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Taking profits

Taking profits
April 18, 2017
Taking profits

Having followed financial markets for over a quarter of a century, I am old and wise enough to know that sell-offs are not only part and parcel of investing, but stock market sales are when the best bargains are to be had, so it pays to have cash available to exploit such opportunities. Bearing this in mind, I have been revisiting some more companies on my watchlist where share prices are trading at or close to record highs to decide whether a degree of profit-taking is in order.

 

A dynamic performance

AB Dynamics (ADBP:625p), a UK designer, manufacturer and supplier of advanced testing systems and measurement products to the global automotive industry, issued an inline pre-close trading update at the end of March ahead of half-year results to be released on Tuesday, 25 April 2017. It's a company I know well, having included the shares in my 2015 Bargain share portfolio at a bargain price of 172p, issued multiple repeat buy recommendations since then, and last advised running profits a couple of months ago, but with the proviso that you should place a trailing 10 per cent stop-loss to protect the huge paper gain ('Building gains', 14 February 2017).

The key take for me in the trading update was news that the company "has seen an increase in demand for its track testing products and, together with its forward order book, has secured a sales pipeline for the remainder of this financial year and well into the next". This is needed if it's going to lift both revenues and pre-tax profits by 19 per cent to £24.5m and £5.6m, respectively, in the 12 months to end-August 2017, rising sharply again to £28.8m and £6.9m next year, as analyst Sanjay Jha at broking house Panmure Gordon predicts. On this basis, adjusted EPS edges up slightly to 24.9p, after taking into account the dilutive impact of the company's placing at the tail end of last year, before ramping up to 30.5p in the 2018 financial year.

The proceeds of the £5.4m fundraise have been earmarked to accelerate existing development programmes and projects for new products, including simulator development, new specialised lab and track testing equipment and virtual vehicle testing; invest in technical and commercial centres; and fund additional facilities. It makes sense to do so given that the automotive industry backdrop remains favourable, the key reason why AB Dynamics has been able to grow revenue and operating profit at a compound annual rate of 23.1 and 24.9 per cent, respectively, in the past five financial years.

However, the share price has now risen by almost a third since December's placing and has taken out Panmure Gordon's 575p target price, and the 600p target of Cantor Fitzgerald, prompting both broking houses to move to hold recommendations on valuation grounds ahead of next week's half-year results. They have a point as in the absence of an earnings beat, a rating of 25 times Panmure Gordon's top of the range EPS estimate for the current year seems to fully factor in expectations of 20 per cent growth in both the 2018 and 2019 financial years, even allowing for a likely year-end cash pile of £13m, a sum worth 68p a share.

In the circumstances, I feel it's time to bank the 263 per cent profit on this recommendation with the shares trading at a record high of 625p. Take profits.

 

In defence of a record high

Another company on my watchlist to hit a record share price high is UK defence group Cohort (CHRT:460p). I initiated coverage at 214p ('Blue-sky buy', 6 October 2014) and subsequently advised top-slicing two-thirds of your holdings at 415p at the end of 2015 ('On a roll', 15 December 2015), a call that worked out well after the share price pulled back sharply last year.

I then turned positive again last autumn, moving my recommendation from hold to an outright buy at 350p ('Riding small cap bumper gains', 24 October 2016), and reiterated that advice at 410p at the start of this year when I upgraded my target price to 475p ('A quartet of Aim-traded buys', 9 January 2017). Cohort's share price got within pennies of that objective earlier this month, buoyed by news that the company has been awarded yet another contract, worth almost £10m, by the UK Ministry of Defence to supply and support hearing protection systems and communication ancillaries for specialist land, maritime and air applications.

It's not the only major contract win announcement since my January article as the company subsequently won a contract worth £15m with the Metropolitan Police Service to deliver a digital-managed service over a seven-year period with an extension option for another three years. It is also available to other police forces within the UK, which provides the possibility to increase the contract value. Analyst Andy Chambers at Edison Investment Research sees medium-term potential to grow the contract size to between £20m and £25m. Add to that the earnings-enhancing purchase of the minority interests in Cohort's Marlborough Communications subsidiary, a specialist communications and surveillance technology to defence and security markets in the UK and overseas, and Edison predicts the company should lift pre-tax profits by 16 per cent to £16.6m, based on a 10 per cent hike in revenues to £139m in the 12 months to end-April 2018. On this basis, expect EPS to surge from 24p to 33p, and support a 14 per cent hike in the dividend per share to 8p.

This means that Cohort's shares are rated on 14 times forecast earnings, and offer a prospective dividend yield of 1.7 per cent, a valuation that could offer further share price upside in the event of the cash-rich company winning yet more contracts. Although that seems likely, I still feel it's prudent to bank some of the 115 per cent profits on this holding, as the company still needs to deliver on analysts' forecasts of 38 per cent EPS growth in the 2017-18 financial year. My advice is to top-slice the holding by selling half in the market and run profits on the balance for free.

 

Renewing an old acquaintance

Renew Holdings (RNWH:470p), an Alternative Investment Market (Aim)-traded engineering services group specialising in the UK infrastructure market, and on the nuclear, rail and water industries in particular, hit a record high of 490p at the end of February before some modest profit-taking kicked in. I first recommended buying the shares at 258p ('A small-cap breakout', 14 August 2014), and last advised running profits at 425p after my target price was hit ('Small-cap watch', 6 December 2016), so in hindsight that proved the right call given Renew's share price subsequently appreciated by a further 16 per cent.

However, analysts are divided as to what represents fair value with Guy Hewitt at broker FinnCap reiterating his 586p target price post this month's inline pre-close trading update ahead of half-year results due to be released on Tuesday, 23 May, but Nick Spoliar at broking house WH Ireland maintains a hold stance given Renew's share price has hit his 470p target price. In terms of the valuation, the shares are now rated on 14 times' likely earnings for the 12 months to end-September 2017 after factoring in EPS growth of 12.5 per cent and the upside from last year's acquisition of private equity-owned St Albans-based Giffin Holdings, a specialist in mechanical, electrical and power services within the rail sector. The prospective dividend yield is almost 2 per cent assuming the payout is hiked by 15 per cent to 9.2p a share as Mr Hewitt at FinnCap forecasts, a sensible prediction in my view given that the cash-generative company should return to a net funds position at the September financial year-end, so enabling the board to reward shareholders once again.

My instinct is that fair value now probably lies somewhere midway between the two targets, reflecting the solid stream of earnings generated by supplying critical infrastructure maintenance services, which produce a return on capital employed north of 60 per cent, significantly ahead of peers. The high capital returns also reflects the cash-generative nature of the business and a relatively low capital base, which in turn enables the company to deliver a rising dividend, and recycle cash flow into earnings-accretive bolt-on acquisitions. High barriers to entry, potential to enhance operating margins further, and a record order book north of £500m which offers decent visibility to future earnings, are other attractions.

In the circumstances, I can see the investment case being reappraised in a positive light by investors post the forthcoming half-year results, so it makes sense to run with the 89 per cent total return on the holding after accounting for dividends of 18.5p a share banked since I initiated coverage. Run profits.

 

In the picture

It's been some time since I looked at Europe's leading cinema chains Cineworld (CINE:670p), but this is a good juncture to revisit the holding as the share price has now achieved the 675p target price of analysts Ivor Jones and Douglas Jack at broker Peel Hunt and is close to the 12-month target price of 700p highlighted by analyst Sahill Shan at broking house N+1 Singer at the time of last month's full-year results.

I recommended buying the shares at 336p when I briefly strayed out of my small-cap hunting ground in the autumn of 2014 ('Lights, camera, action', 28 October 2014), and last advised running profits at 578p in the summer of 2015 ('Running bumper profits', 27 August 2015). It's taken sometime for the operational performance to catch up with that blistering re-rating, so much so that it wasn't until January this year that Cineworld's share price finally made a decisive move through the 600p resistance level that had been acting as a glass ceiling.

It's easy to see why investors have continued to re-rate the shares as Cineworld has posted mid-teens EPS growth for the past two financial years, and buoyed by a solid slate of film releases, Peel Hunt is expecting low double-digit earnings growth in 2017 to lift EPS to 38.3p and support a 5 per cent hike in the payout to 19.9p a share. A progressive dividend policy was a key bull point in my analysis and the board has certainly delivered on this front, declaring total dividends of 46.2p since I commenced coverage in late 2014. A prospective dividend yield of 3 per cent is still attractive, and even though a forward PE ratio of 17.5 can hardly be described as cheap, it still represents a discount to Cineworld's international peers which are priced on multiples of around 23 times earnings, according to analysts.

So, although the company will have to deliver earnings beats to warrant a higher target price, I feel that the benign market conditions in the film industry suggest this is not completely out of the question. That said, it's only sensible to bank some of the 109 per cent gain on this holding, a return that factors in the dividends paid to date, but excludes the forthcoming final payout of 13.8p, which goes ex-dividend on 25 May. Therefore, if you have been following my advice on this company, I would top-slice the holding in order to get your initial capital back and run the balance for free.

Finally, I will be initiating coverage on a very interesting small-cap company on Wednesday, 19 April in an in-depth online-only article for IC subscribers.

 

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

■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com for £14.99, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source. Simon has published an article outlining the content: 'Secrets to successful stock-picking'