In fact, the number of 40-metre-plus yachts increased from just over 1,000 in 2007 to 1,835 by the end of 2015, and is predicted to grow to around 2,285 by 2020, according to industry analysts. This steady growth rate is understandable given that the number of billionaires, who are the only ones who can afford to shell out the huge sums to build and maintain the vessels, has been on an even faster upward curve, rising fivefold to 1,826 between 1995 and 2015, and predicted to hit 2,500 in three years time. Interestingly, the boats are getting bigger too: in the past decade the 50-metre-plus segment of the market has grown at a compound annual rate of 11 per cent, and there are currently 142 superyacht projects under way which have an average length of 70 metres.
This is rather good news for the specialist companies catering for the maintenance of these huge ocean going vessels which require a major survey every five years to comply with certain class, maritime laws and insurance requirements. That's because their wealthy owners usually take the opportunity to undertake some general maintenance and repaint their prized possessions at the same time, and every few years in between too. It's hardly a surprise as keeping the yachts in tip top condition helps chartering them out and reaping big bucks: for example, the 95-metre Indian Empress, owned by Indian playboy multi-millionaire Vijay Mallya, commands a weekly charter rate of €750,000 (£660,000).
Set to make waves
This niche market is of keen interest to me right now because GYG (GYG:100p), the global leader in new build and refit superyacht painting, is floating its shares on London's junior market on Wednesday this week.
Boasting a 17 per cent market share, the company completed 167 refit projects last year with an average contract value of just over €200,000, a sum the owners will easily recoup several times over by chartering out their prized possessions. Clients include half of the largest superyacht owners in the world and, with an overall retention rate of 86 per cent for repeat business, the company has strong customer relationships. This side of the business accounted for €39.5m of GYG's revenues last year, or more than two-thirds of the total, and prospects look well underpinned by an order book worth €26.7m.
The new build part of the business involves skilled painters applying multiple layers of paint to the superyachts, a process that can take between eight to 14 months to complete. GYG aims to complete between one and three such projects a year with an average contract value of €2.5m. It's high-margin business as GYG typically makes a gross profit margin of 30 per cent or so on each contract, implying the divisional order book of €11m should make the company a tidy return.
Importantly, the bid pipeline for refit and new build projects is worth €283m, and rising, offering scope for the company to maintain the 7 per cent revenue growth rate it has posted over the past three financial years, during which time GYG's cash profit has risen from €5.2m to €6.7m, and its operating profit has increased from €4.4m to €6m. The company has a historic win rate of 32 per cent, in excess of its market share and placing it in a good position to win more orders in a superyacht market that is not just growing at a fair lick, but the value of refit business is being buoyed by the increased scale of the superyachts being built. The aforementioned bid pipeline excludes GYG's recent small acquisition of a 70 per cent stake in ACA Marine which has a pipeline of around €73m.
Details of IPO
GYG is being floated on London's junior market by Zeus Capital, the broking house behind last year's IPOs of student accommodation construction group Watkin Jones (WJG:200p), and tissue maker Accrol (ACRL:160p), both of which I recommended buying into successfully at the time of flotation.
The company is placing £21.5m of vendor shares at 100p each for its private equity and management owners, and raising gross proceeds of £6.9m for the company to pay down debt, and pay its share of the IPO costs, to give it a market capitalisation on listing of £46.6m. Based on pro-forma net debt of around £5.5m, this implies an enterprise valuation of less than nine times last year's cash profits of €6.7m (£5.9m), a very fair price in my view and one that has persuaded six institutions - Woodford Investment Management, Old Mutual, Fidelity Investments, Lombard Odier Asset Management, and Close Brothers Asset Management - to buy the 21.5m shares between them, accounting for 46.2 per cent of the enlarged share capital.
Private equity firm Lonsdale Capital will still retain a 19.3 per cent stake, and the five main board directors and the chief operating officer will retain a further 17 per cent, all of which are subject to a 12-month lock-in. However, what this means is that the shares will be tightly held with 82.5 per cent of the issued share capital in the hands of the directors, Lonsdale and the aforementioned six financial institutions. That's not ideal, but given the industry dynamics I have mentioned above, and the decent profit margins GYG makes, then there is the potential for the shares to do very well especially as the directors have outlined credible reasons for the listing.
For starters, chief executive Remy Millott and finance director Gloria Fernandez believe that GYG's newly listed paper will enable it to acquire other superyacht painting and retail companies allowing expansion into new geographic areas. Currently, two-thirds of superyachts are based in the Mediterranean and GYG caters for their needs from facilities in Barcelona and Majorca in Spain, Palumbo, Italy, and the south of France. The small acquisition of smaller rival, ACA Marine, based in the south of France, highlights the potential for GYG to selectively acquire lower rated businesses. In this case, it acquired a 70 per cent stake in that business for €1.46m, a price effectively equating to five times cash profits. The other 30 per cent is held by ACA Marine's management to keep them incentivised. Interestingly, Mr Millott told me during our interview that given the highly fragmented nature of the industry, and GYG's raised profile as a result of the IPO that "acquisition opportunities will come to us. We have had one or two approaches already."
The directors also believe the Aim listing will help the company develop and extend relationships with existing and new shipyards, so support ongoing organic growth. That's important as the company has an asset-light model and operates as a preferred supplier to the shipyards who enter into separate contracts with the superyacht owner, so effectively GYG has access to the vessels but without incurring any fixed leases costs, or associated overheads. This model enables the company to scale up its operations in response to changes in demand, relying on a pool of seasonal workers.
Furthermore, the company should be able to expand its supply business that sells a wide range of marine products and maintenance equipment through its retail and yacht supply divisions. As superyachts constantly require supplies to operate, the side of the business has historically had consistent earnings which have grown with the company's turnover, rising by a quarter to €8.6m in the past two finance years. So, if acquisitions can be made, and relationships entered into with new shipyards, then the supply business should naturally benefit.
Strong financials
Buoyed by a strong and growing order book, and with the potential to make annual costs savings of €2m, a figure that Mr Millott is comfortable with and one supported by a 'back to basics' approach to costs following a review, analysts at the company's broker Zeus Capital believe that both revenues and profits are set to continue making waves in the coming years.
Guidance for the current financial year to the end of December 2017 points to GYG's revenue rising by 20 per cent to €66m, partly buoyed by the inclusion of ACA Marine, to boost cash profit up at a similar rate from €6.7m to €8.1m. On this basis, expect underlying pre-tax profits that exclude one-offs and IPO costs to rise by almost 40 per cent to €7m and deliver net profit of €4.9m. Based on a share count of 46.6m, this produces pro-forma EPS of 10.5¢, or 9.2p at current exchange rates, and implies a current year earnings multiple of 11 times and a cash profit to enterprise valuation of 7.5 times.
The valuation becomes even more compelling once you factor in the high likelihood of revenues continuing to rise strongly as the pipeline of business is converted in line with the company's historical win rate. Guidance suggests that revenue could hit €74m next year, an outcome that could produce cash profit of €9.9m, pre-tax profit of €8.6m and net profit of €6m, implying EPS of 12.8¢, or 11.3p at an average exchange rate of £1:€1.14. On this basis, at the 100p a share listing price, the 2018 forward PE is only nine, a modest valuation in my view.
The company's strong cash-flow generation is well worth flagging up and explains why the board has committed to paying a dividend equivalent to 3.2 per cent of the listing price this year, rising to 6.4 per cent in 2018. That 2018 payout will absorb a third of the €9.9m cash profit forecast, still leaving enough cash flow aside to service gross borrowings of €12.6m on which the company pays an interest rate of 3 per cent above EURIBOR, and also make bi-annual capital repayments of €918,000 on the debt. GYG will start its listed life with a cash pile of €6.3m, so pro-forma net debt on listing is around €6.3m.
The point here is that GYG doesn't really need to gear up its balance sheet to push profit above current guidance. That's because net debt of €6.3m equates to a comfortable 38 per cent gearing of shareholders' funds of €16.4m, so the board has ample room on the balance sheet to effectively recycle the annual €1.83m of debt repayments on its current facilities into earnings-enhancing acquisitions.
Or to put it another way, there is potential here for the company to achieve the Holy Grail: pay a sustainable progressive dividend from rising net profits while at the same time maintain balance sheet gearing at a sensible level and increasing net asset value per share. There are not many companies that achieve that, but GYG certainly looks capable of doing so.
Clearly, I am impressed by the investment story. It also helps that the institutions buying in at the IPO have driven a hard deal as the company's enterprise value of £52m on listing is well below the £64m to £72m range indicated in the pre-IPO institutional roadshow. This should ensure a decent aftermarket. However, there are still risks to consider.
Risk assessment
The most obvious one is the company is coming to the market only 16 months after Lonsdale backed a management buyout (MBO) of GYG at a multiple of over five times 2015 cash profits of €5m to enterprise value, a deep discount to the 7.5 times current year multiple the company is listing at. Admittedly, there were reasons for the apparent bargain exit multiple in the MBO as it was priced to enable some minority legacy shareholders an exit, according to Mr Millott. Also, the fact that GYG's cash profits are predicted to double in the three years to 2018, and equity markets are more highly rated now than they were in March 2016, certainly warrants a higher valuation. Also, both the private equity owners and insiders reassuringly retain substantial skin in the game.
Secondly, there is a risk owners don't pay their bills on time which is worth considering as these are incredibly wealthy individuals who can afford to spend upwards of £400m on a superyacht and employ staff of 100 or more. That hasn't been an issue, though, as GYG has a high level of repeat business, indicating a high level of customer satisfaction. Moreover, all the €2.4m of receivables on GYG's balance sheet at the end of 2016 and which had passed their due date have been settled in full, so there are no bad debts. I also understand from the directors that the company spends less than 1 per cent of its turnover on warranties to insure against having to repaint one of these huge ocean-going vessels, and the level of provisioning has been pretty constant, thus highlighting its reputation as a high-quality specialist in its niche field. Furthermore, when things do go wrong, there is always a fall back to the paint manufacturer which in one particular case we discussed has guaranteed to cover the €800,000 cost of repainting a client's superyacht in full.
The competitive environment is worth considering. GYG's main rival is Yacht Protection which has a similar market share, but specialises more in the new build market. The two market leaders aside, no other company controls more than 10 per cent of the market, so lack GYG's scale and ability to leverage its position. New arrangements with shipyards in Italy and in the US, and ongoing conversion of the bid pipeline, are certainly supportive of Zeus's forecast that GYG can grow its market share from 17 per cent to around 20 per cent in the next three years.
GYG's asset-light business model relies on the availability of specialist seasonal labourers to work on its projects, so there is always the risk of a labour shortage hindering the ability of the company to deliver projects on time given this labour force is not employed full time, albeit this has not been a problem to date. Although the industry pipeline of new builds is clearly robust right now, there is always the risk of billionaires cancelling orders in the event of an economic downturn. In turn this would subdue the level of future painting work for GYG.
Management risk is worth flagging up as the company has a small senior management team and one with significant industry experience: chief executive Remy Millott has 35 years of yachting industry experience; managing director Rupert Savage has over 25 years; and finance director Gloria Fernandez came on board five years ago after finalising the joint venture deal between two of the company's main brands, Pinmar and Rolling Stock. The fact that all the directors have 12-month lock-ins on their shareholdings, and have significant equity stakes in the business, are reassuring although the loss of key personnel would still be an issue. So too would be any material currency movements as any significant appreciation of sterling against the euro reduces the sterling value of GYG's net earnings and impacts the board's ability to pay a chunky dividend to its UK shareholder base.
Finally, and as I have stated already, around 82.5 per cent of the 46.6m shares in issue will be held by the directors, Lonsdale and six financial institutions backing the IPO. This means the shares are tightly held which impacts liquidity and means that the share price is likely to rise more sharply on positive newsflow, but fall more steeply on any adverse news. Clearly, I believe the risk is skewed towards the former, but liquidity risk is still worth noting.
Target price
Having taken into account the industry dynamics, the projected profit build over the next two years, the basis on which guidance is given, and the valuation the company is being floated at, then I believe the investment risk here is favourable.
In terms of the UK support services sector, the company is being rated on a near 40 per cent discount to FTSE 100 defence and support services group Babcock International (BAB:883p) based on an enterprise value to cash profit multiple using 2018 forecasts, and a near 50 per cent discount to marine engineering services group James Fisher (FSJ:1,635p). The valuation discrepancy with Fincantieri Spa (FCT:MIL), a €1.65bn Italian shipbuilding company based in Trieste and listed on the Milan Stock Exchange, is just as pronounced.
In the circumstances, I feel a value for GYG's equity of 13 times 2018 likely EPS of around 11.3p is not an unreasonable valuation as this valuation would be supported by a forward dividend yield of 4.2 per cent based on a 6.4p a share payout, and value the company on a reasonable enterprise value to cash profit multiple of 8.6 times 2018 guidance, a 20 per cent plus ratings discount to James Fisher. Therefore, I initiate coverage with a 12-month target price of 150p, implying 50 per cent share price upside to the 100p a share IPO price. Please note that dealings in the Aim-traded shares commence at 8am on Wednesday 5 July and the TIDM code is GYG. 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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