Analyst Andy Hanson at nominated advisor and house broker Zeus Capital predicts a 15 per cent rise in the company's revenues to £37m in 2014 to propel underlying pre-tax profits and EPS up a third to £6m and 11.5p, respectively. Importantly, cash generation has been robust and year-end net debt of £6m - around £1.4m lower than Zeus had forecast – only equates to 10 per cent of shareholders funds. This gives the company’s board the flexibility to make more bolt-on acquisitions following the purchase in September of Knowsley-based Primary Fluid Holdings, a designer and maker of hydraulic systems and purifiers, and distributor of hydraulic components.
That was a smart looking deal and a sensibly funded one too as it brought in a business making annual profits of £1.1m for a purchase price of £8.1m. The consideration was made up of an initial net cash outlay of £2.95m, new shares issued to the vendors worth £3.5m and a deferred payment of £1.6m due in August 2015. This means that after factoring in a full-year’s contribution from Primary Fluid, Mr Hanson anticipates Flowtech is capable of generating current year revenues of £45.4m, pre-tax profits almost 20 per cent higher at £7.3m and EPS of 13.4p. On this basis, the shares are rated on a modest 10 times earnings estimates and are priced slightly below book value. There’s a decent dividend too as the board are committed to paying 5p a share for fiscal 2014. Analysts anticipate a modest rise in the payout to 5.1p a share this year, implying a prospective yield of 4 per cent.
There is an organic growth strategy here too, mainly through product development and overseas expansion. Last year the company added 2,000 product lines to its range of original equipment manufacturer (OEM) and own-brand products which it sells to 3,000 distributors and resellers. Flowtech's catalogue now contains around 47,000 individual product lines and is distributed to over 90,000 industrial maintenance, repair and overhaul end users from facilities in the UK and Benelux. The scale of this operation is such that the company is now recognised as the definitive source for fluid power products: over 80 per cent of products are stocked and can be delivered the next day by national courier service, providing a 'best in industry' service offering. The domestic market accounts for almost 90 per cent of sales, but there is potential to tap into overseas markets, primarily in Northern Europe to replicate this successful business model.
Growth this year will also be generated by adding a similar number of product lines to the catalogue this year, especially in hydraulics, and improving the high stock and service levels to try to boost customer spend. And with the benefits of a lowly geared balance sheet, there is a distinct possibility that Flowtech’s board will make further earnings accretive debt-funded acquisitions.
Of course there are risks, the most obvious is the macroeconomic backdrop and potential for the UK economic recovery to weaken which would hit a cyclical distribution business like Flowtech. It’s worth pointing out too that although the company trades below book value, around 70 per cent of its net assets are intangible assets so any deterioration in trading has potential for asset write-downs. Still, that seems highly unlikely and with cash generation set to improve – analysts predict free cash flow of £4.9m this year, half of which covers the cost of the dividend – this leaves ample funds available to pay down debt, and invest in the business.
So having considered the investment case, and weighed up the downside risks, I feel that a share price nearer to 165p, or 12 times 2015 earnings estimates, is a fairer valuation for the equity. Please note that I initiated coverage when the price was 118p (‘Powered up for a fluid performance’, 2 June 2014), and last updated my view when the price was 130p (‘Powering on up’, 30 September 2014). Offering 30 per cent upside to my target price, I rate Flowtech shares a sound buy ahead of the forthcoming results on a bid-offer spread of 127p to 130p.
Inland’s planning spat
My first quarter housebuilding sector trade is once again producing the gains we have regularly come to expect, with a 5.2 per cent rise in the nine FTSE 350-listed players. To recap, I jumped the gun this year and advised buying at the end of November (‘A standing dish’, 25 November 2014). My advice is to run your profits ahead of a raft of financial result releases from most of the companies in the next two months.
FTSE 350 Homebuilders price performance (25 November 2014 to 30 January 2015)
Closing price on 24 November 2014 (p)
Latest bid price on 30 January 2015 (p)
Share price gain (%)
However, the one company that has missed out on the rally is Aim-traded housebuilder and land developer Inland Homes (INL: 57.5p). One main reason for this underperformance could be the adverse publicity created by the company’s spat with local residents and the local planning department regarding a proposed change of use for a former Grade II-listed pub in Amersham, Buckinghamshire. Inland has been battling the planners for two years and amended its plans for a residential development on the site, but to no avail. Still, this is part and parcel of the property development game and in the scheme of things this site is really small beer for the company. But Inland’s chief executive Stephen Wicks seems to have taken umbrage, so much so that he sent an abrasive e-mail to local residents (who objected to the proposals) to notify them that Inland Homes would now be applying for planning permission for the land to be used as a site for travellers.
The adverse press coverage is doing Inland no favours at all, not to mention it’s an unwanted distraction from the real business of ramping up residential sales and selling off land parcels to large housebuilders. I would hope that sense will prevail and so will loyal shareholders who have backed the company. Inland shares have fallen from their eight-year high of 63p since the start of January.
But, if like me you believe these playground antics will be long forgotten by the time Inland reports what undoubtedly will be a bumper set of first half results next month, then the recent sell-off is likely to prove to be yet another buying opportunity for the shares. Moreover, it has certainly paid to buy the dips since I selected the shares as one of 2013 Bargain shares at 23.5p (‘How the 2013 Bargain shares fared, 7 February 2014).
Importantly, the valuation is attractive: on 12 times earnings estimates for the 12 months to June 2015, falling to 10 times in the year to June 2016, the rating is modest for a company driving strong earnings growth from a solid development pipeline and forward order book. As I have pointed out before, the underlying value in Inland’s land holdings is worth closer to 90p a share using open market values. In the circumstances, I would be using the current price weakness as a buying opportunity with Inland’s shares priced on a bid-offer spread of 56p to 57.5p and maintain a 70p target price.
Please note that my 2015 Bargain Shares Portfolio will be published in the magazine of Friday 6 February and online well before the markets open. I will update my view on all the constituents of my 2014 portfolio at the same time. I am currently in the process of updating a number of the companies on my watchlist which have issued trading updates recently, including Arbuthnot Banking (ARBB); Secure Trust Bank (STB); 32Red (TTR); KBC Advanced Technologies (KBC); Greenko (GKO); SeaEnergy (SEA); K3 Business Technology (KBT); Safestyle (SFE); and Global Energy Development (GED).
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'