I still feel that the current lowly rating is unjustified for a number of reasons. Firstly, analyst David Buxton at house broker finnCap notes that “management are confident of achieving expectations for the fiscal year to end 28 March 2015”. Mr Buxton is pencilling in full-year revenues of £44.5m, pre-tax profits of £2.1m and EPS of 2.1p, implying a modest 5 per cent growth in net earnings. True, there is a second half bias to those numbers as 600 Group reported flat first half revenues of £21m and pre-tax profits around 10 per cent higher at £670,000.
A strong currency tailwind
But those forecasts still look achievable to me especially since the currency headwind which sliced £100,000 off the company’s operating profit in the first half has reversed. Indeed, in the six months to end September 2014, the average sterling:US dollar exchange rate was £1:$1.676, but following the surge in the dollar the second half average cross rate will be around £1:$1.535, or 14 cents less than in the first half, if sterling stays at the current level of £1:$1.519.
This is important because 600 Group’s laser marking division, accounting for 18 per cent of the company’s revenues, originates 44 per cent of sales from North America. So the margin squeeze on sales here should have been reversed in the second half. And although the business also sells into Europe, the strength of sterling against the euro has been less strong. In fact, the sterling:euro rate has risen from an average of £1:€1.243 in the first half to around £1:€1.294 in the second half. So the positive currency effect on dollar earnings translated back into sterling should exceed any pressure on eurozone earnings from the strength of sterling.
In addition, 600 Group’s machine tools business, accounting for 82 per cent of sales, sources inputs from Europe so has benefited from a more favourable exchange rate on its purchasing costs. It’s worth flagging up too that at the start of October the company’s North American order book was at a two-year high so there was a solid pipeline of business to exploit these subsequent favourable currency movements. It’s realistic to assume that the order book has remained robust given that industry forecasts from Oxford Economics point to a growth rate of around 6 per cent in machine tool consumption in the Americas in 2015, a modest improvement in Europe in the order of 3.7 per cent and 9 per cent growth in Asia.
A value play
I also feel that investors are ignoring the opportunities for the company to make earnings accretive acquisitions. Net debt was only £6.75m at the end of September, representing 30 per cent of net assets of £22.9m. Indeed, the board have indicated acquisitions are actively being considered. Furthermore, a rating of less than 8 times earnings for the March 2015 fiscal year implies that there will be little in the way of growth in earnings in the next financial year. But Mr Buxton at finnCap still expects pre-tax profits to rise by 14 per cent to £2.4m to produce EPS of 2.2p in the 12 months to end March 2016, based on a rise in revenues to £47m. Those estimates are supported by the latest industry forecasts for machine tool consumption.
On a price-to-book value ratio the shares offer value too as there are rated a hefty 38 per cent below net asset value of 25.5p, based on 89.6m shares in issue but ignoring any retained profit on the balance sheet earned in the second half. So ahead of a pre-close trading update in early April, I am comfortable maintaining my buy recommendation on 600 Group’s shares and still believe that my fair value target of 24p is realistic.
Awaiting a potential cash return
Aim-traded South American oil explorer and producer Global Energy Development (GED: 42p) has issued a reserve update and one that has resulted in reductions in both the estimated quantity of proved and probable reserves, and forecast net cash flows to be generated from the company's Colombian contract areas. That’s hardly surprising given that the oil price has plunged 50 per cent from last summer’s high.
Low oil prices mean that the heavy oil reserves within its Bocachico contract area in the Middle Magdalena valley, Colombia, are now uneconomic, so there will be a material write down on the value of these assets when Global Energy releases its 2014 fiscal results at the end of March. This follows news earlier this year that farm-out partner Everest Hill Energy terminated its two farm-out agreements with the company in the region as a result of the depressed oil price.
It may seem an odd thing to say in light of this negative news flow, but this means that a cash return to shareholders is even more likely now given that Global Energy successfully completed the disposal of it Llanos portfolio at the end of last year (‘Undervalued and unloved oil plays’, 17 December 2014). That sale was based on an oil price north of $90 a barrel, so proved well-timed. It also means that Global Energy has net cash of $42m, or £28m at current exchange rates on its balance sheet. Based on 36.1m shares in issue, net funds equate to 77p per share.
Or put it another way, the company could return all of the current share price back to shareholders, and still have 35p a share left over to take advantage of investment opportunities. It would also enable the backers of Everest to recoup some of the cash they paid Global Energy for the farm-out deals. Everest is an affiliated company of the Quasha family trusts which have an interest in Lyford Investments, a major shareholder in Global Energy. HKN, Global Energy's principal shareholder, Lyford Investments, and parties acting in concert with them control a total of 61.92 per cent of Global Energy’s issued share capital.
In fact, I would not discount the possibility of the concert party taking Global Energy private by using the cash on the company’s balance sheet to buy out minority shareholders who own 13.75m of the shares in issue. That’s because a cash bid of 77p a share would only use up £10.6m of Global Energy’s £28m cash pile and would enable these majority shareholders to get their hands on the £17m balance of the company’s cash and take full control of Global Energy’s undeveloped oil reserves (around 24m barrels of oil) in the Boliviar and Bocachico contract areas.
In the circumstances, I think investors will be focusing on that cash pile when Global Energy reports its full-year results at the end of March rather than the inevitable write-down on its oil reserves. That makes Global Energy’s shares a speculative buy on a bid-offer spread of 40p to 42p.
Pure Wafer value opportunity
Clearly when a company announces that a fire has ravaged one of its main production facilities then it’s never good news. However, in the case of Aim-traded Pure Wafer (PUR: 42p), a leading global provider of high quality silicon wafer reclaim services to some of the world's largest semiconductor makers and foundries, the company has been able to take measures to reduce the potential disruption to the business.
Most importantly the company is comprehensively insured against the financial loss caused by the fire that broke out at its wafer reclaim facility in Swansea just before Christmas. It is currently working with insurers and their advisors to ensure that production is resumed as soon as possible. The insurance policy includes extensive three-year business interruption cover. Although it is anticipated that it will take up to 12 months for full scale production to recommence at the plant, a contingency plan is in place to switch, where possible, production to Pure Wafer’s other facility in Prescott, Arizona. The company is also working closely with its customers to minimise any disruption resulting from this incident.
Understandably the shares have come under pressure since the news broke in late December. But investors selling seem to be missing the point that the Arizona facility accounted for 61 per cent of Pure Wafer’s cash profits, or around $4m (£2.66m) in the last financial year to end June 2014. Also, the company has a cash rich balance sheet, ending that period with net funds of £1m. Strip this sum out from Pure Wafer’s current market capitalisation of £11.9m, and this means that without attributing any value to the Swansea facility, then the Arizona business (before apportioning central costs) is being valued on a miserly four times historic cash profits.
But clearly there is still value in the Swansea business even allowing for the potential permanent loss of contracts from customers who are now being forced to look elsewhere for wafer reclaim services. Indeed, two thirds of Pure Wafer’s net asset value of £24.4m at the end of June 2014 was accounted for by plant and equipment alone. And if the insurers pay up as expected for the repair work, and also the business interruption cover, then there is little reason to expect any impairment to the company’s net asset value per share of 86p.
It’s worth noting that Pure Wafer’s share price has found solid support around the 40p price level, indicating that investors are reassured by the announcement last month regarding the insurance covering the Swansea facility. In the circumstances, I would continue to hold the shares for recovery as the risk looks skewed to the upside to me. Please note that I last updated my view just before Christmas when news of the fire emerged (‘Small cap trading updates’, 22 December 2014).
■ 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'
