Join our community of smart investors

Running the slide rule

Simon Thompson assesses implications for five companies on his watchlist, two of which have been bid for
February 19, 2018

I clearly wasn’t the only one running the slide rule over Aim-traded Gama Aviation (GMAA:258p), an operator of privately owned jet aircraft, when I rated the shares a buy after the company issued a positive pre-close trading update ahead of results on Monday 19 March 2018 (Primed for gains’, 29 Jan 2018).

Gama has just announced a placing of 19.5m shares at 245p each to raise £48m of new funds to ramp up its growth plans. Two-thirds of the new equity is being purchased by an affiliate of the mighty Hutchinson Whampoa (China), a Hong Kong-based conglomerate operating across a diverse number of sectors including the provision of aircraft maintenance and logistic services. Hutchinson will own 21 per cent of the enlarged share capital of 63.5m shares.

The fundraising makes commercial and strategic sense. Around $19.8m (£14.2m) of the capital will be used to acquire Hutchinson’s Hong Kong aviation interests, including a 20 per cent stake in China Aircraft Services, a company founded in 1995 and one of only three operators that provide maintenance, repair and overhaul aviation services at Hong Kong International Airport. The $16m being paid for that stake implies a value of $80m for the equity, hardly a punchy valuation for a business that made pre-tax profits of $7.8m in its last financial year and has net assets of $72m. More importantly, it gives Gama access to markets that otherwise would have been difficult to access, and in a less capital intensive way, too.

It also makes sense for Gama to deploy $10m on expanding hangar capacity and tooling and equipment at its fast-growing operations on the east and west coast of the US. The company operates from 14 locations across the country and manages a fleet of 200 aircraft, but growth is being held back by capacity constraints, an issue the new capital addresses, as well as providing cross-selling opportunities on the maintenance side of the business. Strategically, it’s a smart call to allocate $5m as seed capital to develop a new $45m aviation centre at Sharjah International Airport, given capacity constraints at Dubai International Airport. It’s not only a lower cost base, but is geographically well located, thereby offering a platform for expansion in the Middle East.

In the near term, the placing will be dilutive to EPS, which is why analyst John Cummins at broking house WH Ireland expects EPS to dip from 32.9¢ to 30¢ this year, even though pre-tax profits are forecast to rise 29 per cent to $22.6m on revenues up 18 per cent to $691m. The payoff will be seen in 2019 when he predicts a 50 per cent hike in pre-tax profits to $33.1m on revenues of $758m to deliver EPS of 41.2¢, or almost 30p, implying the shares are being priced on a forward PE ratio of 8.5. It’s not hard to understand why chief executive Marwan Khalek is investing £625,000 of his own money to purchase 255,000 shares in the placing. I continue to rate Gama’s shares a buy and reiterate my 325p target price. Buy.

 

Stadium cash bid

I wasn’t the only one running a slide rule over niche electronics company Stadium (SDM:117p), either. Last month, I suggested buying the shares at 84p ahead of the full-year results (‘Value opportunities’, 8 Jan 2018), and it has just received a 120p a share recommended cash offer from electronics group TT Electronics (TTG:217p). That’s well above my 105p target price, and Stadium's shareholders will also receive a special dividend of 2.1p in lieu of the final payout to take total dividends to 9.8p since I first advised buying the shares ('Switch on to the Stadium of light', 30 Jul 2014).

The offer equates to 13 times Stadium’s likely earnings for 2017, and 11 times 2018 EPS forecasts, albeit there is an above-average execution risk in delivering the forecast 20 per cent profit growth this year predicted by analysts. Contract delays in some higher-margin technology products and a global shortage of certain electronic components – memory chips, circuitry and passive components, in particular – contributed to cost pressures in the second half of last year. In the circumstances, I feel the cash offer is fair and unlikely to be trumped. So do shareholders owning a quarter of the shares, having backed it already. Accept.

The knockout 13p a share cash bid for Lombard Risk Management (LRM:12.75p),  a provider of collateral management and regulatory reporting software products from Amsterdam-based financial software provider Vermeg was given the green light by Lombard’s shareholders at the end of last week. The offer represents a hefty premium to my 9p entry point ('Banking on regulation', 13 Mar 2017), and the exit multiple of 11 times forecast cash profits is fair in light of the higher execution risk, resulting from a greater seasonal bias to Lombard’s numbers. Accept.

This means that no fewer than 21 small-cap companies I follow have now exited the stock market in the past four years, a trend I expect to continue as higher-rated rivals take advantage of the valuation anomalies I have spotted in the under-researched small-cap space.

 

Epwin’s high-yielding shares underpriced

Epwin (EPWN:86.2p), a manufacturer of extrusions, mouldings and fabricated low-maintenance building products, has issued an in line pre-close trading update for the 2017 financial year, albeit some perspective is needed here as house broker Zeus Capital’s pre-tax profit expectations of £21.3m are 15 per cent lighter than they were before the company issued a profit warning last summer (‘Targeting a break-out’, 21 Aug 2017). I rated the shares a hold for recovery at 67p at the time, and reiterated that advice at 80p when I covered the half-year results in the autumn (Exploiting hidden value’ 25 Sep 2017). I am doing so again, as I feel that although the ongoing weakness in the repair and maintenance markets is impacting operating margins, and is being felt across the industry, it is priced in.

Based on a realistic 5 per cent contraction in revenues to £279m this year, analyst Andy Hanson at Zeus Capital believes that Epwin should still be able to deliver pre-tax profit of £19m and EPS of 10.9p, implying the shares are rated on a forward PE ratio of eight. Moreover, net debt of £25m equates to just over 25 per cent of net asset value, and less than one times cash profit forecasts of £28.3m for 2018. The £9.4m cost of maintaining last year’s dividend of 6.6p a share is fully covered by free cash flow, and that’s after an £8m investment in capital expenditure and incurring £5m of exceptional costs.  

The money spent on restructuring operations looks well spent as Epwin’s management team hs rationalised manufacturing facilities including the consolidation of sealed glass unit fabrication from two sites into one in Northampton. The £2.5m cost incurred should be recouped over a two-year period, thus offsetting the full financial impact of the anticipated decline in sales this year. Also, with free cash flow of £14m forecast this year, Epwin’s directors have the option of making earnings-accretive bolt-on acquisitions by recycling excess cash flow back into the business to reduce this year’s likely profit shortfall.

The bottom line is that rated on a price-to-book value of 1.3 times, on eight times forecast earnings for 2018, and underpinned by a 7.5 per cent dividend yield, Epwin’s shares are priced to continue their recovery. So, having first suggested buying the shares at 103p when the company joined London’s junior market ('Moulded for gains', 29 Jul 2014), since when the board has paid out total dividends of 19.43p a share to more than offset the capital loss, I would continue to hold them for recovery ahead of full-year results on Wednesday 11 April 2018. Hold.

 

Faroe asset disposal highlights value

Last autumn I suggested buying shares in Faroe Petroleum (FPM:102p), an independent oil and gas company primarily focused on exploration, appraisal and production opportunities in Norway and the UK, to play the ongoing rally in the oil price (‘Gushing higher’, 6 Nov 2017). That’s because there is a strong correlation between Faroe’s share price and the oil price – a critical factor in determining the commercial viability of the company’s projects.

I felt a rally towards my 115p target price was on the cards, representing a discount to Arden Partners' risked net asset value per share of 122.8p (147.2p on an unrisked basis), based on an oil price of $60 a barrel and a gas price of 40p per therm. Faroe’s share price achieved that target in mid-January, after which profit-taking set in as the Brent Crude oil price pulled back by 13 per cent to $62 a barrel. Since then, Faroe has made some important announcements, the most eye-catching of which is the proposed sale of a 17.5 per cent stake in the Fenja development in the Norwegian Sea, a field holding gross recoverable reserves of 97m barrels of oil equivalent (boe), according to the operator, VNG Norge AS.

Suncor is paying $54.5m (£39m) cash for the stake, and Faroe is retaining a 7.5 per cent interest, which reduces its share of future capital expenditure to £70m. After factoring in the $100m Faroe raised from an unsecured bond issue last month, I reckon the company’s cash pile of £149m at the start of 2018 has increased to £260m. It also means that Faroe, which also has an untapped $250m revolving bank lending facility, is fully funded for both Fenja, its 2018 development and production capital expenditure commitment of £175m, and a planned £80m (£20m net of lucrative tax breaks) exploration and appraisal programme.

I also note that a large chunk of 2018 production – guidance is for daily output between 12,000 and 15,000 boe – is hedged at $57 per barrel and 42.5p a therm, well in excess of forecast operating expenditure of between $23 and $27 per boe. This means that a chunk of cash flow from production can be recycled back into exploration, irrespective of the level of the oil price. Of course, for Faroe’s share price to make headway back to the January’s highs around 117p, we need black gold to recover some of the lost ground.

Bearing this in mind, one factor conspiring to depress the oil price has been the equity market correction as investors liquidated positions to cover losses elsewhere. Hedge funds and money managers who had been betting on higher oil prices reduced their net long positions, according to exchange traded fund and official government data, although they are still a net 1bn barrels long in the futures market. When stability returns to equity markets, expect a higher oil price, too. Another reason for the softer oil price is that US shale producers are looking to expand production. The number of rigs drilling for oil has risen to the highest level since April 2015, and Opec is predicting US output will rise by 1.3m barrels per day this year.

Ultimately, the oil price is driven by supply and demand, so it’s worth noting that in its latest guidance Opec predicts global oil demand growth of 1.6m barrels per day in 2018, reflecting strength in the global economy, exceeding non-Opec reported supply growth of 1.4m barrels per day in the year to date. If Opec and Russian producers keep to the renewed output cuts they agreed to last month, I can see a tighter oil market unfolding, even allowing for increased US output.

In the circumstances, I feel it pays to stay long of Faroe’s shares, with the potential for positive newsflow from its exploration activities an added attraction. 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