The operational performance fully supports the ongoing re-rating: the company has just posted a 27 per cent increase in full-year EPS to 26.2¢, better than analysts had expected, and the trading outlook prompted analyst David Buxton at brokerage FinnCap to upgrade his current year EPS forecast by almost 5 per cent to 27.4¢. As I have pointed out before, not only is the business heavily exposed to the buoyant US market - the region accounts for three-quarters of Somero's revenue - but trading activity is being boosted by a combination of new product launches and a healthy non-residential construction market, both of which are supporting demand for replacement equipment, technology upgrades and fleet additions. For good measure, the company is a likely beneficiary of the Republican administration's plans to grant $137bn (£112bn) of tax credits to construction companies to leverage $1 trillion of infrastructure investment, and proposals to cut corporation tax to further stimulate investment spend.
A key take for me in Somero's 2016 financial results was the robust cash generation which has boosted closing net funds by 60 per cent to $20.2m, a sum worth almost 30p a share, and that's after taking into account $4.4m of capital expenditure and the payment of $4.2m of dividends. This has enabled the board to lift the dividend per share by 61 per cent to 11.1¢ and a special dividend is likely to be announced later this year. Mr Buxton predicts a 17.8¢ special payout in addition to the normal dividend announced, implying the shares offer a prospective dividend yield of 8.4 per cent. That's attractive, as is a cash adjusted forward PE ratio of 11.
In the circumstances, I have raised my target price from 275p to 325p to value the company on a more reasonable cash-adjusted PE ratio of 13. Buy.
Momentum building at Miton
Aim-traded asset manager Miton Group (MGR:40p) has not only posted a major earnings beat for 2016, but the company has also announced that assets under management (AUM) have increased by £192m to almost £3.1bn in the 10 weeks since the financial year-end, supporting expectations of another robust year of earnings growth.
In the 12 months to end-December 2016, pre-tax profits rose by 70 per cent to £5.1m to produce a doubling of diluted adjusted EPS to 2.4p, significantly higher than the 2.1p anticipated by analyst Stuart Duncan at house broker Peel Hunt. Moreover, with net funds increasing by more than half to £21.3m, a sum worth 14p a share, the board has rewarded shareholders with a near 50 per cent hike in the dividend to 1p per share, or 25 per cent higher than forecast, in addition to spending £2.5m purchasing 6.6m shares for cancellation in an earnings accretive buyback in the first two months of this year.
Interestingly, Mr Duncan is conservatively factoring in year-end AUM of £3.3bn, only 5 per cent higher than current levels, in his 2017 pre-tax profit estimate of £5.4m. In view of the supportive equity market backdrop, the fact that the performance of eight of Miton's 14 funds are in the first quartile for their sectors, and that the asset manager will be launching a new global infrastructure fund this week, I feel the investment risk is skewed to the upside here. Indeed, I feel there is potential for a number of funds, including both the US Opportunities funds (AUM of £238m) and the 15-month old European Opportunities Fund (AUM of £82m), to build on strong fund inflows and their impressive investment performance.
In the circumstances, it's hardly surprising Miton's shares have rallied since I rated them a buy at 31.5p in the autumn ('On the financial beat', 25 October 2016), and subsequently reiterated that advice at 36p post the pre-close trading update ('In the ascent', 23 January 2017). In fact, the share price is now 73 per cent ahead of the entry point when I first spotted the earnings recovery potential a couple of years ago ('Poised for a profitable recovery', 4 April 2015). There is potential for more gains to come too and not just on valuation grounds as from a technical perspective there is no overhead resistance until the December 2013 high of 50p.
Offering 25 per cent upside to my new target price of 50p, valuing the equity on a reasonable 12 times conservative net profit estimates after adjusting for cash, I rate Miton's shares a strong buy.
Crossrider cyber buy
Aim-traded online distribution and digital product company Crossrider (CROS:68p) is acquiring leading cyber security Saas provider CyberGhost for a maximum consideration of €9.2m (£8m), of which €3.2m is payable in cash, €3m is being settled by issuing new shares in Crossrider and the balance is subject to an earn-out.
The business provides secure mobile virtual private networks (VPNs) for 1.5m active users, of which 145,000 pay for a premium version priced at $30.10 a year payable in advance, or $6.99 per month. The product allows users to connect through a secure tunnel to pass data traffic over public networks, an area of the market that is set to boom at a compound annual growth rate of 20 per cent-plus over the next five years, according to industry experts.
To date, most of CyberGhost's customers have been signed up through organic search and are mainly located in the US, Germany and France, so there appears a good overlap with Crossrider's existing customer base. Crossrider's chief executive, Ido Erlichman, says that "the integration of CyberGhost should accelerate our current sales pipeline while also improving operating margin". Analyst Peter McNally at broking house Shore Capital believes that the acquisition can add 1.3m cash profits in its first full-year, a forecast that could be erring on the low-side, according to Mr Erlichman. Crossrider's board is also looking at other potential acquisitions to broaden the company's exposure to the cyber security vertical including a "significant large deal to scale up". It certainly has the cash to do so as full-year results announced alongside the acquisition revealed closing net funds of US$72m, a sum worth almost 42p a share.
It was the potential to deploy that hefty cash pile on earnings-accretive acquisitions, combined with a return to growth in the existing business, that prompted me to include Crossrider's shares in my 2017 Bargain Shares portfolio. Even though the share price has surged 41 per cent since then, I still feel the company is being significantly undervalued. That's because net of cash on the balance sheet, and after factoring in the CyberGhost acquisition, Crossrider's enterprise value is only £39m, hardly an exacting valuation for a company that's forecast by Shore Capital to grow both current year underlying pre-tax profits and EPS by 50 per cent to $7.3m and 4.6¢ (3.7p) respectively and produce $4m of net cash flow. Effectively, the shares are rated on just seven times cash-adjusted EPS estimates, a rating that fails to take into account the high probability of further earnings-accretive acquisitions. Buy.
Bang on the money
Ray Anderson, chief executive of Aim-traded Bango (BGO:105p), a provider of a state-of-the-art mobile payment platform that enables smartphone users to charge purchases made in app stores straight to their mobile phone account, was in confident mood during our results call. He has good reason to be given the end-use-spend (EUS) processed through the company's platform is increasing at a heady rate, so much so that having almost trebled annualised EUS run rate to £195m at the end of last year, Mr Anderson is "comfortable of doubling it in 2017". Growth from contracts already in place supports this prediction and "on top of that some big opportunities could be landed too".
This rosy trading outlook is worth noting. That's because Bango receives a small payment for each transaction made through its platform and has a raft of agreements in place with the likes of Amazon Appstore and Samsung Galaxy Apps, as well as partnerships with leading mobile network operators (MNOs), cementing its place as the de facto leader in app store carrier billing. Its annual operating costs are stable at around £5m, so with transaction fees rising in line with the growth in EUS spend then analysts forecast the business will hit cash profit break-even in the fourth quarter when annualised EUS spend reaches £315m. Moreover, with cash of £5.7m in the bank, the company is well funded to cover its operating costs upto that inflexion point.
The beauty of the business model is that, having made a sizeable £30m-plus investment in a payment platform capable of handling $2bn plus of annual EUS, and with overheads stable, the profitability of the business is highly operationally geared to incremental increases in revenue. This explains why analyst Ian McNally of broking house Cenkos Securities believes Bango is well on course to making gross profit of £8.2m, cash profit of £3m, pre-tax profit of £1.1m and EPS of 1.8p, based on year-end annualised EUS of £669m, in 2018. And if Bango continues to grow at its current heady rate then profits are set to soar in future years.
For instance, based on the sensible assumption that as EUS rapidly scales up gross margins earned will contract from the current 2 per cent level to say 1.4 per cent in three years' time, then on £1.5bn-worth of transactions Bango's gross profit could surge to £20m and generate north of £10m of net profit, a hefty sum in relation to Bango's market capitalisation of £64m.
So, having first advised buying the shares at 93p ('Bang on the money', 26 September 2016), and reiterated that advice earlier this year at 86p ('Four trading plays', 16 January 2017), I feel that it's well worth buying Bango's shares now in advance of a sustained move into profit. Offering almost 100 per cent upside to my 200p target, Bango's shares rate a strong buy.
Making the connection
The long-awaited recovery in the fortunes of fashion retailer French Connection (FCCN:36.5p) may well be on the cards. The company is still in the red, posting an underlying operating loss of £3.7m in the 12 months to end-January 2017, albeit that was a £1m improvement on the prior year. But more important is that chairman and chief executive Stephen Marks notes the "noticeable improvement we have seen during the second half and into the new financial year leads me to believe that we are moving in the right direction". It's worth noting too that "the reaction to this year's collections has been very strong so far with sales both in our stores and wholesale customers up on last year."
Of course, we have been here before, but the difference this time is that Mr Marks, founder and 41.7 per cent shareholder, is under huge pressure from disgruntled shareholders, including US hedge fund Gatemore Capital Management and OKA Capital, which between them own 14 per cent of the share capital. The closure of unprofitable stores is reducing the cost base, ecommerce presence is improving and accounts for 13 per cent of sales, and the year-end cash pile was only down £500,000 to £13.5m despite the loss incurred, a reflection of cutting stock levels.
Ultimately, French Connection will have to build on the improving sales trends, but if successful the equity is being undervalued on a 30 per cent discount to book value and with net cash equating to almost 40 per cent of the market value. So, having advised buying the shares at 45.7p in my 2016 Bargain Shares portfolio ('How the 2016 Bargain Shares portfolio fared, 3 February 2017), I continue to rate them a recovery buy.
MORE FROM SIMON THOMPSON...
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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