer spread of 90p to 92p, I would continue to run your healthy profits. Please note that I first advised buying Tristel shares at 60p (‘Clean up on superbugs’, 6 May 2014).
MORE FROM SIMON THOMPSON...
At the end of April, I published an article with all the share recommendations I have made this year. Since then I have published articles ona further 40 companies:
■ Marwyn Value Investors: Buy at 220p, target price 260p ('Exploiting a value play', 5 May 2015)
■ Pure Wafer: Buy at 113p, target 140p to 150p; Paragon: Run profits at 440p, but buy on a confirmed breakout above the 445p and new target of 500p; 600 Group: Buy at 16.5p, target 24p; Fairpoint: Buy at 127p, target 190p; AB Dynamics: Buy at 207p, target 230p ('Repeat buy signals', 11 May 2015)
■ Globo: Buy at 56p, target 69.5p; Greenko: Hold at 70p; Pittards: Buy at 128p ('Breakout looms for mobile wonder', 12 May 2015)
■ Macau Property Opportunities: Buy at 214p; Dragon-Ukrainian Properties & Development: Hold at 28p; Raven Russia: Hold at 53p ('Overseas property plays', 13 May 2015)
■ Trakm8: Run profits at 135p; Redde: Buy at 120.75p, target 140p; STM: Run profits at 45p, but conditional buy on close of 48p and new target of 60p ('Smashing target prices', 14 May 2015)
■ Bilby: Buy at 75p, target 100p ('Buy to build' growth play, 18 May 2015)
■ Bioquell: Buy at 148p, target 170p to 185p; Somero Enterprises: Buy at 140p, target 185p; KBC Advanced Technologies: Buy at 109.5p, target 165p; Inspired Capital: Hold at 14.25p ('Three value plays', 19 May 2015)
■ Renew Holdings: Buy at 315p, target range 350p to 375p; Manx Telecom: Buy at 198p, target 210p ('Renewing old acquaintances', 20 May 2015)
■ Marwyn Value Investors: Buy at 228p, target 260p; Charlemagne Capital: Hold at 13.5p; Bloomsbury Publishing: Hold at 178p ('Lights, camera, action', 21 May 2015)
■ Anite: Buy at 91.5p, target 110p ('Testing a breakout', 26 May 2015)
■ Character Group: Buy at 415p, target 525p ('Playtime', 1 Jun 2015)
■ Tristel: Run profits at 96p; Pure Wafer: Buy at 123p, target range 140p to 150p; Crystal Amber: Buy at 153p ('Hitting target prices', 2 Jun 2015)
■ B.P. Marsh &Partners: Buy at 150p, target range 170p to 180p; Moss Bros: Buy at 110p, target range 120p to 130p; SeaEnergy: Sell at 15p ('Exploiting a valuation anomaly', 3 Jun 2015)
■ Globo: Buy at 59p, target 69.5p; London & Associated Properties: Buy at 38.5p; Greenko: Hold at 44p ('Catalysts for share price moves', 4 Jun 2015)
■ Burford Capital: Buy at 148p, target 190p ('Legal eagles', 8 Jun 2015)
■ Market strategy ('Financial Market Watch', 9 June 2015)
■ 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 £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
