I have been taking a close look at UK defence group Cohort (CHRT:390p). It’s a group I know well and one where I have successfully played the share price moves over the past three years, having initiated coverage at 214p ('Blue-sky buy', 6 Oct 2014), subsequently called a top 15 months later when I advised banking profits on two-thirds of your holdings at 415p ('On a roll', 15 Dec 2015), before turning a buyer again at 350p last autumn ('Riding small-cap bumper gains', 24 Oct 2016). That call worked out brilliantly as the share price peaked out in April this year, prompting my recommendation to top-slice once again at 460p and run profits on the balance of your holdings ('Taking profits', 18 Apr 2017). Having bided my time, patiently waiting for an outright buying opportunity since, I feel that time has arrived.
For starters, Cohort’s share price drifted by 22 per cent from the April all-time highs to last month’s intra-day lows around the 363p to 365p mark, and in the process had become very oversold. The subsequent daily share price graph is telling as a series of doji candlesticks highlight that every single time the sellers came in and drove the share price down from an open at 372p to those intra-days lows, the buyers returned to drive the price back to the opening price or slightly above by the close. From my view, the price action suggests that a short-term support appears to be in place at the very least.
Sound fundamentals
Importantly, the fundamentals are supportive, too. In the past month, the group has announced that its majority-owned subsidiary EID, a designer and manufacturer of advanced communications systems for the defence and security markets, has been awarded a contract by the Portuguese Navy for the supply of communications systems to coastal patrol vessels. It’s worth €4.6m (£4.25m) in revenue and is further vindication of the well-timed acquisition of a 57 per cent majority interest in the subsidiary in June 2016.
In fact, in the 10-month period between completing the acquisition and Cohort’s April 2017 financial year-end, EID exceeded management’s expectations by posting a maiden operating profit of £4.2m on revenue of £16m, buoyed in part by the positive currency translation effect on sterling weakness against the euro since last year’s EU referendum. It’s hardly a surprise that Cohort is purchasing a further 23 per cent stake in EID for €4.4m to take its total stake to 80 per cent, with the Portuguese government retaining a 20 per cent shareholding.
It’s not the only recent contract win, either, as SEA – Cohort’s advanced electronics systems and software business focused on the defence, transport and offshore energy markets – has been awarded a contract by Hyundai Heavy Industries, worth in excess of £5m, to supply Torpedo Launcher Systems for the southeast Asian market. The SEA system is unique in that it can be configured to fire any NATO standard light weight torpedo, enabling customers to choose the best weapon independently and to potentially switch during the life of the ship. It’s proving popular as the system is used by the UK Royal Navy, and is being supplied to the Navies of Malaysia and Thailand, too.
Importantly, these contract wins are supportive of forecasts from analysts Andy Chambers and Roger Johnston at Edison Investment Research, which point to Cohort delivering a 10 per cent rise in revenue to £123.8m in the 12 months to the end of April 2018 to lift pre-tax profit from £14.5m to £15.4m and increase adjusted EPS from 26.6p last year, to almost 29p. Admittedly, those profit projections are about 7 per cent shy of Edison’s previous forecasts, which I published when I last covered the investment case in April. When Cohort released its full-year results at the end of June, Edison decided to lower its sales growth expectations, and take a more conservative view on EID’s profit margins, which had been buoyed by high levels of support work and export activity.
That said, the downgrade in June brought Edison back in line with consensus, and the acquisition of the additional 23 per cent stake in EID, combined with the earnings-enhancing purchase of the minority interests in Cohort's Marlborough Communications subsidiary, a specialist communications and surveillance technology to defence and security markets in the UK and overseas, adds further weight to their estimates, as does sterling’s ongoing weakness against the euro which will have enhanced EID’s contribution. Indeed, since Cohort’s April 2017 year-end, the single currency has strengthened around 10 per cent against sterling, thus providing additional scope for Cohort to outperform consensus EPS estimates.
I would also flag up that having started the financial year with better-than-expected net funds of £8.5m, analysts are looking for a closing figure around £11.5m after factoring in payments on acquisitions. This implies Cohort’s shares are being rated on around 12.5 times earnings estimates net of cash on the balance sheet, a rating that should offer upside to my fair value target price of 450p, assuming of course newsflow remains positive and the group continues to win new orders, as it has clearly been doing. There is a 2.1 per cent prospective dividend yield on offer, too, based on analysts’ predictions of a hike in the payout per share from 7.1p to 8.2p.
The bottom line is that I feel Cohort’s shares are worth buying at the current price, a point that a trading update at this week’s annual meeting on Thursday 7 September should reinforce. Trading buy.
Zegona cash windfall underpins Marwyn
Investors are belatedly cottoning on to the implications of the disposal by Zegona Communications (ZEG:180p), a £352m market cap company, of its holding in Telecable de Asturias, the leading quad-play telecommunications operator in northwest Spain, to Spanish telecoms group Euskaltel. The €701m (£649m) consideration paid by Euskaltel valued Telecable at a reasonable 10.8 times cash profit, and was settled with €186.5m (£172m) in cash and 26.8m shares in Euskaltel to give Zegona 15 per cent ownership of the listed Spanish company. Zegona’s holding in Euskaltel is currently worth £212m based on its current share price of €8.56 and using an exchange rate of £1:€1.08.
Zegona’s shareholders are seeing some of the cash, too, as the board has just announced a tender offer to buy back 70m of its 196m shares in issue at 200p each, news of which sent Zegona’s share price up by more than 10 per cent last week. After the £140m tender offer, Zegona will have a market capitalisation of £209m based on its current share price of 180p, in line with the £212m value of the stake in Euskaltel on which it will receive a dividend of almost £9m a year, a sum that easily covers the £5.8m ongoing cost of Zegona declaring an annual dividend of 5p a share to its own shareholders. The company will also retain £32m of cash from the disposal, some of which will be used to cover transaction costs.
The point being that Zegona’s valuation is well supported by that of Euskaltel, and should offer upside as telecom’s analysts calculate that Euskaltel offers an equity free cash yield of 10.8 per cent, or double the European cable average, which should increase to more than 12 per cent assuming annual cost savings of €17m are achieved from the Telecable de Asturias acquisition.
This is rather good news for shareholders in Marwyn Value Investors (MVI:170p), a closed-end investment company listed on the Specialist Fund Market of the London Stock Exchange that indirectly holds approximately 21.3 per cent of the issued share capital of Zegona through its investment in two funds: Marwyn Value Investors LP and Marwyn Value Investors II LP (the Funds). The investment in Zegona accounts for more than 40 per cent of Marywn’s net asset value, so is a chunky holding. It’s reaped bumper gains too because it was acquired at an average price of 141p, so the tender offer will crystallise a 41 per cent profit on 35.7 per cent of Marwyn’s shareholding while the balance is now more than 27 per cent in profit.
Number crunching
Analysts at Liberum Capital have been working through the number and expect Marywn to receive cash proceeds of £26m, which will be used to support the growth plans of new and existing portfolio companies within the aforementioned Funds. About £3.8m of the gross proceeds will be attributable to shareholders of Marwyn Value Investors’ Realisation shares (MVIR:190p), and the board will make an announcement in due course of the process by which capital shall be returned to them.
However, I am not interested in the realisation shares (these are illiquid as there are only 8.52m in issue), and am only interested in the 70.7m Marywn ordinary shares in issue which are priced on a bid-offer spread of 168p to 170p, representing a 24 per cent discount to their last reported net asset value on Friday, 18 August. That’s because Marwyn’s distribution policy is to deliver a minimum of 8.255p per share each year on these ordinary shares, a sum equating to 4.8 per cent of its current share price, with potential for further distributions if half of net realised capital gains have not already been returned via the ongoing quarterly dividends. I would also flag up the long-term track record of the company’s investment managers: since the company’s inception in March 2016, they have delivered a total return to shareholders in excess of 200 per cent, or double that of the FTSE All-Share.
The decent dividend and attractive share price discount to net asset value aside, Marwyn’s ordinary share price is at an important juncture, having traded in a narrow band between 160p and 167p since the end of May. Interestingly, the shares appear to be breaking out of that trading range, and justifiably so given that I reckon Zegona’s share price performance in the past fortnight should boost Marywn’s last reported net asset value by around 10p a share, and the tender offer will increase its cash resources too.
New portfolio investments
Bearing its burgeoning cash pile in mind, Marywn has just increased its investment in Aim cash sell Wilmcote (WCH:135p) to £11.5m, a holding equating to 7 per cent of Marywn’s net asset value, having backed a capital raise at the time of the company’s Aim flotation three weeks ago. Marwyn originally invested pre-flotation in March.
The company is led by Adrian Whitfield, formerly boss of a specialty chemical group Synthomer (SYNT:471p), where he delivered a turnaround and growth strategy. During Mr Whitfield’s nine-year tenure, he more than doubled operating profits and increased Synthomer's market capitalisation from £300m to over £800m. Prior to that, he was chief executive of the plastics division of paper and packaging group DS Smith (SMDS:493p). James Corsellis and Mark Brangstrup Watts, the founders of the Marwyn Group, are both directors of Wilmcote.
Wilmcote has been established to acquire and develop target businesses in the downstream and specialty chemicals sector by capitalising on structural trends and consolidation in fragmented markets. The directors aim to add value through operational improvements, much in the same way that the directors of Zegona have achieved in the telecoms sector, and are targeting acquisitions with an enterprise value of between £500m and £2bn in order to create shareholder value through a buy-and-build strategy. Expect further equity raises as and when acquisitions are announced, so it pays for Marywn to have a cash buffer available to back them.
Marwyn’s other large holding should offer upside, too, BCA Marketplace (BCA:188p), Europe's largest car auction operator, a company in which it owns 3.22 per cent of the equity. The £47m investment in BCA accounts for 27 per cent of Marywn’s net asset value, having raised its stake a few months ago.
Raised target price
So, having highlighted the valuation anomaly earlier this year when Marwyn’s share price was 135p ('Five small-cap buys', 29 March 2017), since when the board have paid out two quarterly dividends of 2.064p a share at the end of April and July, subsequently reiterated that advice at 162p ('Five small-cap opportunities', 23 May 2017), and at 165p ('Investment company watch', 31 Jul 2017), I feel last week’s chart break-out is worth following.
Offering 17 per cent share price upside to the upper end of my new target price range between 190p and 200p, I rate Marwyn’s shares a buy.
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com for £14.99, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source. Simon has published an article outlining the content: Secrets to successful stock picking
