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Riding earnings upgrade cycles

Riding earnings upgrade cycles
July 7, 2015
Riding earnings upgrade cycles

Aim-traded telematics and data provider Trakm8 (TRAK:176p) released a bumper set of results as I had anticipated in my update last month ('Small cap wonders', 17 June 2015). In fact, adjusted pre-tax profit more than doubled from £880,000 to £1.82m, an outcome that was six per cent ahead of house broker finnCap's previously upgraded forecasts, and adjusted fully diluted EPS surged by two thirds to 5.9p.

Moreover, having previously raised guidance for the current financial year to end March 2016, Trakm8's board have done so again, prompting analyst Lorne Daniel at finnCap to raise his adjusted fully diluted EPS estimate from 10.3p to 11p, based on full-year revenues rising from £17.9m to £25m and the company delivering pre-tax profits of £3.4m, or £200,000 higher than at the time of my last update only three weeks ago.

The latest upgrade reflects both underlying growth in the business - like-for-like orders soared by 38 per cent in the latest 12 month period - and upside from acquisitions. Post the fiscal year-end, Trakm8 acquired Bodmin-based DCS Systems, a designer and distributor of camera systems for motor vehicles, bicycles and security markets, a deal I commented on at the time of my last article.

The acquisition is in line with Trakm8's strategy of augmenting its organic growth with selective bolt-on purchases that expand its telematics offering to both insurance and fleet customers. It makes sense to do so as there is clearly strong demand from both the SME and insurance markets for the company's leading-edge technology offering. For instance, Trakm8 has won major contracts with motor insurers Direct Line and Marmalade, and multi-national Saint Gobain on the fleet side. With cash generation strong - operating cash flow more than trebled to £2.6m before working capital movements in the fiscal year - and Trakm8's pro-forma net borrowings still only £2.7m, I see scope for further earnings accretive bolt-on deals too. The company currently has untapped bank facilities of £3m available. There is also potential for upgrades to the aforementioned EPS estimates as the year progresses given that Trakm8 has a robust pipeline of opportunities under trial with potential clients.

Clearly, investors have cottoned onto the fact that the company is in an earnings upgrade cycle which explains why the share price has doubled in less than five months since I recommended buying at 92p ('Zoning in on a profitable price move', 16 February 2015) and hit my 180p target price ahead of this week's financial results. I also advised running profits at 135p ('Smashing target prices', 14 May 2015).

However, with analysts upgrading their EPS estimates and target prices - finnCap upgraded its target from 185p to 220p post results - and given the potential for more upgrades and earnings enhancing acquisitions, I feel that any short-term profit taking post results is worth taking advantage of. Trading on 16 times forward earnings, and rated on a PEG ratio below one, the current rating fails to recognise the realistic possibility of Trakm8 issuing another earnings beat, and by quite some margin.

In fact, I feel so strongly that I have a revised year-end target price of 200p. Trading on a bid-offer spread of 171p to 175p, and offering 15 per cent potential upside, I rate Trakm8's shares a buy.

 

Cashed up Redde bumps up dividend

Trakm8 is not the only company on my buy list that has issued an earnings beat. Aim-traded Redde (REDD:138p), a provider of replacement vehicles for drivers involved in accidents that are not their fault and of legal services designed to assist claimant parties in partnership with leading insurance companies, has too.

A pre-close trading statement for the fiscal year to end June 2015 revealed that profits will exceed the upper end of market forecasts, an outcome which vindicated my decision to favour the strong momentum in the business being maintained through the fourth-quarter trading period ('Smashing target prices', 14 May 2015). Analyst Andrew Watson at broking house N+1 Singer raised his pre-tax profit estimate by 5 per cent to £21.9m for the 12 months to end June 2015, up from £12m in the previous fiscal year, based on a near 20 per cent increase in revenues to £235m. On this basis, expect full-year EPS to now rise by 28 per cent to 8.3p. Moreover, with cash generation strong, reflecting higher case volumes and a better working relationship with insurers, the company's cash position is robust. Net funds of £38.8m at the end of May 2015, up from £36m at the end of March 2015, are the equivalent of 13p a share.

As a result Redde's board is declaring a special dividend payment of 1p a share in addition to a final dividend of not less than 4p a share. This means the total dividend per share will be at least 9p, or 20 per cent higher than in fiscal 2014, reflecting the board's policy to payout all its net profits as dividends. On this basis, the shares now offer a dividend yield of 6.5 per cent and are rated on 15 times cash adjusted earnings.

But as I noted when I initiated coverage at 108p ('In the fast lane', 23 March 2015), the board is also looking to make earnings-enhancing acquisitions which could easily knock a couple of points off that earnings multiple if the cash pile is deployed wisely.

So although Redde's shares are within pennies of hitting my 140p target price, I feel there could be more upside to come as investors warm to the raised payout, the operational progress the business is clearly making, and the possibility of earnings accretive acquisitions leading to additional upgrades.

In the circumstances, I would run your 28 per cent paper gains on the shares to my newly revised target price range of 150p to 155p.

 

Cohort smashes target price

At the risk of sounding like a broken record, small-cap UK defence company Cohort (CHRT:312p) has also posted an earnings beat. Its shares have also smashed through my previous target price of 300p and are firmly in blue-sky territory, having first advised buying at 215p ('Blue-sky buy', 6 Oct 2014), and subsequently reiterated that advice at 280p ('Flying high', 14 April 2015).

Buoyed by acquisitions, the company's revenues increased by 40 per cent to just shy of £100m in the 12 months to end April 2015, but it was the underlying growth rate that really stood out for me. Cohort's like-for-like sales soared by 23 per cent in the period which in turn helped drive up adjusted pre-tax profits from £8.3m to £10.2m, or £400,000 higher than analyst Roger Johnston at Edison Investment Research had predicted. EPS of 20.5p beat forecasts of around 18.5p by quite some margin too, and with cash generation impressive - net funds increased by a fifth to £19.7m despite Cohort paying out £17m on acquisitions - the board were able to hike the payout by a fifth to 5p a share. This means that net of a 48p a share cash pile, Cohort's shares are still only priced on 12.5 times historic net profits and offer a reasonable 1.6 per cent dividend yield.

The other key take for me was that growth was across the board with each of Cohort's business units delivering revenue and operating profit growth. Bolt-on acquisitions are helping in this regard and enabling the company to enhance its position in its chosen niches and expand the product offering. Last summer's acquisition of a 50 per cent shareholding in Surrey-based Marlborough Communications, a supplier of advanced electronic communications and surveillance technology, is a case in point. So too is the purchase of J+S, a leading UK supplier of systems and in-service support for the defence and offshore energy markets. Its defence products include sonar systems, torpedo launchers and a range of other naval equipment.

The company's closing order book of £134m included a £38m contribution from these two acquisitions and is highly supportive of analysts' revenue forecasts of £112m for the current financial year to end April 2016. If achieved this should underpin a 15 per cent hike in pre-tax profits to £11.7m. On this basis, Edison now expect EPS to rise to around 22p, representing a 5 per cent upgrade, and the dividend to be lifted by a further 20 per cent to 6p a share. This means Cohort's shares are priced on 11.6 times forward earnings and offer a 1.9 per cent prospective dividend yield.

So with an order book at record levels, the full benefits of contract wins and last year's acquisitions coming through, and the newly elected Conservative administration offering a degree of stability for UK defence related spending plans, I feel that a higher valuation for Cohort's equity is in order. Indeed, applying a multiple of 15 times current year post tax earnings, and factoring in the company's bumper cash pile, I feel an enterprise value closer to £150m is fair, or around 365p a share, inline with the sum-of-the-parts target price of Edison.

Offering a further 17 per cent potential upside, Cohort's shares remain a buy on a bid-offer spread of 305p to 312p.

 

Burford breaks out

It hasn't taken long for shares to re-rate in Aim-traded Burford Capital (BUR:175p), the world's largest provider of investment capital and professional services for litigation cases to lawyers and clients engaged in major litigation and arbitration. I recommended buying a month ago at 146p, highlighting at the time a very sound investment case and an attractive chart set up ('Legal eagles', 8 June 2015).

In fact, Burford's share price has burst through the 148p glass ceiling which had previously halted progress in March 2012, and at in September 2013 too, and is now in blue sky territory. The shares are also making rapid headway to my year-end target price of 190p. The price surge is mainly down to a stock overhang being cleared after an institutional block trade of 5m shares, or 2.4 per cent of the issued share capital, went through the market at 152p early last week. Hedge fund Eton Park had previously offloaded 8.4m shares to reduce its stake from 7 per cent to less than 2 per cent, and I understand on the grape vine that asset manager Baillie Gifford has snapped up 5m shares.

Trading on less than 10 times EPS estimates of around 18p for fiscal 2016, representing a 35 per cent discount to the rating of the diversified financial sector average according to analyst Peter Lenardos at brokerage RBC Capital, and offering a prospective dividend yield of 2.9 per cent for fiscal 2015, I remain a buyer of Burford's shares ahead of what will undoubtedly be an upbeat pre-close trading update later this month.

 

Profits to flow in at Fluidpower

Skelmersdale-based Flowtech Fluidpower (FLO:136p), the UK's leading specialist supplier of technical fluid power products, has made two smart looking bolt-on acquisitions, both of which will boost the company's earnings per share significantly in the 2016 fiscal year. It's a company I know well, having initiated coverage when the price was 118p ('A fluid performance', 2 June 2014), and updated the investment case a couple of months ago ('Riding the new issues gravy train', 14 April 2015).

If anything my target price of 150p is looking too conservative given that the acquired businesses not only complement Flowtech's Primary Fluid Holdings business and add scale to the original equipment manufacturer side of the company, but according to analyst Andy Hanson at house broker Zeus Capital will lift EPS by 10 per cent in fiscal 2016. That's because for a combined consideration of £7m, of which £1.9m will be funded by cash on the acquired companies' own balance sheets, Flowtech is buying in combined operating profits of £900,000 on annual revenues just north of £8m. Moreover, around £1.5m of the net consideration of £5.1m is subject to an earn-out over the next two years, so the initial cash payment is only £3.6m, or four times annual operating profit. The total consideration represents a sensible 40 per cent premium to book value of the businesses being acquired.

Northern Ireland-based Nelson Hydraulics distributes hydraulic equipment, components and hose assemblies and has been family owned for over 50 years. The acquisition strengthens Flowtech's product offering, and looks an ideal fit with its end markets focused on agricultural and marine fishing. Although smaller than Nelson, the acquisition of North Wales-based Albroco, a distributor of hydraulic and electro-mechanical components to the mobile, on- and off-highway and construction markets, also adds breadth and scale to the company's power and motion control division.

Factoring in a modest contribution to profits this year due to the late timing of the deals, Mr Hanson has edged up his fiscal 2015 pre-tax profit estimate to £7m based on revenues of £46.2m to produce EPS of 12.9p, up from 11.4p in 2014, and is pencilling in a well covered dividend of 5.3p a share. However, factoring in a full 12-month contribution in calendar 2016, Mr Hanson predicts revenues of £52.9m, pre-tax profits of £8.1m, EPS of 15p and a dividend of 5.5p a share.

On this basis, Flowtech shares are priced on 9 times fiscal 2016 earnings estimates and offer a prospective dividend yield of 4 per cent. To put this rating into some perspective, the shares are priced 35 per cent below the distribution sector average earnings forward multiple for the current financial year, widening to 40 per cent next year, an anomalous rating for a company that is set to deliver double-digit earnings growth over both years.

Importantly, Flowtech is modestly geared as pro-forma net debt of £10.3m equates to 16 per cent of net assets of £63m. Admittedly, the company does have some exposure to the offshore oil and gas capital expenditure market which impacts the maintenance, repair and overhaul (MRO) market it services, and the 9 per cent appreciation of sterling against the euro is another headwind worth bearing in mind. However, this looks more than factored into the current valuation. In fact, I have edged up my target price to 155p, or little over 10 times fiscal 2016 earnings estimates. Buy.

MORE FROM SIMON THOMPSON...

At the end of April, I published an article with all of the share recommendations I have made this year. Since then I have published articles on the following companies:

Marwyn Value Investors: Buy at 220p, target price 260p ('Exploiting a value play', 5 May 2015)

Pure Wafer: Buy at 113p, target 140p to 150p; Paragon: Run profits at 440p, but buy on a confirmed breakout above the 445p and new target of 500p; 600 Group: Buy at 16.5p, target 24p; Fairpoint: Buy at 127p, target 190p; AB Dynamics: Buy at 207p, target 230p ('Repeat buy signals', 11 May 2015)

Globo: Buy at 56p, target 69.5p; Greenko: Hold at 70p; Pittards: Buy at 128p ('Breakout looms for mobile wonder', 12 May 2015)

Macau Property Opportunities: Buy at 214p; Dragon-Ukrainian Properties & Development: Hold at 28p; Raven Russia: Hold at 53p ('Overseas property plays', 13 May 2015)

Trakm8: Run profits at 135p; Redde: Buy at 120.75p, target 140p; STM: Run profits at 45p, but conditional buy on close of 48p and new target of 60p ('Smashing target prices', 14 May 2015)

Bilby: Buy at 75p, target 100p ('Buy to build' growth play, 18 May 2015)

Bioquell: Buy at 148p, target 170p to 185p; Somero Enterprises: Buy at 140p, target 185p; KBC Advanced Technologies: Buy at 109.5p, target 165p; Inspired Capital: Hold at 14.25p ('Three value plays', 19 May 2015)

Renew Holdings: Buy at 315p, target range 350p to 375p; Manx Telecom: Buy at 198p, target 210p ('Renewing old acquaintances', 20 May 2015)

Marwyn Value Investors: Buy at 228p, target 260p; Charlemagne Capital: Hold at 13.5p; Bloomsbury Publishing: Hold at 178p ('Lights, camera, action', 21 May 2015)

Anite: Buy at 91.5p, target 110p ('Testing a breakout', 26 May 2015)

Character Group: Buy at 415p, target 525p ('Playtime', 1 Jun 2015)

Tristel: Run profits at 96p; Pure Wafer: Buy at 123p, target range 140p to 150p; Crystal Amber: Buy at 153p ('Hitting target prices', 2 Jun 2015)

B.P. Marsh &Partners: Buy at 150p, target range 170p to 180p; Moss Bros: Buy at 110p, target range 120p to 130p; SeaEnergy: Sell at 15p ('Exploiting a valuation anomaly', 3 Jun 2015)

Globo: Buy at 59p, target 69.5p; London & Associated Properties: Buy at 38.5p; Greenko: Hold at 44p ('Catalysts for share price moves', 4 Jun 2015)

Burford Capital: Buy at 148p, target 190p ('Legal eagles', 8 Jun 2015)

Market strategy ('Financial Market Watch', 9 June 2015)

Software Radio Technology: Buy at 29.5p, target 40p to 43p; Tristel: Run profits at 92p; Creston: Buy at 136p, target 150p; Sanderson: Buy at 69p, target range 80p to 85p ('Blue sky potential', 10 June 2015)

1pm: Buy at 67p, target 80p; Vislink: Buy at 58p, target 70p ('Small-cap growth stocks', 11 June 2015)

Elegant Hotels: Buy at 105p, target 135p to 140p ('Checking into an elegant investment', 15 June 2015)

First Property: Run profits at 45p; AB Dynamics: Run profits at 225p and target 250p; Inspired Capital: Sit tight at 20p (Bargain shares updates', 16 June 2015)

Trakm8: Run profits at 159p, new target 180p; Anite: Sit tight at 126.75p; Trifast: Run profits at 129p, target 140p; Record: Buy at 37p ('Small cap wonders', 17 June 2015)

Inland: Run profits at 71p, target 80p; KBC Advanced Technologies: Buy at 110p, target 165p; Caretech: Buy at 237p, target 300p ('Riding an earnings upgrade cycle', 18 June 2015)

Ensor: Buy at 97p, minimum target 125p ('Building up for a takeover', 22 June 2015)

GLI Finance: Buy at 54p, target 80p; Pittards: Buy at 128p; Netplay TV: Buy at 9.5p ('A tripple play of small cap picks', 23 June 2015)

Bilby: Run profits at 97p; Safestyle: Run profits at 220p; Epwin: Run profits at 134p ('Soaring small caps', 24 June 2015)

Faroe Petroleum: Buy at 86p, target 100p; Greenko: Hold at 65p; Communisis: Buy at 48p ('A slick investment', 25 June 2015)

Mountview Estates: Buy at 12,250p; Inland: Run profits at 71p, conservative price target ('Running bumper profits', 29 June 2015)

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