A good example of how this has worked in practice is Netcall (NET: 58p), a small-cap business offering software to make telephone call-handling more efficient. I made a strong case to buy the Aim-traded shares updated six weeks ago at 47p after the price had drifted back to its 200-day moving average (‘Making the right call’, 4 March 2014). Given the fundamentals supported a far higher valuation, and the 14-day RSI had a massively oversold reading of only 20 at the time, it was only reasonable to assume the share price would bounce back strongly. In the event it has recovered in double quick time and is now closing in on my 60p target price.
Buy on the dips to the 200-day moving average
This example also highlights the important point that in bull markets buying on the dips at the 200-day moving average is a good strategy. In fact, since I first advised buying Netcall shares at 13p ('Queuebusters', 17 January 2011), buying the shares on a pull back to the long-term trend line has proved a brilliant buying opportunity every time this has happened in the past few years. I have remained positive on the shares ever since given the attractive valuation on offer and strong earnings growth predicted. This also explains why I have updated the investment case on a number of occasions in order to take advantage of a several timely buying opportunities. For instance, I reiterated my buy advice when the price was 45p at the end of last year (‘Dial into cloud based profits’, 28 November 2013), and also post a pre-close trading update at 54p (‘Riding earnings upgrade cycles’, 14 January 2014).
Interestingly, the current chart set up is even more positive than it was at those March lows. For starters, a move above the March highs of 58p would signal both a point and figure and swing chart break-out and dramatically shorten the odds of an assault on the January high of 64p. With the 14-day RSI below 60, and the moving average convergence divergence indicator (MACD) on the verge of giving a positive cross over, from my lens it looks as if there is enough pent up buying interest to drive the shares skywards once again and pretty imminently too.
I have also been revisiting my target price as I may have been harsh in my fair value assessment in my previous analysis, not that it has done any harm given the shares are already up over 20 per cent since that buy recommendation. In fact, having reappraised the investment case, I am raising my target price to 70p. This is the same target as broking house finnCap and potentially offers a further 20 per cent share price upside if achieved.
Robust cash generation boosting dividends
One of the reasons why investors continue to warm to Netcall is down to the bumper cash generation of the business. For instance, in the 12 months to end June 2013, both cash profits and cash generated from operations increased by a quarter to £4.2m and £4.9m, respectively. This boosted the cash pile by £800,000 to £9.1m and that was after the company invested £1.5m in research and development and spent £1.95m on acquisitions.
It was déjà vu in the following six months to end December 2013 as a double digit increase in cash profits to £2.48m boosted the cash pile to £10m, or the equivalent of 7.5p a share. That sum equates to 17 per cent of the current share price and means that financial risk is hugely mitigated as there are no financial concerns to worry about at all. It also means Netcall’s management team under chief executive Henrik Bang can recycle the company’s cash into making earnings enhancing bolt-on acquisitions while at the same time having ample resources available to invest in existing operations to support organic growth.
Importantly, loyal investors are being rewarded too since the board have adopted what has turned out to be a very progressive dividend policy. In the last financial year, Netcall’s board declared a 40 per cent increase in the payout to 0.7p a share. Cash returned to shareholders should get a further lift this year too. That’s because even though the payout has grown by 75 per cent in the past two financial years, dividend cover is still very comfortable. Indeed, even after factoring in another 14 per cent hike in the payout to 0.8p a share for current financial year to June 2014 - as forecast by analyst Andrew Darley at brokerage finnCap and Luke Tribe at WH Ireland – the payout is still more than three times covered by underlying EPS. In turn, this offers scope for the board to be even more generous by allocating a quarter (£1.1m) of the company’s forecast cash profits of £4.5m to shareholders when the board releases its full-year results to end June. News on this front can be expected in a pre-close trading update in mid-July when I also expect the company to beat analysts’ earnings estimates.
This belief is not without substance either. That’s because in the first half to end December 2013, Netcall boosted its underlying EPS by 11 per cent to 1.47p, but broking houses finnCap and WH Ireland are both predicting adjusted diluted EPS of 2.5p for the full year to end June 2013. Interestingly, in a note to clients a few months ago analyst Andrew Darley noted there is “strong potential for second half performance to lead to full year outperformance”.
Products in demand
The possibility of an earnings’ beat in a few months time appears well underpinned by the robust demand Netcall is seeing across its whole product portfolio. This is being driven by the private sector and orders for business process management and software-as-a-service (SaaS) solutions. Two thirds of all new business is generated from existing clients, highlighting the quality of Netcall’s products and services, and recurring revenue from a client base of over 700 organisations accounts for a chunky 63 per cent of turnover.
It's hardly surprising either that business is proving buoyant as Netcall’s clients need to balance the need to improve the quality of their customer engagement while at the same time making operational efficiencies and cutting costs. They also have to deal with customers across a growing number of channels including online, mobile, social media, web-chat, telephone and text messages. And this is where Netcall’s offerings come into their own as the company not only offers a suite of software products to support organisations' end-to-end customer engagement strategies, with the aim of improving customer service, retention and acquisition, but its Liberty platform also includes multi-channel contact handling designed to improve customer interactions and workflow capabilities.
It’s also worth considering that Netcall has been able to enhance its product offerings by integrating acquisitions into its Liberty platform in order to offer additional service to customers as well as attracting new ones. For instance, following the company’s joint investment in Farnborough-based Sentiment, a cloud-based platform that monitors global social media, Netcall’s clients are now able to analyse social media information across multiple social networks and engage through a single integrated application. The £250,000 investment here looks money well spent.
In the circumstances, it’s only reasonable to expect further earnings accretive acquisitions as Netcall recycles its bumper cash flow and more of its low yielding cash pile into earnings enhancing bolt-on deals.
Trading strategy
It’s my considered view that the combination of a potential earnings beat against low ball estimates, realistic prospects of a better than forecast dividend rise and scope for what would be well received acquisitions in the near future, all make Netcall shares worth buying.
In fact, I would be very surprised if Netcall fails to beat finnCap’s and WH Ireland’s EPS estimates of 2.7p and 2.8p respectively for the financial year to end June 2015, let alone the 2.5p of fully diluted adjusted EPS forecast by both broking houses for the year to June 2014.
Trading on only 12 times prospective cash profits of £5m to enterprise value (market capitalisation of £79m less net cash of £10m) for fiscal 2015, and after factoring in that Netcall has a record of issuing positive newsflow and earnings beats in the past few years, I rate the shares a trading buy on a bid offer spread of 57p to 58p ahead of the forthcoming pre-close update in mid-July. My new target price is 70p and the time frame for this trade is three months.
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