The first company is specialist engineer Molins (MLIN: 165p). The holding has provided us with total gains of over 60 per cent including dividends since I initiated coverage in February last year, but if I am right the real excitement has yet to come.
To recap, around 60 per cent of sales come from the tobacco industry, where Molins specialises in improving the effectiveness of existing customer plant, monitoring and testing product quality and conducting the analysis of cigarette smoke. This is the high-end part of the business, accounting for a quarter of revenues, and a likely source of some exciting news if, as expected, Molins' tobacco testing business, Arista Laboratories, receives a boost in demand for its services resulting from tighter US regulations that are expected to be implemented by the Food & Drug Administration (FDA).
The US regulator has now heard representations from cigarette manufacturers in advance of issuing guidance on testing requirements with a view to tightening up the testing regime for harmful compounds found in tobacco smoke. The new regulations were scheduled to be published in April, but have been delayed which is why Molins shares have been trading sideways since I last updated the shareholding in early February.
True, the timescale and nature of the FDA testing regime is uncertain, but what is not in doubt is that Molins is well-placed to capitalise on the opportunities, especially as Arista has a significant logistical and marketing advantage to attract new business for its onshore US testing services.
Analyst Michael O’Brien at broking house Canaccord Genuity believes that several major tobacco manufacturers, which currently do the testing of these compounds in-house, will have to outsource much of it in future if the FDA dramatically expands the number of harmful compounds on its consultation list. Mr O’Brien notes that "to date, draft guidance has already committed to enforcement of testing for 20 out of the 93 harmful compounds on the FDA's list of constituent - typically the ones where testing methods are well established and widely available."
It's therefore worth noting that Canaccord have factored in minimal upside from contract wins for Arista (resulting from the new FDA regulations) into their earnings forecasts. However, the broker is advising clients that "the issues relating to substantial equivalence, cigars and other tobacco products that are prevalent in the FDA's evaluations all offer opportunities for Arista, particularly given its US-infrastructure." This is important in my view because any forthcoming FDA related news flow will be a key share price driver if, as expected, the regulator extends the list of harmful compounds that tobacco companies need to test. In turn, this could offer a real opportunity for Molins to grow its testing business and prompt analysts to upgrade their earnings estimates for future years.
Lowly valued
For the current financial year, Canaccord are forecasting Molins will grow revenues by around 2 per cent to £95m and raise operating profits by 10 per cent to £5.5m. A higher tax charge means underlying EPS is expected to be flat at 22p. However, this is unlikely to hold back the dividend which is expected to rise to 5.7p a share, having been raised from 5.3p to 5.5p last year. On this basis, the shares trade on 7.5 times forward earnings and yield around 3.5 per cent. That is a pretty attractive rating, which becomes even more compelling once you consider that Molins had net funds of £7.4m, worth 36p a share, at the December year-end. Strip this cash out from the share price and the multiple drops to a bargain basement six times earnings. For good measure, the shares trade on a modest 10 per cent premium to net asset value.
Chart break-out looms
Interestingly, shares in Molins started an upmove late last week which I believe signalled the end of a five month long consolidation period. In my opinion, there is a real possibility that the price could rally through the late February high of 173.5p and towards Canaccord's target price of 200p. The technical set-up is certainly supportive of such a move and a close above this level would improve the odds of the shares rallying back to the August 2007 bull market high around 220p.
So with both the fundamentals and the chart set-up positive, and an announcement due from the FDA later this year, I remain a buyer of Molins' shares on a bargain basement six times this year’s earnings estimates net of cash. My target price is 220p - equating to 8.5 times earnings estimates net of cash - which I feel could be achieved by late September after the company releases its half-year results. This also assumes the FDA releases its guidance by then.
Offering 33 per cent potential upside to my target price, I continue to rate Molins shares a trading buy on a bid offer spread of 163p to 165p.
ebooks drive Bloomsbury sales
Growing demand for ebooks has been doing wonders for Bloomsbury Publishing (BMY: 135p), the company best known for JK Rowling's Harry Potter books. It is also doing wonders for the share price which has risen by around 20 per cent since I last highlighted the investment case in the spring.
In an upbeat first-quarter trading update to the end May, Bloomsbury revealed that revenues rose 19 per cent in the three-month period, helped by a 31 per cent surge in digital revenues. In the adult division, the early success of And the Mountains Echoed by Khaled Hosseini, which was released in May, drove revenues up by over 20 per cent. Interestingly, half of the sales of this title in the period were e-books. Other best-selling titles include Paul Hollywood's Bread and How to Bake, which led the continuing strong sales of cookery titles, Wisden Cricketers' Almanack and in the US The Cooked Seed by Anchee Min.
Interestingly, revenues from rights and services increased by 25 per cent which not only highlights a very strong start to the financial year, but it also means that with these revenues in the bag the importance of revenues generated from this source in the final quarter of the financial year is likely to be far less significant than in previous years. That mitigates risk and gives confidence to broker’s earnings estimates which have been underpin the recent rise in the share price.
Share price momentum
Post the trading update, shares in Bloomsbury rose 4 per cent to 135p and look well on their way to hitting the 148p high dating back to August last year. The fundamental case certainly supports a higher price as based on Peel Hunt’s bottom of the range and conservative EPS estimate of 12.3p for the 12 months to end February 2014, the shares would still only be priced on 12 times earnings at that level. There is a decent yield too as Bloomsbury paid out a dividend of 5.5p last financial year and this is expected to rise to 5.7p this year. On that basis, the shares yield over 4 per cent.
It’s also worth pointing out that Bloomsbury has a strong and cash rich balance sheet which is highly supportive. In fact, net of a cash pile of £8.5m, worth 11.5p a share, the shares trade on only 10 times prospective earnings and are priced 13 per cent below net asset value of 155p. In my view, a share price far closer to net asset value is in order and I continue to rate Bloomsbury’s shares a buy on a bid offer spread of 133p to 135p.
Finally, I will be on holiday between Monday 15 July and Friday 19 July inclusive. My next column will appear online on Tuesday 23 July.
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