Buoyed by $40m (£31m)-worth of orders won over the past couple of years, chief executive Dr Arnab Basu and finance director Derek Bulmer expect revenue to surge from £9m to £12.5m in the financial year to the end of April 2018, a performance that would result in the company hitting cash profit break-even on an underlying basis as analysts at Equity Development and house broker Cenkos predict. Mr Basu says that the business has "fantastic visibility of revenue, and we are entering an exciting phase", and justifiably so given that 60 per cent of the revenue projection is supported by a flow-through from the order book, around 20 per cent is backed by repeat orders from customers, and only £2.5m reflects new orders. These estimates could prove conservative.
For example, the company has been developing CZT-based SPECT (single-photon emission computed tomography) modules for an established manufacturer of X-ray diagnostics and analysis equipment in China, described by Dr Basu as a "significant opportunity", potentially worth $159m in revenue over a seven-year period. He has a point as there are 60,000 hospitals in the country and "nuclear medicine is a priority". Moreover, having developed its cutting-edge technology, the company is well placed to offer it to other original equipment manufacturer (OEM) customers as adoption of CZT-based gamma radiation detectors gathers pace.
The point being that revenue forecasts have taken a conservative view on orders from the technology even though healthcare giant GE launched its own range of CZT-based SPECT scanners last year, which means that its three OEM rivals (Toshiba, Siemens and Philips) are playing catch-up, thus offering Kromek the opportunity to supply its own detectors to them. A five-year contract, valued at $12.6m, with a longstanding OEM client in the bone mineral densitometry (BMD) market is a strong endorsement of Kromek's detector modules, which help to produce some of the most accurate imaging to diagnose the strength and health of bones.
There is also potential for the company to win more sizeable orders for its 'dirty bomb' detectors, which are 10 times faster at detecting gamma and neutron radiation and a tenth of the cost of conventional detectors. They have been field-tested by the US authorities in Washington DC, are currently being deployed by the New Jersey Port Authority in New York, and were used to protect US President Donald Trump during his recent visit to Brussels. To date, Kromek has won $11m of orders, but if they are deployed across the 23 cities in the US then each contract could be worth north of $10m, according to Dr Basu. Kromek certainly has the cash to fund such chunky contracts if they were to materialise, having raised net proceeds of £20m in a placing and open offer in late February.
It's worth noting that Kromek is highly operationally geared as the business could easily support a trebling of revenue without the need to invest in fixed costs, according to Mr Bulmer, so with gross margins stable at around 57 per cent, a healthy amount of incremental sales should drop down to the bottom line.
Admittedly, investors have been warming to the company as the shares have risen sharply since my buy recommendation at 25p ('Follow the smart money', 27 Feb 2017). I subsequently advised running profits at 31.5p ('Small-cap gems', 13 Jun 2017), after which the share price hit a high of 37p and my 34p target price was achieved. However, I feel that with contract momentum strong, the adoption of CZT-based SPECT and medical imaging technology gaining traction, and potential for a multi-million dollar order from the US Department of Defense, then it's well worth running your gains.
Gama shares in the ascent
Aim-traded shares in Gama Aviation (GMAA:240p), an operator of privately owned jet aircraft, hit my 250p target price last week, having risen by 15 per cent since my full-year results call with finance director Kevin Godley and chief executive Marwan Khalek ('Five small-cap buys', 29 Mar 2017). I previously advised buying at the start of the year at 175p ('In the ascent', 23 Jan 2017), although this has proved to be a volatile holding and the price is now only back above the 225p level at which I initiated coverage, albeit it did subsequently hit a high of 380p in late 2014 ('Ready for take-off', 12 May 2014).
That said, this year's share price recovery looks fully warranted. The company's robust pre-close trading update ahead of half-year results on Wednesday 19 July is highly supportive of adjusted EPS, rising by 10 per cent to 33¢ as forecast by analyst John Cummins at brokerage WH Ireland.
Gama's fast-growing US aircraft management business continues to generate strong organic growth and is also benefiting from the Landmark fleet joint venture with BBA Aviation (BBA). Importantly, "right sizing" the company's European air business and exiting from underperforming contracts is paying off and this unit is on target to deliver modest growth. Modest growth is materialising from the European ground services business, too, underpinned by "increased maintenance activity from contract wins announced at the start of the year, as well as the return of some discretionary aircraft improvements and modifications spend".
Importantly, the directors "are focused on building on the improvements in operating margins, working capital and cash conversion that we delivered in 2016". That's important for the company to achieve its target of halving net debt to a range $9m to $10m by the December year-end. It's also supportive of the progressive dividend policy, and further bolt-on acquisitions. Last year's acquisitions of FlyerTech and Aviation Beauport are on track to achieve their budgeted growth after posting strong first-quarter results, and "are working on enhancing cross-selling opportunities and new joint sales initiatives within Gama's European air and ground services divisions".
Trading on 9.5 times forward earnings, representing a 40 per cent ratings discount to peers, and with another upbeat outlook statement likely later this month, I am upgrading my target price to a range between 275p and 300p to reflect the operational improvements being made and de-risking of earnings estimates. Buy.
Smart investor banks on digital gains
Aim-traded shares in Satellite Solutions Worldwide (SAT:7.25p), a satellite internet service provider offering an alternative high-speed broadband service and one that has been growing rapidly by acquisition, have been under pressure since hitting a record high of 10p ahead of the full-year results ('Eight small-cap plays', 27 Mar 2017). I first advised buying at 5.5p ('Blue-sky tech play', 21 Mar 2016), so a chunk of those gains have been whittled away.
Bearing this in mind, well-regarded fund manager Christopher Mills has just taken a 10.63 per cent stake in the company through Oryx International Growth Fund and Harwood Capital LLP, which has over £1.1bn of funds under management. He obviously believes the equity is undervalued at this level, and so too does analyst Kevin Fogarty at house broker Numis Securities, who has just initiated coverage. Mr Fogarty has adopted a blended valuation approach in his analysis to include a comparison of peer-group-based revenue and cash-profit-based valuation metrics. This suggests an implied valuation range of between £48m and £82m for the equity, equating to a range of 8.6p to 14.7p a share, and a target price halfway in between.
Not surprisingly, trading in the first half has been in line with Numis's recently issued forecasts, which point to annual cash profit more than trebling to £4.4m on revenue of £40.6m, buoyed by last summer's acquisitions: Norway-based Breiband, a provider of radio and satellite broadband with a 13,000-strong customer base; SkyMesh, a Brisbane-based national provider of satellite broadband to 28,000 residential and business customers in Australia; and UK rival Avonline, a satellite broadband business with a customer base of 9,500. It's reassuring that the customer base has increased organically from 85,000 to 90,000 in the past three months, suggesting the board's year-end target of hitting 100,000 customers is in sight.
In turn, scaling up the customer base continues to support low teens underlying revenue growth rates, so generating the cash profit required to cover the interest charge on net borrowings of £13.2m. This may seem high as it implies balance sheet gearing of 135 per cent, but this is an asset-light business with low working capital needs and one producing a high level of recurring revenue, so far more relevant is a debt-to-cash profit multiple of three times, a level of indebtedness I am comfortable with as long as the company maintains its high customer retention rates and continues to post decent organic growth.
In the circumstances, I feel my target price of 10.5p is not unreasonable and I rate the shares a buy ahead of the half-year results. Buy.
Reacquainting an old flame
A number of readers have been asking me to comment on the recent corporate activity at Molins (MLIN:138p), a small-cap packaging company that has announced some important disposals. I have history here as I included the shares in my 2012 Bargain Shares Portfolio at 107p, enjoyed an 82 per cent surge in the share price by the end of the next year, before a series of trading setbacks sent the shares tumbling and prompted my exit in the autumn of 2014, marginally below my advised buy-in price ('Molins profits go up in smoke', 14 Oct 2014). My concern was the scale of the deterioration in the company's tobacco machinery division as customers delayed equipment orders. It was justified, too, as trading deteriorated further and the shares continued to head south. They ended up bumping along the 50p level for all of last year.
However, what makes the company interesting now is that it's selling off its underperforming tobacco business for £30m in cash to recoup the book value of the assets after accounting for £2.7m of fees and taxation. A further £2.7m of the cash will be paid into the company's UK pension fund, and £1.5m set aside for warranties and indemnities pursuant of the sale. That leaves £23.1m of cash, a healthy sum in relation to Molins' market value of £27.8m. In addition, the company is selling off a packaging facility in Ontario, Canada, for a net £5.9m, a sum well in excess of the £1.5m book value of the assets, and will pay £350,000 a year to lease out a newly built plant instead. After fit-out costs this disposal effectively boosts Molins' cash pile by a further £4.9m to £28m, or 139p a share.
For good measure, I understand from analysts Paul Hill and Hannah Crowe at Equity Development that "there might be additional treasure tucked away in Buckinghamshire where the board has submitted an appeal for residential planning on 10 acres of spare land. If granted, this plot could be sold to developers for £15m plus." Of course, the appeal may fail, but it does offer potential for further good news.
Furthermore, the board has just announced that "order intake in the ongoing packaging business is considerably ahead of the same period last year". Analysts at Equity Development believe that the packaging business should increase revenue from £41.5m to £49.8m this year to deliver a near-50 per cent rise in pre-tax profit to £1.3m. Moreover, they are predicting 10 per cent revenue growth in 2018 to underpin a doubling of pre-tax profit to £2.6m after factoring in £400,000 cost savings, and better profit margins, too. On that basis, the shares are trading on 13 times next year's likely earnings, hardly a punchy valuation for a business with a war chest to invest in earnings-accretive acquisitions in the packaging sector. In the circumstances, analysts' sum-of-the-parts valuations of 180p a share seem reasonable to me.
Finally, I will be initiating coverage on a new small cap company in tomorrow's online column.
MORE FROM SIMON THOMPSON...
A comprehensive list of all the investment columns I have written in 2017 is available here.
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