It also means that the chance of uncovering mis-priced shares is skewed far more in my favour given the lack of analyst coverage. Furthermore, by spotting a company that is already undervalued without factoring in the potential for earnings upgrades, then the odds become very heavily weighted towards achieving a positive outcome.
It’s fair to say that given my success in the ongoing bull market, and the hefty returns made on dozens of small-cap gems I have managed to uncover, an increasing number of investors are now regularly reading my columns and buying into the companies I highlight. That is something I am humbled by as I have always endeavoured to act in the best interest of our readership. It’s also quite a responsibility given that my articles are now being read by thousands of subscribers, the vast majority of which are placing some value on my comment. It also explains why share prices in the companies I am writing about have a habit of rising sharply after I highlight these valuation anomalies.
For instance, since the start of last week, shares in SeaEnergy (SEA: 38p), London & Associated Properties (LAS: 59p), Nationwide Accident Repair Services (NARS: 87p), Pittards (PTD: 205p) and yesterday’s write-up, GLI Finance (GLIF: 58p), have all surged after I initiated coverage on these small-cap companies. In fact, around 10 per cent of the issued share capital was traded in shares of SeaEnergy alone in less than five hours following the publication of my article ('Making waves, 20 February 2014). Given the weight of money trying to buy into this particular special situation, shares in the company rose by a third from my recommended buy in price of 29p. That price was readily available in the market when the article was released to our online readership, albeit it clearly didn’t last long once the buyers moved in. The point I am trying to make is that it is clearly impossible for every reader to buy into every single one of the companies I write about at the prices I identify the investment opportunity at. Put simply, there is too much money trying to buy a finite number of shares.
Furthermore, and as I have pointed out in previous articles, it’s the decision of each individual whether or not to buy shares in a company I am writing about. That’s what makes a market as some investors will disagree with my analysis, or find the investment case and/or entry point unattractive. But even if an investor finds my reasoning sound and decides to invest, ultimately it’s down to each individual to decide on what represents an acceptable price point to buy into the shares of a company. Ultimately, it’s a trade-off between the level of future returns needed over a specific timeframe and the investment risk being taken to deliver that return. All I personally can do is identify the investment opportunities at the price available in the market at any one time, having undertaken extensive and time-consuming research before publishing my analysis.
It’s worth pointing out too that I have made around 400 share recommendations across hundreds of in-depth articles over the past 18 months, the vast majority of which have been published online so have been very timely. By keeping a close eye on the newsflow from my watchlist of 200 companies listed on the London Stock Exchange main market and traded on the Alternative Investment Market (Aim), I am able to cherry pick the best time to buy into new special situations. I have also updated previous recommendations, as and when there is newsflow worth reporting on, or when an investment opportunity opens up due to what I believe is mis-pricing.
I will continue to do this because these repeat buy recommendations can prove to be just as profitable as initiating coverage on a new company. Ultimately, it depends on how much potential upside there is and the risk you are taking on by entering an investment at a specific entry point. In some cases, the investment risk can actually be lower on a repeat buy recommendation than at the time of the original buy advice even though the share price is now higher.
That may seem an odd statement to make, but it certainly occurs. For instance, if a company’s share price has not correctly reacted to significant newsflow, or if a major deal is likely to be announced that will further transform the prospects of a company, and one that is not being priced into a company’s valuation, then more often than not this creates a pricing anomaly which I endeavour to flag up to our readership.
With this in mind, one of the companies on my watchlist has just won yet another contract, the implications of which have not yet been fully digested by the market, therefore offering another chance to have a bite into what is proving to be a most profitable investment.
Contract wins drive earnings upgrade cycle
I noted with interest that Aim-traded Thalassa (THAL: 302p) has won a contract with Nasdaq-quoted SAExploration (SAEX: $9.23) to provide shallow water source handling and deployment services for seismic acquisition projects in the North Prudhoe Bay, Alaska. Mobilisation is anticipated to commence on 15 June and the survey will last three months from 15 July. The total contract value for services provided will be around $4m (£2.4m).
SAExploration is an established operator on the North Slope, Alaska, a region which has a large and repeat client base of multinational oil companies. Thalassa will assist SAExploration in developing a shallow water source handling and deployment system with the aim of increasing of productivity during the short summer weather window. To recap, Thalassa provides 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.
It’s proving a popular technology and not just with Statoil ASA (NO: STL), the Norwegian energy giant, which signed a massive $85m (£51.9m) nine-year contract with Thalassa to provide long-term seismic acquisition services for permanent reservoir monitoring of the Snorre and Grane oil fields in the Norwegian sector of the North Sea. Other contract wins include one with SMG Ecuador, the Ecuador business of State Sevmorgeo Company, the Russian geological sea survey company. Interestingly, chairman Duncan Soukup expects his business to announce further contracts wins “in the foreseeable future”. Moreover, with the company scheduled to release its full-year results in the week commencing Monday 17 March, I would not be surprised at all to see that announcement coincide with yet another contract win(s).
And as I have pointed out in previous articles, this is proving to be a very profitable line of business, so much so that Thalassa is firmly in an earnings upgrade cycle. Indeed, in a pre-close trading statement last month the company reported that its 2013 earnings would exceed market expectations by more than 20 per cent. That wasn’t a one-off upgrade in guidance either as it followed on from a 30 per cent earnings upgrade last September. As a result, analyst John Cummins at brokerage WH Ireland expects Thalassa’s revenues to more have more than doubled to $30.6m (£18.6m) in 2013. Combined with an improvement in gross margins, this should mean that pre-tax profits will surge by 250 per cent to $4.3m and lift EPS from 10¢ in 2012 to 22.4¢ in 2013.
True, EPS growth is trailing behind profit growth, but this reflects the extra shares in issue following a placing of 4.5m shares at 120p last April, and a subsequent institutional placing of 7.24m shares at 250p in October. These fundraisings strengthened the company's balance sheet to fund the working capital needed to service a record order book and to undertake new work. Given that order enquiries are running at record levels, these equity raises made a lot of sense.
The funds raised will also enable Thalassa to undertake a $10m capital expenditure programme this year to refurbish two compressors acquired, upgrade some of its existing systems, build a mini-PMSS™ system in advance of undertaking work later this year in the high resolution 3D sector. Thalassa will use the P-Cable 3-D seismic system here, a proven technology for the collection of low-fold high-resolution 3-D seismic data. It’s only reasonable to expect all of these programmes to yield profitable results for Thalassa as the company ramps up its business.
Expect further seismic profit gains
It’s also reasonable to expect further analyst earnings upgrades as the year progresses as Thalassa completes on yet more contracts.
That’s because WH Ireland has only factored in that a quarter of the tender pipeline will be converted into firm contracts this year and next. On this basis, current year revenues are predicted to rise to $36.5m and deliver pre-tax profits of $5m and EPS of 16.9¢. The respective forecasts for 2015 are turnover of $41.6m, pre-tax profits of $6.1m and EPS of 20.7¢. Please note that the EPS figures have been adjusted to reflect the greater number of shares in issue post the placings.
In my opinion, that's taking a far too conservative an assumption on the conversion of the $120m bid pipeline. For instance, assuming that $45m in contract wins come through for completion in 2015 (against current forecasts of $30m embedded in WH Ireland’s numbers above), and assuming a gross margin of 28 per cent, this would imply 2015 EPS of 34¢, or 21p a share, a 50 per cent-plus upgrade on current earnings estimates. That looks a far more realistic outcome to me and one that should provide ample further share price upside even though Thalassa’s shares have already risen 120 per cent since I initiated coverage at 138p last March (‘Potential for seismic gains’, 19 March 2013).
That’s because the valuation is hardly racy once you factor in a low-yielding cash pile of $16.8m (£10.6m) at the end of June 2013, and the proceeds from October’s equity placing, and then deduct capital spend of around $10m this year. On this basis, the pro-forma cash pile should be around $28.5m, or 70p a share at the end of this year which means the shares are being rated on a cash adjusted multiple of 11 times earnings estimates for 2015, assuming of course that $45m in contract wins come through for completion in 2015 as I firmly expect.
Highly operationally geared
It’s worth noting too that as revenues ramp up, Thalassa’s operational gearing accentuates the profit growth given the fixed cost base. So with the company riding an earnings’ upgrade cycle, and the historic contract conversion rate significantly higher than those embedded in existing analysts estimates, then I am firmly of the view that the risk to earnings is to the upside. To put this into some perspective, in a bull case scenario when half of the $120m tender pipeline is converted for next year and two further PMSS™ units are built and are in operation, EPS could soar to 67¢, or 41p, assuming gross margins rise to 35 per cent, according to WH Ireland. Strip out net cash on the balance sheet and in this scenario the cash adjusted earnings multiple falls to a miserly 5.5 times in 2015.
Target price
Clearly there are execution risks to factor in, but even so this would be a bargain basement valuation. In the circumstances, I have no hesitation repeating my previous buy recommendation with Thalassa shares trading on a bid-offer spread of 300p to 302p, valuing the company at £75m. I am also maintaining what could be a conservative price target of 350p, but realistically fair value could be nearer to 400p, in line with WH Ireland’s target price. Either way, there is ample share price upside especially since the technical set-up is also very positive.
In fact, Thalassa shares are on the verge of breaking above last month’s all-time high of 316p. That would give a repeat buy signal on the swing chart and another point-and-figure buy signal too. And with the 14-day relative-strength index (RSI) only reading 60, a chart break-out from here should be followed as there is scope for the price to run up without being too overbought to start with.
