KEH is a well established holding company for a group of businesses focused on the financial services, leisure and healthcare sectors. The business was set up in 2008 and is owned by a prominent Kuwaiti family. Interestingly, KEH purchased 6.03m shares, or 23.1 per cent of the 26.1m shares in issue at 140p yesterday, representing a significant premium to the previous market price.
I have been following the company for quite some time, having initiated coverage at 68p ('Broking for success', 1 Aug 2011), and last rated the shares a recovery buy at 94p (‘The inside view’, 2 Aug 2016). Clearly, a 28 per cent return in the space of seven weeks can’t be sniffed at, nor for that matter can a 76 per cent return on the holding since I initiated coverage, but with a buyer willing to pay a hefty premium to gain a foothold raises the question is whether an even higher valuation can be justified in due course? I feel it’s more than feasible.
That’s because even if one ascribes nil value at all to WH Ireland's corporate broking activities, and ignores the value in its advisory and execution-only mandates which have total assets under management (AUM) of £1.7bn, then net of £10m cash on the company’s balance sheet post the sale of its Manchester head office, discretionary AUM are in effect being valued at £26.5m, or 2.35 per cent of AUM. To put that sum in perspective, the price paid by Tilney BestInvest for Towry was around 5 per cent of AUM.
Analysts are of the same opinion too. For instance, John Borgars and Gilbert Ellacombe at equity research firm Equity Development believe WH Ireland's asset management business is worth around £57m, or 221p a share based on a valuation of 4 per cent of discretionary funds under management, 2 per cent for advisory and 0.5 per cent for execution-only. They have a sum-of-the-parts valuation of £62m, or 240p a share. That’s almost double the current share price.
Importantly, there are significant benefits of having the backing of a wealthy shareholder and one with a presence on the main board including access to capital to fund attractive acquisition opportunities, and providing investment advice to high net worth individuals in the Gulf states and Kuwait. Equity Development believes having the backing of KEH could be a game changer for WH Ireland's corporate broking division as the business seeks to expand its client list. In addition, WH Ireland's office on the Isle of Man offers a base for legitimate investment by wealthy Kuwaitis.
So, if you followed my earlier advice, I would run the hefty profits on your holdings and see how this unfolds. The FCA has approved a "change of control" allowing KEH to buy up to 29.9 per cent of the issued share capital, so this is not a takeover situation, but clearly one where the KEH believe there is capital upside to the £8.4m invested at 140p a share for their initial 23 per cent stake. Run profits.
Directors buying at SAT
I noted with interest that four directors of Satellite Solutions Worldwide (SAT:8.25p), a satellite internet service provider offering an alternative high-speed broadband service, have splashed out £75,000 between buying up almost 1.1m shares to raise their combined stakes to 12 per cent of the issued share capital. I first recommended buying the shares at 5.5p earlier this year ('Blue sky tech play', 21 Mar 2016), and last rated them a buy at 7p when I felt a target price of 9p to 10p was fully warranted (‘Priced for blue sky gains’, 31 Aug 2016).
Interestingly, the share buying coincides with news of a debt restructuring of satellite operator Avanti Communications (AVN:28p). A group of note holders are supporting the issue of $45m of new senior secured loan notes to allow Avanti to meet its $32m (£24.6m) coupon payment due in October, and to give it some additional time to finalise its strategic investor or sale process. The cost of the fundraise is not cheap as there will be an additional 5 per cent yield on consenting bondholders’ paper, taking the yield on the paper to an eye-watering 15 per cent.
Although Avanti is not a company I have covered in the past, analyst Michael Armitage at SAT’s house broker Arden Partners “believes part of Avanti’s problems have been down to a disappointing level of sales and cashflow, in part due to relatively high prices, and any resolution of the company’s balance sheet problems will result in a more competitive price offer to resellers, such as SAT”. Moreover, the fact that SAT’s directors have been buying adds further weight to the lenghty investment case I outlined a few weeks ago. For good measure, the chart set up is pretty bullish too. Buy.
Unloved and undervalued
Aim-traded Gama Aviation (GMAA:162p), an operator of privately-owned jet aircraft has issued a decent enough trading update alongside yesterday’s first half results.
I recommended the shares as a trading buy at 162p ahead of the announcement (‘Priced to gain altitude’, 25 Aug 2016), and although the price subsequently hit a high of 204p there was some selling post results yesterday which has taken the price back to where it was three weeks ago. However, rated on a very modest forward PE ratio of only six, I still feel there is scope for Gama's share price to regain altitude towards my initial price target of 220p.
As anticipated Gama’s lower margin, but higher growth US operations continue to benefit from a strong tailwind, reflecting the strength of the North American economy. This is in stark contrast to the challenging market conditions the business faces in Europe. In the first half, the US air division increased aircraft under management from 93 to 105 planes on the back of a number of contract wins, up from only 78 in June 2015. Expect further additions to the fleet as tender activity remains high, so much so that chief executive Marwan Khalek says that a successful outcome to these negotiations, coupled with contracted growth in place, offers potential for a further 30 aircraft to be added to the fleet between now and end 2018. The point being that having made up-front capital investment in the US air business, principally in infrastructure and IT systems, underlying cash profit margins in this business unit are expected to cruise up towards a target of 5 per cent within the next two years. To put that into perspective, it’s double the margin the unit made on revenues of $110m (£84.6m) in the first half.
Another key take for me was the expansion in the US network of hubs of the ground services division which means the business can now service clients’ line maintenance requirements on a national basis. The benefits of this expanded capability should contribute to the second half numbers, and coupled with the growth in the US air division, analysts believe that Gama Aviation’s US segment can deliver cash profits of around US$8.3m, up from $7.4m on revenues in 2015. It looks a solid contribution given the positive trading outlook and one that should account for around 40 per cent of Gama Aviation’s full-year cash profit estimate of $21.6m according to analyst John Cummins at brokerage WH Ireland.
The move into modest profitability of the Middle Eastern businesses, reversing a loss of $542,000 at the same stage last year, is worth flagging up too as this positive trend is expected to continue as the unit has a number of promising managed aircraft tenders in the pipeline, and its ground services business is now benefiting from new parking and hangarage contracts. It was also pleasing to see the Asian operation break-even, albeit the unit is in a start up phase and the latest results benefited from a full six months contribution.
But why the share price weakness?
The main reason why the shares reversed their pre-results rally yesterday is due to ongoing weakness in Gama Aviation’s European market segment. The European air division earned a cash profit margin of 1.7 per cent on revenues of $55.6m in the first six months of this year and analysts believe that it may only turn in cash profits of $1.6m on revenues of $120m for the full-year, well down on the respective figures of $142m and $2.1m, in 2015. Decisive action has been taken to reduce costs, so the divison should have greater operational gearing to benefit from revenue growth when markets eventually recover. I would also point out that underperforming legacy contracts have been dumped, partly because of the management time they were taking up to administer, but also due to their unattractive risk profile.
Gama’s European ground services division, the key contributor to group profits, has faced challenging markets too. The timing of customers’ discretionary spend on modifications, improvements and refurbishments works have been harder to predict with a tendency for such projects to be deferred or put on hold pending an improvement in sentiment and confidence. Such uncertainty is expected to persist through the second half, although chief executive Marwan Khalek does rightly point out that the deferred business will come through at some point, so this is more of a timing issue. Still, it is having an impact as in the first half the unit reported cash profits down a third at constant currencies to $4m on revenues of $18.6m.
But what seems to have been lost on investors selling their shares yesterday is that growth elsewhere in the business is making up the shortfall and Gama’s second half performance will also benefit from a couple of acquisitions made earlier this year: Aviation Beauport, a privately owned Jersey based business offering a range of business aviation services; and Flyertech, a privately owned Gatwick based businesses offering a full complement of airworthiness management services. Gama paid a combined initial consideration of £8.3m for the two businesses, a sensible price based on the £1.4m of cash profits they made in their last financial year.
Guidance from finance director Kevin Godley during our results call yesterday was that the two acquisitions are trading in line with those levels of profitability. This means that at current exchange rates their combined profits will be more than 10 per cent of the profits earned by all of Gama Aviation’s European operations last year. Of course, that contribution will be needed as Gama’s European ground services business has a $2.6m profit shortfall to make up in the second half.
That said, although the European market segment remains challenging, analysts still expect Gama to grow cash profits from $20.4m to $21.6m and increase pre-tax profits from $15.6m to $16.6m. On this basis, expect a modest rise in EPS to 33.9 cents, or 26p a share at current exchange rates. In my view, a rating of a little over six times earnings estimates is far too low for a business that appears to have reached an inflexion point in its Middle Eastern business, is enjoying strong growth in North America, and has a solid balance sheet and a lowly geared one to support further bolt-on acquisitions.
Indeed, analysts expect the company’s net borrowings to decline from $13.2m at the half year stage to $3.8m at the end of the year, so balance sheet gearing could be less than 8 per cent of shareholders funds by the year-end. In turn, this offers scope for the board to at least maintain last year’s dividend of 2.5p a share. It also offers scope for the board to make further strategic acquisitions to scale up the business. The aim is to double its size within the next couple of years. Strategically, that makes a lot of sense as scaling up the fleet size has a positive impact on contract value and ancillary service volumes such as fuel, training and insurance, and gives management greater leverage during negotiations with suppliers.
So, having taken into consideration the profitability of each of Gama’s regional segments, and the trading back drop too, I am comfortable maintaining my buy recommendation and 220p target price with the shares trading on just six times earnings estimates. Buy.
