CareTech is paying £9.23m for Spark of Genius, the Scottish provider of residential care and education services for young people with complex needs. The company was founded 16 years ago by its chairman and sole shareholder, Tom McGhee, and it currently has 48 residential places in nine residential homes in Scotland and 100 education places in three schools. Spark also offers employability training and leaving-care services for those over the age of 16. In England, Spark has a joint venture with a local authority, which has already registered two residential homes and one school, offering 10 residential and 35 education places respectively.
It’s the first deal that CareTech has announced since it raised £21m in a placing in March to strengthen its balance sheet and provide the firepower for complementary bolt-on acquisitions. It looks sensibly priced too as Spark made pre-tax profits of £1.2m on revenue of £10.9m in the 12 months to end March 2015. Based on the initial cash consideration of £7.48m and issue of £250,000 worth of CareTech shares to Mr McGhee, the purchase price is a reasonable 5.2 times last year’s cash profits of £1.5m. There is also a further earn-out of £1.5m based on Spark’s cash profit performance over the four financial years ending 30 September 2019.
Earnings upgrades
Although the acquisition will not have much impact on the current year earnings as it comes late in CareTech's financial year, analyst John Cummins at broking house W.H. Ireland has raised his EPS estimates by 3.8 per cent and 5 per cent, respectively, for the 2016 and 2017 fiscal years. He now expects CareTech to report pre-tax profits of £25.5m and EPS of 32.9p in the 12 months to end September 2016 assuming the company grows revenues by 12 per cent to £147m. For the following year, Mr Cummins is pencilling in pre-tax profits of £27.4m and EPS of 35.4p in fiscal 2017 on revenues of £152m. On this basis, the shares are rated on less than 7.5 times fiscal 2016 earnings estimates and offer a decent 3.5 per cent prospective dividend yield. This is based on a payout of 8.5p a share covered more than 3.5 times by net earnings.
The company is clearly gearing itself up for further earnings accretive acquisitions as alongside news of the Spark deal the board announced that it has extended its banking facilities by two years to January 2019, reduced the cost of borrowing from 4.33 per cent to 3.96 per cent, deferred four loan repayments due between now and October 2016 amounting to £21.6m, and agreed a new uncommitted credit facility of £30m to support its acquisition strategy.
Moreover, with the company’s cash generation strong, and W.H. Ireland forecasting end September 2015 net debt of £153m, the loan-to-value ratio on CareTech’s portfolio of around 170 properties is still only 55 per cent of their open market value of £280m after accounting for the acquired Spark properties. This offers the company ample asset backing and cashflow to support a higher level of borrowings without stretching its finances.
Indeed, chairman of CareTech, Farouq Sheik, expects the balance of the proceeds from the March share placing to be deployed on acquisitions within the coming months. In turn, I would anticipate more analyst earnings upgrades to follow after these deals are announced which can only add weight to the investment case I outlined when I initiated coverage on the shares at 230p (‘Time to take care’, 16 March 2015). I subsequently reiterated the same advice seven weeks ago (‘Riding an earnings upgrade cycle’, 18 June 2015).
Trading on a bid-offer spread of 243p-245p, and offering potentially 22 per cent share price upside to my 300p target price, I rate CareTech shares a strong buy.
Burford’s bumper results
Aim-traded Burford Capital (BUR: 171p), the world's largest provider of investment capital and professional services for litigation cases to lawyers and clients engaged in major litigation and arbitration, has reported a bumper set of half year results that fully vindicate my decision to recommended buying the shares at 146p last month ('Legal eagles', 8 June 2015).
I maintain a conservative fair value target price of 190p a share, or little over 10 times the fiscal 2015 EPS estimate of 28.3 cents (18.3p) of analyst Trevor Griffiths at brokerage N+1 Singer. This is based on Burford growing full-year pre-tax profits by 15 per cent to $65.7m driven by a 20 per cent increase in revenues to $96m.
Those forecasts look achievable to me given that the company has just reported a 30 per cent hike in underlying pre-tax profits to $23.8m in the first six months of the year. This performance was underpinned by Burford’s largest recovery to date – $61m in gross proceeds on a $25m investment for a return on invested capital of 144 per cent. Guidance from the board is for a seasonal skew to earnings in the second half due to timing of activity in litigation cases. Bearing this in mind the company’s average return on capital employed on completed litigation cases is a jaw-dropping 71 per cent, up from 60 per cent at the end of 2014, highlighting the impressive track record of its legal team in identifying and successfully backing legal cases where the odds favour a positive outcome for its capital investment. There is little reason to expect this run of success and high investment returns driving profits to end here.
Conservatively valued
The 16 per cent share price re-rating since I initiated coverage aside, the company’s board have lifted the interim payout by a third to 2.33 cents (1.5p) and N+1 Singer predict a full-year dividend per share of 9 cents (5.8p), up from 7 cents in 2014. On this basis, the cost of prospective payout is covered almost three times over by net earnings and a forward dividend yield of 3.4 per cent is attractive.
The shares are also rated on a modest 1.35 times book value, a conservative valuation considering that Burford does not mark up litigation investments (and thus creating unrealised income) as time passes and the investment goes through the litigation process. Instead, the board only increase (or decrease) investment values modestly based on objective events in the progress of the litigation. This means that when it experiences investment successes there is a large incremental income to book as clearly was the case in the first half.
This conservative approach doesn’t maximise current income, but defers the income to the future. So, if you have confidence in the quality of Burford’s investment portfolio then it’s only rational to expect portfolio growth to underpin a ramp-up in income as investments mature. In turn, cash receipts from settlement of litigation cases will rise, delivering a significant boost to book value per share and supporting the board’s progressive dividend policy. It’s a decent investment story and one that has yet to run its course.
In fact, there is a chance that my 190p a share target price may prove too conservative if Burford delivers on those earnings estimates as even at that price level, the shares would be trading a third lower that the average earnings multiple for the specialty finance sector. Trading on a bid-offer spread of 169p to 171p, I continue to rate Burford’s shares a buy.
K3 hits target
It’s taken time but shares in Aim-traded retail software company K3 Business Technology (KBT: 275p), the Salford-based supplier of software to the retail, manufacturing and logistics sectors and provider of managed IT and web hosting services, have now hit my 275p target price. I initiated coverage when they were 220p ('Tapping into retail growth', 16 Sep 2014), and last updated the investment case when the price was 226p (‘On the acquisition trail’, 23 April 2015).
The 22 per cent share price re-rating in the past 13 weeks is understandable as investors warm to a company that is still priced on an earnings discount to peers even though the board have confirmed that trading for the financial year to end June 2015 will hit market estimates.
For the financial year to end June 2015, head of research Andrew Darley at brokerage finnCap expects K3 to grow pre-tax profits by 13 per cent to £7.5m based on an 11 per cent rise in revenues to £80m to produce EPS of 19.5p. Moreover, the company is expected to report a major step change in profitability again in the new financial year. Mr Darley pencils in fiscal 2016 pre-tax profit and EPS of £10m and 25.3p, respectively, based on revenues of £90m. Those estimates are pretty similar to those of Katherine Thompson at Edison Investment Research. This means that even after the recent re-rating, K3’s shares are still only trading on 11 times fiscal 2016 earnings estimates, a four point rating discount to the average earnings multiple of 15 times for UK software and IT services stocks with a market value below £200m.
Improving quality of revenue stream
It’s worth pointing out that in the pre-close trading update the company highlights that “recurring income remains high” which strengthens the case for a higher share price rating given the quality and stability of this revenue stream. Indeed, K3’s sales and profit growth is being underpinned by licence fee renewals, support contracts and hosting income; an increasing focus on K3's own IP, which is driving margins higher and boosting recurring revenues from a base of over 3,100 customers; and a focus on growing the SYSPRO and Sage businesses and selling hosting services to a larger proportion of customers. Oxfordshire-based K3′s core business offering is a Microsoft Dynamics-based range of retail software that provides a single platform for the entire business. The company is Microsoft's largest Dynamics Retail reseller in the UK.
Of course, there is execution risk in achieving the aforementioned ramp up in sales and profits in the current financial year to end June 2016, but this risk is factored into the current valuation given the deep ratings discount to peers. Importantly, the company’s net debt of £12.1m, equating to a little over 20 per cent of shareholders' funds, is modest so there are no financial worries to justify an earnings discounts of that magnitude.
So ahead of K3’s full-year results in mid-September, I would run your healthy profits as there is a realistic chance the shares could run up to Edison’s fair value of 289p, or even finnCap's target price of 330p. Run profits.
Institutional demand for Trakm8
Five directors of Aim-traded telematics and data provider Trakm8 (TRAK: 178p) have sold an aggregate of 1.22m shares at 157.5p each to a new institutional investor. The shares disposed of equate to 9.6 per cent of the directors’ combined holdings and 4.2 per cent of the company’s issued share capital, but it’s worth pointing out that they still hold an aggregate of 39.7 per cent in the company.
By far the largest shareholder on the board is chairman John Watkins who has an interest in 5.5m shares, or 19 per cent of the share capital, but finance director James Hedges with a 6.7 per cent stake, engineering director Tim Cowley with a 5.9 per cent shareholding and technical officer Matt Cowley who owns 5 per cent of the company also have substantial interests even after the share sales. These are multi-million pound holdings and give the insiders ample financial interest to align their own interests with those of other shareholders.
It’s easy to see why a new investor has come on board as the company is set for another step change in profits on the back of a bumper sales pipeline and robust order book. Analyst Lorne Daniel at brokerage finnCap recently upgraded his adjusted fully diluted EPS estimate from 10.3p to 11p, based on revenues rising from £17.9m to £25m and the company delivering pre-tax profits of £3.4m in the 12 months to end March 2016. This means that EPS are predicted to rise by over 80 per cent in the current fiscal year and this is after a 66 per cent hike in the prior year. I discussed the reasons for the latest upgrade in my last article (‘Riding earnings upgrade cycles’, 7 July 2015).
Furthermore, there is scope for additional upgrades as the year progresses given that Trakm8 has a robust pipeline of opportunities under trial with potential clients. So even though the shares have almost doubled since I recommended buying at 92p ('Zoning in on a profitable price move', 16 February 2015), I feel there is a very decent chance of my upgraded target price of 200p being hit. Trading on 16 times forward earnings, and rated on a PEG ratio below one, I rate Trakm8’s shares a buy on a bid-offer spread of 175p to 178p.
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 in the past 13 weeks:
■ 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 Jun 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 Jun 2015)
■ Elegant Hotels: Buy at 105p, target 135p to 140p ('Checking into an elegant investment', 15 Jun 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 Jun 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 Jun 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 Jun 2015)
■ Ensor: Buy at 97p, minimum target 125p ('Building up for a takeover', 22 Jun 2015)
■ GLI Finance: Buy at 54p, target 80p; Pittards: Buy at 128p; Netplay TV: Buy at 9.5p ('A triple play of small-cap picks', 23 Jun 2015)
■ Bilby: Run profits at 97p; Safestyle: Run profits at 220p; Epwin: Run profits at 134p ('Soaring small-caps', 24 Jun 2015)
■ Faroe Petroleum: Buy at 86p, target 100p; Greenko: Hold at 65p; Communisis: Buy at 48p ('A slick investment', 25 Jun 2015)
■ Mountview Estates: Buy at 12,250p; Inland: Run profits at 71p, conservative price target ('Running bumper profits', 29 Jun 2015)
■ Redde: Run profits at 138p, target range 150p to 155p; Trakm8: Buy at 175p, target 200p; Cohort: Buy at 312p, target 365p; Burford Capital: Buy at 175p, target 190p; Flowtech Fluidpower: Buy at 135p, target 155p ('Riding earnings upgrade cycles', 7 Jul 2015)
■ Crystal Amber: Buy at 161p; Stanley Gibbons: Buy at 258p; Somero Enterprises: Buy at 150p, target 185p; Globo: Buy at 49p, target 69.5p ('A quartet of small-cap buys', 8 Jul 2015)
■ H&T: Buy at 200p; STM: Buy at 47p, target 60p; Stadium: Buy at 113p, target 140p ('Exploiting upgrades', 9 Jul 2015)
■ Cambria Automobiles: Buy at 57.5p, target 75p ('Driving a re-rating', 13 Jul 2015)
■ Walker Crips: Buy at 47p, target 60p; 600 Group: Buy at 18p, target 24p; Henry Boot: Buy at 235p, target 260p ('A trio of small-cap value plays', 14 Jul 2015)
■ Bilby: Buy at 90p, target 120p; 32Red: Buy at 67.5p, ('Exploiting a valuation anomaly', 20 July 2015) target 90p; Marwyn Value Investors: Buy at 244p, target 275p (‘Acquisitions drive earnings upgrades’, 15 July 2015)
■ Vislink: Buy at 53p, target 70p ('Awarding success', 16 July 2015)
■ SPARK Ventures: Buy at 4.5p (‘Exploiting a valuation anomaly’, 20 July 2015)
■ W.H. Ireland: Run profits at 120p, target 140p; Safestyle: Run profits at 235p; Charlemagne Capital: Sell at 11p (‘Cash rich small-caps’, 21 July 2015)
■ Amino Technologies: Buy at 150p, target 180p; Arbuthnot Banking: Buy at 1,530p; Globo|: Buy at 49p, target 69.5p ('Primed for major re-ratings', 22 July 2015)
■ SPARK Ventures: Buy at 4.5p; Entu: Buy at 115p, target 165p ('Cashed-up for gains', 23 July 2015)
■ Capital & Regional: Buy at 60.25p, target 70p ('Hot property', 27 July 2015)
■ LMS Capital: Vote against proposals at EGM; Marwyn Value Investors: Buy at 238p, target 275p to 280p ('Game changers, 28 July 2015)
■ Stadium Group: Buy at 130p and take up open offer, new target range 155p to 160p; 1pm: Buy at 68p and take up open offer at 60p, new target 90p (‘Powered up for gains’, 29 July 2015)
■ CareTech: Buy at 245p, target 300p; Burford Capital: Buy at 170p, target 190p; K3 Business Technology: Run profits at 275p; Trakm8: Buy at 178p, target 200p ('Hitting the right numbers', 30 July 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'
