The board’s investment strategy is to acquire assets, restructure them to improve efficiency, and then sell them on to release the hidden value in the balance sheet. It’s a similar business model to FTSE 250 industrial group Melrose Industries (MRO:401p), albeit Avingtrans is only a fraction of the size and at a much earlier stage in its development. But the company is building up a fine track record, having sold off its industrial division Jenatec to Kuroda of Japan for £13.75m in 2012, and reinvested the proceeds in developing its aerospace, energy and medical divisions.
That disposal was definitely worth doing because under the leadership of chief executive Steve McQuillan, finance director Stephen King and chairman Roger McDowell, who between them own almost 11 per cent of the shares, the company subsequently built up its aerospace unit into a business that’s expected to deliver operating profit of £4.6m on revenues of £41.6m in the year just ended. And having achieved all its strategic goals, Avingtrans announced the sale of the aerospace business for £65m a couple of months ago to funds controlled by European private equity firm Silverfleet Capital Partners LLP. After accounting for debt and working capital adjustments, the exit multiple equates to two times net asset value and 14 times operating profit to enterprise value, a very decent price in my view. Avingtrans is likely to book a profit of around £27m on the disposal, a significant sum in relation to its net assets of £34.8m at the last balance sheet date.
The sale completed at the end of May and means that the company currently has net funds in excess of £47m which matches its current market value. The plan is to return £28m to shareholders through a tender offer worth 100p a share, full details of which will be announced at the time of the full-year results in September, and reinvest the rest in both new acquisitions and its existing energy and medical businesses. This will still leave the board with £19m, or 68p a share to invest.
The point being that at the current price we are getting Avingtrans’ remaining operations in the price for free even though trading prospects are underpinned by a number of large contract wins. There are also decent prospects of earnings accretive acquisitions being made to drive a re-rating especially as the company is in the enviable position of being cashed up in an environment where deals are likely to be executed at keen prices.
Growth potential
Earlier this year, Avingtrans energy and medical division diversified into the materials technology market, winning a three-year contract worth £3.5m to provide composite components for airport scanners with Rapiscan, a leading security screening provider based in California. It’s a well timed move.
Under the terms of the agreement, Avingtrans is providing key components for Rapiscan's new and ground-breaking airport scanner, the RTT110 (Real Time Tomography), the first scanner to successfully pass the European Civil Aviation Conference's (ECAC) Standard 3 threat detection test for baggage-borne explosive risks - a standard that will become compulsory for airports around the world by 2020. Security is a real challenge for airports as passenger numbers increase around the world but, until now, this increase has not been matched by advances in security risk detection technology. However, this supply contract means that production can be scaled up to meet fast-growing demand. The atrocious events at Istanbul international airport this week can only increase calls for greater security at airports to detect explosive devices.
In addition, Avingtrans’ Stainless Metalcraft subsidiary has signed a framework agreement worth £1m a year with Bruker BioSpin AG, a Swiss based market leader in analytical magnetic resonance instruments, to produce high integrity cryostat components for Bruker's Nuclear Magnetic Resonance systems (NMR). NMR spectroscopy complements other structural and analytical techniques, such as X-ray, crystallography and mass spectrometry and can be used alongside MRI related technology to provide multidimensional images and spatially resolved information. The company will work closely with Bruker to develop a fully value-engineered solution for the components for their NMR programmes, ensuring all procedures and processes are firmly established, before transitioning the work to its Chinese site. This will not only generate additional cost savings, but bring te manufacturing closer to end customer locations.
And that’s not the only important deal Metalcraft has pulled off as just over 12 months ago it secured a 10-year contract with Sellafield, worth £47m, to provide waste storage containers for the Cumbrian nuclear power station. Phase one of the project is worth between £5m and £8m over a two to three year period and covers the set-up and development of a production facility for nuclear waste storage containers. During the second phase, the facility will produce 1,100 of these three-meter-cubed storage waste containers over a period of seven years.
It was a landmark contract for Metalcraft and Avingtrans’ management rightly describe the potential for the company in nuclear decommissioning as “a cracking opportunity”. I would agree because the first tranche of the three-meter-cubed waste containment vessels contract represents just 10 per cent of the potential business Avingtrans could win at Sellafield. That’s because the nuclear power station will need more than 40,000 of the vessels over the next 20 to 30 years, according to chairman Roger McDowell. Furthermore, analysts at finnCap believe that Sellafield represents only half of the potential UK nuclear decommissioning opportunity.
Proftitable growth to drive re-rating
True, it’s not all plain sailing and the downturn in the oil and gas markets has impacted the business which is why the energy and medical division posted an operating loss of £170,000 on revenues of £8.3m in the first half to end November 2015. However, expect a return to profit in the second half. Moreover, with the benefit of the new contracts, analyst David Buxton at brokerage finnCap expects the company to turn in a pre-tax profit of £300,000 on revenues of £24.3m in the 12 months to end May 2017, rising to pre-tax profits of £1.4m on revenues of £31.1m the following year when the Sellafield contract really kicks in.
The point being that the three aforementioned contracts offer solid revenue visibility which in turn gives investors reassurance that the company will hit those profit estimates. And this is clearly not in the price given that the ongoing businesses are being attributed no value whatsoever in the current share price even though they are expected to generate EPS of 8.2p in the financial year to end May 2018.
Furthermore, as the £19m of low yielding cash retained by the company is deployed on profitable earnings enhancing acquisitions in the energy and high value engineering sectors, then there is scope for the shares to re-rate sharply as any bolt-on deals will boost EPS. It’s also worth noting that the company’s central overheads and head office costs of £1.4m are factored into the above profit forecasts, so there is additional scope for cost savings from the acquired business by removing duplicated head office costs.
Sum-of-the-parts valuation
The fact that Avingtrans is forecast to book a profit on disposal of around £27m on the sale of its aerospace division, in addition to a post tax profit on discontinued operations of £2.6m in its full year accounts to end May 2016, is evidence of the significant value its management team have created here. Indeed, I reckon that the company’s proforma net asset value at the end of May 2016 is around £64m, up by around £29m on the end November 2015 interim balance sheet date.
On this basis, I estimate spot net asset value per share at about 232p, of which net cash equates to 169p. So not only are we getting a free ride on the energy and medical divisions, even though they have some exciting contracts in place which have transformed trading prospects, but retained businesses have a net asset value of around 63p a share. And they would be hardly overvalued at that level given it equates to less than 8 times post tax earnings for the financial year to end May 2018. Add to that prospects of a substantial capital return which should focus investors minds on the value on offer here and there is substantial upside to my 230p a share estimate of fair value.
Trading on a bid-offer spread of 168p to 170p at the opening this morning, I initiate coverage on Avingtrans’ shares with a strong buy rating.
