Profit from corporate activity

Balu’s business comprises two subsidiaries: Beaumanor Engineering, a Leicester-based fluid power equipment distributor and a longstanding competitor to the company’s Flowtechnology; and Derek Lane, a specialist fluid power engineering business that has crossover with Flowtech’s Power Motion Control division. The bolt-on deal also expands Flowtech’s geographic footprint by providing a second logistics centre in Leicester, and brings in new customers and product lines. Analysts at Zeus Capital believe there is potential to drive operational improvement from stock purchasing, cross-selling opportunities for Flowtech’s own-brand products, and enhance Balu’s margins.

I agree and see this as another sensible strategic acquisition to add further substance to expectations that Flowtech can deliver 2018 revenues of £107m to propel pre-tax profits up by a third to £11.4m. That’s after factoring in the full benefit of previous acquisitions made, and a strong order book. On this basis, expect EPS of 16.1p and a raised dividend per share of 6.2p.

Rated on a forward PE ratio of 10, and offering a prospective dividend yield of 3.8 per cent, I maintain my 205p target price ahead of full-year results on Tuesday, 17 April (‘Primed for gains’, 29 January 2018), having first advised buying at 118p ('A fluid performance', 2 June 2014), and banked dividends of 17.69p a share. Buy.

Satellite Solution’s in the ascent

Andrew Walwyn, chief executive of Aim-traded Satellite Solutions Worldwide (SAT:8.5p), a satellite internet service provider offering an alternative high-speed broadband service, was upbeat during our results call this morning. He has reason to be as his company has now reached critical mass, having made 18 bolt-on acquisitions at a cost of £33m in the past few years, and achieved its target of 100,000 subscribers ahead of schedule.

Moreover, he is targeting a 50 per cent organic growth in the subscriber base by 2020. Key to achieving this growth is a transformational sales and marketing deal signed at the end of 2017 with the European broadband joint venture (JV) company (established between Viasat, Inc. and Eutelsat Communications) which is building a retail consumer broadband business across Europe.

SSW will provide in-language/in-market sales, installation, billing, customer care and logistics services. The JV will provide marketing support, satellite network capacity and customer premise equipment, thus enabling SSW to grow much faster as well as entering new markets. Broadband service operations have been launched in Poland, Norway, and Spain. A roll-out into Sweden and Finland is expected too, adding substance to Mr Walwyn’s prediction that the JV will generate half the 50 per cent targeted subscriber growth.

Analyst John Kardis at brokerage Numis Securities predicts a gross margin of 25 per cent on these JV sales, adding substance to predictions that the company can lift revenues by 18 per cent to £52m this year to boost cash profit by a third to £6.3m. Finance director Frank Waters says that the seven acquisitions made in 2017 are forecast to make cash profits of £1.7m this year, or double their initial contribution in the 2017 accounts, justifying the £8.5m paid for them and supporting forecasts.

So, having initiated coverage at 5.5p ('Blue-sky tech play', 21 Mar 2016), and advised buying at 8.4p ahead of the results (‘Enlightening calls’, 5 Feb 2018), I feel an enterprise value to cash profit multiple of 10 times for the 2018-19 financial year is reasonable, suggesting a further 30 per cent share price upside. Buy.

Faroe Petroleum’s shares poised to gush higher

Shares in Faroe Petroleum (FPM:106p), an independent oil and gas company primarily focused on exploration, appraisal and production opportunities in Norway and the UK, duly rallied by 10 per cent in the three weeks after I suggested buying at 102p last month as a short-term play on the oil price recovery (‘Running the slide rule’, 19 February 2018). 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.

Faroe’s share price has since pulled back, but I can see scope for it to make headway again towards January’s highs of 116p. Beyond that, Peel Hunt’s risked net asset value estimate of 141p a share is the next obvious target. News flow should be supportive as Faroe is participating in at least four exploration/appraisal wells in Norway this year and its £255m capital expenditure plans are fully funded by production cash flows, cash in the bank and untapped bank facilities. Faroe also receives generous tax rebates from the Norwegian government on exploration spend.

Furthermore, with Brent Crude trading at $70 a barrel, up from $48 last summer, and management guidance pointing towards operating expenditure in the range of $23- $27 a barrel, this means that Faroe’s forecast daily production of between 12,000 and 15,000 barrels should produce substantial cash flows to invest in exploration activities. The directors are also looking at “potential value-accretive acquisitions”.

Ultimately, Faroe’s share price will be determined by the direction of black gold, which is getting a boost from the weakness in the greenback and a tighter oil market which points towards Brent Crude breaking out above January’s highs of $71 a barrel. Buy.

Cambridge Cognition targeting Alzheimer's sufferers

I had an interesting results call with Dr. Steven Powell, chief executive of Aim-traded Cambridge Cognition (COG:118p), a company that has developed a suite of computer-based cognitive assessments to improve the understanding, diagnosis and treatment of neurological and psychological diseases.

The Cambridge-based company reported a small underlying pre-tax loss on revenues of £6.7m in 2017, mainly because the start dates of two contracts worth £2.3m were pushed back into this year, but what really matters is the current order book, and pipeline. The news here is more than encouraging, with the sales order pipeline up by more than half year on year and “worth a multiple of FinnCap’s current-year revenue forecast of £7.9m..... it has never been stronger”. Moreover, the company has just announced a major pharaceutical clinical trial contract award "that will have a material impact on 2018 and 2019 revenues."

Dr. Powell notes that the collaboration with US-based Takeda Pharmaceuticals to monitor and assess cognitive function in patients with Major Depressive Disorder (MDD) using a specially designed app on an Apple Watch, has generated sales orders of £590,000 to date and he can see revenues “doubling year on year”. MDD is a leading cause of disability worldwide, affecting an estimated 350m people of all ages.

Another product, CANTAB Recruit – an online platform to improve the efficiency of recruitment of patients into clinical trials, initially focused on patients with Alzheimer’s disease – has contracts with two of the world’s largest Alzheimer’s disease trials, the first of which has been extended more than 15 times and is covering more than 50,000 patients. It’s already worth “hundreds of thousands of pounds in revenue, and increasing”.

Other products with potential to accelerate sales growth include one using artificial intelligence (AI) and automatic speech recognition technologies to make language-based verbal cognitive assessments that are scaleable, automated and consistent. Language exhibits measurable changes in many psychiatric and neurological conditions, including Alzheimer's disease, depression and schizophrenia. Expect the “first collaboration later this year ahead of a roll-out in 2019”. 

Of course, there is execution risk, but if revenues ramp up to £7.9m this year and £9.2m in 2019 as analysts predict based on the new IFRS 15 revenue recognition, then the company could be making pre-tax profits of £500,000 and £900,000, respectively. On this basis, expect EPS of 2p and 3.8p for the two years. Moreover, given the operational gearing of the business, there is potential for earnings to acclerate sharply thereafter.

So, having first advised buying the shares at 87p ('Positive thinking', 19 Apr 2017), and subsequently recommended running profits at 120p ('Six small-cap plays', 22 Jan 2018), I now rate the shares a buy, at 118p, ahead of further contract wins and a sustainable move into profit. Buy.

Strix heating up nicely

Isle of Man-based Strix (KETL:133p), a global leader in the manufacture and design of kettle safety controls, has reported a slight earnings beat in its maiden full-year results following last summer’s IPO (‘Tap into a hot IPO', 7 August 2017). Underlying operating profit of £29.1m last year was almost £1m ahead of house broker Zeus Capital’s forecast on revenue up 3 per cent to £91.3m, highlighting the hefty profit margin Strix earns from controlling 39 per cent of the global market by volume and 50 per cent by value.

The business is highly cash generative too, which is why net debt of £45.9m is predicted to be slashed to £31m by the end of 2018 based on annual free cash flow of around £23m. Also, an Isle of Man tax base means the corporation tax charge is minimal, thus enabling the board to pay out a dividend per share of 2.9p for the five months Strix was listed in 2017, rising to a forecast payout of 7p a share in 2018, covered more than two times by reported EPS estimates of 14.7p. A healthy start to the 2018 financial year offers substance to those forecasts, and to the rationale behind raising my target price from 150p to 165p last autumn (‘Engineering gains’, 2 October 2017), and maintaining my positive stance ahead of last week’s results (‘Primed for gains’, 29 January 2018).

Trading on 9 times likely reported EPS for 2018, offering a 5.2 per cent prospective dividend yield and 24 per cent upside to my target price, Strix’s shares are a buy.

Cello lacks a spark for a rerating

I have been taking a close look at the full-year results from pharmaceutical and consumer strategic marketing company Cello (CLL:117p). I last advised running profits on the shares at 133p last autumn (‘Exploiting hidden value’, 25 September 2017), after the price achieved my 130p target price. I first suggested buying at 105p ('Marketing a breakout', 5 September 2016) and the board has paid out dividends of 4.45p a share since then.

The reason for maintaining an interest was based on the potential for Cello to use some of the £13m cash on its balance sheet following a £14.2m placing at 97p a share in January 2017 to make earnings-accretive acquisitions. Only £11.3m of a £20m low interest debt facility is currently drawn down, so Cello is still in a net cash position.

I also like Cello’s US exposure in healthcare and its robust client base: the company has relationships in place with 24 of the top 25 pharmaceutical companies. And as I have noted before, Cello’s social media analytics platform, Pulsar, continues to grow rapidly, ending last year with 346 clients, up from 257 in 2016, and exit monthly revenue run rate in software licence sales of £500,000. It’s in the process of leveraging the Pulsar software suite into the healthcare market too.

Importantly, industry dynamics are supportive of demand for Cello’s clients’ healthcare products, including: ageing populations; a trend towards more effective diagnosis; greater regulation and compliance which increases the need for better and smarter communication. This should be positive for Cello’s services too.

However, despite these positives the company’s share price has drifted, a reflection perhaps of slower than expected progress on the acquisition front (due to high valuations) to complement the organic growth story, and the dilutive impact of the placing, which resulted in EPS declining from 8.66p to 7.93p in 2017 even though Cello’s underlying pre-tax profits rose by 12 per cent to £11.4m on modestly higher revenues of £169m.

The problem I have is that in the absence of corporate activity, I can’t see a catalyst to drive the rating higher than the current forward PE ratio of 14 and that’s after factoring in expectations of 10 per cent EPS growth this year. Take profits.

■ Simon Thompson's new book Successful Stock Picking Strategies was published on 15 March and can be purchased online at www.ypdbooks.com for £16.95, 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's second book Stock Picking for Profit can also 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.