Firstly, Aim-traded Stadium Group (SDM: 132p), a specialist provider of niche electronic technologies, has delivered the robust set of half year results I had anticipated when I last updated the investment case (‘Powered up for gains’, 29 July 2015).
The key takes for me is that the important relocation to a new facility in China has successfully completed on schedule over the summer. The £1m one-off cost of this investment should be recouped through lower rental costs alone over the next three years, so it makes commercial sense. Moreover, the strategic inventory build in the first half to support customers during the move, which led to a £1m rise in both stocks and net debt, will unwind itself in the second half.
Analysts predict unchanged closing net borrowings of £4.5m at the year-end, down from £5.9m at the half year stage, representing proforma gearing of about 27 per cent of shareholder funds after factoring the £6m placing and open offer last month which funded the bolt-on purchase of Stontronics', a UK based maker and supplier of power units. I commented on that deal in my last article. More significantly, the new facility in China supports the growth of Stadium’s technology products division.
Revenues from this part of the business more than doubled from £5m to £11m in the first six months of the year, representing 44 per cent of the company’s turnover, after factoring in the contribution from the value accretive acquisition of United Wireless in July 2014. This gave Stadium exposure to the design and manufacture of electronics for the high growth machine-to-machine (M2M) wireless sector to support wireless connectivity between devices. Experts predict that demand for M2M devices will grow at a compound annual rate of between 20 to 23 per cent over the next five years, so it’s a hot area of the technology business to be exposed to. I understand from chief executive Charles Peppiatt that Stadium’s United Wireless business increased its own revenues by 29 per cent in the first six months of this year, so it’s actually outperforming a fast growing market.
This means that with the benefits of the Stontronic acquisition yet to come, analysts believe the higher margin technology segment will contribute half of revenues for the full-year, rising to around 55 per cent in fiscal 2016. That’s not to say that Stadium’s existing technology related activities are not generating growth either; underlying sales shot up by almost 13 per cent in the six month period, having risen by over 17 per cent last fiscal year.
True, the contribution from Stadium’s integrated electronic manufacturing supply business dipped 14 per cent, much as expected, reflecting pricing pressures and a challenging market environment. But guidance from finance director Joanne Estell is that operating profit pre-central overheads is expected to stabilise at around £2.7m a year from this activity. More importantly the business is acting as a vertically integrated supplier for the rest of the group and is now seeing its customers seek the supply of a number of other technology related products, such as power supply or wireless connectivity.
Growth prospects not yet priced in
The bottom line is that Stadium is well on course to lift revenues by a third to £56m this year and deliver pre-tax profits of £4m and EPS of 8.9p, up from £2.7m and 7p, respectively, in 2014. On this basis, expect a 29 per cent hike in the full-year dividend to 2.7p, in line with the increase in yesterday’s results. Technology analyst Jon Lienard at broking house N+1 Singer believes that after factoring in the contribution from the acquisition of Stontronics, Stadium should be able to lift pre-tax profits by half again to £6m on revenues of £65.6m in 2016 to deliver EPS of 12.3p and a dividend of 3p. On this basis, the shares are rated on a modest 10.5 times earnings estimates for 2016 offer prospective yields of 2.1 per cent and 2.3 per cent, respectively, for the current year and next.
So having initiated coverage at 75.5p ('Switch onto the Stadium of light', 30 July 2014), and last recommended taking up the open offer at 110p (‘Powered up for gains’, 29 July 2015), I have no hesitation in repeating that advice. On a bid-offer spread of 129p to 132p, I rate Stadium’s shares a buy and my fair value target price is a range between 155p to 160p, or the equivalent of 12.5 to 13 times fiscal 2016 earnings forecasts. Buy.
On firm foundations
Aim-traded Somero Enterprises (SOM:145p), a Florida-headquartered company that specialises in the design, assembly, and sale of patented, laser-guided concrete levelling equipment for commercial floors, has highlighted strong momentum in business since the company's last trading update in early July (‘A quartet of small cap buys’, 8 July 2015).
Revenues rose by a fifth to $35.3m (£23m) and pre-tax profits increased from $7.4m to $9.5m in the first six months of the year, buoyed by strong activity levels in North America. The region accounted for 68 per cent of turnover in the period, having posted 27 per cent growth in the trading period. New product introductions, ongoing construction growth in the US economy and project backlogs customers are experiencing all support a continuation of this positive growth trend. Somero also reported bumper sales increases from its activities in the Middle East, Europe, Southeast Asia, and Latin America. Combined these regions contributed $5m of revenue, up two thirds on the same period last year. So although the revenue contribution from China slipped from $4.7m to $3.3m, representing less than 10 per cent of the total, the incremental growth seen elsewhere easily covered the shortfall.
The net result is that the company is trading in line with previously upgraded analyst forecasts for the financial year to end December 2015. Subject to review post results, analyst Mark Hughes at equity research firm Broker Profile anticipates current year adjusted pre-tax profits will rise from $14.5m to $16.3m (£10.7m), based on a 12.4 per cent increase in revenues to $66.7m, to produce adjusted EPS of 19.8 cents which equates to about 12.9p at current exchange rates. Mr Hughes was previously pencilling in a further 9 per cent hike in the dividend per share to 6¢, or 3.9p, but this could prove conservative as Somero’s board have just raised the interim payment by 27 per cent.
Still, on this basis, the shares are rated on a modest 11 times earnings estimates and offer a prospective dividend yield of 2.7 per cent. But it’s worth noting too that Somero has a burgeoning cash pile. Net funds rose from $6.6m to $9m in the six month period, a sum equivalent to 10.3p a share. So on a cash adjusted basis, the forward PE ratio is only 10.5. And that rating will drop again as I reckon Somero should be able to produce net cashflow of around $5.6m after capital expenditure and taxation. Indeed, half year net funds still increased by $2.4m even though the company invested $2.4m in its Houghton facility in Michigan and new Fort Myers head office in Florida.
So having initiated coverage when the share price was 140p ('On solid foundations', 22 April 2015), and reiterated that advice at the same price ('Three value plays', 19 May 2015), and again at 150p after the pre-close trading update in July (‘A quartet of small cap buys’, 8 July 2015), a move up to my 185p year-end target price is still very achievable. Please note that a move through the June high of 158.5p which coincides with the 2007 bull market high, would be a very bullish signal indeed and would open the door for strong rally to my earnings multiple derived target price.
Trading on a bid-offer spread of 142p to 145p, I continue to rate Somero's shares a buy.
Decision time
Shares in Skelmersdale-based Flowtech Fluidpower (FLO:151p), the UK's leading specialist supplier of technical fluid power products, rallied strongly after I highlighted the two smart looking bolt-on acquisitions the company made in the summer (‘Riding earnings upgrade cycles’, 7 July 2015).
In fact, the company’s share price moved up from 136p at the time of that article to hit my revised target price of 155p at the end of last week. It's a company I know well, having initiated coverage when the price was 118p ('A fluid performance', 2 June 2014), updated the investment case at 121p ('Riding the new issues gravy train', 14 April 2015) and again at 130p ahead of the full-year results for 2014 (‘A fluid performance’, 2 February 2015). The question now is whether there is scope for any more upside?
I think there is as the contribution from two sensibly priced acquisitions made in recent months - Northern Ireland-based Nelson Hydraulics, a distributor of hydraulic equipment, components and hose assemblies, and North Wales-based Albroco, a distributor of hydraulic and electro-mechanical components to the mobile, on- and off-highway and construction markets - means that the company remains on course to raise full-year pre-tax profits from £6m to £7m as analysts predict. There is also scope for decent growth next year too.
Admittedly, Flowtech Fluidpower only edged up pre-tax profits to £3.3m on revenues up by 24 per cent to £21.4m in the first six months of this year and that’s after factoring the benefits of an acquisition made in August last year. There were mitigating reasons for this subdued performance as the rapid fall off in demand from end markets in the oil and gas industry offset decent growth from other sectors. Also, the strength of sterling against the euro masked what was a strong operational performance in the Benelux region.
Clearly, the pressures facing offshore oil and gas capital expenditure markets are not going to ease any time soon and this impacts the maintenance, repair and overhaul (MRO) market Flowtech Fluidpower services. I also feel that the 6 per cent appreciation of sterling against the euro is another headwind that’s unlikely to ease given the ongoing strength of the UK economy.
Hitting the numbers
But even after factoring these dual headwinds in, I still feel that the odds still favour Flowtech hitting analysts’ numbers. That’s because the two acquisitions made in recent months generated combined operating profits of £900,000 on annual revenues just north of £8m in their last financial years. The acquired businesses complement Flowtech's Primary Fluid Holdings business and add scale to the original equipment manufacturer side of the company. I published a full analysis of the deals at the time (‘Riding earnings upgrade cycles’, 7 July 2015).
The second half of this year will also benefit from a full six months contribution from the Primary Fluid Holdings acquisition made in August 2014. So after factoring in 20 per cent growth in second half revenues, albeit driven by these three acquisitions, I believe the company should be able to make second half pre-tax profit of £3.6m on revenue of £24.8m. On this basis, expect EPS to rise from 11.4p to 12.9p. This means the shares are priced on a reasonable 11.5 times earnings estimates.
It’s also significant that the board raised the interim payout by 5 per cent indicating that a similar hike in the full-year payout is a reasonable assumption to make. The prospective yield is 3.5 per cent based on a forecast full-year dividend of 5.3p a share.
Importantly, fiscal 2016 will benefit from a full 12 months contribution from the Nelson Hydraulics and Albroco acquisitions, rather than only six months in the current year. This will add another £450,000 to Flowtech Fluidpower’s operating profit and gives weight to predictions that the company’s revenues will rise from £46.2m to £52.9m to drive up pre-tax profits from £7m to £8.1m as analyst Andy Hanson at house broker Zeus Capital believes will be the case. On this basis expect EPS of 15p and a dividend of 5.5p a share.
I would point out that current guidance for forecast year-end net debt is about £9.4m, or only 1.3 times operating profit, and implies balance sheet gearing of 16 per cent. This year’s forecast operating profits cover finance charges almost 25 times over, so the company is not only sensibly geared but I would not rule out more value enhancing bolt-on acquisitions either.
Priced on a 25 per cent discount to the distribution sector average earnings forward multiple, I can see scope for the valuation gap to narrow, if as I believe Flowtech Fluidpower hits analysts full-year numbers. On a bid-offer spread of 148p to 151p, I would run profits.
MORE FROM SIMON THOMPSON...
I have published articles on the following companies in the past month:
■ 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; Cambria Automobiles: Run profits at 68p ('Poised for a strong rally', 7 September 2015)
■ Avation: Buy at 127p, target 200p; Fairpoint: Run profits at 177p, target 190p, Redde: Run profits at 158p (‘Get ready for take-off’, 8 September 2015)
■ Stadium: Buy at 132p, target 155p to 160p; Somero Enterprises: Buy at 145p, target 185p; Flowtech Fluidpower: Run profits at 151p (‘Switch on for gains’, 9 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'
