Following the disposal of its aerospace business for £65m at the end of May, the company has net cash on its balance sheet of £51m, a sum worth 182p a share, of which the board intends to return £28m to shareholders, equivalent to 100p a share, through a tender offer scheduled to complete in November. Details of the capital return will be announced shortly. It made sense to sell the aerospace unit as Avingtrans had achieved all its ambitions in building up the business to a point where it could book a hefty £27.5m profit on disposal, or more than double the unit’s net assets. Shareholders will also receive a higher final dividend of 2.1p a share payable in early December.
Sellafield contract a major opportunity
The bumper cash returns aside, there was much to like about the progress being made in the remaining businesses which are focused on manufacturing highly engineered components for the energy and medical markets. These ongoing operations turned in a modest underlying pre-tax profit of £100,000 in the 12 months to end May 2016, but have exciting prospects on the back of a raft of contract awards. The biggest of which is 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 to Avingtrans over a two to three year period and covers the set-up and development of a production facility for nuclear waste storage containers. I understand from my results call with finance director Stephen King that Avingtrans expects to earn a 10 per cent operating profit margin once the contract is fully up and running, a factor that’s clearly not reflected in the company’s valuation given that its market capitalisation of £52.7m is only slightly above net funds of £51m on its balance sheet, and significantly below net asset value of £64.7m. In terms of the timing of the contract, around £2m of revenue will be generated from the contract in the current financial year, rising to £3m the year after. But it’s during the second phase when revenues will ramp up sharply as the production facility will produce 1,100 of these three-meter-cubed storage waste containers over a period of seven years.
It was a landmark award for Avingtrans’ and chief executive Steve McQuillan rightly describes the potential for the company in nuclear decommissioning as a great opportunity. He has a point as Sellafield will need 40,000 of these boxes over the next 30 years, so the initial contract with Avingtrans just scratches the surface. In fact, Mr McQuillan pointed out during our call that 6.4 per cent of all nuclear waste in the UK is classified as intermediate level and half of this is at Sellafield. To put the scale of the opportunity into some perspective, it will take 70,000 of these boxes over the next 100 years to remove the waste at a cost of £3bn to the UK government.
Contract wins point to solid growth
And that’s not the only interestingly contract the company has won. Over the summer, its Maloney Metalcraft subsidiary secured a contract with EDF Energy, worth £3.5m, to supply gas-cooling process-critical valves for each of the seven EDF managed Advanced Gas-Cooled Reactors around the country (Dungeness B, Hinkley Point B, Hunterson B, Hartlepool, Heysham 1, Heysham 2 and Torness). The contract is part of a life extension programme that will also see engineering support and on-site services supplied to EDF Energy. The Maloney Metalcraft team designed the original Carbon Dioxide gas drying systems for the stations back in the 1970s but, with delays to the Hinkley Point C programme, extending the life of these older nuclear power stations is now critical.
Avingtrans has been diversifying into the materials technology market too, 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. The company is providing key components for Rapiscan's new 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 all airports by 2020. Airport security poses a real challenge as passenger numbers increase around the world but, until now, this growth has not been matched by advances in security risk detection technology.
In addition, another of Avingtrans’ subsidiaries has signed a deal 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 is working closely with Bruker to develop a fully value-engineered solution for the components for their NMR programmes, before transitioning the work to its Chinese site. Mr McQuillan says that the China facility gives the company a competitive cost advantage which can reduce manufacturing costs by up to 30 per cent dependent on the type of contract.
Significant scope for profit growth
The important point is that a raft of contract wins support analysts’ expectations that point towards Avingtrans growing revenues organically by almost 15 per cent to £24.3m in the 12 months to end May 2017, rising to £30.7m the year after. On this basis, and after factoring in the margin being earned on the contracts won, expect cash profits to double to £800,000 in the current financial year, before almost trebling to £2.2m the following year to generate pre-tax profits of £300,000 and £1.3m, respectively.
It’s worth pointing out that these forecasts are based on contracts already in place, and do not factor in the potential for earnings accretive acquisitions as Avingtrans’ shrewd management team look to replicate their ‘buy-to-build’ success in the energy and medical sectors. Indeed, the company will have around £17.5m of free cash on its balance sheet after taking into account the return of £28m cash in the tender offer, £1.5m of capital investment on the Sellafield contract, settlement of £3m of transaction costs on the aerospace division sale, and other working capital movements.
Another driver for earnings growth is the tender offer mechanism. For instance, a return of £28m of cash at a tender price of 200p would halve Avingtrans’ fully diluted share count to 14m shares, so net profits from existing businesses, and profits bought in from acquisitions, will feed through to higher EPS given the lower share count. Indeed, pre-tax profits of £1.3m in 2018 are worth 7.6p using a 17 per cent corporation tax rate. Factor in acquisitions and EPS could easily be double that if Avingtrans buys sensibly. And that potential upside is simply not being factored into the current price. That’s because Avingtrans will still have a cash pile worth 125p a share after the tender offer completes based on the lower share count, so on a cash adjusted basis the shares are being priced on just 8.5 times 2018 EPS estimates.
Target price
So, having initiated coverage on the shares at 170p (‘Engineering a profitable free ride’, 30 Jun 2016), and reiterated that advice at the current price ahead of the full-year results (‘Priced for nuclear gains’, 3 Aug 2016), I have no hesitation repeating my buy advice. My target price of 230p is bang in line with Avingtrans’ net asset value per share. Buy.
LXB hefty capital return
As expected LXB Retail Properties (LXB:68p), a Jersey resident closed-end real estate investment company focused on edge-of-town and out-of-town retail assets, which is being wound down, has announced another hefty cash return.
I initiated coverage at 85p ('Bag a retail property bargain', 6 Oct 2015), so after adjusting for a 38p cash return earlier this year ('Exploiting a valuation anomaly', 11 May 2016), this gives an entry point of 47p, or significantly below the current share price. I last advised buying the shares at 56p (‘Deep value small-caps’, 12 Jul 2016), and at 64p (‘Hot property sales’, 31 Aug 2016), so you will be doing well if you followed that advice.
LXB’s share price move is fully justified too because following the sale of assets at Kingsmead Stafford, B&Q Greenwich and Ayr, transactions which generated gross proceeds of £70m and net proceeds of £29.5m after settling borrowings, the company has a debt free balance sheet. In fact, I calculate that LXB will shortly have net cash of around £40m, a sum worth 23.75p a share, and that’s before taking into account other deals in the pipeline. So the board of LXB are proposing an 18p a share cash return at a cost of £30.3m. The shares will be marked ‘ex’ for the capital return at 7am on 20 October and shareholders can either opt for a cash dividend which will be treated as income for tax purposes and payable no later than 3 November; or a ‘B’ share redemption, which will deemed a capital return for tax purposes and redeemed in cash by the company no later than 27 October.
The point here is that once the shares are marked ‘ex’ the 18p a share capital return, they will be priced 18 per cent below Stifel's end September 2016 net asset value estimate of 61p (79p before the capital return) even though the board have stated that they expect future capital returns to shareholders to exceed the 64.2p a share end March 2016 net asset value by a "comfortable margin". Furthermore, with the majority of the portfolio forward funded and pre-sold to institutions, so guaranteeing cash receipts when they are handed over on completion, I feel that LXB’s shares are still worth holding on to given the potential for the share price discount to net asset value to narrow even further.
It will be interesting to see whether the insiders decide to recycle their cash from the 18p a share capital return back into LXB shares as proved the case after the 38p a share capital return a few months ago. If they do it will be a strong signal that the final cash return from this investment is likely to exceed the current share price. Run profits.
