Watkin Jones beds in outperformance

Having completed all 10 PBSA schemes and delivered 3,415 beds for the start of the 2018/19 academic year, the directors have tweaked up their full-year revenue and underlying earnings guidance. The news prompted analysts at brokerage Peel Hunt to pencil in a 13 per cent rise in underlying pre-tax profit to £49.5m and that excludes a £4m one-off profit the board also revealed in the company’s trading update. Net funds are expected to have risen by almost half to £60m, or 23p a share, over the 12 month trading period to end September 2018, according to analysts at Equity Development, adding weight to expectations of a double-digit hike in the payout per share to 7.4p and one covered more than two times over by EPS.

Moreover, all bar 77 of the 2,723 beds slated for delivery in the new financial year have already been forward sold, and so too have 70 per cent of the 2,606 beds scheduled for delivery in the 2019/20 financial year. This solid pipeline not only significantly de-risks earnings forecasts, but with the company targeting delivery of 1,500 build to rent apartments over the course of the next three financial years, and entering into development agreements with major institutional investors, then there is a solid and growing contribution from private rented housing to augment the PBSA revenue stream. The board are still considering the option of spinning off the build to rent business into a new investment vehicle to enhance shareholder value.

There is no doubt in my mind that Watkin Jones’ shares remain undervalued even after doubling in value since I initiated coverage around the 100p mark at the IPO ('A profitable education', 3 April 2016). That’s because the forward cash-adjusted PE ratio is only 11 for the 2018/19 financial year, falling to 10 the year after. The board have also paid out total dividends per share of 13.07p in the past two and a half years, and the progressive dividend policy is well underpinned by the cash flow generated from completed developments. The respective prospective dividend yields are 3.9 per cent and 4 per cent.

So, having last advised buying the shares, at 207p, ahead of last week’s trading update ('Watkin Jones offers robust visibility', 4 October 2018), I maintain my positive stance and reaffirm my 250p target price. Buy.

US dollar strength bodes well for Bioquell

Shares in Bioquell (BQE:420p), a provider of specialist microbiological control technologies to the international healthcare and life science markets, smashed through my 550p target price after analysts pushed through material upgrades post the interim results ('Bug busting results', 8 August 2018). The price subsequently peaked out at 579p before profit taking took hold, perhaps not that surprising to some extent given that long-term holders of my 2016 Bargain Shares Portfolio had averaged into the shares around the 125p level, so were sitting on a 363 per cent gain made in only 30 months.

What’s interesting to note since my last article was published and since the interims were released in the summer is that the sterling:US dollar exchange rate has weakened significantly and is now 10 per cent below its April 2018 high of £1:$1.44. By my reckoning, Bioquell’s average second half exchange rate on US dollar sales is around £1:$1.29, or 6 per cent below that in the first half. That’s worth flagging up because in the first six months of 2018 almost half of revenue was denominated in US dollars, and 29 per cent in euros. This means that the second half currency tailwind offers potential for further operational outperformance at a time when Bioquell’s end markets are being buoyed by a raft of factors including the need for customers to achieve and maintain regulatory compliance, the growing threat posed by antibiotic resistance, and ongoing growth in research and small-scale production associated with cell-based healthcare products.

These demand drivers were there for all to see in the first half numbers. A rising gross margin – highlighting the pricing power behind its hydrogen peroxide vapour (HPV) patented technology, the gold standard for bio-decontamination – healthy turnover growth and operational leverage helped propel Bioquell’s first half pre-tax profit up by 41 per cent to £2m on 9 per cent higher revenues of £15.7m, all of which was organic growth. Analyst Chris Glasper at broking house N+1 Singer subsequently raised his 2018 EPS estimates by 10 per cent to 12.2p based on Bioquell delivering cash profit of £6m and pre-tax profit of £3.5m on revenue of £31.8m. Importantly, I feel that the real possibility of second half currency gains fuelling even more earnings upgrades is not embedded into those forecasts.

Furthermore, with the share price retreating back to around the level at which I last rated the shares a buy at three months ago, the rating is even more compelling now in light of this possibility. To put this into perspective, after stripping out Bioquell’s forecast closing net funds of £17.1m, a sum worth 77p a share, from its market capitalisation of £93.9m then the company’s enterprise valuation of £76.8m equates to a modest 12.8 times conservative looking cash profit estimates for 2018. The enterprise valuation to cash profits multiple drops to around 11.5 times in 2019 after factoring in a rise in net funds to £21.6m.

That is hardly a punchy multiple for a highly cash generative and operationally geared business and one with potential to deliver mid-teens operating margins on a revenue base of £40m in the years ahead. For good measure, there is positive divergence on the chart with the reading on the 14-day relative strength indicator (RSI) higher at the retest of the 400p support on Friday, 2 November, suggesting the profit taking since the summer has run its course.

So, ahead of the mid-January 2019 pre-close trading update, I rate Bioquell’s shares a buy.

Gama shares hit major turbulence

October was not the month for a company to issue a profits warning. In the case of Aim-traded Gama Aviation (GMAA:126p), shares in the operator of privately owned jet aircraft were hit doubly hard. That’s because news of a $3m (£2.3m) profit shortfall, representing 15 per cent of broking house WH Ireland’s previous full-year pre-tax profit estimate of $19.9m, came only a matter of weeks after the directors had confirmed profit guidance at the interim results when I rated the shares a hold at 187p ('Gama on course for a strong second half', 24 September 2018). Analyst John Cummins at WH Ireland slashed his full-year EPS estimate by almost a fifth to 21.3¢ (16.5p). 

There were a number of issues raised in the trading update, the most surprising of which was news that “profit from Gama’s US Air associate is not now in line with expectations for the full year due to slower than the expected growth in charter and aircraft management revenues.” Only a month ago, the directors reported that first-half divisional revenues increased by almost 9 per cent to $206m, and were positive over prospects for this operation in light of the buoyant US economy. I was equally surprised that “growth in US ground maintenance revenues, while strong, has not been at the level required to achieve our expectations, partly as a result of it taking longer for new capacity to come on stream.”

The board was also overly bullish on forecasts for their European ground division as they had “assumed a level of revenue growth during the transition [of operations from Farnborough and Oxford airports to Gama’s major new facility at Bournemouth International Airport] that has proved too ambitious in the circumstances”.

Moreover, investors who backed a £48m placing at 245p a share in February must be questioning the wisdom of using $16m (£12.4m) of the proceeds to buy a 20 per cent stake in China Air Services (CAS), the owner and operator of one of only three maintenance, repair and overhaul facilities at Hong Kong International Airport. Gama’s board revealed in their trading update that CAS “has continued to underperform with the unexpected loss of contracts significantly impacting margins in an operationally geared business”.  

In the circumstances, it’s not surprising that some investors headed for the exit. It’s not difficult to make a case to join them as management’s credibility has taken a major knock. However, Gama’s shares are now only trading on 2018 forecast PE ratio of 7.5, the company has 25p a share of net cash on the balance sheet, there’s a progressive dividend policy (the board declared a 2.75p a share payout in 2017), and the company should now be in a position to return to growth in 2019 following investment made in both its US and European operations. Furthermore, the shares are massively oversold with the 14-day RSI on the floor, the share price has tested a major support around the 105p level, and is 40 per cent below its 200-day moving average. A technical rally at the very least is likely, and possibly more.

So, if you are holding onto your Gama shares, I would continue to do so as I feel they have recovery potential from this depressed level. Hold.

■ Simon Thompson's new book Successful Stock Picking Strategies 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 and is priced at £16.95 plus £2.95 postage and packaging. Simon's second book Stock Picking for Profit has been reprinted and is available to purchase 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. Details of the content of both books can be viewed on www.ypdbooks.com.