Not only were the company’s pre-tax profits for the 12 months to end-May 2016 materially ahead of expectations of £3.1m, prompting analyst Eric Burns at WH Ireland to lift his pre-tax profit estimate by 13 per cent to £3.5m at the time of the pre-close update in July (‘Deep value small-caps’, 13 Jul 2016), but the company actually exceeded those upgraded numbers by posting profits of £3.7m, up from £1.6m in 2015. This is the sixth consecutive year of organic growth.
True, the acquisition made in March of Bradgate Business Finance, a leading independent specialist provider of 'hard' asset finance to clients buying business equipment within the construction, recycling and haulage sectors, and last summer’s purchase of Academy Leasing, a provider of equipment finance and an equipment and vehicles broker to the SME market, contributed £4.5m of the £12.6m revenues in the 12-month period and £1.5m of profits. But organic growth was robust nonetheless. Strip out acquisitions and 1pm increased revenues by 45 per cent to £8m and delivered a 35 per cent boost to adjusted pre-tax profits to £2.2m, buoyed by an 18 per cent rise in the new lease and hire purchase portfolio to £29.8m and a 140 per cent hike in business loans to £12m. At the end of the financial year, Academy had a lease portfolio of £21.1m and Bradgate’s stood at £4.6m.
Receivables of £66.5m include £14.6m of deferred interest, underpinning a chunk of profits in the coming year when recently appointed house broker Cenkos Securities expects revenues to rise by a third to £16.5m to deliver a 16 per cent hike in pre-tax profit to £4.3m and EPS of 6p. Of course, credit quality is critical when a business is growing fast, so it was reassuring to see the net bad debt charge falling slightly to 0.8 per cent of the average loan book. If you annualise the £49.7m of asset, business loans and vehicle transactions originated in the 12-month period, the current run rate is around £70m. The company is well funded to support this level of business as only 70 per cent of its finance facilities of £62.2m were drawn down at the year-end, so there is significant headroom on existing credit lines. A leverage ratio of 2.3 times receivables to shareholders' funds is not stretched either.
It’s hugely profitable too. That’s because 1pm’s average cost of borrowing of 5.7 per cent, down from 6.3 per cent in the prior year, generates a stable net interest margin of 12 per cent and one that’s underpinned by a policy to match fixed-rate funding for the duration of the lease agreement, so eliminating interest rate risk. Commission income of £1.39m generated by the acquired companies accounted for 11 per cent of 1pm’s total revenues and highlights the flexibility in the business to either add to own-book, or broke-on lending based on a range of underwriting factors, including risk, price, quantum, existing exposure and nature of the asset. This allows a balance to be achieved between future profits built in to own-book deals and short term cash generation from broker commission.
As with any investment there are risks and deterioration in the economic outlook is the obvious one as business owners are more likely to postpone capital investment, and the ability to service financial commitments comes under pressure. That said, the evidence to date is that the widely predicted UK economic downturn post the EU referendum has failed to materialise. I made this point in quite some detail in my online-only articles on car dealers Vertu Motors (VTU: 50p) and Cambria Automobiles (CAMB:72p), both of which have not seen any change in consumer buying patterns (‘Priced to motor’, 6 Sep 2016). The same can be said for 1pm as trading in the first quarter of the new financial year is bang in line with management guidance and Cenkos’ estimates.
The shares have rallied 12 per cent since I last rated them a buy at 64p (‘Deep value small-caps’, 13 Jul 2016), and rated on 1.5 times book value, 11.5 times earnings estimates, and offering a one per cent prospective dividend yield, I still see further upside to my target price of 85p. Buy.
Somero on solid foundations
Aim-traded shares in Somero Enterprises (SOM:172p), a Florida-headquartered company that specialises in the design, assembly and sale of patented, laser-guided concrete levelling equipment for commercial floors, appear to have completed a five month sideways consolidation following a breakout above the key 170p resistance level yesterday.
It’s fully warranted as a bumper set of interim results and a positive trading outlook suggest the company is well on course to deliver a 15 per cent hike in full-year adjusted pre-tax profits to $20.3m on revenues up 9 per cent to $76.5m as analyst David Buxton at brokerage FinnCap predicts. More than half of that full-year profit estimate was delivered in the seasonally stronger first half when both underlying pre-tax profits and EPS surged by 30 per cent to $10.8m and 13 cents, respectively.
Trading in the US, a region accounting for 75 per cent of Somero’s first-half revenues of $29.8m, remains robust, buoyed by new product launches and a healthy non-residential construction market underpinned by strong demand for replacement equipment, technology upgrades and fleet additions. Sales in North America increased by a quarter in the first half and order backlog there supports further growth for the rest of the year, and well beyond. Trading activity levels in Europe, China and Australia, countries accounting for a combined 19 per cent of Somero’s sales, all posted double digit growth too.
Importantly, the company remains highly cash generative and reported operating cash inflow of $5.8m after working capital movements needed to support the higher levels of business activity. So, after paying out $3.8m for the final costs of a new 14,000 sq ft head office in Fort Myers, Florida, and $2.8m on dividends, Somero ended the half year with net funds of $11.1m, a sum worth 15p at current exchange rates. Mr Buxton is looking for a 20 per cent year-on-year increase in Somero’s closing year-end net cash balance to about $15.2m. This means that after stripping out cash the shares are priced on a modest nine times likely post-tax earnings and offer a 3.5 per cent prospective dividend yield, assuming the payout is hiked by 10 per cent to 7.6c as analysts forecast. A cash profit to enterprise value ratio of five times is hardly punchy either.
So, having initiated coverage on the shares at 140p ('On solid foundations', 22 Apr 2015), and reiterated that advice at 167p ahead of this week’s results (‘Business as usual’, 18 Jul 2016), I am very comfortable reiterating that advice. In fact, I have raised my target price from 195p to 200p. Buy.
Stadium’s order book a buy signal
The transition from electronic manufacturer to a design-led technology company has stepped up a gear at Stadium (SDM:85p), a niche electronics firm specialising in wireless, power and human machine interface products. Three years ago only a quarter of sales were derived from higher-margin technology products, but this segment is set to account for around 60 per cent of the total this year.
It’s just as well as Stadium’s electronic assembly business continues to face challenging market conditions, with pressure on pricing and oversupply in the market. Sites have been closed, savings made and the unit has been repositioned to provide high-tech production capabilities as a vertically integrated supplier across the company’s various business units.
In fact, more than half of the unit’s output is expected to support the technology products division and its growing order book. One consequence of this shift is to enhance Stadium’s gross margins, which rose by 2.5 percentage points to 24.1 per cent in the six months to end-June 2016 on revenues down slightly to £24.3m. Coupled with £300,000 of like-for-like cost savings and efficiency gains, and the greater proportion of higher margin technology products in the mix, this largely explains the 14 per cent increase in Stadium’s adjusted pre-tax profits to £1.62m. A further £300,000 of annual cost savings are being targeted in the second half.
Not that the transition has been straightforward as the loss of a key telematics customer led to a profit warning, which sent the shares tumbling from 110p to 80p ('Stadium warns on profits', 23 June 2016), and subsequently below the 75p level at which I initiated coverage ('Switch on to the Stadium of light', 30 July 2014). This loss explains the dip in sales, but chief executive Charlie Peppiatt says that this was a one-off and the move to a more customer focused operating model built around strategically located and staffed regional design centres is now paying off.
Stadium has opened four facilities to provide in-depth design and technology development support for its customers in key geographical locations including Zhangjiang Hi-Tech Park in Shanghai, and one of the world’s leading high-tech clusters in Stockholm. The order book indicates the strategy is working, up from £19m at the end of 2015, to £22.8m at the time of the client loss in late June, rising to £25.4m now.
Order intake in the first half increased by 22 per cent to £30.7m, suggesting that the £27.8m of second-half revenues forecast by analyst Jon Leinard at brokerage N+1 Singer is well underpinned, an outcome that’s expected to drive up full-year pre-tax profits by 7 per cent to £4.3m and deliver flat EPS of 8.9p, reflecting a higher share count following an acquisition in the summer of 2015. On this basis, Stadium’s shares are rated on nine times earnings and offer a forward dividend yield of 3.5 per cent based on a raised payout per share of 2.9p. Free cash flow of £1m generated from £1.9m of underlying operating profit in the first half covers the interim payout three times over, and with net debt reduced from £4.7m to £3.6m, the company is operating well within its credit facilities and gearing is only 19 per cent of shareholders funds.
The legacy pension deficit is worth flagging given the sharp fall in corporate bond yields since the EU referendum in late June. The yields on these bonds are used to discount the pension liability under IAS19 accounting standard and finance director Joanne Estell says that the £5.4m pension liability at the half-year-end, up from £4.2m at the start of the year, has since risen to £9m by the end of August. The company is paying £500,000 into the pension scheme, in line with an agreement with the trustees. Of course, Stadium is not alone in being impacted by a rising pension deficit and I do feel that it’s being discounted in a price-to-book value of 1.6 times and a multiple of seven times earnings estimates for 2017, assuming the company delivers the £10m rise in revenues and pre-tax profits of £5.8m as analysts at N+1 Singer predict.
The fact that the order book continues to do rise strongly would suggest that Stadium’s management team is still worth backing given scope for earnings to accelerate on the back of exposure to the design and manufacture of electronics for the high growth markets including the machine-to-machine wireless sector that supports connectivity between devices. I remain positive and the shares are a recovery buy.
