Admittedly, it has still taken time to reconcile the underlying performance with the reported profits in the full-year income statement, but the bottom line is that in the 12 months to end June 2015, the company reported underlying pre-tax profits from leasing activities of US$14.8m, up from US$13.2m in the prior year. This figure was arrived at after stripping out exceptional gains of US$3.3m on disposal of aircraft in the 2014 fiscal year which were not replicated this time round as Avation booked a $729,000 one-off net loss on these activities. The absence of any short-term profits on selling on aircraft orders is because the company has opted instead to add new ordered aircraft to the fleet for long-term gains.
It’s a strategy that makes complete commercial sense, albeit the fact that reported pre-tax profits of $15.5m were shy of the $17.3m (boosted by that $3.3m gain) comparable figure in 2014, and short of the $21.5m forecast when I last covered the investment case in February may have given some investors the wrong impression. So it’s worth pointing out that the company incurred the best part of $3m of upfront costs setting up a $500m guaranteed loan note facility at the end of May and profits were primarily held back by these one-off costs. It’s worth noting too that the board raised the dividend by almost half to 3 cents a share, hardly the action of management short of confidence in the future prospects of their business.
Furthermore, it’s clear to me to that having initially raised $100m (£66m) from an unsecured five-year loan note issue at the end of May, the proceeds of which will help fund the acquisition of four aircraft in the next four months, and another six in the first six months of 2016 to take the fleet to 39 planes, there is good visibility on the revenue and rising profit stream Avation will generate in the coming financial year. Indeed, those 10 aircraft deliveries, a mixture of Airbus A321 and ATR72 planes, have a purchase value of $280m (£184m) and represent a near 50 per cent increase in the value of the fleet. That may seem a chunky sum, but Avation has low cost credit lines - average cost of debt of 4.4 per cent on secured borrowings – and over $109m cash on its balance sheet which can be used to fund the purchase costs of new aircraft. Interest rate risk is mitigated by fixing in the cost of borrowings on 89 per cent of all debt raised.
So with the new planes simultaneously being leased on to major airlines including US Airways, Virgin Australia, Condor, Fiji Airways and UNI Air, the largest regional domestic airline in Taiwan, and operating expenses being kept in check, then the incremental lease payments collected on new aircraft easily covers the company’s additional overheads and supports a sharply rising net income stream for the current fiscal year and beyond.
Strong earnings growth trajectory
To put the likely growth rate into perspective, analyst Ian Berry at broking house W.H. Ireland expects Avation’s revenue to rise from $60m to $70.5m in the current financial year to end June 2015 to drive up pre-tax profits from $15.5m to $23.6m. On this basis, EPS rises from 26.1 cents (17.1p) to 38.4 cents (25.2p) and should enable the board to increase the dividend to 3.3 cents (2.2p). This means the shares are trading on only 7.5 times historic earnings, falling to 5 times in the current year, on a 16 per cent discount to book value of 151p, and offer a dividend yield of 1.5 per cent, rising to 1.7 per cent. That’s hardly punchy for a company predicted to increase EPS by almost a half in the coming 12 months. It’s also well below the ratings of major US peers (6 to 11 times earnings estimates, according to Mr Berry).
True, Avation shares are below my original buy-in price of 159p ('Get on board for blue sky gains', 11 September 2014), and have yet to hit my 200p target price, having peaked out at 182p last November. They have also fallen 10 per cent since I updated the investment case at 142p in February. However, I still feel they are grossly undervalued. In fact, I have more confidence in the company hitting 2016 fiscal earnings estimates now than when I recommended buying a year ago. So although the holding has yet to reap the predicted returns I envisaged I am keeping faith.
Interestingly, from a technical perspective, the sell-off from June appears to have run its course: the shares are at the 120p support level dating back to last February and November, there is positive divergence on the daily chart, and the 14-day relative strength indicator is very oversold. On a bid-offer spread of 123p to 127p, I rate Avation’s shares a medium-term buy offering significant upside potential.
Fairpoint rally set to continue
Shares in Fairpoint (FRP:177p), a leading provider of consumer professional services including debt solutions and legal services, have surged by 28 per cent since I highlighted they were on the cusp of giving a major buy signal a month ago at 138p (‘Break-out looming’, 4 August 2015).
At the time I noted that a close above 140p would complete a 14-month long reverse head and shoulders pattern and open the door to a rally towards the April 2014 high of 164p and ultimately to my long-term target price of 190p. That target is still not unreasonable, implying a rating of little over 10 times this year's expected earnings based on an EPS estimate of 18.5p, up from 17.2p in 2014, according to analysts John Borgers and Gilbert Ellacombe at research firm Equity Development. Adjusted EPS shot up by a fifth to 7.38p in last week’s half-year results, so after factoring in the benefits of the legal services acquisitions made in the second half last year, I reckon the company is bang on course to hit those full-year estimates.
Moreover, the improved composition of the company’s revenue justifies a higher rating as the contribution from more cyclical IVA activities becomes a far less significant proportion of profits. In fact, legal services now accounts for half of Fairpoint’s revenues and this segment will increase to around two-thirds post last month’s acquisition of Colemans-CTTS and Holiday Travel Watch, a provider of consumer-focused legal services specialising in volume personal injury, volume conveyancing and travel law. I commented on the positive financial implications of that deal in my article last month. It’s also clear from the half-year results that last year’s acquisitions of both Simpson Millar LLP Solicitors, and Fosters & Partners, a Bristol-based law practice specialising in all aspects of family law, are performing as expected.
Significantly, there is still value in the shares which are rated on a modest 1.5 times book value, and on 8.5 times earnings estimates of 20p a share for 2016. A prospective dividend yield of 3.8 per cent, based on a raised payout of 6.8p a share, is also supportive of the investment case. So although Fairpoint’s share price has surged since I included them at 98.25p in my 2013 Bargain Shares Portfolio - since when the company has paid out total dividends of 15.95p a share to give a total return of 91 per cent – I would recommend running profits at 177p and maintain what could yet prove to be a conservative price target of 190p.
Redde’s earnings upgrade cycle worth running with
Fairpoint was not the only company on my watchlist to issue a stand out set of results at the end of last week. Shares in Aim-traded Redde (REDD: 158.5p), a provider of replacement vehicles for drivers involved in accidents that are not their fault and of legal services designed to assist claimant parties in partnership with leading insurance companies, hit a five-year high of 165p after its full-year results for the 12 months to end June 2015 beat analysts’ estimates by some 4 per cent. This prompted pre-tax profit forecast upgrades in the order of 7 to 10 per cent.
I had anticipated as much when I highlighted the strong momentum in the business at the time of the pre-close trading update a couple of months ago when the price was 138p (‘Riding earnings upgrade cycles’, 7 July 2015), having initiated coverage at 108p ('In the fast lane', 23 March 2015). I also reiterated my buy advice when the shares were 120p in May ('Smashing target prices', 14 May 2015). It has proved the right call in hindsight as Redde’s share price has now smashed my target price range of 150p to 155p.
But I am not ready to recommend banking profits just yet as the latest round of upgrades, and a better than expected final dividend of 4.25p a share, warrants a reappraisal. Having upgraded estimates significantly post last month’s earnings enhancing acquisition of FMG, a provider of fleet management services, for a total consideration of £43.2m, analyst Andrew Watson at broking house N+1 Singer has been forced to raise his pre-tax profit estimate by a further 7 per cent to £27m for the 12 months to end June 2016, up from £22.7m in the fiscal year just ended. This forecast is based on a 32 per cent rise in revenues to £328m. On this basis, expect fiscal 2016 fully diluted EPS to rise by 11 per cent to 8.8p.
Moreover, with cash generation strong, reflecting higher case volumes and a better working relationship with insurers, and the board pursuing a policy of paying out all its net profits as dividends, we can realistically expect a payout of 8.7p a share in the current financial year. In the last fiscal year, Redde declared normal dividends of 8.25p a share, including a final payout of 4.25p (ex-dividend: 8 October) and a special dividend of 1p a share which was paid in July. This means that the shares offer an attractive prospective dividend yield of 5.5 per cent.
That income stream is decent enough to recommend running your 46 per cent paper profits if you followed my earlier advice even though Redde’s shares are now rated on a far more reasonable 18 times earnings estimates, falling to 16.5 times EPS forecasts of 9.6p for the 2017 fiscal year. My rationale being that there is there is potential for the share price rally to continue if revenue benefits not factored into N+1 Singer’s upgrades materialise, a point I made when I discussed the FMG acquisition last month (‘Running bumper profits’, 27 August 2015). Run profits.
MORE FROM SIMON THOMPSON...
I have published articles on the following companies in the past month:
■ Non-Standard Finance: Buy at 107.5p; Software Radio Technology: Buy at 27.5p, target 40p; Character: Run profits at 500p; Communisis: Hold at 50p ('Value judgements', 3 Aug 2015)
■ Fairpoint: Buy at 138p, target 190p; Creston: Run profits at 155p; Sanderson: Buy at 71p, target 80p to 85p; Renew: Buy at 340p, target 375p ('Break-outs looming', 4 Aug 2015)
■ Globo: Buy at 42.75p, target 69p; Cambria Automobiles: Run profits at 72p ('Short sellers in for shock treatment', 5 Aug 2015)
■ Cohort: Run profits at 357p, target 375p; Cineworld: Run profits at 530p; Paragon: Buy at 412p ('Acquisitive growth drives re-ratings', 6 Aug 2015)
■ PROACTIS: Buy at 93p, target 117p ('Procuring growth', 10 Aug 2015)
■ Town Centre Securities: Buy at 310p, target 350p ('Equity market watch', 11 Aug 2015)
■ Equity market strategy ('Equity market watch', 11 Aug 2015)
■ KBC Advanced Technologies: Buy at 122p, target 165p; Getech: Buy at 59p, target 80p ('Fuelled for strong growth', 12 Aug 2015)
■ Pure Wafer: Run profits at 162p, target 178p; Inland: Run profits at 71.5p, next target 80p; Macau Property Opportunities: Take profits at 189p ('Bumper cash returns', 13 Aug 2015)
■ Inspired Capital: Accept cash offer of 21.5p; Record: Buy at 40p; Pittards: Buy at 128p; Netplay TV: Buy at 9.5p ('Bargain shares updates', 17 Aug 2015)
■ Equity market strategy ('Stay calm', 25 Aug 2015)
■ Capital & Regional: Run profits at 67p; Redde: Run profits at 152.5p; Cineworld: Run profits at 578p; Cohort: Run profits at 375p; H&T: Buy at 195p; Record: Buy at 33.5p; Bioquell: Buy at 137p, target range 170p to 185p ('Running bumper profits', 27 Aug 2015)
■ Equity market strategy ('A sense of perspective', 1 Sep 2015)
■ LMS Capital: Buy at 73p ahead of tender offer; STM: Buy at 53p, target 60p; Entu: Hold at 65p ('Shareholder activism works', 2 Sep 2015)
■ Henry Boot: Buy at 235p, target 260p; Amino Technologies: Run profits at 162p, target 180p; PV Crystalox Solar: Hold at 9.5p ('Planning for success', 3 Sep 2015)
■ Vertu Motors: Buy at 66p, target range 80p to 85p ('Poised for a strong rally', 7 September 2015)
■ 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 £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
