I really can have no complaints with the performance of Aim-traded stockbroker and financial services outsourcer Jarvis Securities (JIM: 435p) as the shares have almost doubled in value since I initiated coverage when the price was 220p ('Solid income buy', 25 Feb 2013). However, with a significantly higher share price comes a higher rating and less margin for error. In the case of Jarvis, it's fiscal 2014 reported pre-tax profits were only 2 per cent down on WH Ireland's pre-tax profit estimate of £3.24m, and still well up on the 2013 reported figure of £3.07m. But behind that performance there was a definite slowdown in the second half, inline with the experience of many stockbrokers when the autumn chill in the stock market hit trading volumes. In fact, Jarvis's second-half pre-tax profits actually declined slightly to £1.5m, and were well down on the £1.68m reported in the first six months of the year.
This more subdued trading backdrop has prompted analyst Nick Spoliar at broking house WH Ireland to rein back his 2015 pre-tax profit forecast by over £200,000 and he now expects a flat performance this year and a maintained dividend of 16.5p per cent, albeit that payout is still well up on the 14.5p a share declared in 2013, and covered 1.4 times by EPS of 23p. Still, with expectations being dampened down somewhat, even though Jarvis flagged up a decent pipeline of business for its outsourcing business where it provides partnered financial administration services to a number of third-party organisations, then there is a definite lack of a catalyst for immediate share price upside. It also explains why the shares have drifted since I reiterated my buy advice last autumn ('Exploit a cash rich income play', 6 November 2014).
Changing expectations
The other thing that has changed in the past three months are market expectations for the first base rate hike from the Bank of England. That's important for Jarvis because it has more than £140m of cash under administration placed on short-term deposit of less than one year with triple A-rated banks, so small changes in the interest it earns on this money will have a significant impact on profits.
Bearing this in mind, I had expected the Monetary Policy Committee (MPC) of the Bank of England to raise base rates by June this year as record UK employment levels, falling unemployment - at 5.7 per cent it is the lowest level for seven years and some economists believe the rate will dip below 5 per cent by the end of this year - and real wage growth create the potential for a wage spiral driven by the lack of spare capacity in the economy.
Indeed, the central bank's own economists now predict real wage increases of above 3 per cent in fiscal 2015 as inflation dips below zero. However, the MPC doves are taking a very cautious view in light of the troubles in the eurozone economy, our major trading partner. As a result, expectations for the first base rate rise have been pushed out to 2016, and with it a likely profit boost for Jarvis's corporate outsourcing business.
Assessing the valuation
That leaves the shares trading on 19 times last year's earnings and yielding around 4 per cent. Cash on the balance sheet was £8.3m at the end of December, or the equivalent of 73p a share, so the cash adjusted PE ratio is 16, a rating that no longer represents value with earnings set to stagnate.
In the circumstances, I have decided to bank profits on this holding, but will keep a close eye on the interest rate futures markets to try to capitalise on the next buying opportunity as and when the MPC eventually raise base rates. In the meantime, the shares may not necessarily drift further as the dividend is supportive and the board have stated they will look at purchasing its own shares "should it be considered an appropriate means to improve shareholder returns". And of course, Jarvis could yet beat those earnings expectations. Still, I have had a great run here and feel it's time to take profits.
Undervalued, and misunderstood
Aim-traded shares in aircraft leasing company Avation (AVAP: 142p) are unchanged from my last buy advice ('Investors alight on Ebola scare', 21 October 2014), but are 10 per cent below my original buy recommendation ('Get on board for blue sky gains', 11 September 2014). The company's half-year results at the end of last week failed to provide a boost, but in my opinion this was mainly caused by the presentation of the financial results.
That's because at first glance it would appear that pre-tax profits fell from $7.9m to $7m (£4.5m) in the six months to end December 2014 despite the company posting a 13 per cent rise in revenues to $27.7m. However, drill down through the notes to the release, and it becomes clear that the prior six months figures in 2013 benefited from a $1.43m profit windfall from the sale of aircraft. Strip this sum out and underlying pre-tax profits actually rose by around 8 per cent. Moreover, Avation is in the process of selling two aircraft so it's second-half profits will benefit from the profits on these sales, something that would have been worth flagging up in the results release.
Investors also seem to have missed the point that following the renegotiation of its credit lines (funding 29 aircraft that are leased out to clients), Avation's average weighted cost of debt has fallen by 90 basis points to 4.6 per cent year on year. That's significant as the company had net debt of $331m at the end of December 2014. The annual interest saving alone on those borrowings is around $3m, so even if the company flatlines over the next six months then second-half profits are set to get a major uplift.
Not that the company is doing any such thing as chairman Jeff Chatfield is committed to growing the fleet of 29 planes. In fact, Avation has no fewer than 13 new aircraft scheduled for delivery by 2016 at a cost of $307m, or the equivalent of 61 per cent of the company's total assets of $503m. The 12-month delivery schedule will increase the fleet size to 38 planes by March 2016 including eight new ATR 72-600s and two new Airbus A321-200s.
Funded for strong growth
Avation also has a further 22 options on future aircraft deliveries scheduled from 2017 onwards. At the end of last year the company successfully refinanced $31m of debt secured on two A321-200 aircraft, currently on lease to Thomas Cook Airlines, highlighting Avation's ability to tap into low-cost funding in the credit markets. And that wasn't the only deal as Avation entered into a conditional agreement with Thomas Cook for the purchase and leaseback of two new Airbus A321 aircraft worth $100m (£65m) to be delivered from Airbus in the first quarter of 2016. These lease agreements have an initial term of 12 years with an option for Thomas Cook to extend them for a further six years.
Moreover, Avation has announced today that it has signed a lease agreement with UK airline, Flybe, to supply Flybe with three ATR72-600 aircrafts this year and another in 2016 for a lease period of six years, with an option to extend the lease for another six years. These aircraft will be operated by Flybe in Scandinavia on behalf of Scandinavian Airlines System. What was not made clear in last week's results release, or for that matter today's announcement from Avation, is that this means that the company has leased out almost all of its available aircraft upto early 2016. That's not only well ahead of schedule, but it gives far greater confidence that Avation will deliver on the robust earnings growth profile projected by analysts as the size of the fleet ramps takes off. In fact, the company has just firmed up its options with the manufacturer ATR for the delivery of five additional new ATR72-600 aircraft next year.
Importantly, the ability to finance these multi-million pound deals highlights the quality of the lease covenants in place with major airlines including US Airways, Virgin Australia, Condor, Fiji Airways and UNI Air, the largest regional domestic airline in Taiwan. Two-thirds of the company's portfolio of 29 planes are ATR72 aircraft, and the balance are Airbus A320 family aircraft and Fokker 100s.
Earnings forecasts intact
The bottom line is that Avation is on track to meet analyst pre-tax profit estimate of $20.5m for the 12 months to end June 2015, up from $16.6m in the previous year. On this basis, adjusted EPS rises by 20 per cent to 21.5p a share at current exchange rates. So not only are the shares trading on a forward PE ratio of 6.5, but having paid a 2 cents a share payout to shareholders last month, there is a near 1 per cent dividend yield, too.
True, some investors will be deterred by the company's high balance sheet gearing - net debt equates to 272 per cent of shareholders funds of $331m - but borrowings are secured on aircraft worth $443m, and interest and debt repayments are well covered by the lease payments made by clients on the aircraft. In any case, Avation is ready to sell on aircraft when it sees an opportunity to realise value for shareholders and that includes before it takes delivery of new planes under option.
In the circumstances, I feel that the lack of share price progress has more to do with a lack of understanding in the investor community of the progress the company has been making, an issue the company could easily address by providing more detailed disclosure. Trading on a deep valuation discount to US peers - average rating of between 8 to 15 times earnings estimates (for June 2015 fiscal year-end), according to analysts - Avation's shares rate a decent recovery buy. My price target is 200p.
Finally, my colleague Jonas Crosland has provided an indepth analysis of Aim-traded Inland Homes (INL: 63p) at the end of last week ('Unlock Inland Homes hidden value', 19 February 2015) and I can only reiterate his positive view. Offering 10 per cent share price upside to my target price of 70p ('A fluid performance', 2 February 2015), and with last week's pre-close trading update indicating the company is bang on track to deliver a robust profit uplift this year, then I have no hesitation in reiterating my buy advice. Indeed, my target price is looking increasingly conservative. Buy.
Please note that I published four columns last week and assessed the investment case on seven companies of which two were new recommendations including a property company ('A bootiful investment', 19 February 2015) and a telematics company ('Zoning in on a profitable price move', 16 February 2015). These articles are avaliable on my IC homepage...
■ 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'
