The company completed 10 schemes encompassing 3,819 beds in the financial year just ended, and has 21 developments with over 6,800 beds slated for delivery during 2017 and 2018. The pipeline beyond 2018 is equally robust given that sites with capacity for over 2,000 beds have been secured, a quarter of which will be developed at a £100m scheme in Stratford, east London.
Bearing this in mind, the company has just forward sold three schemes to institutional investors in Glasgow, Cardiff and Belfast. These have a total of 1,161 beds and are slated for delivery in August 2018, ahead of the 2018-19 academic year. Forward selling sites reduces the working capital requirements of the company as the end-purchaser, usually a blue-chip institution, funds the development and is billed on a monthly basis, as opposed to a non-forward sold development where revenue is only received on sale of the asset post completion. Watkin Jones also enters into asset management contracts, usually for a seven-year term, with these investors when the properties are handed over on completion of the build.
Factoring in these sales, and others likely to complete, construction analyst Andy Hanson at house broker Zeus Capital anticipates that forward sales will account for 90 per cent-plus of his current year gross profit estimate of £59.8m by March, and materially underpin earnings visibility into 2018 and beyond. He predicts a 10 per cent rise in current year pre-tax profits and EPS to £43.6m and 13.7p, respectively, rising again to £46.7m and 14.6p the year after. On this basis, the shares are rated on nine times forward earnings. Another consequence of forward selling schemes is to reduce the capital Watkin Jones has tied up in the developments, one reason why the company is expected to increase its net funds from £36m to £66m by next September, a sum worth 26p a share. The strengthening of the balance sheet aside, the highly cash-generative nature of the business supports forecasts of a dividend per share of 4p in the year just ended, rising to 6.3p in the new financial year.
Trading on a single-digit forward earnings multiple and offering a 5 per cent-plus prospective dividend yield, I can only see investors warming to the investment case as Watkin Jones continues to build up a track record, evidence of which will be for all to see in next month's full-year results. The shares are well up on the 103p level at which I initiated coverage at the time of the Aim-flotation ('A profitable education', 3 April 2016), and the target price of 140p I outlined in my last article is now looking increasingly conservative ('High yielding cash rich small-cap gems', 29 September 2016). Buy.
Characteristics for a playful investment
Watkin Jones is not the only cash-rich company on my watchlist that is rated on a single-digit earnings multiple and offers a decent dividend yield. The same is true for toy company Character Group (CCT:485p), which has just reported a 22 per cent increase in both underlying pre-tax profits and EPS to £12.5m and 47.6p, respectively, in the 12 months to end-September 2016, on revenues ahead by the same order to £121m. The payout per share has been hiked from 11p to 15p, covered three times over by post-tax earnings, with the company's closing net funds of £6.9m, up from £4.5m in 201, covering the cost of the final dividend of 8p a share four times over.
This is a highly cash-generative business, so much so that the board also spent £1.2m repurchasing 1.2 per cent of the issued share capital over the course of the financial year, a sensible use of surplus funds given the shares were bought on a 10 per cent earnings yield, so these purchases were earnings-accretive. The directors have authority to repurchase a further 13.2 per cent of the share capital, too.
Character's business model is pretty simple to understand: it owns a portfolio of 10 long-lasting iconic toy brands that target the niche pre-school market (aged three to four years) and makes its money by licensing brands, developing products and then distributing them after outsourcing manufacturing to China. It's a global business as half the product range is for international companies, and 25 per cent of sales are overseas. The portfolio of iconic brands accounts for 70 per cent of sales and makes the business far less susceptible to the vagaries of a cyclical toy market characterised by the fleeting fads of children.
Top performing brands include Peppa Pig, licensed from Entertainment One (ETO), the largest film distributor in Canada and the UK and the distributor and joint-venture owner of the brand; Minecraft which is owned by Microsoft (US:MSFT) and out-licensed to Jazzwares; Little Live Pets by Moose Enterprises; and Teletubbies owned by DHX Media, the most recognised pre-school brand in the world. Following the launch of a new television series earlier this year, Tinky Winky, Dipsy, Laa-Laa and Po are still working their magic in Teletubbyland, and creating demand for Character's range of products.
Importantly, trading prospects are well underpinned as the company is operating in one of the strongest toy markets for 20 years, according to analyst Peter Smedley at brokerage Panmure Gordon. He notes that the toy market has grown by 5 per cent in the UK so far this year, and in the US it has posted its best growth rate in a decade.
Of course, there are risks, of which adverse movements in the sterling:US dollar exchange rate is the most obvious. That's because a large proportion of the company's input costs are effectively in US dollars. However, the impact of a stronger greenback has been successfully mitigated through efficiency gains, better sourcing and pricing initiatives. Also, increasing exposure to international markets acts as a natural currency hedge. And it goes without saying that there is always the risk that consumer demand for a product may not live up to the company's expectations, leaving it with unsold inventory.
But the company has been performing well and a focus on iconic brands looks a winner. And so, too, do the shares which are only being priced on a forward PE ratio of 9.7, based on expectations of EPS rising to just shy of 50p in the current financial year, and offer a prospective dividend yield of 3.5 per cent based on a raised payout per share of 17p. That's hardly an exacting valuation for a company operating in an industry with a benign tailwind. So, having first recommended buying at 415p ('Playtime', 1 June 2015), since when the board has paid out dividends of 18p excluding the final dividend of 8p a share payable in January, and last reiterated that advice at 525p ('Toying with a breakout', 9 May 2016), I continue to rate Character shares a value buy at 485p and have a target price between 625p and 675p. Buy.
Priced for blue-sky gains
Satellite Solutions Worldwide (SAT:8p), a satellite internet service provider offering an alternative high-speed broadband service, will exceed market expectations for the financial year to end-November 2016 and is also likely to exceed its previous target of having 100,000 customers by this time next year.
Analyst Michael Armitage at the house broker had pencilled in cash profits of £1.1m and adjusted pre-tax profit of £500,000 on revenue of £19.8m in the 12-month trading period. Furthermore, he had factored in "a mere 95,000 customers by November 2017" in his forecasts for the new financial year to support revenues of £38.1m, cash profits of £5.5m, pre-tax profits of £3.4m and EPS of 0.6p, so there could be upside to these estimates.
The ramp-up in profits reflects the addition of 50,000 new customers through three game-changing acquisitions that Satellite Solutions made over the summer: Norwegian-based Breiband, the only provider of radio and satellite broadband in the country and one that has a 13,000-strong customer base; SkyMesh, a Brisbane-based national provider of satellite broadband to 28,000 residential and business customers in Australia; and UK rival Avonline, a satellite broadband business with a customer base of 9,500, of which 92 per cent are consumers. These three businesses generate over £21m of annual revenue and £4.2m of cash profits, so have not only scaled up the company's user base, but have also proved transformational to profitability.
Importantly, they are all bedding down well and have delivered organic growth post completion. Indeed, the Australian business has been adding 1,000 new connections each month and new distribution opportunities have been identified in both Scandinavia and Australia. Furthermore, as customer numbers rise, there will be incremental benefits to operating margins from cost savings, economies of scale and streamlining management structures.
But is it in the price?
Valuing the company is far from straightforward, a point I made when I rated the shares a buy at 7p in the summer ('Priced for blue sky gains', 31 August 2016), having first recommended buying at 5.5p earlier this year ('Blue sky tech play', 21 March 2016). That's because based on the current share count of 536m, the company is being valued at £42.3m or on a cash-profit forward multiple of 9.5 times enterprise value after accounting for net debt of around £10m. However, we need to make some adjustments due to the terms of the borrowings which, alongside the £11.4m proceeds from a share placing over the summer, funded the three acquisitions.
The debt is provided by the Business Growth Fund (BGF), which subscribed for £9.6m of unsecured loan notes at a fixed coupon of 10 per cent and repayable in May 2024, or earlier subject to an early repayment charge of 12 months' interest; and £2.4m of convertible loan notes which carry a 10 per cent coupon and are convertible into 26.66m shares at 9p each. The loan notes have a redemption premium of £5.5m and the company has issued BGF with warrants on 74m shares with a strike price of 7.5p a share. These warrants are exercisable between July 2019 and August 2021.
So, after taking into account the £5.5m cost of the BGF redemption premium, which is funded entirely by the £5.55m cash inflow from the exercise of the 74m BGF warrants, conversion of BGF's £2.4m convertible loan stock into 26.66m new shares and director options over 29.5m shares, Satellite Solutions' fully diluted issued share capital increases from 536m to 666m shares. However, the exercise of share options and conversion of the convertible loan notes into equity should reduce net debt by a third to below £7m by November 2017. This means that at the current share price of 8p, and using the fully diluted share count, the company's enterprise value is 11 times cash profit estimates for the 2017 financial year.
True, the debt funding is expensive, but it has enabled Satellite Solutions to grow the business and pull off major earnings-enhancing acquisitions. Moreover, if the management team continue to outperform as seems likely, there is every chance that the shares will make further headway towards my valuation target of 13 to 14 times cash profits to enterprise value on a fully diluted basis, and one that suggests a target price nearer 10p to 10.5p is in order. Ahead of the next trading update alongside results in February, I rate the shares a buy.
