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Small-cap trading updates

Small-cap trading updates
May 24, 2017
Small-cap trading updates

Half-year results from Renew (RNWH:462p), 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, were bang in line with analyst expectations. Adjusted pre-tax profit increased by 11 per cent to £12m on revenue up 9 per cent to £289m in the six month trading period and, with the engineering services order book up 5 per cent to £435m to maintain the group order book at around £517m, analysts expectations of a similar revenue performance in the second half are fully covered by orders.

Clearly, the board is confident of delivering the 16 per cent increase in full-year EPS to 31.7p as analyst Nick Spoliar at broker WH Ireland predicts as they raised the half-year payout by 13 per cent to 3p, suggesting a 9p a share full-year payout is on the cards. They can certainly afford to be generous as net debt of £3.5m at the end of March 2017 is expected to turn into a net cash position of between £4m and £5m at the end of September 2017 after factoring in the second-half profit and cash flow.

The solid stream of earnings generated by supplying critical infrastructure maintenance services, which produce a return on capital employed north of 60 per cent, looks well underpinned by a raft of contracts in rail infrastructure, the AMP6 cycle in the water industry, and the nuclear industry where Renew is an established player in both decommissioning and decontamination work. Also, the board's decision to withdraw from its loss-making low pressure, small diameter gas pipe replacement activities is a sensible one as it is expected to return Renew's gas business to profitability in the next financial year, albeit it will result in £500,000 of one-off cash costs in the second half and a £5.8m non-cash impairment charge.

The bottom line is that having first recommended buying the shares at 258p ('A small-cap breakout', 14 Aug 2014), and banked dividends of 18.5p since then, I am comfortable advising running profits on this holding having previously recommended top slicing at 470p last month ('Taking profits', 18 Apr 2017). With the shares rated on a forward PE ratio of 15, my instinct is that a bull market top probably lies somewhere between the two target prices of the brokers who cover the stock: WH Ireland's (470p target price) and finnCap's (586p). Run profits.

  

easyHotel's roll-out on track

I have covered Aim-traded budget hotel operator easyHotel (EZH:99p) several times since I first advised buying the shares at 83p ('Check in for a profitable booking', 14 Dec 2015), most recently after the company announced that Islington Borough Council refused retrospective planning permission in relation to 78 of the 162 bedrooms at its Old Street hotel, located on the edge of London's financial district, which were built without planning consent under previous management ('Value opportunities', 11 Apr 2017). That article is well worth a read as no matter which option the company decides to adopt, and the board will make a decision by the end of September, cash profits should get a boost in the medium term.

Moreover, current trading is actually slightly ahead of internal expectations with the board revealing that like-for-like revenue in its five owned hotels shot up 17 per cent in the latest six-month period to end March 2017, and rose by almost 7 per cent in its 20 franchised hotels. Importantly, the business is well funded to execute the accelerated roll-out of owned hotels across the UK and Europe, having raised £38m at 100p a share in a placing last autumn and refinanced a £12m existing bank facility.

As a result of that fundraise, net funds of £25.2m account for a chunk of easyHotel's net assets of £69.4m, a sum worth 69p a share, with property assets of £46m looking conservatively valued in the accounts. Indeed, the net book value of the Old Street hotel is only £13m even though the board is confident that a sale of the property, if this is the option pursued, should fund the development of at least 500 new rooms in the UK, implying a sale price of £27.5m or double the book value based on Investec Securities estimated development costs of £55,000 per room.

The point being that with easyHotel's shares being offered in the market at 99p, then the company's market cap of £99m only equates to a small premium to book value once you mark-to-market value the property estate. This means that the value being created through the roll-out strategy, and one being led by chief executive Guy Parsons, the former chief executive of leading budget hotel chain Travelodge, is being attributed little value even though the strategy aims to deliver a 15 per cent return on capital employed on an unleveraged basis. To put this into some perspective, the development programme has the potential to increase the company's hotel stock to over 2,152 owned hotel rooms from 590 rooms at present, and increase the franchised room stock from 1,750 to 3,100 rooms by September 2019. If achieved then the estate should be able to make cash profit north of £8.5m, up from £1.6m in the 2016 financial year, on a hefty profit margin of 40 per cent.

My financial models suggest that fair value for the equity is around 120p a share and with positive news expected on the development pipeline in the second half, I have no reason to change that bright view. Buy.

 

Bioquell starts buy-back programme and reports upbeat trading

Shares in Andover-based Bioquell (BQE:166p), a provider of specialist microbiological control technologies to the international healthcare, life science and defence markets, and a constituent of my 2016 Bargain Shares Portfolio ('How the 2016 Bargain Shares Portfolio fared', 3 Feb 2017), have rallied 22 per cent since I last advised buying at 135p and are making good progress towards my 180p target price ('Five value opportunities', 15 Mar 2017).

An upbeat trading update at the annual meeting has certainly helped sentiment, and this follows on from a major earnings beat at the full-year stage in early March when Bioquell reported a 78 per cent surge in pre-tax profit to £1.6m, an outcome that was 15 per cent better than analyst Chris Glasper at broker N+1 Singer had expected. At the time chairman Ian Johnson noted that "a number of different drivers of growth are positively affecting our business, including the need for customers to achieve regulatory compliance, the increasing threat posed by antibiotic resistance and continuing growth in research and small-scale production associated with cell-based healthcare products."

His message to shareholders at the annual meeting was just as positive, noting that "the outlook for the balance of the year remains favourable. In the past six months some radical changes have been made in the structure and focus of the business. This has resulted in a reduction in the cost base and greater emphasis on the opportunities in the life sciences market". Three-quarters of Bioquell's sales are generated overseas so sterling's devaluation is benefiting margins, as are cost reductions from a restructuring programme. This explains why Mr Glasper at N+1 Singer expects pre-tax profit to increase from £1.6m to £1.9m this year on revenue up 6.5 per cent to £28.2m. On that basis, expect a 23 per cent hike in EPS to 6.9p.

The company remains very well funded with net cash at the end of March 2017 rising to £12m, significantly up on closing net funds of £8.8m at the end of 2016. This sum equates to around a third of Bioquell's current market capitalisation of £37.5m and the company is now using the authority given by its shareholders at last month's annual meeting to use some of this cash to buy back shares with the first purchase of 20,000 shares made a fortnight ago.

It's certainly a positive backdrop and one highly supportive of my 180p target price being achieved. Indeed, net of cash on the balance sheet the shares trade on 16 times forward earnings, falling to 13.5 times in 2018, a very reasonable valuation for a business predicted to generate 20 per cent plus earnings growth both this year and next. Or to put it another way, strip out cash on the balance sheet from Bioquell's market capitalisation of £37.5m and a business that has increased cash profit by a fifth to £4.1m last year is being valued at only £25.5m.

So, with the trading outlook remaining positive, and the board committed to returning cash by earnings-accretive share price supportive buybacks, albeit instead of a cash dividend, then I feel my 180p target price is not only achievable, but could prove conservative. Buy.

 

Alpha Real Trust banks hefty gains

There has been a raft of announcements in the past few weeks from Alpha Real Trust (ARTL:126p), a company that invests in high-yielding property and asset-backed debt and equity investments in western Europe, with the aim of delivering strong risk-adjusted cash flows.

Firstly, the company's hard ball stance in the takeover situation of small-listed property company Industrial Multi Property Trust (IMPT:330p) has paid off with the bidder, FTSE 250 property group Hansteen (HSTN:128p), raising its cash bid by 10 per cent to 330p a share. This means that Alpha will receive almost £5.2m for its 18.7 per cent stake and there is a strong likelihood that the five-year subordinated loan of £10.3m (including accrued interest) outstanding to Industrial Multi Property Trust, and on which Alpha earns an annual coupon of 15 per cent, will be redeemed before its maturity date of December 2018. If this happens then Alpha will be due an exit fee of 2 per cent. Alpha has now sold its shareholding to Hansteen, the effect of which is to boost Alpha's last reported book value of 153.9p a share by around 2.2p a share.

Secondly, Alpha has just agreed to sell a 70 per cent equity interest in its wholly owned H2O shopping centre in Madrid to CBRE European Co-Investment Fund at a 4.8 per cent premium to the latest published valuation of the shopping centre. Alpha will retain a 30 per cent stake in a joint venture to participate in the future growth of the centre. In addition, the company has completed the refinancing of the borrowings secured on the shopping centre with a new €65m (£56.5m) seven-year loan with Aareal Bank. The new margin of 1.8 per cent represents a 70 basis point saving on the previous financing and borrowings are non-recourse to Alpha. By my reckoning the part disposal will lead to €5.4m (£4.7m) uplift on the previous valuation of H20, adding almost 7p a share to Alpha's last reported net asset value of 153.9p.

 

And it gets better...

The news gets even better because a few weeks ago the Delhi High Court upheld the award declared in favour of Alpha with respect to its Galaxia investment, a development site extending to 11.2 acres located in NOIDA, an established suburb of Delhi and one of the principal office micro-markets in India. I highlighted the potential for a windfall gain on its investment in the Galaxia project in my last article after Alpha initiated arbitration proceedings against its joint venture development partner, Logix, in order to protect its investment ('Shareholder activism', 22 Feb 2017).

The total award has now accrued to £13.8m at the current exchange rate whereas it is held in Alpha's accounts at £5.2m. If the company can recoup this sum in full, and admittedly there is no guarantee it will, then it will add 12.5p a share to Alpha's last reported net asset value of 153.9p a share. Bearing this in mind, Alpha has commenced execution of the award, and the Logix Promoters have been restrained from alienating their Corporate Office in NOIDA as well as their residential home in New Delhi. They have also been directed by the Delhi High Court to submit on affidavit a list of all their assets and bank statements. I understand that the Delhi High Court has issued a warrant of attachment against the primary residential property owned by Shakti Nath and Meena Nath, promoters of Logix. Alpha has had the residential property independently valued at £6m. This offers some assurance that the £5.2m carrying value of the award in Alpha's accounts will be recouped at the very least, and perhaps significantly more on top.

In the circumstances, it's hardly surprising that Alpha's shares have risen from 112p to 126p since my last update ('Shareholder activism', 22 Feb 2017) and are now well ahead of the 80p level when I initiated coverage 15 months ago ('High-yield property play', 10 Feb 2016). This partly reflects a narrowing of the share price discount to book value, but also the fact that net asset value per share hit a record 153.9p at the end of December 2016, or 23 per cent ahead of valuations 12 months earlier. For good measure the company has paid out five quarterly dividends of 0.6p a share since I initiated coverage, so has provided a decent income flow.

By my reckoning, the shares are trading 23 per cent below my 163p a share estimate of book value, a share price discount that has scope to narrow further. So, if you followed my repeated buy recommendations on this company in the past 15 months, I would run your healthy profits as my 130p target price could prove conservative. Run profits.

 

K3 warns on profits

The vast majority of the announcements from companies on my watchlist have been positive, but this is not the case with retail software company K3 Business Technology (KBT:157p), the Salford-based supplier of software to the retail, manufacturing and logistics sectors and provider of managed IT and web-hosting services.

At the start of the year the company warned of weak trading in the key selling month of December due to a softening in market conditions, lengthening of sales cycles around larger deals, and an accelerating shift to cloud-based solutions among customers. Although K3's management team insisted that these deals had merely been delayed, and the company remains firm on pricing, the directors downgraded their cash profit guidance for the financial year to end of June 2017 by £3.5m, prompting analysts at both Edison Investment Research and finnCap to rein back their cash profit estimates from £16m to £12.4m based on flat revenue of £89m. This implied a 12 per cent fall in pre-tax profit to £7.7m, to produce EPS in the range between 16.7p and 17.7p, a hefty shortfall on Edison's previous estimate of 26p, and way below last year's reported figure of 23p even though the company has made a number of acquisitions that have boosted the bottom line.

That news wiped 20 per cent off the company's share price, but having reviewed the investment case I felt the shares were worth holding on to for recovery at 255p ('Funded for growth', 15 Feb 2017), having first advised buying at 220p a few years ago ('Tapping into retail growth', 16 Sep 2014). Unfortunately, the company warned last week that it has failed to secure some large contracts in its enterprise software division with the result that full-year results will be significantly below even those heavily downgraded profit estimates. The news wiped a further 40 per cent off K3's share price and analysts at both broking houses have suspended their forecasts pending greater clarity either in the pre-close trading update or in the final results.

The results will also include exceptional costs resulting from a senior management reorganisation that has streamlined the operating structure with the aim of boosting sales and delivering cost savings. It's come at a price as K3 will book a one-off cost of £3m. Analysts had been predicting year-end net debt close to £10m, up from £8.9m in June 2016, but I can see this being revised upwards given the profit shortfall.

 

All is not lost

There are positives although as the directors point out that operations elsewhere have been making encouraging progress and generating healthy cash flows, and it has secured pilot customers for its new cloud-based modular technologies which is promising as this highlights the opportunities for its high-margin own IP. The board are also starting a review with the aim of refocusing the growth strategy around its cash generating businesses and installed 3,700 strong customer base.

The bottom line is that although selling out in January would have been the right call in hindsight, I see little point exiting now. That's because the company's market value has halved to £55m, so its enterprise value is little over five times the level of cash profit in the 2016 financial year. Clearly, profit will be sharply down in the year to June 2017, so that multiple will expand - it could even double in the worst-case scenario - but with banking facilities refinanced last autumn to take advantage of favourable interest rates, and the directors now aiming to focus the business on the most highly cash-generative segments, then the bad news looks priced in.

Moreover, the share price is as oversold as it was in the dark days of the last bear market with the 14-day relative strength indicator (RSI) on the floor. In the circumstances, it makes sense to hold onto your shares ahead of the pre-close trading update. Hold.

 

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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