It was therefore with great interest that I noted the company has announced a £20m equity fundraising by issuing 50m shares at 40p, of which 37.5m have been placed with institutions and 12.5m shares are subject to a placing and open offer on the basis of one new share for every 11.284 held. The offer price represents a 12.3 per cent discount to the previous closing price and shareholders on the share register at close of trading on Thursday 14 February are entitled to participate. The closing date is 11am on Monday 4 March for open offer applications.
The proceeds of the fundraising will be used in three main areas of the business: investment in new contracts (around £6m of the £18.9m net proceeds); to fund previously announced restructuring costs of £1.4m in connection with the company's Lisburn (closure) and Leeds (restructuring) operations; and to make small acquisitions and fund working capital (around £11.5m).
Sensible use of funds
This looks sensible as Communisis has been winning significant (and profitable) long-term new contracts in the past few months, including agreements with BT and Nationwide Building Society, which will contribute from early in 2013. In fact, the company has confirmed that 70 per cent of 2013 revenues will come from multiyear contracts. This is good for profits, and underpins analyst profit estimates, but it also means Communisis needs to invest in working capital and capital expenditure to fulfil the new contracts. Deploying £1.4m of the funds raised on restructuring of the direct mail operations in Leeds and consolidation of facilities makes strategic sense, too, as this will make the business more efficient as well as reducing overheads to boost profitability. The process will complete in the first quarter of this year, so is being carried out quickly.
True, the company only had net borrowings of £21m at the end of December, which equates to 16.5 per cent of shareholders' funds of £128m, so the balance sheet is hardly stretched. Moreover, it is trading well within its new credit facility of £55m. But it still makes sense to keep borrowings as low as possible rather than run up higher debt levels to fund the increased working capital and investment needs of the business in order to service new contracts. Otherwise the company could find itself in the position of having to turn down tenders for new business in the future simply due to a lack of funding. So, by strengthening the balance sheet at this stage, this situation is avoided and the company is not constrained in seeking out business opportunities.
That's an important point to note because when the board appraises new contracts they have to be consistent with an internal objective of delivering double-digit operating margins on sales, generating an internal rate of return of 20 per cent on capital employed and have a maximum payback period of three years. In other words, the rates of return on the new contracts are well in excess of both the cost of the new equity being issued and the blended cost of the company's capital. That's well worth considering as there is little point in a company raising equity for expansion if it is destroying shareholder value by generating a net return below the cost of the new capital raised.
Analyst forecasts
Ahead of the general meeting to approve the placing and open offer, broking house N+1 Singer has suspended forecasts as it is obliged to do. However, analysts there were previously expecting revenues to rise from £230m to £235m and pre-tax profits to increase from around £10.5m in 2012 to £11.2m in 2013. Assuming 191m shares in issue post the placing and open offer, a 23 per cent tax charge and lower finance charges in 2013 to reflect reduced debt levels - the funding for new contracts is expected over a period of six months whereas the company receives £18.9m of cash immediately which virtually wipes out debt - in my view the company should still be able to produce diluted EPS of around 5p a share in 2013, which would underpin the dividend of 1.6p forecast for 2012.
On this basis, the shares are trading on a modest prospective PE ratio of eight and offer a yield of 4 per cent. The share price is also a hefty 42 per cent below my estimate of pro-forma book value of 77p post the issue of the new equity. That discount is narrower than before, but importantly the risk profile of the company has improved significantly due to the strengthened balance sheet. Add this to the ability to win new contracts, and those profit estimates could prove conservative. I continue to rate the shares a buy, trading on a bid-offer spread of 44.5p-45p and would advise taking up your allocations in the open offer. My target price remains 55p.
■ I have also published another online column today ('A high yield property play in the north', 18 February 2013). My next article will appear online tomorrow morning and on my homepage.
Please note that I released seven online articles last week: 'A share set to hit the jackpot', 'A highly profitable arbitrage play, 'Seeking Alpha among the housebuilders', 'Chart break out for a solid income play', Time to dial into profit', 'Buy the breakout', 'A conundrum to solve', 15 February 2013.
Finally, I will be taking a four-week break during April to complete a book on 'Profitable stockpicking', my follow-up to Trading Secrets: 20 Hard and Fast Rules to Help You Beat the Stock Market. The book will be published in early summer.
MORE FROM SIMON THOMPSON ONLINE...
Since the start of this year I have written no fewer than 32 online articles, all of which are available on my homepage. These include articles on the following companies or investment strategies:
Week of Monday 18 February 2013
Town Centre Securities ('A high yield property play in the north', 18 February 2013)
Week of Monday 11 February 2013
API (A conundrum to solve, 15 February 2013)
Daejan Holdings (Buy the breakout, 14 February 2013)
IQE (Time to dial into profit, 13 February 2013)
Mountview Estates ('Chart break out for a solid income play', 12 February 2013)
Bellway (Seeking Alpha, 11 February 2013)
Marwyn Value Investors (A highly profitable arbitrage play, 11 February 2013)
Netplay TV (A share set to hit the jackpot, 11 February 2013)
Week of Monday 04 February 2013
Oakley Capital, Randall & Quilter, Inland, Terrace Hill, Heritage Oil, Cairn Energy, Polo Resources, Trifast, Noble Investments, Fairpoint (Bargain Shares for 2013, 8 February 2013)
Telford Homes, MJ Gleeson, Stanley Gibbons, Molins, Indigovision, Trading Emissions, Mallett, Bloomsbury Publishing, Rugby Estates, Eurovestech (How the 2012 Bargain Shares fared, 8 February 2013)
Future (Decision time after a bright start, 5 February 2013)
Sanderson (An 'app' online investment, 5 February 2013)
Aurora Russia ('Time to play Russian Roulette', 4 Feb 2013)
Week of Monday 28 January 2013
BP Marsh & Partners ('Hyper value gains', 31 Jan 2013)
Bellway ('Profit from the London property boom', 30 Jan 2013)
Telford Homes, MJ Gleeson, Mallett, Rugby Estates ('Taking profits after a winning streak', 28 Jan 2013)
Week of Monday 21 January 2013
Market timing ('Lessons to learn', 24 Jan 2013)
Communisis, Netcall ('Bumper trading gains', 23 Jan 2013)
Crystal Amber, API, Sutton Harbour ('More upside to come', 22 Jan 2013)
PV Crystalox Solar ('Seeing the light', 21 Jan 2013)
Week of Monday 14 January 2013
Bloomsbury Publishing ('A publisher for the digital age', 18 Jan 2013)
Housebuilders first-quarter effect and performance table on all my recommendations from the final quarter of 2012 ('Stockpicking Marvels, 16 Jan 2013)
Eros ('A share firmly in the picture', 15 Jan 2013)
Netcall ('Jumping the gun: take two', 15 Jan 2013)
Moss Bros, Communisis ('Jumping the gun', 14 Jan 2013)
Week of Monday 7 January 2013
Stanley Gibbons, MJ Gleeson, Spark Ventures ('Small cap wonders', 11 Jan 2013)
IQE, Trading Emissions ('A tech share worth buying now', 10 Jan 2013)
S&P 500 portfolio of dog shares ('Dog shares barking back', 8 Jan 2013)
Air Partner ('A share ready to take off', 7 Jan 2012)
Week of Monday 31 December 2012
FTSE 100 traded options strategy ('Highly profitable options', 3 Jan 2012)
Telford Homes, MJ Gleeson, Molins, Noble Investments ('Rampant bargain shares', 31 Dec 2012)
