Of course there have been losers along the way too, as is the nature of investing in the stock market, but the gains on the winners have more than compensated for investments that have failed to live up to my expectations and provided the financial rewards to warrant pursuing the value orientated investment strategies I favour.
On the right track
A great example of this is Aim-traded AB Dynamics (ABDP: 390p), a UK designer, manufacturer and supplier of advanced testing systems and measurement products to the global automotive industry. It was well below the radar of most investors when I spotted the investment potential in February last year and included the shares in my 2015 Bargain shares portfolio. My rationale for making the investment was pretty simple: the shares were rated on 11.5 times cash-adjusted earnings estimates at the time and offered a prospective yield of 1.7 per cent even though the earnings risk looked firmly skewed to the upside, driven by ongoing demand from a resurgent car industry, and a robust order book.
The fact that AB Dynamics’ share price has surged by 125 per cent in the subsequent 13 months tells a story. Not only did the company completely obliterate analysts’ estimates for the 2015 financial year (August year-end) with pre-tax profit soaring by over 40 per cent to £3.8m, an outcome that was £1m ahead of market estimates when I initiated coverage, but the business still looked firmly in an earnings upgrade cycle driven by its track-testing systems division. This unit includes driving robots and soft crash vehicles and accounts for almost 70 per cent of revenues.
Moreover, when I updated the investment case at the start of February, I concluded that it was only reasonable to expect these positive trends to continue given the upbeat comments in third quarter results from the world’s fourth-largest tyre maker, Continental AG. At the time analysts at Panmure Gordon predicted that AB Dynamics’ track-testing systems, soft crash and robots, will deliver revenue growth of 13 per cent in the 12 months to end August 2016 and account for almost £13m of their current year revenue estimate of £18m, up from £16.5m in the 2015 financial year. This means that AB Dynamics would only need to maintain revenue from laboratory testing and its much smaller measurement and analysis unit to grow operating profit from £3.74m to £4.4m and deliver EPS of 20.3p as Panmure forecasts.
A pre-close trading update at the end of last week highlighted that the company is actually trading modestly ahead of the house broker’s upgraded estimates, reflecting increased industry investment in new car models with a focus on advanced safety systems, and strong sales of both track and lab testing products. AB Dynamics also announced a strategic partnership with Williams Advanced Engineering, the technology and engineering services business of the Williams Group, to bring novel vehicle dynamic simulators to the global automotive sector. This is an exciting collaboration and one that combines Williams' expertise in F1 simulators and high speed dynamic motion platforms, with AB Dynamics' industry knowledge, manufacturing capabilities and sales channels.
This news has not been lost on investors which explains why the share price has risen by 26 per cent since I updated the investment case in February and now trades on a far more reasonable 19 times Panmure’s earnings estimates. However, strip out net funds of 48p a share, and the cash adjusted forward PE ratio drops to 16.5. That still doesn’t look too punchy to me given that the risk to earnings remains skewed to the upside. In fact, I wouldn’t discount the possibility of analyst upgrades when the interim results are published on Tuesday, 26 April.
In the circumstances, and given the strong industry drivers supporting demand for AB Dynamics’ track testing equipment, not to mention the potential upside from the strategic partnership with Williams, I recommend that you run your 125 per cent gain ahead of the next trading update. Run profits.
Bilby’s smart bolt-on buys
One of the reasons I like focusing on small cap shares is that more often than not there is a lack of analyst research, thus enabling private investors to assess the merits of businesses and gain an edge to exploit.
A prime example of this is Aim-traded Bilby (BILB:128p), a provider of gas heating appliance installation and maintenance services to residential and commercial properties. The company listed its shares on the junior market exactly a year ago with a view to using its paper to grow the business through acquisition and complement the organic growth in its existing operations. The upside from this ‘buy-to-build’ strategy and the strong dynamics underpinning demand in this niche business area are the key reasons why I initiated coverage on the shares at 75p ('Buy-to-build' growth play, 18 May 2015).
I have followed developments closely ever since as contract wins have been announced and acquisitions made. I subsequently upgraded my target price to 120p ('Acquisitions drive earnings upgrades', 17 July 2015), and raised it again to 160p when the shares were trading at 132p at the end of last year ('Bilby set for new highs', 10 December 2015). A month later the share price hit an all-time high of 175p before profit taking set in. However, if my analysis proves prescient then I think there is a very good chance of revisiting that high point.
Firstly, the good news keeps on flowing. In a pre-close update, the company confirmed that trading is in-line with Panmure Gordon’s estimates for the financial year to end March 2016. The house broker’s forecasts suggest pre-tax profit will rise by more than half to £3.1m on revenues of £32.6m and deliver EPS of 7.2p, a performance reflecting both strong organic growth and the contribution from last summer's earnings-accretive acquisition of Waltham Abbey-based privately-owned property services business Purdy. The bolt-on purchase expanded Bilby's services and geographical scope from its core gas maintenance installation and building maintenance services speciality into new areas of heating, building and complementary electrical services in neighbouring boroughs in north east London.
Prospects for another year of growth look well underpinned by a lucrative gas support contract for the South East Consortium (SEC), a group of housing associations responsible for over 140,000 homes in the region, which Bilby announced last autumn. I also understand that more than 90 per cent of Bilby's contracts are from customers who have employed the company in the previous 12 months, so there is a high level of repeat business which improves the quality of its revenue.
Reflecting the full benefits of contract wins and acquisitions, analyst Michael Donnelly at Panmure had pencilled in another 50 per cent plus rise in pre-tax profits to £4.9m in the financial year to end March 2017 to deliver a sharp increase in EPS from 7.2p to 11.3p. However, we can now expect significant upgrades to these estimates after Bilby announced two important earnings enhancing acquisitions at the tail end of last week.
Number crunching points to hefty upgrades
The first one is DCB, a provider of building, refurbishment and maintenance services to housing associations and local authorities throughout Kent, Sussex, Essex and London. DCB also provides disabled adaptations to occupied homes and public buildings through a specialist division, Living Solutions, which was founded in 2001.
The second acquisition is Spokemead, a 35-year old firm that specialises in electrical installation, repairs and maintenance services to local authority owned housing stock. It has been the principal contractor for a major London borough for the electrical installation, repairs and maintenance for some 25 years.
Bilby is paying a maximum consideration of £4m for DCB and £8.7m for Spokemead, but the terms of the earn-outs are very revealing. For DCB, the initial consideration is £2m of which £500,000 is being settled through the issue of shares, and an additional £1m (split equally between cash and shares) only becomes payable if DCB’s pre-tax profits hit £650,000 or more for the 12 months to end March 2016. The other £1m of deferred consideration is based on DCB’s revenue performance in the 2017 and 2018 financial years.
For Spokemead the initial consideration is £5.7m in cash and £500,000 in shares. An additional £1m of cash consideration is subject to the business achieving at least £1.1m of pre-tax profits in the year to end June 2016; a further £1m of the earn-out is dependent on profits hitting at least £1.6m in the following financial year; and £500,000 is payable to the vendors on the renewal or continuation of certain key contractual agreements.
These earn-out terms look well structured to me and will act as a major incentive for the existing management to maximise profits of the businesses they are selling. I would also point out that both DCB and Spokemead will expand the range of services that Bilby offers, as well as broadening its customer base and geographical reach in London and the South East. They will continue to operate under their respective brands and will also benefit from the increased purchasing power and strong financial position of being part of a larger entity.
In my opinion, the acquisitions should help the company tap into the increasing business opportunity in servicing the needs of housing associations and local authorities in London and the South East markets as these bodies seek to comply with government legislation such as the Right to Repair and the Decent Homes Standard. They are sensibly financed deals too.
In order to fund the £7.2m initial cash consideration Bilby has placed 4.23m new shares with institutions to raise £5m at a price of 118p, of which Miton Asset Management has taken 2.3m shares. The net effect of the placing and the new shares being issued to the vendors means that Bilby’s issued share capital rises from 34.2m shares to 39.3m shares, but if DCB and Spokemead can hit those first year earn-outs then it could add £1.75m to Panmure Gordon’s previous pre-tax profit estimates of £4.9m for the 12 months to end March 2017. Using a normalised tax charge, I reckon EPS estimates will rise from 11.3p to around 13p, a 15 per cent upgrade, and a hefty 80 per cent higher than net earnings in the year just ending.
Target price
This means that Bilby’s shares are only being rated on 10 times my estimate of the likely net earnings the company should be able to report in the new financial year to end March 2017. Panmure has yet to release its new forecasts.
Moreover, with the company’s balance sheet relatively ungeared – I reckon net debt will be around £6m on completion of the acquisitions, or 36 per cent of proforma shareholders funds of £16.7m – then there is scope for decent dividends too. Panmure was previously forecasting a well covered payout of 2.8p a share for the year to March 2016, rising to 3p in the 2017 financial year. On this basis, Bilby’s shares offer an attractive 2.3 per cent dividend yield.
I would also flag up that another effect of the placing is that it increases the free float by reducing the stake of founder and deputy executive chairman Phil Copolo to 30 per cent from 52 per cent when the company floated 12 months ago. Furthermore, with a market capitalisation of £50m, up from £17m at the time of listing on Aim, Bilby is now of interest to small cap funds.
Offering 36 per cent upside to my new target price of 175p, equating to 13 times likely earnings for the 2016/17 financial year, I rate Bilby’s shares a strong buy ahead of imminent analyst upgrades and the full-year results. Buy.
Please note that I have published 21 columns in the past fortnight, all of which are listed below.
MORE FROM SIMON THOMPSON...
I have written articles on the following companies recently:
■ Plethora Solutions: Take profits at HK$0.079 ('On the takeover trail', 14 Mar 2016)
■ Somero Enterprises: Buy at 150p; target 185p ('A solid buy', 15 Mar 2016)
■ 32Red: Run profits at 150p ('32Red in the money, 15 Mar 2016)
■ Communisis: Sell at 44p ('Patience running short at Communisis', 15 Mar 2016)
■ Global Energy Development: Sell at 27p ('Global Energy plays waiting game', 15 Mar 2016)
■ Raven Russia: Sell at 30p ('Raven Russia battens down the hatches', 15 Mar 2016)
■ Stadium: Buy at 122p, new target price 150p ('Switch on for bumper gains', 16 Mar 2016)
■ French Connection: Buy at 42.75p ('Return to profitability looms for chic operator', 16 Mar 2016)
■ Fairpoint: Run profits at 159p ('Fairpoints to make', 17 Mar 2016)
■ Netplay TV: Buy at 10p ('Netplay's shares spin higher', 21 Mar 2016)
■ Satellite Solutions Worldwide: Buy at 5.5p, target 9p to 10p ('Blue sky tech play', 21 Mar 2016)
■ Miton: Buy at 30.5p, new target 38p ('Riding earnings upgrades', 22 Mar 2016)
■ Inland: Run profits at 86p, new target 95p ('Valuation surge boosts Inland', 22 Mar 2016)
■ Pittards: Crystallise loss at 71p ('Subdued demand hits Pittards', 22 Mar 2016)
■ French Connection: Buy at 43p ('Stakebuilding gathers pace at French Connection', 22 Mar 2016)
■ Safestyle: Run profits at 276p ('Exploiting a window of opportunity', 23 Mar 2016)
■ PV Crystalox: Speculative buy at 10p ('Lights start to glow at PV Crystalox', 23 Mar 2016)
■ Arbuthnot Banking Group: Buy at 1340p ('Banking on a banking duo',23 Mar 2016)
■ Cenkos Securities: Sell at 130p ('Cenkos profits slide', 23 Mar 2016)
■ Burford Capital: Run profits at 256p ('Legal eagle flying high', 24 Mar 2016)
■ 1pm: Buy at 62p, target 82p ('1pm's smart bolt-on buy', 24 Mar 2016)
■ 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
