This particular subject is of interest to me right now, and hopefully to those of you who have bought into a host of companies on my watchlist that keep on delivering. In fact, they have overdelivered to such an extent that I have been forced to reassess the investment case on numerous occasions since I initiated coverage, having seen my original and subsequent fair value targets surpassed. It's time to do so again.
On the right road
Shares in Aim-traded Redde (REDD:178.5p), 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 insurers, hit a five-year high of 184p after the board revealed at last week's annual meeting that the company was trading ahead of expectations for the fiscal year to end-June 2016.
Having initiated coverage at 108p in the spring ('In the fast lane', 23 March 2015), and last recommended running profits at 158p in early September (‘Get ready for take-off’, 8 September 2015), the holding is now showing a total return of 70 per cent after factoring in a special dividend of 1p a share paid in July and the final dividend of 4.25p a share paid this week.
At the time of the fiscal 2015 results, analyst Andrew Watson at broking house N+1 Singer upgraded his pre-tax profit estimate by 7 per cent to £27m for the 12 months to end-June 2016, up from £22.7m the year before, driven by 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 and, reflecting a 100 per cent payout ratio of earnings, the normal dividend to be raised from 8.25p to 8.7p. Sensibly, Mr Watson has left these upgraded forecasts unchanged ahead of the all important November to February trading period, during which time road users face difficult conditions and Redde's case volumes spike. However, the fact that the company is trading ahead of budget going into the key winter months leaves room for upgrades down the road, assuming of course targets are hit over the next three months. The earnings risk still looks to the upside to me.
The other key take from the trading update came from the earnings-enhancing acquisition of FMG, a provider of fleet management services. I analysed the deal in the summer ('Running bumper profits', 27 August 2015), and when it completed at the end of last week FMG's cash holdings were much higher than analysts had anticipated. In fact, after stripping out net funds of £7.3m on FMG's balance sheet, the cash consideration of £34m payable by Redde was £4.2m less than I had factored in. In addition, the vendors received £5m of new Redde shares as originally agreed. This means that, based on FMG delivering cash profits of £5.4m in the fiscal year to end September 2015, the take-out multiple represents only seven times cash profits. In turn, and also reflecting Redde's positive cash generation in the past four months, the company now has pro-forma net funds of around £5.6m, which has forced analysts to upgrade their June 2016 year-end net cash forecast from £3.9m to £10.4m.
The bottom line is that even after a sharp rise in Redde's share price since I initiated coverage I can still see potential for the re-rating to continue. Trading on 18 times fiscal 2017 EPS estimates of 9.6p, but offering scope for more earnings upgrades if the company continues to beat expectations, and underpinned by a 5 per cent prospective dividend yield, I would run your 70 per cent paper profits.
On track for another upgrade
Redde is not the only company I follow that is firmly in an earnings upgrade cycle. The same is true of Aim-traded telematics and data provider Trakm8 (TRAK:250p) whose shares have surged since I first advised buying at 92p ('Zoning in on a profitable price move', 16 Feb 2015) and have smashed through my upgraded target price of 220p ('Cashed up for cash returns', 22 September 2015).
When I initiated coverage in February this year analyst Lorne Daniel at FinnCap predicted that Trakm8's revenues would rise by 18 per cent to £21.3m in the 12 months to the end of March 2016 to drive up pre-tax profits by 41 per cent to £2.4m and produce EPS of 8p. On this basis, they were trading on a prospective PE ratio of 11 at my recommended buy in price of 92p. However, following multiple upgrades, on the back of contract wins and acquisitions, Mr Daniel now predicts that Trakm8 will deliver pre-tax profit of £3.4m and adjusted EPS of 11p on revenue of £25m in the current financial year.
This means that the earnings multiple has expanded twofold as investors attribute a higher rating to the company based on its improved growth profile. That's because analysts predict another step change in profitability in the 2017 fiscal year (March year-end), pencilling in revenue of £29.9m, pre-tax profit of £4.8m and EPS of 15.4p. On this basis, the forward PE ratio falls sharply from 22 to 16, not that stretched for a fast-growing company generating significant interest from the insurance and fleet industries.
Indeed, at the end of last week, the board announced that it had reached agreement to supply a major US-based data company with its T10 BLE (Bluetooth Low Energy) telematics unit, which communicates with mobile phones via Bluetooth to relay real-time journey data to the registered device. The new client is expected to purchase more than 25,000 devices during the first two years of the contract agreement. It's a major award and highlights the potential to provide the company's technology to the North American insurance market and elsewhere. In the 2015 financial year, Trakm8 derived 92 per cent of sales in the UK, and just 3 per cent in North America and Europe each.
So if Trakm8 can replicate its success in domestic markets overseas, then this offers another source of potential earnings upgrades. Mr Daniel has left his fiscal 2016 and 2017 estimates unchanged, but moved his target price up from 220p to 250p. On both counts I feel this could prove too conservative, and am willing to bank on Trakm8 beating forecasts once again. Ahead of the next scheduled trading update alongside what will undoubtedly be impressive half-year results in early December, I would run your 167 per cent paper profits.
On a roll
Shares in Aim-traded online gaming company 32 Red (TTR:95p) have risen by almost 30 per cent in the five weeks since my last article ('Building momentum', 29 September 2015) and have just taken out my upgraded target price range of 90p. I originally recommended buying at 51.75p ('Game on', 7 Jul 2013), so after accounting for dividends of 7.8p a share the total return is 100 per cent.
The company certainly looks like one of the winners in the post UK point of consumption tax marketplace, a fact that investors are clearly warming to. For instance, the internet casino operator reported a 20 per cent increase in net gaming revenue to a record £18.6m in the first half and trading has remained buoyant since then. In fact, a breakdown of trading updates implies acceleration in the growth rate through August and September. Improvements in customer retention and reactivation of players, more focused digital marketing investment and softer competition in the new tax environment are all helping to drive up customer numbers and support their spend.
True, 32 Red's shares are now priced on 14.5 times house broker Numis Securities' upgraded full-year EPS estimates of 6.5p, but still only trade on nine times the fiscal 2016 EPS estimate of 10.5p and are 20 per cent below Numis's 120p target price. Furthermore, 32 Red has net funds of £5.7m, or 6.5p a share, on its balance sheet after factoring in the summer acquisition of remote online gaming operator Roxy Palace. So with cash available for further earnings-accretive acquisitions, and underpinned by a prospective dividend yield of 2.8 per cent, I would run your 100 per cent gains.
Burford's shares on the case
Shares in Aim-traded Burford Capital (BUR: 189p), the world's largest provider of investment capital and professional services for litigation cases to lawyers and clients engaged in major litigation and arbitration, are within a penny of hitting my 190p target price. I last advised buying at 171p ('Hitting the right numbers', 30 July 2015), having first recommended buying at 146p ('Legal eagles', 8 June 2015). The company has also paid out a 1.52p a share interim dividend and analysts predict a full-year payout of 9¢ (5.8p), up from 7¢ in 2014, implying a 3 per cent forward yield.
My conservative fair value target price equates to 10.5 times the fiscal 2015 EPS estimate of 28.3¢ (18.3p) of analyst Trevor Griffiths at brokerage N+1 Singer, based on full-year pre-tax profits rising by 15 per cent to $65.7m on revenues up by a fifth to $96m. But given that Burford reported a 30 per cent hike in first-half underlying pre-tax profits to $23.8m, underpinned by its largest recovery to date, and there is a seasonal skew to second-half earnings due to timing of activity in litigation cases, I feel very comfortable with those forecasts.
The shares are rated on a modest 1.5 times book value too, a conservative valuation considering that Burford only increases (or decreases) investment values modestly based on objective events in the progress of the litigation. This means Burford has significant incremental income to book when the cases it has invested in are successful in the courts. And the track record of its legal team in identifying and successfully backing the winners is mightily impressive: average return on capital employed on completed litigation cases is an eye-watering 71 per cent. In turn, cash receipts from settled cases boost net asset value per share and support a progressive dividend policy. It's an investment story that looks to have further to run, too.
Priced on a 30 per cent-plus discount to the average earnings multiple for the speciality finance sector - and well below N+1 Singer's upgraded target price of 217p - I would run the 30 per cent paper profit.
Jewel in the Irish Sea
High-yielding shares in Isle of Man telecom company Manx Telecom (MANX: 208p) touched my target price of 210p a fortnight ago and look poised to launch another attack on this price level. It's one I am willing to run with, too. I first recommended buying at 164p ('High-yield telecoms play', 15 May 2014), since when the company has paid out dividends of 10.1p a share, so the holding is showing a 32 per cent total return. I last rated the shares a buy at 188p ('Income plays with capital upside', 1 October 2015).
True, dividend cover is thin - expect full-year EPS to rise from 12.2p to a range between 12.9p (Liberum Capital) and 13.4p (Edison Investment Research) - but with borrowings of only two times cash profits, and gearing of around 65 per cent, the attractive prospective payout of 10.4p a share looks solid enough to me. And given the defensive merits of the business - the company has a virtual monopoly on the Isle of Man and enjoys a high degree of customer loyalty - I feel that an enterprise value of 10.5 times annual cash profits is fair. With a 5 per cent forward dividend yield on offer, that valuation could yet be surpassed. Run profits.
Please note that I have written one other column today ('Getech warns', 3 November 2015).
MORE FROM SIMON THOMPSON...
I have published articles on the following companies in the past two weeks:
■ MS International: Buy at 180p, initial target price 240p ('Making waves', 19 October 2015)
■ Pure Wafer: Buy at 175p, new target 200p ('Valuation anomaly worth exploiting', 20 October 2015)
■ Greenko: Hold at 87p, new target 100p ('Greenko's cash return', 20 October 2015)
■ Elegant Hotels: Buy at 108p, target range 130p to 135p ('An elegant investment', 20 October 2015)
■ BP Marsh & Partners: Buy at 157p, target 180p ('Cash-rich value play', 21 October 2015)
■ Crystal Amber: Buy at 170p; Dart Group: three month trading buy at 468p; Grainger: three month trading buy at 247p; Leaf Clean Energy: await news on Invenergy asset sale ('A quadruple play', 22 October 2015)
■ UTV Media: Buy at 184.5p, target 215p ('On the right wavelength', 26 October 2015)
■ Globo: shares suspended at 28p ('Globo bombshells', 26 October 2015)
■ Globo: shares suspended at 28p ('The truth about Globo', 29 October 2015)
■ Getech: sell at 38p ('Getech warns', 3 November 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'
