I first advised buying at 13p ('Queuebusters', 17 Jan 2011) and have remained positive ever since. I updated the investment case at the end of November (‘Dial into cloud based profits’, 28 November 2013) when the price was 45p, and post a pre-close trading update from the company I reiterated the advise when the price had risen to 54p (‘Riding earnings upgrade cycles’, 14 January 2014).
I also upgraded my fair value target price at the time from 55p to 60p, a level that was achieved when Netcall’s share price hit a 12-year high of 64p at the end of January. In the circumstances, it hardly came as a surprise that some investors have been banking some profits following last month’s half year results. The pull back has been quite severe though, and in my view has opened up yet another great long-term buying opportunity.
That’s because the whole point about bull markets is that the best time to buy into a long-term uptrend is when the price pull backs to the 200-day moving average. In the case of Netcall, we are almost there as this long-term trend line is around 46p, within a penny of where the share price has retraced back to today. Moreover, the 14-day relative strength indicator is absolutely on the floor and is showing a massively oversold reading close to 20. As a result I believe this represents a buying opportunity where the risk is heavily skewed to the upside and one that should be taken advantage of.
Impressive cash generation
One of the reasons why Netcall shares have performed so well is down to the awesome cash generation of the business.
To put this into some perspective, in the financial year to end June 2013, both cash profits and cash generated from operations increased by a quarter to £4.2m and £4.9m, respectively. As a result Netcall’s cash pile rose by 9 per cent to £9.1m, or the equivalent of 7.4p a share, and that was after factoring in a £1.5m investment in research and development and a further £1.95m spent on acquisitions.
It was more of the same in the first half of the financial year to end December 2013 as cash profits surged by a further 13 per cent to £2.48m to drive the cash pile up to £10m, or the equivalent of 8.1p a share. In turn, this gives the company the flexibility to recycle its cash into making earnings enhancing bolt-on acquisitions, invest in existing operations to support organic growth ,and to reward shareholders with a very progressive dividend policy. In the latest six-month trading period, Netcall invested £900,000 in research and development, but still managed to grow net funds by a similar amount.
The burgeoning cash pile also enabled the board to lift the dividend by 40 per cent from 0.5p to 0.7p a share in the last financial year, a payout that was covered more than three times over by post tax earnings. For the 12 months to end June 2014, analyst Andrew Darley at brokerage finnCap expects Netcall to pay out £1m in dividends based on cash profits rising from £4.2m to £4.5m. The final dividend of 0.8p a share forecast could potentially be higher because historically the company’s free cashflow is stronger in the second half of its financial year (to end June).
It also appears that analysts are being too conservative with their earnings estimates. That’s because in the first half Netcall boosted its underlying EPS by 11 per cent to 1.47p, but broking house finnCap are predicting diluted adjusted EPS of 2.5p for the full year, only seven per cent higher than the previous financial year. In my opinion, this offers plenty of scope for Netcall to outperform consensus and issue an upbeat pre-close trading statement in mid-July ahead of the full-year results in September.
Strong fundamentals
At last week’s results, chief executive Henrik Bang reported that the company continues to experience robust demand across its whole product portfolio, driven principally by the private sector and orders for business process management and software-as-a-service (SaaS) solutions. Recurring revenue from a client base of over 700 organisations accounts for an impressive 63 per cent of the company’s total turnover. Moreover, two thirds of all new business is from existing clients, highlighting the quality of Netcall’s products and services.
Customers include NHS Acute Health Trusts, telecoms companies BT and Orange, financial institutions Lloyds TSB and Prudential, cinema operator Cineworld and utility Thames Water. It's hardly surprising either that business remains so strong as Netcall’s clients are increasingly facing the balancing act of having to improve the quality of their customer engagement while at the same time making operational efficiencies and reducing costs. Furthermore, businesses have to deal with customers across a growing number of channels including the internet, mobile networks, social media, web-chat, telephone and text messages. New customer wins in the latest six-month trading period include car park operator NCP, insurer Axa, PPP Healthcare and Leicestershire Police.
To recap, Netcall platform of products provides a suite of software solutions which support organisations' end-to-end customer engagement strategies with the aim of improving customer service, retention and acquisition. The company’s Liberty platform includes multi-channel contact handling that has been designed to improve customer interactions and workflow capabilities. It has been well received by customers who have been choosing to acquire or upgrade to the platform. The benefits to customers have been immediate with service desk interaction rates increasing by 50 per cent at King’s College, London and email response times reduced to minutes.
So, to win even more business, earlier this year Netcall made a joint investment in Farnborough-based Sentiment, a cloud-based platform that monitors global social media. Sentiment will be integrated into the Liberty platform to enable Netcall’s customers to analyse social media information across multiple social networks and engage through a single integrated application. The investment in Sentiment is a smart move given the growing importance of social media for businesses when engaging with customers.
Expect more earnings enhancing acquisitions
I understand that Netcall is actively seeking out further complimentary acquisitions where the company can boost its underlying revenue growth rates and also enhance earnings per share. It makes sense to do so because that low-yielding cash pile now accounts for a fifth of Netcall’s market capitalisation.
It’s for this reason that I believe that I believe that finnCap’s EPS estimate of 2.7p for the financial year to end June 2015 is simply too low as is the 2.8p estimate of analyst Luke Tribe at broking house WH Ireland. But even if we accept these forecasts, then the shares are still only trading on 14 times EPS estimates net of the current cash pile, a rating that will either fall as the cash pile grows or as Netcall makes earning enhancing acquisitions. Either way, that’s hardly an exacting valuation for a company that has grown underlying EPS by 63 per cent over the past couple of years and has been relentlessly issuing positive newsflow and beating expectations.
In the circumstances, I am more than happy to rate Netcall’s shares a buy on a bid-offer spread of 46p to 47p, and would use the current market shake-out as a decent medium-term buying opportunity ahead of the forthcoming pre-close trading update in July. In the short-term, I not only expect strong support from the rising 200-day moving average, but with the 14-day RSI so heavily oversold I expect a hefty bounce of it too. On a six month basis, my fair value price target is 60p, below finnCap’s target price of 70p. Buy.
Please note that I have written another article today: Undervalued and oversold. I am currently working my way through a very large number of updates following the release of trading statements and financial results from several of the companies on my watchlist. These include announcements from other 2014 Bargain shares in this year’s portfolio, Barratt Developments (BDEV) and Taylor Wimpey (TW.) and last year's constituent, Heritage Oil (HOIL). I will also be publishing investment updates following announcements from Bovis Homes (BVS), BP March & Partners (BPM), First Property (FPO), and Macau Property Opportunities (MPO).
