Earnings upgrades underpin Pilat
Half-year results from Aim-traded Pilat Media Global (PGB: 61p), a supplier of business management software to the media industry, were not only ahead of my expectations but also ahead of those of Robin Speakman, an analyst at broker Shore Capital.
In fact, post results Mr Speakman upgraded his full-year adjusted pre-tax profit forecast by 4 per cent to £2.24m and now expects the company to report EPS of 2.65p, up from £1.78m and 2.15p, respectively, in 2012. And this follows a hefty 19 per cent earnings upgrade at the time of the final results in March.
The key take for me in the latest results was that that recurring maintenance revenue for the second quarter was 8 per cent above forecast at £1.57m (£3.14m for the first half) and licence fees - a key indicator of long-term growth - beat forecasts by an eye-catching 54 per cent at £0.77m (£1.29m for the first half). For good measure, professional fees came in 9 per cent above estimates at just shy of £8m. As a result, analysts now expect full-year revenues to grow from £23.5m in 2012 to £26.8m, of which £12.4m was booked in the first half. And with contract delivery costs taken in the first half and sales momentum clearly building, profits now look set to ratchet up in the second half and beyond.
These positive trends also mitigate investment risk since Pilat is a highly seasonal business with profits and sales heavily weighted to the second half, and specifically to the fourth quarter. It also underpins Shore Capital's hefty 9 per cent earnings upgrade for 2014. For that period, Mr Speakman now expects pre-tax profits to jump to £2.68m on revenues of £28.8m to produce EPS of 3.15p. In other words, this is a business that is expected to grow profits and earnings by around 50 per cent this year and next. It could be far more since Mr Speakman believes these new forecasts are "suitably conservative, allowing for the prospect of new business continuing to accelerate". He adds that "the outlook for continued growth (and for potential future upgrades) remains positive".
He has a point since Pilat's strategic move into the complimentary field of broadcasting streaming, catch-up TV and 'video on demand' through the 'OTTilus' project (set to be launched later this year) could lead to a step-change in prospects in 2014. Revenues and earnings from OTTilus are excluded from Shore Capital's forecasts above.
Contract wins building
It's well worth pointing out that Pilat's future profit growth is already well underpinned by a number of contract wins. That's because the company's main product, IBMS - a business management system for large broadcasters - is now attracting real interest across the world. The product manages workflows, channel scheduling, airtime pricing and billings, and streamlines the running of TV businesses, from small single-channel operations to large multi-channel and on-demand platforms. In total, Pilat's client base includes more than 60 blue-chip media companies across the globe. That figure has been increasing sharply this year.
For example, in the first half Pilat won a raft of contracts, worth well over £11m, including a $5m (£3.3m) deal with Starz, a US leading provider of premium pay TV content and services. As part of the agreement Starz will license and implement Pilat Media's IBMS software to replace a number of legacy systems in the areas of content and rights management, on-demand programming, and transmission scheduling.
Pilat also won a contract with Seven Television, Australia's largest free-to-air television network. The Australian broadcaster is licensing the full suite of IBMS modules, and will be implementing the system across its entire TV business operations. The value of the contract is AUS$7.5m (£5m) and further revenues are expected from additional services and support and maintenance. This is Pilat's tenth client in Australia and New Zealand, further strengthening its presence in the region and reinforcing IBMS as a leading integrated broadcast management system for multi-platform businesses.
The company is also making inroads into emerging markets and won a further three contract wins, worth £3m over the next 18 months, in Turkey and South America. As Avi Engel, chief executive of Pilat Media, points out: "The new contracts not only contribute to revenues, but they are in important emerging markets. In Latin America, Pilat has built on its success in winning its first major client three years ago, GloboSat in Brazil, and Turkey is a large potential market where the board has identified other opportunities for the company."
Impressive cash generation
Equally important for a fast-growing business is cash flow. On this score Pilat ticks all the right boxes. In the second quarter to the end of June, the £428,000 of cash generated from operations reversed a £1.3m outflow in the same three-month period in 2012. In fact, in the first half Pilat generated a total of £2.48m of operating cash flow to bolster its cash pile to £16.5m. Net of a £4.3m fixed-term loan, net funds ended the period at £12.2m, or the equivalent of 20p a share. That's a significant sum considering Pilat only has a market value of £39m, so net cash accounts for around a third of the share price. Furthermore, assuming Pilat hits Shore Capital's numbers for 2014, that cash pile is predicted to rise even further to £14.7m, or 23.5p a share, by the end of next year.
To put this burgeoning cash pile into some perspective, if you strip out cash from the current share price Pilat is being rated on a modest PE ratio of 16 for the current year, falling to only 12.7 times likely earnings for 2014. And remember these are conservative earnings assumption given the obvious potential boost from contract wins in the future.
Repeat buy signal
Interestingly, Pilat's shares have smashed through the 55p level, which capped the previous major rally in March 2011, skewing the odds in favour of a return to the record high of 88.5p, which dates all the way back to January 2007. In fact, there is very little technical resistance between 55p and 88p, so the re-rating could be quite sharp especially if the 65p high from a couple of weeks ago can be well and truly taken out.
I think it will be since the fundamental case fully supports a higher share price: Pilat is a company winning major new contracts; generating bumper cash flow; has potential to return excess cash to shareholders; looks nailed on to increase EPS by 50 per cent this year and next; and is now in the early stages of an earnings upgrade cycle.
Ahead of the company's third quarter results at the end of November, I continue to rate Pilat's shares a strong buy on a bid-offer spread of 59p to 61p and have a three-month price target of 72p. It could prove conservative.
Please note that the company has two large shareholders that control half the issued share capital and over two-thirds of the shares are deemed not in public hands under Aim rules, which affects the free float and liquidity. The shares are also dual-listed on the Tel Aviv Stock Exchange. I have taken both factors into consideration when making this recommendation.
A share ready to smoke
Investors are playing a waiting game at specialist engineer Molins (MLIN: 165p) and I am happy to bid my time too.
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 already 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 and the latest indication from the FDA is that guidance will be published in December. This largely explains why Molins' shares have been trading sideways since February, having enjoyed a bumper performance in the previous 12 months after I included them in my 2012 Bargain Share Portfolio.
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. The unit is fully operational from its new laboratory facility in Richmond, Virginia, where it services all the tobacco industry's tobacco and smoke testing requirements, and from where non-tobacco testing will be carried out as the business extends its activities into other end markets.
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. In my view, any forthcoming FDA-related newsflow will be a key share price driver for Molins if, as expected, the regulator does extend the list of harmful compounds that tobacco companies need to test. It would also prompt analysts to upgrade their earnings estimates for future years.
Lowly valued
But even without upside from a change in US legislation, Molins is performing well enough if last week's half-year results are anything to go on. In fact, the company grew sales by 20 per cent to £47.8m and almost doubled underlying pre-tax profits from £0.8m to £1.5m. For the full year, Canaccord forecasts that Molins will raise operating profits by 10 per cent to £5.5m, mainly reflecting the heavy second-half bias to the reported numbers. Guidance from the company's management is that the business is trading in line with these forecasts.
True, a higher tax charge means underlying EPS is likely to flat at 22p, but 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 that basis, the shares trade on a miserly 7.5 times forward earnings and yield around 3.3 per cent. That is a pretty attractive rating, which becomes even more compelling once you consider that Molins had net funds of £5.6m, worth 28p a share, at the end of June. 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 hefty 25 per cent discount to net asset value of 211p.
Positive technical set up
The technical set-up is certainly supportive of another leg up in the company's share price and a rally back to the August 2007 bull market high around 220p. The 14-day relative strength index (RSI) is neutral after a modest pull-back from the mid-July high of 177p, and the price is not overextended, trading just above the 200-day moving average around 159p. Interestingly, the long-term trend line has acted as support for the share price for the past couple of years and each time it has been tested has been the precursor to a major rally. There is little to expect any difference this time around.
Needless to say, I remain a buyer of Molins' shares on a bargain basement six times this year's earnings estimates net of cash. My target price remains 220p - equating to 8.7 times earnings estimates net of cash - which I feel could be achieved by the year-end assuming of course the FDA releases its guidance by then. Offering 33 per cent potential upside to my target price, I continue to rate Molins' shares a value buy on a bid-offer spread of 163p to 165p.
Please note that my next column will appear tomorrow at 12pm. 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'
