Time to take a punt

That's because I continuously keep tabs on the newsflow and price action on around 200 companies with the aim of recommending these shares as and when the valuation becomes attractive enough on a risk-reward basis. It is also important that the chart set-up, and likely forthcoming newsflow, are both positive to support a share price re-rating. Timing is everything, which is why I confidently believe now is the right time to buy shares in Aim-traded online casino operator 32 Red (TTR: 57.5p) ahead of half-year results on Thursday 12 September.

A share set to hit the jackpot

To recap, the Gibraltar-based company operates eight websites including: casino site 32red.com; 32redpoker.com; 32redbingo.com; 32redmobile.com; and 32redbet.com, a sportsbetting website. It also has three other casino sites: nedplay.com, goldenlounge.com and dashcasino.com.

The business has clearly been performing well because in the first half of this year I know for a fact that 32 Red's casino revenues increased 14 per cent to £16.5m, total revenues hit a record of £19m and active casino accounts increased by a third to 42,500 customers after 32 Red recruited 17,500 new players. Importantly, acquisition costs for these new recruits have been kept in check at £159 per player, which is easily covered by a casino yield of almost £400 per player. And this momentum has shown little sign of waning as the gross win was up 12 per cent in the first two weeks of July.

As I pointed out ahead of last month's trading update, this type of business is highly cash generative, which is very good news for income seekers ('Game on', 8 Jul 2013). In fact, when the company issues its half-year results in two weeks' time, the cash pile could be as high as £7.4m, or the equivalent of 10p a share. This has already enabled the board to pay a special dividend of 2.5p a share since the period end, which we banked last month. And it is only reasonable to expect more good news as analysts predict the half-year and final dividend's payout will both be raised by around 17 per cent to 0.7p and 0.94p, respectively, to produce an attractive forward yield of 3 per cent.

Low valuation

I also think that analysts are bang on the money with their forecast that 32 Red's revenues will rise by over 20 per cent from £32.1m last year to £39.2m in 2013. On that basis, cash profits jump from £3.4m to £4m, pre-tax profits rise from £3.2m to £3.8m and underlying EPS increases by over a fifth from 4.1p to 5p. The respective forecasts for 2014 are for revenues of £45.6m, cash profits of £5m, pre-tax profits of £4.8m and EPS of 6.3p.

To put the modest valuation into perspective, with the shares priced on a bid price-offer price spread of 56.5p to 57.5p, the rating is only nine times this year's earnings net of cash, falling to a bargain-basement 7.5 times 2014 earnings estimates. That rating is not only anomalous, but with 32 Red very likely to issue an upbeat outlook statement alongside its half-year results on 12 September, there is an obvious catalyst for an immediate re-rating.

In my opinion, a rating of around 11 times 2013 earnings estimates net of cash is more appropriate for this type of business. If achieved, this would imply a share price closer to 66p, or 15 per cent above the current price. It's also worth noting that my target price is also bang in line with that of broker Daniel Stewart, although it is well shy of the more ambitious 100p target price of Numis Securities. A higher rating is certainly justified on fundamentals. It is also well supported by the technical set-up.

Positive technical set-up

Shares in 32 Red rocketed last month after I initiated coverage when the price was 51.75p, but in the past two-and-a-half weeks they have unwound the overbought status after the price peaked out at 60p in the first week of August. Interestingly, the price action since then is textbook stuff, whereby the price retraces back to the prior breakout point - around the 55p price level, which for good measure is also the level of the 50-day moving average - and then tests it, before the rally begins to take out the previous high. So, with the 14-day relative strength index (RSI) now neutral, having hit a low of 40 on Wednesday this week, I now think that the technical set-up is ideal for a share price rally to start from this point.

It could also be quite a share upmove to my target price due to 32 Red's lower than average free float. That's because the company's seven largest shareholders hold 68.7 per cent of the issued share capital. These investors include chief executive and founder Ed Ware, who has a beneficial interest in 18m shares, or 25 per cent of 32 Red's issued share capital. Mr Ware was the former managing director of Ladbrokes before he set up the company as a start-up venture. Director David Fish, QC, is also a major shareholder, having been a non-executive of 32 Red since inception. Mr Fish holds 12.7 per cent of the equity. I actually see these chunky shareholdings as a positive since the interests of shareholders and the board are clearly aligned. For example, there is every incentive for the board to be generous with the normal dividend, and continue to adopt a very progressive policy, not to mention return any excess cash back to shareholders through special payouts as has been the case.

Table: 32 Red's major shareholders

Needless to say, if 32 Red's forthcoming half-year results and update are as good as I expect them to be, the shares could re-rate quite quickly and take out that 60p seven-year share price high. On a tight bid-offer spread of 56.5p to 57.5p, I rate 32 Red's shares a trading buy and have a one-month target price of 66p. If achieved, the shares would be trading on 11 times 2013 earnings estimates net of cash. It would also provide us with a further 15 per cent upside. Trading buy.

Please note that in response to requests from dozens of readers, I have published an article outlining the content of my new book, Stock Picking for Profit: 'Secrets to successful stock picking'