Another seismic contract win
A month ago I noted that executive chairman and former banker Duncan Soukup of Aim-traded Thalassa Holdings (THAL: 147p) had been on a massive buying spree and noted it was well worth following his lead when the share price was 141p (‘Small-cap stock picks, 1 May 2013). I previously advised buying the shares six weeks earlier at 135p (‘Potential for seismic gains’, 19 March 2013). If anything, the investment case is even stronger now after the company announced yet another contract win yesterday.
To recap, Thalassa provides energy companies with marine seismic equipment and, in particular, a technology called Portable Modular Source System (PMSS™). This equipment is installed on vessels to provide a seismic source to enable oil and gas exploration and production companies to perform life-of-field seismic studies or permanent reservoir monitoring.
And it is proving popular as not only has Thalassa won a major contract with Statoil ASA (NO: STL) to provide seismic acquisition services for reservoir monitoring of the Snorre and Grane oilfields in the Norwegian sector of the North Sea, but the business is now seeing increased demand from other energy companies, too. For instance, earlier this year, the company announced a contract with SMG Ecuador, the Ecuador business of State Sevmorgeo Company, the Russian geological sea survey company. This contract runs between February and June and is worth $6.7m (£4.4m), or almost half of Thalassa's revenues in 2012. However, Thalassa has just announced that it has a letter of intent from SMG for a second phase of the contract, relating to surveys that are planned to commence on 1 October 2013 and continue until 31 March 2014. Revenues in respect of the additional contract will be between $4m and $5.4m, depending on the acquisition, standby and downtime incurred. In other words, the total revenues from this contract will now be at least $10.7m and could be well over $12m, or the equivalent of 85 per cent of the company's revenues last year.
Modest assumptions in earnings forecasts
It is an important win, too, because the earnings from the second phase of the contract are not in analysts' estimates. In fact, oil analyst John Cummins at house broker WH Ireland has been forced to upgrade his 2013 pre-tax profit estimate by $0.3m to $2.7m, a 11 per cent uplift, after factoring in that around $2m of revenues from the second phase of the SMG contract will fall into this financial year. On this basis, adjusted EPS for 2013 rises from 13.7c to 15.2c, or 10p a share.
It's worth noting that these estimates are purely based on contracted revenue to date, so the risk to forecasts is to the upside if the company wins more contracts as it has been doing so. WH Ireland has held 2014 pre-tax profit estimates at around $3m, but in my view this is looking increasingly conservative given the momentum in the business and the scope for more contract wins. For a company nailed on to increase profits by at least 125 per cent this year, and potentially more if more contracts are won, a prospective PE ratio of 15 is not expensive from my lens.
True, a low free float means the small-cap shares are volatile, so an investment in Thalassa’s shares will not appeal to everyone. That said, after factoring this risk in, I still believe that the shares remain very undervalued. Priced on a bid-offer spread of 142p to 147p, I rate the shares a strong buy and my target price is 200p.
A chic performance
Shares in Moss Bros (MOSB: 57.5p) moved up 2 per cent in a falling market yesterday and with good reason. A trading statement for the 18 weeks to 1 June 2013 revealed a 2 per cent rise in like-for-like retail sales, including e-commerce, and an improvement in underlying cash gross profit. That represents a decent recovery in trading after a sluggish performance in the first seven weeks of the period. In fact, analyst John Stevenson at brokerage Peel Hunt estimates that underlying sales have risen by 4.3 per cent in the past 11 weeks "after cold, unseasonable weather until mid-April proved a drag on performance". Mr Stevenson also adds that "coming up against weakening comparatives from last year's sporting events, we expect retail sales to remain robust over the summer".
That prediction is based on some sound reasoning. For instance, following the launch of the company's new retail website in January, e-commerce sales have ramped up sharply and were 138 per cent ahead year on year between the end of January and late May. Internet sales now account for 3.3 per cent of Moss Bros' total sales and the segment is likely to become an increasingly important sales channel given that trends for both traffic flow and conversion rates are improving strongly. In addition, a mobile-enabled site was successfully launched last month and a transactional website for the company's suit hire business is planned for launch in September. Both developments augur well for future digital sales. Moss Bros is also using the web to maximise the margin it earns on clearance stock.
Boosting returns from high-street estate
Importantly, Moss Bros is making headway with its store refits, too. A further four stores have been refurbished this year as part of an ongoing programme, bringing the total number of stores trading on the new format to 24, comprising 18 refitted stores and six new stores out of a total portfolio of 136 sites. The new format stores are "trading ahead of non-refitted stores and are on track to achieve their anticipated payback targets".
It's also worth pointing out that around 50 per cent of Moss Bros's store leases expire over the next three years, so the company is in an incredibly strong position to play hard ball with landlords over the terms of renewal, or to take advantage of opportunities elsewhere to relocate to new space with better footfall. In the financial year to end January 2013, management was able to negotiate an average reduction on the rent bill of around 17 per cent on stores with expired leases and demanded break clauses at five or even two years on these new leases.
Conservative profit forecasts
So, with the combination of accelerating growth emerging from new sales channels, a lower cost base, upside from store refits and soft comparatives to beat over the next few months, then the business case is well underpinned. In fact, Mr Stevenson notes that Moss Bros is "currently trading ahead of our forecast assumptions" and notes that "retail sales were growing at above 5 per cent" at the end of the 18-week trading period to 1 June.
For the financial year to January 2014, Peel Hunt expects sales to rise from £104.6m to £106.6m, pre-tax profits to increase from £2.7m to £3.1m and adjusted EPS to rise from 1.9p to 2.3p. Having raised the dividend from 0.4p to 0.9p last year, Peel Hunt expects the board to raise it again to 1.1p a share in the 12 months to January 2014. The company can certainly afford to as net cash is estimated to be around £24.4m, or 24p a share.
So, with Moss Bros's shares trading on a bid-offer spread of 56p to 57.5p, valuing the company at £57.5m, this means that net of the low-yielding cash pile, the shares are trading on a prospective PE ratio of 14 and offer a forward yield of 1.9 per cent. However, with margins improving and further cost reductions expected as store leases expire and are renewed on far more favourable terms, Peel Hunt expects pre-tax profits to ramp ahead to £3.9m on revenues of £110m in the 12 months to January 2015. This largely reflects an improvement in the operating margin from 2.7 per cent to 3.3 per cent, which looks realistic to me. On this basis, EPS rises to 2.9p and the PE ratio net of cash drops to only 11. Mr Stevenson also sees scope for the dividend to be raised again to 1.3p a share, implying a yield of 2.3 per cent.
Target price
I first recommended buying Moss Bros's shares at 39.5p ('Dressed for success', 20 February 2012) and subsequently reiterated that advice last autumn when the price was 48.5p (‘Small-cap wonders’, 1 October 2012). I also rated the shares a trading buy in January when I lifted my original target price of 60p to 80p (‘Jumping the gun’, 1 January 2013). In the event, the price peaked out at 72p in February.
Interestingly, the retracement in the share price has been more or less identical to other phases in the up-move over the past couple of years. Namely, the price peaks, falls back to the previous resistance level, tests it and then starts a new up-move to take out the previous peak. This process can take several months. However, it's my firm view that the test phase is now over as Moss Bros's share price found strong support in the range between 53p and 57p over the past six weeks (the previous peak was 51p in April 2012).
If I am right then this is an ideal time to take advantage of the 20 per cent fall in the share price since mid-February as investors concerns over soft trading have clearly proved misplaced. Ahead of interim results on 26 September, I rate the shares a decent trading buy at 57.5p and maintain my target price of 80p. If achieved, this offers us potentially 39 per cent upside.
An ‘app’ investment
Aim-traded software company Sanderson (SND: 49p), a specialist in multi-channel retail and manufacturing markets in the UK has produced a bumper set of half-year results.
Operating profits from ongoing operations rose 13 per cent to £910,000 and, with cash generation strong, net cash rose by around £0.45m to £4.5m in the six months to end-March 2013. This equates to around 10.3p a share, or a quarter of the company's share price. In turn, the board rewarded shareholders with a 30 per cent hike in the interim dividend to 0.65p a share. Analysts at WH Ireland expect the full-year payout for the 12 months to end-September to be raised by a quarter to 1.5p a share. On this basis, the shares offer a prospective yield of around 3 per cent.
True, revenues rose by just under 4 per cent to £6.37m, but a shift in the mix to higher-margin products is clearly benefiting overall margins. For instance, operating profit from the multi-channel retail division jumped a fifth to £0.61m, buoyed by projects for Aspinal of London, JoJo Maman Bébé and Axminster Tool Centre. Future demand is well underpinned, too, because Sanderson makes its money by offering software products and services that have the benefit of reducing costs or improving the efficiency of their business. That's important in a low-growth environment where companies have a keen eye on costs.
Strong demand for e-commerce software
For example, Sanderson works in partnership with clients to deliver e-commerce software systems that underpin their online operations and enable them to cross and upsell products, offer a '3D' secure payment process and integrate online offerings with other parts of their business. It's a fast-growing segment of the retail market to be operating in. Analysts at IMRG, the industry association for e-retail, and Capgemini, a leading consultancy, estimate that UK online sales will grow by 12 per cent in 2013, having grown by 14 per cent in 2012. Sanderson’s ongoing investment in proprietary software for mobile devices is also paying off; mCommerce now accounts for 10 per cent of sales, having shot up by 162 per cent in the six month period.
In turn, this creates a recurring revenue base - around 62 per cent of revenues were recurring in the six months to end March 2013 - which not only helps cover the company's fixed cost base, but offers earnings visibility, too. Importantly, the order book is growing and stood at £1.6m at the end of March, which offers a degree of confidence that Sanderson can produce a similar performance in the second half and deliver the £2m to £2.1m of pre-tax profits forecast in the 12 months to end-September 2013. Those estimates look achievable since the key decision-making period of the company's clients is between February through to September. As a result, there is a second-half weighting to profits.
On this basis, EPS of 4p to 4.1p are forecast by analysts for the 12-month trading period, which means the shares are trading on a forward PE ratio of 12, a hefty discount to the software and computer services sector average of 19. However, once you factor in Sanderson's 10p-a-share cash pile, then the forward PE ratio is even lower at only 10, or half the sector average.
Target price
I first advised buying the shares at 33.5p ('A valuable stock check', 18 Jul 2011) and reiterated that advice when they were priced at 40p ('An 'app' investment', 15 Oct 2012). I then upgraded my target price from 50p to 60p when the shares were at 51p (‘An 'app' online investment, 5 Feb 2013) and they subsequently peaked out a few weeks later at 58p. I last updated the investment case when the price was 49p, targeting a return to my previous target price of 60p (‘Jumping the gun take three’, 14 March 2013). I still believe this target price is achievable as the shares would still only be trading on a forward PE ratio of 12.5, a sizeable discount to peers and unwarranted too.
Interestingly, analyst Darren Nathan at brokerage WH Ireland notes that "should the company's growth strategy be executed smoothly we sees cope to raise our fundamental valuation as a high as 100p a share, or more in the event of a corporate bid". That may be some way off, but for now I am comfortable maintaining my buy recommendation with Sanderson shares priced on a bid-offer spread of 46p to 49p.
