It has been a busy couple of months during which time I have written almost 80 small cap company-specific articles including initiating coverage on some very interesting IPOs as I discussed during last week’s podcast. Of course, I am keeping a close eye on my active watchlist of companies, a large number of which have been reporting pretty positive half year results that are not only supportive of some the share price gains made to date, but suggest potential for further upside too.
Inland Homes (INL:59.5p), a specialist housebuilder and brownfield land developer, has exceeded market profit expectations by over £1m by delivering an underlying pre-tax profit of £18.1m for the 12 months to end-June 2017, up from £15.7m the previous year, excluding revaluation gains on the portfolio.
The company sold 188 open market homes at an average price of £306,000 on which it generated a gross profit of £8.7m, a margin of 15.1 per cent, and sold off 780 plots in land sales to generate gross profit of £19.1m including joint ventures and corporate disposals. Inland also raked in £2.5m of rental income including £1m from a portfolio of 86 properties, worth £46.9m, on the 100-acre Wilton Park site in Beaconsfield, Buckinghamshire where it has submitted a planning acquisition for upto new 350 homes with a gross development value (GDV) of £350m, and a further £500,000 from letting out space for storage and film production on the site.
The bullish outlook statement aside, which highlighted a rise in forward sales from £19.9m at the end of June to £33m, the company has entered into construction contracts, worth £41.5m, on land sales with three housing associations. The plan is to ramp up activity here to release profit and revenue earlier by selling parcels of consented land from a land bank of almost 7,000 plots, the proceeds from which can be used to reduce borrowings and avoid the need for development loans and investment in sales and marketing. In turn, this strategy will drive up the forward order book, thus de-risking the company in the event of a downturn, the lower profit margin earned being the trade off for the lower risk being taken. It seems a sensible approach to take at this point of the cycle, not that there are any issues with Inland’s finances as net debt of £68m equates to gearing of 35 per cent of EPRA net asset value (NAV) of £194m. Over half of the company’s borrowings have a maturity profile over three years.
The board’s bullish outlook also explains the 33 per cent increase in the dividend per share to 1.2p, covered six times over by underlying EPS (excluding valuation gains). Admittedly, the shares have underperformed recently, but priced on a near 40 per cent discount to EPRA NAV per share of 96p, rated on a PE ratio of 8 and offering a 2.5 per cent dividend yield, I feel that any concerns about the southern England property market where Inland operates are being overplayed. The company predominantly has development sites around the M11 and M25, as well as on the South Coast around Poole in Dorset and Southampton.
So, having included Inland’s shares in my 2013 Bargain Shares portfolio at 23p ('How the 2013 Bargain Shares fared, 7 Feb 2014), and maintained my positive stance since then – I last recommended buying at the current price in mid-summer (‘Value opportunities’, 19 Jul 2017) – I feel there is value here. And so clearly do the board who have just announced a share buy back programme today. I still maintain a fairer valuation for the equity is around the 80p level, representing a 25 per cent discount to end June 2018 EPRA NAV estimates of 107p a share. Buy.
A fluid performance
Skelmersdale-based Flowtech Fluidpower (FLO:145p), the UK's leading specialist supplier of technical fluid power products, has delivered a 11 per cent increase in half-year operating profits to £4.5m, driven by a 25 per cent rise in revenues to £34.1m, a performance that must be the envy of rivals.
True, acquisitions have played their part – Flowtech has completed five so far this year at a total cost of £8.1m excluding earn-outs of £3.5m over the next two years, funded by the proceeds of a £10m placing at 120p a share at the end of March – but so have price rises which have bounced back to pre-EU Referendum levels. Having a broader spread of businesses has also helped as Flowtech now offers original equipment manufacturer (OEM) and own-brand products to more than 3,400 distributors and resellers. Its catalogue contains 100,000 individual product lines and is distributed to more than 80,000 industrial maintenance, repair and overhaul end users from facilities in the UK and Benelux. Recognised as the definitive source for fluid power products, over 80 per cent of products are stocked and can be delivered next day by national courier service, providing a 'best in industry' service offering.
A good example of the upside from the company’s acquisition strategy can be seen in its power motion control (PMC) division, which designs, assembles and supplies engineering components and hydraulic systems. Revenues here shot up by more than half to £12.7m, but 13 per cent of the £4.4m revenue gain was organic. Nelson Hydraulics, acquired in the summer of 2015, has been benefiting from Flowtech’s larger geographic footprint and network to increase market share, primarily in Northern Ireland. The directors say that just like its Flowtechnology business, which increased organic revenues by five per cent in the half year and now accounts for 56 per cent of total revenues, trading in PMC has been buoyant since the June half year end, thus supporting house broker Zeus Capital’s forecasts which point to a 35 per cent rise in full-year revenues to £72m to propel pre-tax profits by more than a fifth from £7m to £8.6m and deliver EPS of 13.7p.
On this basis, Flowtech’s shares are rated on 10.5 times forward earnings estimates, a near 50 per cent discount to the UK distributor average, highlighting the potential for Flowtech to be an attractive target for a trade buyer, or even an international predator taking advantage of sterling’s share depreciation since the end of 2015; the currency is down over 20 per cent against the euro and US dollar.
Moreover, with year-end net debt expected to be around £12m, balance sheet gearing is pretty conservative at 17 per cent of shareholders funds, suggesting room for additional bolt-on acquisitions. Investors are seeing more of this profit too: Zeus expects the full-year payout to be raised from 5.5p to 5.8p this year, increasing to 6.1p in 2018, implying the shares offer prospective dividend of four per cent, and rising.
Needless to say there is a very positive story emerging here which is why the shares are making headway back towards their May 2017 all-time high of 157p. So, having last rated them a buy at 143p ('On the case', 10 Apr 2017) after first advising buying at 118p at the time of the Aim listing ('A fluid performance', 2 Jun 2014), since when the board has declared dividends of 17.69p a share, I feel my fair value of 170p is a reasonable target and one equating to 12 times earnings estimates for the 2017 financial year. Buy.
Renewing an old acquaintance
Shares in Renew (RNWH:425p), an Alternative Investment Market (Aim)-traded engineering services group specialising in the UK infrastructure market, and on the nuclear, rail and water industries in particular, have struggled to make headway since I recommended top slicing the holding at 470p ('Taking profits', 18 Apr 2017).
I last advised running profits at 462p post half year results at the end of May which revealed that adjusted pre-tax profit increased by 11 per cent to £12m on revenue up 9 per cent to £289m ('Small-cap trading updates', 24 May 2017). At the time the company’s engineering services order book had increased by 5 per cent to £435m to maintain the group order book at £517m, supporting expectations of a similar revenue performance in the second half. That has proved to be the case with the directors guiding investors to expect adjusted pre-tax profits in line with analyst forecasts of £24.9m in the 12 months to end September 2017 to produce EPS of about 32p and support a 15 per cent hike in the dividend to 9.2p per share. Please note that the company is withdrawing from its loss-making low pressure, small diameter gas pipe replacement activities in order to return its gas business to profitability in the 2017/18 financial year, and the aforementioned forecasts are stated before accounting for £500,000 of one-off cash costs booked in the year just ended and exclude a £5.8m non-cash impairment charge.
On this basis, Renew’s shares are rated on 13.3 times earnings, and offer a 2.1 per cent dividend yield, a fair rating in my view, but one that’s also supported by analysts expectations of pre-tax profits and EPS rising by just shy of 7 per cent to £26.6m and 34.1p, respectively, on five per cent higher revenues of £588m in the financial year to end September 2018. The company’s earnings stream is underpinned by a raft of contracts supplying critical infrastructure maintenance services, which produce a return on capital employed north of 60 per cent, in rail infrastructure, the water industry, and the nuclear industry where Renew is an established player in both decommissioning and decontamination work.
There is an acquisition story here too as Renew has made some astute bolt-on purchases in recent years, so news that it has degeared its balance sheet and is now in a net funds position – analysts are predicting net cash of between £4m and £5m at the end of September 2017 after factoring in the second-half profit and cash flow – offers scope for further earnings accretive bolt-on deals.
So, ahead of the full-year results due to be released on Tuesday, 21 November, and rated on 12.5 times earnings estimates for the 2017/18 financial year, I believe that there is potential for modest multiple expansion to drive Renew’s share price higher, albeit finnCap’s top of the range target price of 586p looks far too bullish to me. Run profits.
A chic financial performance
Given we are now into the ninth year of the current bull market, and small caps have been on fire all this year, I am now running profits on a fair number of companies on my watchlist after they hit my target prices. That’s hardly surprising in light of some of the chunky gains racked up.
For instance, I moved to a run profits recommendation on formal clothing retailer Moss Bros (MOSB:98p) in early summer when the price was around 113p ('Running profits and banking gains', 5 Jun 2017), having first advised buying the shares at 38p ('Dressed for success', 20 Feb 2012), since when the board has declared dividends of almost 25p, so the holding was and still is showing a thumping return.
True, the share price been trading sideways for the past few years, but there is an attractive income stream on offer as the board paid out a dividend of 5.9p a share in the year to end January 2017, and has just hiked the interim payout for the six months to end July by six per cent to 2.03p, in-line with the 6.3p full-year forecast of analyst John Stevenson at broking house Peel Hunt. I am not concerned that analysts EPS expectations of 5.6p fail to fully cover that forecast payout as Moss Bros’ non-cash depreciation charge (£5.9m last year) and amortisation charge (£800,000) depress the reported pre-tax profit estimate of £7.2m. Far more important is the company’s annual cash profits of £14.2m which are more than double the £6.2m cash cost of the forecast dividend, leaving ample cash left over to invest in the store estate.
In fact, a key driver of profits since i initiated coverage has been Moss Bros’ investment in an accelerated store refurbishment programme which has resulted in 103 of its 129 stores being spruced up. This has the immediate effect of lifting underlying sales and, with an attractive cash payback period of just three years, the company has been able to recycle cashflow from previous refurbishments into new ones too. A short lease length of less than five years on the portfolio means there is potential to make savings when negotiating new leases with landlords too, or simply relocating stores to better locations.
Another reason why the company has fared better than rivals in what is a cut throat retail environment is because management has been embracing the opportunities in e-commerce, a segment that now accounts for 11 per cent of total sales; and has launched a range of sub-brands to keep the offering fresh. Retail sales increased by five per cent on an underling basis in the first half, and at a maintained gross margin, the key driver behind Moss Bros’ pre-tax profits rising 15 per cent to £4.2m, or five per cent ahead of Peel Hunt’s forecast. Admittedly, trading in the hire part of the business was softer than expected, but this partly reflects some customers opting to buy their outfits instead, and Peel Hunt expects an improving trend in hire sales in the second half as sales switch from weddings to evening wear.
True, there are headwinds facing the profits including sterling’s weakness against the US dollar which is expected to impact second half gross margins, but even so Peel Hunt still expects the company to hit its aforementioned full-year forecasts. On this basis, the shares are priced on 14 times full-year EPS estimates of 5.6p net of a £21m cash pile worth 21p a share, a reasonable valuation in my view, and one further supported by a 6.5 per cent prospective dividend yield.
So, although Moss Bros’ share price has drifted back since my last update, I still believe it’s worth running profits.
■ 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
