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A quartet of Aim-traded buys

A quartet of Aim-traded buys
January 9, 2017
A quartet of Aim-traded buys

That's because the company's heady organic growth rate - sales have grown at a compound annual growth rate of 16 per cent over the past four years - is being mainly driven by its exposure to the discount retailers, and private-label products, in particular. This segment of the tissue market has been growing at 10 per cent a year, and with the UK inflation rate set to rise sharply this year following the sharp devaluation of sterling and the doubling of the oil price in the past 12 months, it's not unreasonable to expect more cash-strapped consumers to substitute higher-cost branded products with lower-cost private-label ones from discounters, as they strive to balance their weekly shopping budgets in a low wage inflation environment.

Accrol is in a prime position to benefit, as it has an estimated 50 per cent market share of the discount sector, up from 35 per cent at the time of the IPO, reflecting a raft of contract wins, including ones with Booker (worth £6.5m), Poundstretcher (£5m) and German discount chain Lidl (£10m). In fact, the Lidl contract is going so well that latest guidance points towards annualised sales exceeding the £10m level.

Moreover, Accrol is also benefiting from the fact that, unlike its larger rivals, it doesn't own paper mills, so avoids the hefty cost burden. Instead, the company outsources supply, so enjoys the lower cost advantages that international manufacturers of paper reels benefit from, compared with UK peers. It's also benefiting from a global oversupply of both pulp and industrial paper reels as additional capacity is set to flood the market until 2019. True, the fall in sterling is an issue, but Accrol's management team was shrewd enough to take out hedging arrangements before the EU referendum, and continues to actively manage its foreign exchange risk, too. As a result, the 7 per cent reduction achieved on international paper reel purchases in the six months to end-October 2016 more or less offset the negative exchange rate movement net of currency hedging arrangements.

The upshot of which is that Accrol's underlying pre-tax profits rose from £3.8m to £5.4m on revenues up almost 9 per cent to £63.9m in the six-month trading period, placing the company well on course to increase revenue by almost a quarter to £74m in the second half and lift adjusted pre-tax profits from £8.3m to £13m for the 12-month period, as analysts at Equity Development predict. On this basis, expect adjusted EPS of 15.6p and a full-year dividend of 6p, in line with the board's guidance at the time of the IPO. There are decent prospects for a progressive dividend policy, too, as net debt has been reduced by £3.2m to under £20m since flotation, and investment has already been made in additional operating capacity at the plant in Leyland, which will enable the company to increase output to support annual sales of up to £180m.

When the company floated its shares on Aim at 100p last summer, I was so impressed with the business model that I had no hesitation recommending buying them at the time ('Clean up with Accrol', 6 June 2016). I have not changed my positive stance either, having subsequently recommended buying at 127.5p ('A trio of value plays', 8 November 2016). My original 130p target price has now been taken out and my new target price range of 155p-160p equates to a reasonable 10 times earnings estimates, and is supported by a near-4 per cent prospective dividend yield. Buy.

 

Director buying at Satellite Solutions

It's always reassuring to see substantial director share buying, especially in small-cap companies. Bearing this in mind, I noted that Simon Clifton, chief technical officer of Satellite Solutions Worldwide (SAT:9.75p), a satellite internet service provider offering an alternative high-speed broadband service, has recently acquired 2.5m shares in the company at a price of 7.7p each and at a total cost of £192,500. Following the transaction, Mr Clifton now owns 33.8m shares, or 6.3 per cent of the issued ordinary share capital.

I last advised buying shares at 8p after the board announced that it would exceed market expectations for the financial year to end-November 2016 and is likely to exceed its previous target of taking customer numbers to 100,000 this year, too ('Small-cap value plays', 5 Dec 2016). I first recommended buying at 5.5p last year ('Blue-sky tech play', 21 Mar 2016).

Mr Clifton's purchase looks well-timed as the company announced at the end of last week a new commercial contract with one of its key suppliers of satellite capacity on improved commercial terms on existing business, in addition to agreeing new satellite broadband capacity to support its ongoing sales in the UK and French markets. The company has also acquired, for £870,000, the customers and related assets of a provider of satellite broadband services in France. This business has 1,900 customers and operated at break-even in the last financial year, so offers obvious scope for a move into profit as part of a much larger operation. It's worth flagging up too that the board has just appointed heavyweight brokerage Numis Securities as its nominated adviser and broker.

So, with the technical set-up promising - the share price has just taken out last April's all-time high of 9.25p - and offering 18 per cent further upside to my new target price of 11.5p based on an enterprise value to forecast cash profit multiple of 15 times for the financial year to end November 2017, I continue to rate shares in Satellite Solutions a buy.

 

Cohort hits target price

Aim-traded shares in UK defence group Cohort (CHRT:410p) came within pennies of their 432p all-time high post-results last month, much as I predicted when I previewed the announcement ('Targeting record highs', 21 Nov 2016). It's a company I know well, having initiated coverage at 214p ('Blue-sky buy', 6 Oct 2014), and subsequently advised top-slicing two-thirds of your holdings at 415p at the end of 2015 ('On a roll', 15 Dec 2015).

The only question I now have is whether there is sufficient upside to warrant maintaining an interest. Having assessed the first-half figures, and taken into consideration guidance that points towards pre-tax profits rising by a fifth to £14.3m on 12 per cent higher revenues of £125m in the 12 months to end-April 2017, as analysts at Edison Investment Research predict, I feel that a chart breakout is likely in due course. That's because almost £50m of Cohort's £129.6m order book at the end of October is deliverable in the second half, so underpinning a large chunk of Edison's full-year profit estimates, and the company has also won £16m-worth of additional orders since the end of the first half. Moreover, I feel that Edison's forecast of a further double-digit increase in pre-tax profits to £16.6m on revenues of £139m in the financial year to end-April 2018 is certainly achievable, a performance that would lift EPS from 24.1p to 33.4p, and support a rise in the payout from 7p to 8p a share.

That's because in the new financial year the company will benefit from a full 12-month contribution from EID, a Portugal-based supplier of advanced electronics, communications and control products for the global defence market that gives the company direct access to the EU, as well as new export markets. Cohort acquired a 57 per cent stake in EID for £8.9m last summer and is in the process of purchasing a further 23 per cent from the Portuguese government for £3.5m. The investment has proved earnings-accretive to Cohort - EIS contributed operating profit of £1.4m in the four months since acquisition of the 57 per cent stake - so it makes sense to deploy some of the company's net funds of £9.9m, a cash pile worth 25p a share, to raise its stake further. In fact, the Portuguese government has just granted EID a €7.5m (£6.4m) contract for the purchase of tactical radios for the Portuguese Army.

In addition, Cohort reported a much improved financial performance from its subsidiary MCL, a specialist in the sourcing, design, integration and support of communications and surveillance technology for the defence and security markets. The company has just acquired the 49.9 per cent minority interests in this business from its management, for £5.5m. The net result of these two transactions is to underpin a chunk of the forecast profit rise in the 2018 financial year, as will the elimination of losses at its defence consultancy business SCS, which has been reorganised with activities subsumed into other parts of Cohort's business.

The bottom line is that if Cohort can deliver on Edison's expectations, its 473p-a-share sum-of-the-parts valuation doesn't seem unreasonable to me, equating to a forward PE ratio of 14 post recent analyst earnings upgrades. Buy.

 

MXC Capital update

Of course, not all share recommendations reap financial rewards. The de-rating of Aim-traded MXC Capital (MXCP:1.8p), a technology-focused merchant bank run by a management team that has been successfully backing investee companies they represent, as well as earning lucrative advisory fees, is a case in point.

When I initiated coverage ('Dealmakers', 31 May 2016), I believed that fair value of 3.75p a share was a reasonable target price based on the operational and share price performance of MXC's investee companies. In the event, the share price rose from the 2.65p level at which I advised buying to a high of 3.5p last summer. The company also completed a £3.8m tender offer pitched at 3.6p a share, in line with the board's policy of returning part of the proceeds from investment disposals to shareholders.

However, at the start of November, one of MXC's investee companies, Redcentric (RCN:96p), a leading UK IT managed services provider, announced an internal review in relation to the overstatement of its net assets and post-tax profits and commenced a forensic review, too. This news not only sent shares in Redcentric into a tailspin, but also hit those of MXC hard. That's because MXC retained 50,000 shares in Redcentric, call options over 1.7m shares with a strike price of 32p, and a further 7m call options with a strike price of 80p, which had been 'in-the-money' to the tune of £8.9m, a significant sum in relation to its net asset value of £80.7m at the end of August 2016.

MXC's board firmly believed that the accounting issues could be dealt with by the new management team installed at Redcentric, and backed their judgment by spending £4.9m purchasing 7.61m shares in Redcentric at an average price of 59.68p after the share price had collapsed ('A trio of value plays', 8 Nov 2016). That holding has since increased in value by £2.8m, as investors have been reassured by subsequent announcements from Redcentric and the publication of its financial results. Importantly, this £2.8m gain offsets more than half my £5m estimate of the paper losses on the Redcentric call warrants, the upshot of which is that MXC's last reported net asset value has only declined by 3 per cent.

However, MXC's share price has halved since the summer, a reaction completely out of sync with the actual loss suffered on the company's investment in Redcentric. The directors of MXC are fully aware of this and announced a share buy-back programme just before Christmas, noting that "MXC's current share price is not representative of the underlying value of the company and its prospects". I agree and believe that with MXC's shares trading on a 20 per cent discount to my estimate of pro forma book value of 2.25p, and that's without factoring in the recovery potential in Redcentric, they are well worth buying.

 

MORE FROM SIMON THOMPSON...

Please note that I published two columns last week, including a detailed analysis of the housebuilding sector, both of which are available on my homepage.

A comprehensive list of all the investment columns I have written in 2017 is available here.

The archive of all the share recommendations I made in 2016 is available here

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