Join our community of smart investors

Primed for gains

Simon Thompson highlights six small cap plays primed for share price upside.
Primed for gains

The corporate reporting season for the small-cap companies I follow starts in four weeks, so there has been a raft of pre-close trading updates to digest ahead of the financial results being released. They have made good reading.

For instance, Skelmersdale-based Flowtech Fluidpower (FLO:176.5p), the UK's leading specialist supplier of technical fluid power products to around 3,400 distributors and resellers, has guided investors to expect a 25 per cent hike in its full-year pre-tax profits to a range between £8.6m and £8.8m on revenues up 45 per cent to £77.9m. Acquisitions have played a part in delivering such eye-catching top-line growth as the company made no fewer than six in the 12-month period at a total cost of £9.6m. However, strip out their contribution and underlying sales still rose by 8 per cent. Orders are well ahead of this time last year, too, suggesting the ongoing recovery in the business has substance. Joint house broker Zeus Capital believes so, upping its revenue estimates by 4 per cent for this year and next.

The upgrade looks warranted as Flowtech’s main distribution business increased sales by 6 per cent to £37m last year, almost all of which was organic. This unit offers over 100,000 individual product lines to more than 80,000 industrial maintenance, repair and overhaul end users in the UK and Benelux. Accounting for £34.5m of last year’s revenues, Flowtech’s Power Motions Controls business designs, assembles and supplies engineering components and hydraulic systems, so is more focused on project-based work. It was encouraging to note that its order book is “well ahead of the same period last year.”

Admittedly, Flowtech’s share price has rallied strongly after I suggested buying at 167p in the autumn (Targeting a break-out’, 23 October 2017), hitting my 192p target price earlier this month. Longer-term holders who followed my advice to buy at 118p at the time of the Aim listing ('A fluid performance', 2 June 2014) have reaped even bigger gains, including dividends of 17.69p a share. However, with the full benefit of acquisitions still to be seen, order books strong, and a lowly-geared balance sheet providing firepower for earnings-accretive acquisitions, expectations that Flowtech can lift 2018 revenues to £100m and deliver a 20 per cent-plus hike in pre-tax profits to £10.6m look achievable. On this basis, the shares are rated on 11 times EPS estimates of 16.1p, or five points less than the average for small-cap industrial engineering businesses. A prospective dividend yield of 3.5 per cent is supportive, too.

So in light of the positive trading update, I am raising my target price to 205p ahead of full-year results on Tuesday, 17 April 2018. Buy.

 

Scisys in the ascent

The board of Scisys (SSY:130p), a supplier of bespoke software systems to the media, broadcast, space, defence and commercial sectors, have said its 2017 results will “comfortably meet current market estimates”. This implies it will increase pre-tax profits by a third to £4m on revenues of £54m in 2017.

The order book is at record levels and robust across all its business segments, bolstered by an €18m contract win to deliver the ground-station control and communications infrastructure for the German national satellite-communications mission, Heinrich Hertz. I also understand from the directors that the strong organic growth seen at the end of last year “is continuing into 2018”. Moreover, having taken on debt to fund the acquisition of Munich-based Annova Systems, a supplier of software-based editorial solutions, principally to major European broadcasters, year-end net borrowings of £5.9m have been cut by a third since June, buoyed by Scisys’ stellar cash generation. Closing net debt is well below the £7.1m level analysts had anticipated.

So, having suggested buying the shares at 102p (‘Tune into a media play’, 11 October 2017), I have no hesitation reiterating that advice and my conservative 155p target price. Scisys’ enterprise value of £44m still only equates to 7.5 times FinnCap’s cash profit estimate of £6m for the 2018 financial year. Furthermore, investors are likely to value Scisys’ earnings stream more highly as debt is cut further. There is a progressive dividend too: the board has lifted the payout by at least 10 per cent a year since 2013. The prospective dividend yield is 1.8 per cent for 2018. Ahead of the results on Tuesday, 27 March 2017, I rate the shares a buy.

 

Strix warming up nicely

Isle of Man-based Strix (KETL:149p), a global leader in the manufacture and design of kettle safety controls, is on course to deliver a 5 per cent increase in cash profits to £35m on revenues of £92.6m in 2017, as analyst Andy Hanson at house broker Zeus Capital predicts. The hefty profit margin reflects Strix’s commanding global market position, controlling 39 per cent of the market by volume and 50 per cent by value.

Furthermore, with cash generation effervescing, borrowings are being paid down faster than analysts had predicted. Mr Hanson predicts that net debt has been cut by £10m to £48m since last summer’s IPO, and is set to fall to £32m by the end of 2018 based on free cash flow of £24m being generated. That’s great news for the dividend, especially as the Isle of Man tax-free base means the company retains all its profits. Zeus forecasts a dividend of 2.9p for the five months the company was listed last year, rising to 7p a share in 2018, covered 1.8 times by adjusted EPS estimates of 12.4p, and two times by reported EPS of 14.7p.

So, having suggested buying the shares at the time of the IPO (‘Tap into a hot IPO', 7 August 2017), and raised my target price from 150p to 165p in the autumn (‘Engineering gains’, 2 October 2017), on 10 times reported EPS estimates for 2018, and offering a 4.7 per cent prospective dividend yield, I remain a buyer ahead of the results on Thursday, 22 March 2018. Buy.

 

STM resolution a buying opportunity

Aim-traded STM (STM:50p), a company that administers assets for international clients in relation to retirement, estate and succession planning, has come to an amicable resolution in its spat with the Gibraltar Financial Services Commission (GFSC).  The parties have agreed to appoint accountancy firm Deloitte to review certain aspects of STM’s compliance, governance and controls and the provision of professional and trustee services. As it happens, Deloitte is also STM’s auditor. I expect a positive outcome to be announced by the end of March when STM releases its full-year results.

Clearly, other investors share this view as STM’s share price has risen 25 per cent since I rated the shares a hold at 40p (‘Three small-cap stars’, 27 November 2017), albeit that’s slightly below the 55p level when I last rated them a buy before the spat with the GFSC emerged (‘Trading opportunities’, 30 October 2017). The rerating is justified as STM’s directors have just revealed that pre-tax profits last year will be not less than £3.8m – a record level – up from £2.8m in the 2016 financial year, with over 70 per cent of annual revenues of £20.5m recurring.

Importantly, new business from STM’s International self-invested personal pension business has replaced the shortfall from its Qualifying Recognised Overseas Pension Schemes (Qrops) business following the tax changes in the 2017 UK Budget. Qrops is 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. As a result of those tax changes, it’s no longer economically viable for smaller rivals to run their legacy Qrops books. STM is taking full advantage, acquiring a Malta-based provider which generates over £800,000 of annual revenue, and is pursuing further bolt-on acquisitions. A cash pile of £11.4m, equating to 39 per cent of STM’s £29.4m market cap, provides fire-power for further deals.

So, with STM’s shares priced on six times cash-adjusted EPS of 5.3p, and offering a prospective dividend yield of 3.6 per cent, I feel they are worth buying at 50p ahead of results on Tuesday, 27 March 2018. I reinstate my 70p target price, too. Buy.

Gama in the ascent

Shares in Aim-traded Gama Aviation (GMAA:260p), an operator of privately owned jet aircraft, have reacted positively to a pre-close trading update ahead of results on Monday, 19 March 2018. I expect the share price to continue to make headway towards the 325p target price I set out at the time of the interims ('Riding earnings momentum', 6 September 2017).

Analyst John Cummins at brokers WH Ireland expects revenues to have climbed by over a third to $586m in 2017, buoyed by significant growth in Gama’s US air division following the Landmark fleet joint venture with BBA Aviation (BBA), and in its US ground handling business, too. As expected, Gama’s European air division has produced a far better margin improvement on the back of cost savings. As a result, pre-tax profits are forecast to rise by 28 per cent to $17.5m and deliver EPS of 32.9¢. The strong operational progress is set to continue in the new financial year, especially as the US economy remains buoyant, suggesting that Mr Cummins’ EPS estimate of 36¢ is well supported. On this basis, Gama’s shares are rated on 10 times earnings estimates.

One reason for the modest rating is that Gama is involved in legal proceedings relating to its legacy Hangar 8 business brought by its former chief executive Dustin Dryden who resigned in September 2015. In a separate case, the company is trying to recover a longstanding trade receivable on which it holds adequate security. The board expects the net effect of these proceedings to lead to a net cash inflow to the company. I am unconcerned.

More importantly, with net debt reduced by almost a third to $13m year on year, and the trading outlook upbeat, I would expect a hike on last year’s dividend of 2.6p a share and see potential for further earnings-accretive bolt-on acquisitions. Buy.

 

Character in recovery mode

When a company warns on profits it pays to ascertain the reasons why to determine whether the share price reaction is overdone. I felt this was the case with Character Group (CCT:460p), the owner of a portfolio of 10 longlasting iconic toy brands targeting the niche pre-school market. The share price plunged by 20 per cent to 370p last autumn after it warned on profits for the financial year to end-August 2018 (‘Tune into a media play’, 11 October 2017).

A contributing factor was retailer Toys R Us entering into Chapter 11 bankruptcy protection in the US and Canada. Toys R Us accounted for eight per cent of Character’s annual sales of £120m in its financial year to end-August 2017. This has had subsequent knock-on impact in every market where Character trades, prompting analysts at brokerage Panmure Gordon to cut their pre-tax profit estimate last autumn from £14.5m to £10.5m for the 12 months to end-August 2018, based on revenues declining by 10 per cent to £108m. Those forecasts are still intact following a positive trading update earlier this month, which suggests EPS of 37p could be reported this year, albeit that’s down a quarter on last year’s outcome.

The fact that the directors sanctioned a 26 per cent hike in the full-year dividend to 19p a share in December’s results is informative, as is the 66 per cent increase in the company’s cash pile to £11.5m, a sum worth 55p a share. They are using the cash pile wisely to make earnings-accretive buybacks, and have authority to buy a further 13 per cent of the 21m shares in issue.

So, having recommended buying the shares at 415p ('Playtime', 1 June 2015), and banked 45p a share of dividends to date, on 11 times earnings estimates net of cash the shares are worth holding on to given that Character’s exciting product portfolio supports analyst predictions of 20 per cent EPS growth in the 2018-19 financial year. Hold.

■ 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