A good example is newly listed diversified financial services company Ramsdens (RFX:134p) which released bumper results last week. Having run through the investment case in quite some detail, and grilled the directors, I am pretty confident the cash-rich company will be able to deliver the 20 per cent-plus growth in EPS predicted by analysts at Liberum Capital this year, so much so that I initiated coverage with a buy rating and a target price of 180p in an in-depth online column ('A jewel in the north', 12 Jun 2017).
Funded for explosive growth
Another good example is Sedgefield-based Kromek (KMK:31.5p), a radiation detection technology company focused on the medical, security and nuclear markets.
I had been patiently monitoring the company for some time, noting a raft of contract wins, but what prompted me to recommend buying the Aim-traded shares at 25p in late February was news of an oversubscribed placing and open offer which raised £20m ('Follow the smart money', 27 Feb 2017). It was an unusual fundraise as Kromek didn't need the money, but tapped shareholders to strengthen its position when negotiating contracts with government bodies and original equipment manufacturer (OEM) customers who had concerns about the company's financial strength and ability to supply significant quantities of its core cadmium zinc telluride (CZT) technologies.
It's a hot area to be operating in given the geopolitical backdrop and heightened risk of terrorism. In fact, Kromek revealed this week that its next generation standalone radiation detector was deployed by the European Commission Counter Terrorism Unit during the NATO Security Summit and the visit to Brussels last month of US President, Donald Trump. It's a strong stamp of approval for the company's technology and can only be supportive of Kromek's revenues ramping up sharply as more potential customers sign on the dotted line.
Bearing this in mind, although analysts Hannah Crowe and Paul Hill at research firm Equity Development predict Kromek can lift revenues by more than a third to £12.5m in the financial year to end April 2018, prompting a move into cash profitability, only £2.24m of this sum is dependent on new shipments. That's because £7.2m of the £12.5m revenue forecast is backed fully by a flow-through of the order book, and a further £3m is supported by repeat or expected orders. It wouldn't take many new contracts to accelerate the move into profitability.
Reassuringly, while I was on annual leave, Kromek announced in a pre-close trading update that "products continue to gain traction in all our business segments from the increasing adoption of CZT-based technology and other products. The company expects to continue to win new customers and, together with the momentum of contract wins, it expects a step change in revenue growth in the new financial calendar year." Equity Development's forecasts look on the money to me.
In the circumstances, it's hardly surprising that Kromek's share price subsequently hit my 34p target price. That was the cue for some profit taking, but after consolidating gains the share price looks well placed once again to achieve that discounted cash-flow-based target price. Rated on 1.8 times book value of £44m, and with pro-forma net cash of £22m equating to 8.5p a share, I would run profits ahead of next month's results.
Investors show cognitive powers
Aim-traded shares in Cambridge Cognition (COG:120p), a company that has developed a suite of computer-based cognitive assessments to improve the understanding, diagnosis and treatment of neurological and psychological diseases, have risen from 87p to 120p since I highlighted the investment potential ('Positive thinking', 19 Apr 2017).
The move is fully justified after the company turned in a maiden pre-tax profit of £116,000 for the 2016 financial year, reversing a hefty loss in 2015, on revenues up from £5m to £6.9m. The top-line growth not only reflects a move to accelerate the commercialisation of its valuable intellectual property (IP), but the greater attention that's being paid by individuals, carers and employers to all aspects of cognitive function in health. Moreover, buoyed by a year-end sales pipeline worth £2.68m in its clinical trial division, analysts Alex Pye and Mark Brewer at broking house finnCap believe that revenues can rise to £8.2m and £9.5m, respectively, this year and next.
New products have potential to accelerate sales growth, too. In fact, the company has just announced that it has developed a product using artificial intelligence (AI) and automatic speech recognition technologies to make language-based verbal cognitive assessments that are scalable, automated and consistent. Language exhibits measurable changes in many psychiatric and neurological conditions including Alzheimer's disease, depression and schizophrenia. However, to date it has been difficult for clinical researchers to perform language-based assessments or measure verbal cognitive changes without highly trained experts. This new combination of speech recognition technology with Cambridge Cognition's validated computerised tests will make this possible. The first products are expected to be available commercially in 12 months' time, highlighting the significant advances the company is making in clinical trial design.
Analysts haven't factored any contribution from this new AI product into their forecasts, but they didn't need it to warrant the current valuation. That's because with revenues rising faster than operating costs, and gross margins stable, finnCap forecasts pre-tax profits more than quadrupling to £500,000 this year, and doubling again to £1m in 2018, to support an increase in EPS from 1.3p to 2.2p this year, rising to 4.6p in 2018. I would also flag up that analysts expect net funds to increase by £500,000 to £2.8m by the December year-end, rising to £3.7m at end 2018, highlighting the cash generation of the company. This implies that net cash could equate to 14p of the share price by the year-end, rising to 18p by the end of 2018.
On this basis, my initial 130p target price equates to 24 times next year's cash adjusted earnings, a valuation that could yet offer further upside if management over delivers. Run profits.
Mind the valuation gap
I revisited the investment case of Minds + Machines (MMX:12p), a service provider in the domain name industry focused on the new top-level domain (TLD) space, when I updated my 2016 Bargain Shares Portfolio in an online column last month ('Corporate activity boosts Bargain shares', 31 May 2017).
At the time the board had just appointed US investment bank, Headwaters MB, to review various strategic options to maximise value for shareholders including an acquisition by or sale/merger of the company and one that I fully expect to value the equity way in excess of the 13p a share Goldstream Capital Management paid last year for its 6 per cent stake. Goldstream is owned by Hony Capital, a leading Chinese private equity company.
I have good reason to think this way as the company has just revealed that first year renewals of its .vip domain are running at around 70 per cent, well ahead of competing Chinese-focused new TLDs, and suggesting significant hidden value in an asset which accounted for 59 per cent of the company's gross billings last year. In fact, analyst Harold Evans at brokerage finnCap believes that even if the .vip domains under management are only maintained at the current level of 824,000 then this could generate $8.8m (£6.9m) of annual billings, and suggests a valuation of £57m for .vip alone.
To put that valuation into perspective, Minds + Machines' entire portfolio of 29 TLDs including .vip is only in the books at $45.6m, or £36m. If a valuation for .vip of that order can be achieved, and there is absolutely no guarantee of this, then Minds + Machines' current market capitalisation of £84m is woefully undervaluing the other 28 TLDs in its portfolio. The company also has net funds of £12m, a sum worth 1.7p a share.
So, although the shares are 50 per cent higher than when I included them in my 2016 Bargain Shares Portfolio, it's not wishful thinking for a valuation 50 per cent higher still in the event of a major corporate transaction taking place. Buy.
Hitting record highs
Aim-traded shares in UK and eastern European property fund manager and investor First Property (FPO:53p) hit my 56p target price following the release of a bumper set of results at the end of last week, which revealed a 24 per cent increase in reported pre-tax profit to £9.1m, buoyed by a 35 per cent increase in assets under management to £477m, and one-off gains on the sale of property. On an underlying basis, analyst Chris Thomas at house broker Arden Partners calculates the pre-tax profit increase was nearer 11 per cent to £8.59m, a cracking result and one I had anticipated when I last advised buying the shares ('Taking profits and running gains', 4 Apr 2017).
Moreover, with the benefit of recent UK mandate wins, Mr Thomas is pencilling in a £500,000 increase in First Property's pre-tax profit to £9.1m in the 12 months to the end of March 2018 to produce adjusted EPS of 5.9p and support a dividend per share of 1.6p. On this basis, the shares are trading on nine times prospective earnings, offer a 3 per cent forward dividend yield and are priced on 1.1 times book value. There should be scope for upside to those forecasts as First Property retains £16m of cash on its balance sheet to deploy on further debt-funded acquisitions of high-yielding commercial property in Poland and Romania.
Also, Mr Thomas assumes an average exchange rate of £1:€1.189, well above the current rate of £1:€1.13, thus offering scope for a currency tailwind on the hefty profits First Property earns from its 10 wholly owned overseas properties. There is potential for earnings multiple expansion, too, given that First Property's fast-growing fund management business is becoming a more valuable part of the company, albeit the majority of profits are still earned from property investment.
So, having first recommended buying First Property's shares at 18.5p in my 2011 Bargain Shares Portfolio, and booked dividends of 7.265p a share since then, excluding the final payout of 1.1p which goes ex-dividend on 31 August 2017, I would run profits.
K3's fundraising
Retail software company K3 Business Technology (KBT:150p), the Salford-based supplier of software to the retail, manufacturing and logistics sectors and provider of managed IT and web-hosting services, is raising £8.5m in a placing and open offer of shares at 140p to strengthen its balance sheet, and provide working capital.
I last advised holding the shares for recovery at 157p ('Small-cap trading updates', 24 May 2017), and I have to admit the deterioration in trading, announced in the fundraise document, is far worse than I anticipated. The board is guiding investors to expect an operating loss of between £400,000 and £2.4m for the 12 months to the end of June 2017, and that excludes £3.5m of one-off costs announced in January, £1.8m of write-downs, and a goodwill impairment charge of £2m. The company would have breached its banking covenants if its lenders had not agreed to defer the test until November.
House broker finnCap now only expects a pre-tax profit of £4m in the 2018 financial year, less than half the £8.8m reported in the 2016 financial year, and given the far greater scale of turnaround needed, a forward rating of 19 times net profits, based on the enlarged share count, is too rich for me. So, although the shares are well down on my 220p entry point ('Tapping into retail growth', 16 Sep 2014), and were showing a 66 per cent paper profit last autumn, I am cutting the loss. Sell.
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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