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OPINION

Four trading plays

Four trading plays
January 16, 2017
Four trading plays

A case in point is Aim-traded STM (STM:49p), a financial services company specialising in the administration of assets for international clients in relation to retirement, estate and succession planning and wealth structuring.

Almost all of STM's earnings are derived from its Qualifying Recognised Overseas Pension Schemes (Qrops) business, an offshore pension scheme approved by HMRC and used by expatriates and internationally mobile employees whose tax domicile can change as a consequence of employment. Bearing this in mind, it was reassuring to discover that a pricing initiative introduced early last year, whereby STM waived its £800 inception fee and reduced its annual management charge from £900 to £750 on new Qrops plans, has had the desired effect of boosting new business significantly: new Qrops business in the second half of 2016 was 50 per cent higher than in the first half, and was up by more than a quarter on the same period in 2015. The point being that although STM's pre-tax profit for 2016 will be flat at £2.7m on revenue of £16.5m, in line with analysts' estimates and largely a reflection of the absence of the inception fee earned on over 1,000 new plans signed up in 2016, the additional recurring revenue generated from these plans will boost this year's profit significantly.

The company will also reap the full benefits of last autumn's acquisition of Haywards Heath-based London & Colonial (L&C), an independent financial services group. After factoring in cost savings by merging L&C's operations with those of STM, analyst Jeremy Grime at broker FinnCap expects the acquisition to boost STM's profits by £500,000 in 2017, a decent return on the £5.4m purchase price. Moreover, around £4m of L&C's book value of £4.8m is cash held for regulatory purposes which is being released. That's because £4m of STM's net funds of £9.3m, worth 16p a share, is already held for the same purpose. Reassuringly, I understand the integration process is going smoothly. Also, the appointment of a new head of enterprise risk management, who boasts valuable experience with Credit Suisse in Gibraltar, is a sensible move to beef up STM's senior management team. I would also flag up that L&C has a UK self-invested personal pensions (Sipp) business with 2,000 clients, thus diversifying STM's product range by offering a Sipp to its network of financial intermediaries.

The bottom line is that the sharp increase in pension plans in STM's Qrops business, and the upside from the L&C acquisition, underpin a large chunk of the 50 per cent-plus growth in STM's pre-tax profit that FinnCap predicts this year. On this basis, Mr Grime expects EPS to rise from 3.8p to 5.9p to support a 50 per cent hike in the payout per share to 2p, implying the shares are priced on eight times forward earnings and offer a prospective dividend yield of 4 per cent. That's value in my book.

So, having first advised buying at 35p ('Tapping into a pensions payday', 27 Apr 2015), and reiterated that advice at 50p at the time of the L&C acquisition ('On the financial beat', 25 Oct 2016), I continue to rate STM's shares a strong buy ahead of the full-year results on Tuesday 14 March 2017. My 70p-a-share target price is not unreasonable. Buy.

 

Bango on track for profitability

Aim-traded Bango (BGO:86p), a provider of a state-of-the-art mobile payment platform that enables smartphone users to charge purchases made in app stores straight to their mobile phone account, has reported a surge in end-user spend (EUS) in a pre-close trading update ahead of full-year results on Tuesday 14 March 2017.

The business is not difficult to understand as the company receives a small payment for each transaction made through its platform and has a raft of agreements in place with the likes of Amazon Appstore and Samsung Galaxy Apps, as well as partnerships with leading mobile network operators (MNOs), cementing its place as the de facto leader in app store carrier billing. Maintaining the strong growth rate in EUS is critical if the company is going to turn profitable, so it was very positive to see that EUS almost trebled to £132m over the course of last year, resulting in Bango's revenue doubling to £2.6m. However, it was the £195m annualised exit run-rate of EUS at the year-end that really caught my eye, around £10m higher than forecast by analyst Ian McNally at house broker Cenkos Securities.

That's because with Bango's annual operating costs stable at around £5m to £5.2m, and the company having already invested in capacity to enable it to process $2bn (£1.64bn) of transactions a year, then the business is highly operationally geared to rising EUS. In fact, Mr McNally believes that if Bango can grow EUS to an exit run-rate of around £350m by the end of 2017, then the business will achieve break-even with profit rising sharply thereafter.

I would flag up that if Bango nails a small number of the deals it's pursuing then there is potential for a move into profitability earlier than 2018 when Cenkos predicts it will make gross profit of £8.2m, cash profit of £3m, pre-tax profit of £1.5m and EPS of 2.6p, based on year-end annualised EUS of £669m. I would also point out that the company has net funds of £5.6m, so it is cashed up to cover all its trading losses until it hits cash profitability.

Furthermore, if Bango continues to grow at its current heady rate then there is serious profit to be made here. For example, assuming its gross margin contracts from 1.67 per cent in the first half of last year to 1.4 per cent by 2020, then on £1.5bn-worth of transactions its gross profit could soar to around £20m and generate north of £10m of net profit, a hefty sum relative to Bango's current market capitalisation of £55m.

And it's the potential for the company to maintain its heady growth rate that attracted me to the shares at 93p last autumn ('Bang on the money', 26 Sep 2016). My analysis suggested a target price of 200p to place a value of £130m on Bango's equity, or 13 times its potential net profit in 2020. The latest trading update suggests my target price could be achievable this year. Buy.

 

Somero's rock-solid trading prospects

Aim-traded shares in Somero Enterprises (SOM:240p), a Florida-headquartered company that specialises in the design, assembly and sale of patented, laser-guided concrete levelling equipment for commercial floors, have taken out my 230p target price.

I first recommended buying the shares at 140p ('On solid foundations', 22 Apr 2015), and reiterated that advice at 193p when I rated them a strong buy on the basis that the business is not only heavily exposed to the buoyant US market - the region accounts for 75 per cent of Somero's revenue - but trading activity is being boosted by a combination of new product launches and a healthy non-residential construction market, both of which are supporting demand for replacement equipment, technology upgrades and fleet additions ('Exploiting earnings potential, 14 Nov 2016).

In the event, the company's trading update ahead of results on Wednesday 15 March not only exceeded analysts' profit expectations, but with cash generation strong, net funds at the year-end were significantly higher than previous forecasts. This news prompted analyst David Buxton at FinnCap to increase his 2016 pre-tax profit estimate by 7 per cent to $21.8m, implying 24 per cent growth on 2015, and raise his EPS estimate to 24.4¢, a sum worth 20p a share at current exchange rates. Year-end net funds of $18.7m, up from $11.1m at the end of June 2016 was more than $3m higher than previous estimates. It's also well in excess of the board's $10m targeted cash reserves, prompting the directors to raise the payout ratio from 30 to 40 per cent of net earnings, implying a 2016 dividend of 11¢, up from 6.9¢ in 2015.

Furthermore, with the trading outlook strong, and the company a likely beneficiary of new US President Donald Trump's plans to grant $137bn of tax credits to construction companies to leverage $1 trillion of infrastructure investment, then analysts have sensibly upgraded their 2017 estimates. Trading on 11 times 2017 EPS estimates of 26.1¢, offering a prospective dividend yield of 3.8 per cent, and with the 27p-a-share cash pile offering potential for a special payout, I continue to rate Somero's shares a buy and have a new target price of 275p. Buy.

 

Stadium's enlightening update

Stadium (SDM:87p), a niche electronics company specialising in wireless, power and human machine interface products, has hit analysts' downgraded profit estimates for 2016, having previously warned in the summer following the loss of a contract with a key telematics customer ('Stadium warns on profits', 23 Jun 2016).

At the time, chief executive Charlie Peppiatt reassured me that this was a one-off and that the company's move to a more customer-focused operating model built around strategically located and staffed regional design centres was paying off. The fact that the closing order book has shown strong year-on-year growth certainly supports this view, as does the fact that Stadium's higher-margin technology products division now accounts for 60 per cent of revenue, up from only 25 per cent three years ago. The recently announced small complementary bolt-on acquisition of Colchester-based Cable Power, a specialist manufacturer and distributor of bespoke cable and power products and accessories to single board computing providers, looks an excellent fit with the company's existing portfolio of businesses and underlines the board's strategy to grow its design-led range of technology products.

Of course, it will take time for investors to regain their confidence, and the fact that a new finance director was unable to take up his job on health grounds is hardly ideal, albeit the appointment of an interim finance officer this week is a step in the right direction. Moreover, with Stadium's shares rated on only 10 times 2016 flat EPS estimates of 8.9p, and supported by a prospective dividend yield of 3.3 per cent, the valuation fails to take into account the likelihood of a return to strong earnings growth in 2017 - N+1 Singer expects EPS of 11.5p - nor the fact that a lowly geared balance sheet (net debt of £3.5m was far lower than expected) offers scope for more earnings-accretive bolt-on deals.

So, having last rated the shares a recovery buy at 85p at the time of the half-year results ('On the upgrade, 7 Sep 2016), having originally initiated coverage at 75p ('Switch on to the Stadium of light', 30 Jul 2014), I am comfortable reiterating the same advice ahead of the full-year results on Tuesday 14 March 2017. My target price of 120p is based on a forward PE ratio of 10 for 2017 and assumes the company will be able to increase annual revenue by £10m to £62m and lift pre-tax profit by a third to £5.8m. Buy.

Finally, I am carrying out extensive equity research on my 2017 Bargain Shares Portfolio at the moment ahead of its publication on Friday 3 February. I will publish updates on a number of other companies in due course that have also reported trading updates recently, including: high-street retailer Moss Bros (MOSB); privately owned aircraft operator Gama Aviation (GMAA); stockbroker and fund manager Walker Crips (WCW); pawnbroker H&T (HAT); retail software company K3 Business Technology (KBT); and Minds + Machines (MMX), a service provider in the domain name industry and one focused on the new top-level domain space.

 

MORE FROM SIMON THOMPSON...

Please note that I published two columns last week, including a detailed analysis of the housebuilding sector, both of which are available on my homepage.

A comprehensive list of all the investment columns I have written in 2017 is available here.

The archive of all the share recommendations I made in 2016 is available here

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