60. Gooch & Housego
Over the past year, we’ve noted the trend among UK manufacturers to move up the value chain. Intuitively, one would imagine this is primarily driven by a simple desire to boost margins, but we think that there is actually a defensive aspect to the trend; ergo the ability to increase barriers to entry through technical specialisation.
We certainly think this applies to Gooch & Housego (GHH), a specialist manufacturer of optical components, which has regularly augmented its technical offering through targeted
acquisitions, the most recent of which, US-based StingRay Optics, also increased the Dorset-based group’s exposure to defence markets.
The impact of the group’s M&A schedule is certainly apparent in the value of the order book at the end of half year trading to the end of March, which stood at £66.6m, an increase of 71 per cent compared with the same time last year. Along with the impact of acquired businesses, the figure also benefited from favourable currency translations, although orders were still 17 per cent ahead of 2016 on a like-for-like basis.
The core of the business is concerned with photonics, essentially the physical science of light. The group’s markets are predominantly specialist and not volume-driven. Although there are relatively few competitors in the space, continued investment has enabled Gooch & Housego to develop a substantial intellectual property portfolio.
The benefits of the shift towards aerospace and defence contracts should be further evident in June’s regulatory release, following on from the integration of the StingRay acquisition, in addition to the impact of earlier deals to acquire Kent Periscopes and Alfalight. The former company, a manufacturer of periscopes and sights for armoured fighting vehicles, provides a prime example of the specialist capabilities that Gooch & Housego has been acquiring.
However, the group is also increasingly looking to supply photonics systems, which usually generate higher margins than component supply contracts. Looking ahead, investors would be well advised to take account of changes in the business mix, which is set to become an increasingly important determinant of profitability. The diversification strategy has also been partly put in place to limit the cyclicality that has hit the group’s progress in the past.
We should see elevated levels of capital expenditure through to the September year-end, while June’s half-year figures should reveal the degree to which the group’s hedging strategy and increases in costs will weigh on earnings. Buy. MR
59. Patisserie Holdings
When we last looked at Patisserie's (CAKE) full-year results, we learned that the Patisserie Valerie owner doesn’t like to report an underlying sales growth figure. That could suggest new site openings – of which there were 21 last year – are behind much of the company’s reported top-line growth.
As for this year, there are a couple of issues on the horizon, including higher business rates and food costs. However, margins are expected to hold up thanks to renegotiations with key suppliers and efficiency measures elsewhere in the business. Another 20 new stores are also slated to open their doors this year.
Rising cost inflation and concerns over the consumer picture in the UK took their toll on the share price last year, but the stock has found renewed momentum in 2017. That said, the shares exchange hands for a lofty 23 times forward earnings, so even a slight miss on targets could destabilise the stock’s current trajectory. Hold. HR
58. Pan African Resources
Gold mining might promise riches, but the reality is often far more precarious. Pan African Resources (PAF) has had a very good run at several points in the last 18 months, but operational challenges are never far off for a South African resources company with relatively high break-even costs.
At the end of 2016, a combination of local community unrest and government-enforced safety stoppages at the Barberton mine resulted in several weeks of lost production and higher costs. This was then compounded by the forced closure of underground operations at Evander, after management identified “critical infrastructure issues”, together with the conclusion of a retrenchment agreement with workers at the site. Fortunately, the refurbishment is on track, and an employee agreement has been forged, albeit at a cost of $4.1m.
Settling these matters will allow management to focus on financing the newly sanctioned Elikhulu project, after a definitive feasibility study showed that a very low-cost mine capable of producing 56,000 ounces a year could be up and running by late 2018. That, and a supportive gold price, should be the key drivers to watch here. Buy. AN
57. Polar Capital
Polar Capital (POLR) may be starting to turn a corner. Following the US presidential election, inflows picked up “markedly” for the specialist asset manager, according to chief executive Tim Woolley. Its North America, biotechnology and income funds were popular.
However, the long-only investor has a long way back to prosperity. It has been hamstrung particularly by heavy outflows from its Japan funds, as progress on the reforms and growth promised by Abenomics has been slower than anticipated. During the six months to September assets under management for its Japan strategy reduced by more than a third to $1.4bn (£1.1bn). However, by March 2017 assets were up overall to £9.3bn, from £7.3bn a year before.
Management expects to hold the dividend at 25p a share for the 12 months ending 31 March. This would be the fourth consecutive year that payouts have been held at the same level. The shares trade at 18 times forward earnings: far too pricey, considering the level of outflows. Sell. EP
For investors with their heads in the clouds, iomart (IOM) looks an ideal fit. The IT market’s transition to shared computer processing and the clamour for on-demand data and devices has seen the cloud computing specialist deliver compound annual revenue growth of 23 per cent between 2012 and 2016.
Broadly speaking, that momentum has been maintained through to its recent March year-end, with the group guiding for a 17 per cent rise in the top line, together with a 19 per cent hike in adjusted pre-tax profit, with results for the key cloud services segment benefiting from the full year contribution of SystemsUp, which was acquired in June 2015. It also flagged higher dividend payments to shareholders, with a maximum payout ratio of 40 per cent of adjusted diluted EPS replacing the previous limit of 25 per cent.
In a crowded marketplace, iomart remains focused on differentiating its product offering through improved “certainty, scalability and flexibility”. Those qualities will be paramount if, as expected, an increasing proportion of iomart’s consultancies will be generated through the public sector. Our long-term buy tip (238p, 27 August 2015) is 25 per cent to the good, but we envisage further upside. Buy. MR
55. Keywords Studios
Keywords Studios (KWS) has performed exceptionally since our tip a year ago (263p, 19 May 2016), its share price more than tripling. The digital game service provider’s impressive revenue growth – up 67 per cent in the year to €96.6m (£81.9m) – was largely driven by acquisitions, but the group estimates like-for-like growth was strong, too, at 24 per cent. This was driven by audio services, including multi-language voice-over and original language voice recording, and localisation, by which is meant video game translation.
The group completed eight acquisitions during 2016, covering everything from a Beijing-based art business to an audio business based in Madrid. It also put its expanding range of services to work, increasing the number of clients using three or more of its services by 25 per cent to 64.
The prospects for growth still look good. And with an enlarged loan facility of €35m the group is well placed to make further acquisitions, justifying the high rating of 34 times forecast earnings. Buy. TD
Since Brexit, recruiters have been falling over themselves to highlight how much of their operations are based outside of the UK, and thus insulated from the impact. Not so for Staffline (STAF), which is based entirely in the UK and Ireland, but is managing to do well anyway.
The group increased organic revenue by 26 per cent to £882m at its full-year results and is aiming to break the £1bn mark in 2017. The group claims it has not seen a reduction in demand for its services in the wake of the referendum vote, but said any tightening in the labour force would make it easier to place its Work Programme candidates.
The group hasn’t slowed down since the announcement of its full-year results in January. In March it unveiled the acquisition of Oak Recruitment, a specialist in industrial recruitment based in Ireland. It is also trading at an enterprise value-to-cash profit ratio of nine times, its lowest level since 2012. Buy. TD
53. 4D Pharma
There really isn’t much point investing in a company with a line of clinical trials unless you believe that one of these will eventually be approved for general use.
4D Pharma (DDDD), well funded and with an interesting pipeline of treatments using human gut bacteria, is a case in point, and in the last six months its share price has all but halved. The good news is that it had £75m cash at the June 2016 half year, more than enough to finance a cash burn of around £10m a year. Like all companies developing new treatments, everything depends on gaining regulatory approval.
Progress so far on Blautic, a treatment for irritable bowel syndrome, has been encouraging, but further trials will have to take place. It has also set up MicroDx, a diagnostic platform designed to diagnose and monitor the treatment of patients based on their gut microbiome, which is the bacteria that colonises the human gastro-intestinal tract. This could be a slow burner. Hold. JC
52. Oakley Capital Investments
There is good reason to perceive value in Oakley Capital (OCL). The investment trust makes its money by taking stakes in private equity ventures established by its associated limited partnership Oakley Capital Private Equity, which provides mezzanine debt finance. It also co-invests directly in some companies.
The group has a 24 per cent stake in Time Out (TMO) following its admission to Aim last year (see number 95) in June last year, as well as a further 23 per cent indirect interest via one of its funds. A fall in the media group’s share price post-referendum depressed its fair value during 2016. However, this has since recovered to almost its IPO price.
Overall, the group’s portfolio fair value increased 30 per cent on a like-for-like basis during the 12 months to December. This pushed its NAV up 16 per cent to 231p a share. Post year-end, private equity investor Cinven sold hosting provider Host Europe to Go Daddy (US: GDDY), which Oakley has a minority interest in. This generated €14.6m in proceeds to the group. The shares trade at a 36 per cent discount to NAV, compared with an historic average of around 20 per cent. Buy. EP
In the last few months, US healthcare has not been far from the headlines. Although President Trump has, so far, not had much success in overthrowing the way the US healthcare system is run, subtle changes are helping to reduce costs for patients. Today, about half of US hospitals offer a value-based approach to reimbursement. This ties payments for care delivery to the quality of care provided and rewards providers for efficiency. It is an alternative to fee-for-service reimbursement which pays providers retrospectively for services delivered based on bill charges or annual fee schedules.
Craneware (CRW) is well placed to benefit from these changes. Its Value Cycle software helps US hospitals navigate the complex changes in reimbursement models and helps providers increase efficiency. Demand for these solutions is flying, which helped the group report a double-digit leap in half-year revenue and profit in the six months to December 2016.
Not only that, but the group has already booked 94 per cent of the revenue forecast by broker N+1 Singer for the financial year to June 2017, which suggests that full-year numbers are likely to come in ahead of expectations. The long-term outlook is also very stable. About 50 per cent of revenue comes from long-term contracts that are normally renewed every three years. Therefore a high proportion of group revenue is booked in advance. As of December 2016, the group had visible sales for the three-year period to June 2019 worth $156m, from $128m for the same three-year period at 31 December 2015.
This long-term stability, not to mention high US exposure, served Craneware’s share price well last year, but in 2017 that geographical positioning has created uncertainties. The company’s share price has traded sideways since November amid fears that political upheaval will dent demand for services. But management continues to believe that the ever-increasing need for greater efficiencies in hospitals has not changed with the Trump administration. In fact, according to chief executive Keith Nielson, the majority of new customers from the first half of the year were picked up after the election.
Craneware’s shares trade on 25 times forward earnings, which we don’t think adequately reflects the quality of earnings growth on offer, or the potential for a takeover from a big US health company. Buy. MB
See our analysis of the rest of Aim's numbers 100-51