As the first-quarter results season winds down, I have further good news to report from yet more companies on my watchlist. It’s been a recurrent theme among the 56 small-cap companies I have reported on since the start of March, or the more than 100 companies I have covered so far this year. It may also explain why the stock market minnows have been doing relatively well in terms of their share price performance: the FTSE Aim index is flatlining whereas the FTSE All-Share index, with its hefty boas towards blue-chips and mid-caps, is down around 8 per cent since the start of January. I expect this relative outperformance to continue.
In the picture
The directors of Scisys (SSY:132p), a supplier of bespoke software systems to the media, broadcast, space, defence and commercial sectors, were in upbeat mood during our results call. They had good reason to be, having just reported a 44 per cent rise in underlying operating profit to £4.6m on revenue up by a quarter to £57m. Scisys also started the new financial year with a bumper order book of £91m, up 41 per cent year on year and one that covers over two-thirds of budgeted revenue for 2018.
The acquisition of Munich-based Annova Systems, a supplier of software-based editorial solutions to major European news rooms including the BBC, contributed £800,000 of annual cash profit on revenue of £7.3m. Buoyed by a bumper order book, the unit is expected to double its cash profit on “revenue north of £9m this year”, according to finance director Chris Cheetham. That represents a healthy return on the €13.3m (£11.6m) consideration paid to date and €2m future earn-out payments.
Moreover, chief executive Klaus Heidrich told me that his company is generating cross-selling opportunities between clients taking Annova’s OpenMedia software and Scisys’ media and broadcast unit’s dira radio software solution. The latter offers an array of functions for radio broadcasters including automatically recording feeds, researching sounds, writing scripts, editing an item or planning programmes. German media group MDR, French commercial broadcaster RTL and the BBC have all signed contracts for both products.
Scisys space business is in fine fettle, too. The unit increased its cash profit contribution by 17 per cent to £4.9m (pre-central overheads) on revenue of £23.5m and doubled its order book to £34m. Given that around a fifth of divisional revenue comes from work on EU-funded Gallileo projects, Scisys has sensibly put in place a contingency plan to relocate its domicile to Germany in order to protect this business and mitigate the effect of Brexit if the need arises. The majority of revenue comes from European Space Agency (ESA) funded programmes, so is unaffected by Brexit.
The other major take was Scisys’s robust cash generation, which cut net debt by 40 per cent to £5.9m, and that’s after paying £1.7m for the first earn-out on the Annova acquisition. Budgeted free cash flow for this year is in line with the £3.5m forecast of analyst Lorne Daniel at house broker finnCap, suggesting that net debt could more than half to £2.7m by the year-end. That’s good for savings on the interest bill, and for adjusted pre-tax profit that Mr Daniel expects by to rise by £600,000 to £4.4m in 2018 and deliver a 19 per cent hike in EPS to 11.7p.
On this basis, Scisys’s shares are rated on 11.5 times forward earnings, on a modest 7.5 times cash profit estimates to the company’s enterprise value, and offer a prospective dividend yield of 1.8 per cent based on another 10 per cent rise in the dividend to 2.4p a share.
So, having suggested buying Scisys's shares at 102p (‘Tune into a media play’, 11 Oct 2017), and reiterated that advice at 130p (‘Primed for gains’, 29 Jan 2018), I maintain my conservative looking 155p target price. Buy.
STM’s record results
Aim-traded STM (STM:57p), a company that administers assets for international clients in relation to retirement, estate and succession planning, has delivered record full-year pre-tax profit of £4m, up from £2.8m in 2016, on revenue up a quarter to £21.5m. Profit was also £200,000 ahead of finnCap’s estimate.
New business from STM’s international self-invested personal pension (Sipp) business has been the main profit driver and has replaced 80 per cent of the shortfall from its Qualifying Recognised Overseas Pension Schemes (Qrops) business, which was hit in the 2017 UK Budget by the imposition of a 25 per cent tax on transfers into Qrops for residents located outside the European Economic Area (EEA). 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.
STM added 600 new international Sipps last year, and new business remains robust as finance director Therese Neish says the current run rate is now 100 applications a month. STM is still attracting between 20 and 25 Qrops members from outside the EEA. The company earns an annual management fee of £500 on Sipps, a third less than on Qrops, but the Sipp plans are far more efficient to run, so they have a similar level of profitability. STM also charges a £300 establishment fee whereas the Qrops plans have no charge.
Moreover, the tax changes have meant that it’s no longer economically viable for smaller rivals to run their legacy Qrops books. STM is taking advantage, having paid just £950,000 last autumn for a Malta-based provider that generates over £800,000 of annual revenue from its 1,600 Qrops plans, and will contribute £400,000 to STM’s operating profit this year. Not surprisingly, chief executive Alan Kentish says STM is pursuing additional bolt-on acquisitions to boost the £10.2m annual revenue contribution from its pensions businesses, around 95 per cent of which is recurring. Closing net funds of £15m, a sum equating to 25p a share, means the company has ample cash available to pursue earnings-accretive deals.
STM’s management team has a decent track record as highlighted by the well-timed acquisition 18 months ago of Haywards Heath-based financial services company London & Colonial. This business not only provided the platform for the launch of STM’s international Sipps offering, but having reduced the running cost of L&C’s life assurance business, STM has been able to reduce its technical expense reserve and free up cash to recycle into further acquisitions.
Shareholders are benefiting as the dividend per share has been hiked by a fifth to 1.8p, covered almost three times over by underlying EPS of 5.3p, and analyst Jeremy Grime at finnCap predicts a further increase to 2p this year, having just upgraded his EPS estimate by 7 per cent to 6.1p. On that basis, the shares are trading on a forward PE ratio of five (net of cash on the balance sheet), offer a prospective dividend yield of 3.5 per cent, and are rated on a price-to-book value of just 1.1 times. That represents value in my book.
Furthermore, I expect investors to start to warm to the shares again in light of the board’s decision to move its head office from Gibraltar to the UK. It’s a sensible decision given the substantial amount of new business now being generated by its UK regulated entity. I also expect an amicable resolution to the spat between the company and the Gibraltar Financial Services Commission (GFSC) when accountancy firm Deloitte (STM’s auditor) produces its report later this month.
So, having first spotted the investment opportunity when STM’s shares were priced at 35p ('Tapping into a pensions payday', 27 Apr 2015), and last rated them a buy at 50p ahead of the results (‘Primed for gains’, 29 Jan 2018), I see decent upside to my upgraded target price range between 70p and 75p. Buy.
Shore Capital’s profit surge
The primary reason for including shares in Shore Capital (SGR:270p), an investment bank and asset manager, in my 2018 Bargain Shares Portfolio, was the fact that it’s market capitalisation of £46m at the time failed to take into account the rock-solid asset backing and realistic prospects of profit growth. Full-year results released last week highlighted the valuation anomaly still exists even though the company’s share price is 26 per cent higher than in early February.
In the 12 months to the end of December 2017, Shore Capital’s underlying pre-tax profit surged by 27 per cent to £6.5m on 6 per cent higher revenue of £42m to produce a 53 per cent rise in EPS to 20.5p. An eye-catching 50 per cent hike in pre-tax profit to £3m at Shore Capital’s asset management arm was the key driver behind this performance. For example, on the private client side, assets under management (AUM) in its Puma EIS Service and recently launched Puma Alpha EIS increased by 30 per cent to £65m, while inflows to its Puma Aim Inheritance Tax Service continue to grow at a double-digit rate. Including institutional mandates, AUM rose by 5 per cent to £865m.
In corporate broking, preparations for MiFID II impacted the cost base but the division still had a decent year, advising on three IPOs, 24 secondary fundraisings, four takeovers, and adding 13 new clients. Importantly, the outlook is positive for the year ahead, with chairman Howard Shore, who founded the company in 1985 and holds 8.94m of the 21.57m shares in issue, noting “excellent opportunities to grow our asset management platforms and strong support from institutional clients signing-up to take our research [post MiFID II]”.
The dividend per share was doubled to 10p a share, covered twice over by EPS of 20p, and by a strong balance sheet that includes £25.9m of net cash, £2.7m of gilts, £4.8m of listed equities, £3.9m in various Shore Capital Puma Funds, £2.2m of unquoted holdings, and £5.7m in a social care joint venture, Puma Social Care Investments.
The bottom line is that the value of net cash, gilts and listed equities on Shore Capital’s balance sheet equates to 155p a share alone, which means that the shares – trading in line with net asset value of 270p – are effectively being valued on less than six times cash-adjusted EPS. Add to that a near 4 per cent dividend yield, and a positive trading outlook, and I continue to rate Shore Capital’s shares a buy.
Cenkos doubles profits
Shares in corporate broker Cenkos Securities (CNKS:110p) have performed well since I included them, at 89p, in my 2017 Bargain Shares Portfolio, and the board has also paid out total dividends of 9.5p a share excluding the proposed final dividend of 4.5p a share for 2017.
Cenkos's operational performance in 2017 supports that re-rating as the company doubled pre-tax profit to £10m on revenue up by more than a third to £59.5m and boosted EPS from 5.9p to 15p. The broker raised £2.5bn in funds for clients in 41 transactions, of which £1.34bn came from Aim-traded companies, representing a fifth of all fundraises on London’s junior market. There were some chunky deals, too, with four companies accounting for half the capital raised: the IPO of Eddie Stobart Logistics (ESL) raised £393m, and there were secondary equity raises of £302m for Civitas Social Housing (CSH), £408m for Hurricane Energy (HUR), and £150m for Smart Metering Systems (SMS).
Admittedly, the 50 per cent hike in the dividend to 9p a share was less than analysts has anticipated even though Cenkos has net funds of 66p a share on its balance sheet, and investors are likely to be more cautious on near-term prospects in light of comments from chief executive Anthony Hotson who noted: "The market volatility [this year] does appear to have had an impact on investor sentiment with a pause in the momentum the Firm experienced in the second half of 2017. Despite this, we remain ranked as one of the leading brokers in London for growth companies, institutional investor appetite to fund high-quality companies is likely to return and our business model is resilient. Consequently, we look forward to the future with cautious optimism.”
Still, I can’t ignore Mr Hotson’s comments on the trading outlook, so feel it’s prudent to bank profits.
Arena Events litigation issue
Arena Events (ARE:51p), a small-cap specialist in temporary structures and seating, has announced a robust start to trading in the 2018 financial year ahead of full-year results on Wednesday 11 April. However, the positive news has been overshadowed by a contract issue with a former client at its US subsidiary, Arena Americas, to whom the company acted as a sub-contractor on a US Department of Defense contract.
The sums involved are relatively small as Arena earned cash profit of $0.5m and revenue of $4m – or less than 1.5 per cent of its total revenue – working for the client between 2013 and 2017, primarily for the provision of tenting equipment and supplying it to the US Department of Defense, an area outside its normal activities, which are focused on supplying corporate customers for major sporting, music and exhibitions.
The problem is that the client violated the conditions of the US Small Business set-aside program when it won its contract and has been formally charged by the US Attorney’s Office. Arena chief executive Greg Lawless says that his company has fully complied with the US Attorney’s Office investigation into the client’s activities, and ended all work with the party when it was notified of the violation last August.
Major shareholders have been supportive of Arena’s board and understandably want to draw a line under the matter, albeit the US Attorney’s Office could (and it’s not certain it will) potentially fine Arena anywhere between $1m (£0.7m) and $8m based on a multiple of two times profit or revenue it earned under the contract. Mr Lawless, who has a 5.67 per cent shareholding, says he expects the matter to be resolved quickly and that Arena “has sufficient facilities to cover any fine”.
Importantly, he also says that it’s not going to impact on Arena’s “robust pipeline of acquisitions”, a key reason why I suggested buying the shares (‘Alpha Company Research: Arena Events’, 26 Mar 2018). Trading on a modest 11 times 2018 earnings estimates, falling to nine times estimate for 2019, and offering a 3.6 per cent prospective dividend yield for 2018, I view this as a buying opportunity.
■ Simon Thompson's new book Successful Stock Picking Strategies was published on 15 March and can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source.
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