First-half results from Pennant (PEN:150p), an Aim-traded supplier of training and support products and services that train and assist engineers in the defence and civilian sectors, highlight the dramatic transformation of the company’s fortunes under the leadership of chief executive Philip Walker, who was appointed 19 months ago.
Pennant’s pre-tax profits more than doubled to £2m on revenues up by more than a third to £13.2m, exceeding the £1.8m profit reported for the whole of the 2017 financial year. Cash flow generated from operations hit the £3m mark, which in turn led to a doubling of net funds to £3m since the start of 2018, reflecting receipt of milestone payments on multi-year awards including one with General Dynamics UK, a leading defence company. General Dynamics has a £3.5bn contract to supply 589 Ajax fighting vehicles to the British Army and sub-contracted the requirement for electro-mechanical trainers and computer-based training to Pennant three years ago. Pennant’s original £7m award has since been increased to £12m, half of which will be delivered between now and the first half of 2020.
The company's relationship with the UK Ministry of Defence (MoD) dates back to 1958 and continues to generate business, as highlighted by a £370,000 contract awarded for its virtual parachute systems. Pennant’s close relationship with BAE Systems has opened doors in new foreign markets, too. For example, Pennant is delivering on a £2m contract with Lockhead Martin, one of the world's leading aerospace and defence contractors, for the provision of a Rotary Wing Rear Crew Winch Trainer.
Other services the company offers include an Oracle-based software product, OmegaPS, which reduces the support cost of maintaining major assets such as trains, tanks or airplanes. The speed and frequency of maintenance and repair of major capital equipment has a major impact on the overall cost of ownership, so by minimising life-cycle costs, and providing timely and quality information, Pennant’s software offers tangible financial benefits to its customers. It is used by several aerospace manufacturers including Boeing, Thales, and Airbus Helicopters.
Around three-quarters of revenue is derived from the defence sector, but there is a growing civilian focus too. Awards include a £125,000 contract for the reconfiguration of a rail cab simulator, and a £50,000 order for additional control room simulators with Network Rail. These contracts contribute to a three-year order book worth £40m, but it’s a £100m-plus pipeline of work that really excites me and the reason why I suggested buying the shares, at 109p, in my August Alpha Report ('Pennant International: Poised for a return to growth', 13 Aug 2018).
Pipeline transformational
Last month Pennant revealed that it has been provisionally selected for the largest contract in its history and one that could generate revenue of £25m to £30m, deliverable over 2019, 2020 and 2021. The contingent contract involves the design, build and delivery of training equipment to an unnamed customer and is expected to be formally awarded later this year. It’s not the only one as Pennant has just landed a £10.2m contract to supply training aids (mainly off the shelf equipment) to a Middle Eastern customer. The majority of the £10.2m of revenues will be recognised in the 2019 financial year and means that over 90 per cent of house broker WH Ireland's revenue estimate is already covered.
Of course, Pennant has to have the infrastructure to deliver on such contracts. Bearing this in mind, a £1.8m investment in new property and infrastructure has trebled production capacity, so facilities are in place to ramp up output sharply. Also, a healthy cash position and robust current ratio (current assets of £8.8m are more than three times current liabilities of £2.5m) means it has ample working capital too. Moreover, any development work undertaken is paid for by the customer at the start of a contract, and milestones embedded into contracts make programmes self-funded for Pennant.
Importantly, industry drivers are supportive of Pennant continuing to convert its healthy bid pipeline into contracted orders. These include a move by defence forces and other organisations towards outsourcing training services, including updating their training devices; the use of 'real' equipment for training has safety implications, is expensive and often impractical, thus supporting demand for Pennant’s training aids; and new capital equipment platforms for land, naval, air and rail are becoming ever more sophisticated, thus increasing the requirement for training.
So, with Pennant on course to deliver full-year pre-tax profit of £3.5m on revenues of £20.5m and EPS of 9.8p, and its three-year order book set to rise from £40m to £70m if the second major aforementioned contract is landed later this year, then profits could really take off. That’s simply not reflected in the price of the £45m market capitalised company with the shares trading on a 2018 PE ratio of 14 net of cash on the balance sheet. I maintain my conservative looking 180p target price and continue to rate Pennant’s shares a buy.
Please note this article was first published online on Thursday, 27 September when the share price was 123p and has been updated on Tuesday, 2 October to incorporate news of the £10.2m Middle Eastern contract win.
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