The contract momentum at Pennant (PEN:130p), an Aim-traded supplier of training and support products and services that train and assist engineers in the defence and civilian sectors, shows no sign of abating.
At the start of October, the company landed a £10.2m contract to supply training aids (mainly off the shelf equipment) to a Middle Eastern customer. The majority of revenue will be recognised in the 2019 financial year, which means that over 90 per cent of house broker WH Ireland's revenue estimate is already covered. The news gets better as the Canadian government has just awarded the company a new consulting services contract for the use of Pennant’s OmegaPS suite of software that provides analytics around logistics support and asset life cycles and is the product of choice for The Canadian Department for National Defence.
The contract is for an initial two-year term with an option to extend it until November 2023. The value of the two-year framework agreement is C$11.9m (£7m), rising to C$30m (£17.7m) if extended for five years, representing a 50 per cent increase on the previous contract Pennant was awarded.
In addition, Pennant has secured an initial order (undisclosed value at this stage) from a new customer (a prime rail car builder) for the provision of technical documentation services, an area in which the company has extensive experience and developed a well-established reputation.
Moreover, Pennant is making “good progress in negotiations relating to a potential contract for the design, build and delivery of training equipment for which it has been down-selected”. It is anticipated that the (undisclosed) customer will formally award the contract either later this year or in the first half of 2019. The potential value of the contingent contract is £25m to £30m, deliverable over 2019, 2020 and 2021. If landed this would almost double Pennant’s order book to £70m. It’s worth noting that analysts have not factored in any contribution from this massive contingent contract in their conservative looking 2019 pre-tax profits and EPS estimates of £3.65m and 10p, respectively, based on annual revenues of £21.3m.
The contract momentum is unlikely to slow anytime soon given that industry drivers are very supportive. 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’s cash-rich balance sheet providing the funding to deliver on the raft of contract wins, and the shares rated on a 2019 forward PE ratio of 13 and earnings upgrades highly likely, then I remain very positive on the investment case. I first suggested buying the shares, at 109p, in my August Alpha Report ('Pennant International: Poised for a return to growth', 13 Aug 2018), and maintain my 180p target price. Buy.
Mission Marketing de-gears its balance sheet
UK advertising and marketing specialist The Mission Marketing Group (TMMG:57p) is selling its BroadCare business, part of the group's Fuse innovation incubator, for a cash consideration of £4.4m, a sum representing nine times its profit contribution in the 2017 financial year. BroadCare is a comprehensive tracking and reporting system specially designed for managing all aspects of NHS-funded continuing healthcare. The rationale for the disposal is that having developed the business to this point Broadcare’s future growth potential will be easier to realise within an organisation already providing a wide range of services to the NHS.
I regard this as a positive development as it not only highlights the board’s ability to crystallise significant value from internally developed intellectual property, but the sale proceeds will be used to materially deleverage the group’s balance sheet. Indeed, analyst Roddy Davidson at house broker Shore Capital estimates year-end closing net bank debt of £4.5m, or just 0.4 times annual cash profits, falling to £896,000 at the end of 2019 and a net cash position of £3.9m at the end of December 2020.
Moreover, Mr Davidson rightly points out that the sale of Broadcare highlights the latent value of other assets within Mission Marketing Group’s Fuse incubator – in particular, its Pathfindr asset tracking and intelligence platform which has already secured global business with a number of corporate clients, most notably Rolls-Royce, has applications across several industries (including aerospace, energy and construction), and had been “gaining real traction” at the half-year stage. The rest of the group’s agencies are performing well, too, which is why earnings per share (EPS) should rise by a fifth to 8.6p in 2018 and support expectations of a 2p a share payout.
Furthermore, with cash generation improving no end – last year cash profits of £9.9m generated £9.1m of free cash flow – and borrowings set to be negligible at the end of next year, then predictions of a 10 per cent hike in the dividend per share to 2.2p in 2019, covered by EPS estimates of 9.1p, look well founded. On that basis, The Mission Marketing Group’s shares are trading on a PE ratio of 6.2 for 2019, offer a prospective dividend yield 3.8 per cent and are priced 42 per cent below net asset value (NAV) of 98p. That’s an incredibly harsh rating for a business that has: developed a reputation for innovative and effective creative work based on a collaborative approach across its 16 agencies; boasts an impressive roster of long-standing blue-chip clients (35 per cent of its 1,100 clients have been customers for at least a decade), which is being driven by a strong management team that has increased EPS at a compound annual growth rate of 14 per cent since 2010, and doubled the dividend since 2013.
I highlighted the investment potential of The Mission Marketing Group during the market rout when it was possible to buy the shares around the 53p mark (‘Alpha Company Research: Simon Thompson’s latest bargain buy’, 11 Oct 2018). Since then analysts have raised their dividend forecasts sharply, a reflection of the improving cash-flow generation, and have slashed their borrowing forecasts. I maintain my 100p target price. Buy.
Lighthouse a beacon of value
I included shares in financial services group Lighthouse (LGT:25p) in my June Alpha Report at 29p ('Alpha Company Research: Simon Thompson looks to profit from the right advice', 6 Jun 2018), and my target price of 40p was achieved in mid-summer.
Even though the share price has retreated from the 30p level since I covered the half-year results (‘Profit from growing affinity towards Lighthouse’, 4 Sep 2018), this is in no way a reflection of the company’s operational performance. In fact, Lighthouse has recently won a new three-year agreement with The National Education Union, the fourth-largest trade union in the UK and one with more than 450,000 members, of which three-quarters are members of the National Union of Teachers (NUT). Lighthouse didn’t previously offer financial advice to NUT members, so this is a significant new distribution channel to tap into for its 400 independent financial advisers (IFAs).
Lighthouse has also renewed its contract with British Airways Club and the Bakers, Food and Allied Workers Union. These renewals highlight the solidity of Lighthouse’s affinity relationships. Indeed, the company now offers its services to over 6m members belonging to 21 trade unions and major organisations in the UK.
Prospects for Lighthouse’s fast-growing fund management business, Luceo Asset Management, have gained further traction since my last article. In fact, the company has just made a £1m Strategic Investment in Aim-traded Tavistock Investments (TAVI:3.6p) to give it a 5.3 per cent stake in the financial advisory and fund management business.
Lighthouse currently advises clients with assets in excess of £5bn and on new investment and pension flows of around £1bn a year. The Strategic Agreement will enable Lighthouse’s advisers and clients to access Tavistock's investment solutions, including its capital protection fund products that are principally invested in iShares by BlackRock and guaranteed by Morgan Stanley, all of which are managed to the client's agreed risk profile. Tavistock also has an existing model portfolio service and risk-progressive Acumen fund range, again managed to the client's agreed risk profile. These funds will now be available as part of Lighthouse’s Luceo range of investment solutions (which launched in 2016) to accelerate Lighthouse's strategy of expanding its fund range.
It’s a timely investment as Tavistock appears to be at an inflexion point, having almost trebled funds under management in the past two years to £941m, the benefit of which was seen in the results for the six months to the end of September 2018 when Tavistock increased underlying cash profits by three-quarters to £516,000 on revenues of £14m.
So, with Lighthouse on course to increase pre-tax profits from £2.5m to £2.7m in 2018 to produce reported EPS of 2.1p, and close this year with a £9.1m cash pile worth 7p a share, I feel that the shares continue to offer very decent value on a cash-adjusted PE ratio of nine. For good measure, investors can expect the payout per share to be lifted from 0.42p to 0.6p, so the 2018 prospective dividend yield is 2.4 per cent, rising to 2.8 per cent in 2019 based on a 0.7p a share anticipated dividend. Buy.
Oil price fall creates value opportunities
The 26 per cent slump in the West Texas Intermediate crude oil price from US$76.56 at the start of October to US$56.76 per barrel has put considerable pressure on share prices in the oil sector. Trinity Exploration & Production (TRIN:12p), an independent oil and gas exploration and production company focused solely on Trinidad and Tobago, is no exception.
Clearly, the oil price reversal isn’t helpful, but the investment case I made 11 weeks ago still holds (‘Resurrection points to a strong recovery’, 3 Sep 2018). That’s because it is predicated on Trinity ramping up low-cost production, specifically from its onshore wells which accounted for 1,530 of the 2,771 barrels of oil per day (bopd) output in the first half of 2018, and at an operating break-even cost of just $15.70 per barrel.
A third-quarter trading update confirmed that Trinity exceeded 3,000 bopd in October, and is on course to spud the final two wells of this year’s six well campaign by the year-end, setting it up nicely to continue to expand production next year. The debt-free company retains a cash balance of US$17.6m (£13.8m), equating to 30 per cent of its market capitalisation of £46.4m, part of which is being recycled into its profitable onshore drilling programme.
Importantly, house broker Cenkos Securities’ 2019 revenue forecast of US$72.2m was based on an average 2019 realised WTI crude price of US$63.38 a barrel, and not last month’s US$76.56 high, albeit it’s now 10 per cent above the median WTI futures price for 2019 deliveries. However, the lower oil price means Trinity will pay less Supplemental Petroleum Tax (SPT), which is charged at a rate of 18 per cent and 33 per cent on net revenues (gross revenue less royalties less incentives) on onshore and offshore assets, respectively, when realised oil prices are higher than $50 a barrel. Trinity receives a 20 per cent discount for its mature offshore fields through a SPT Sustainability Incentive, and the same discount for its onshore fields through the SPT Investment Tax Credit. That softens the blow as does a nil corporation tax charge to reflect the benefit of past tax losses.
My models suggest that Trinity should realistically be able to make 2019 post-tax profits of £5m based on the median WTI future oil price for 2019 delivery and using an average exchange rate of £1:US$1.28. This means that net of its cash pile Trinity’s shares are rated on a PE ratio of six. They are also priced almost 70 per cent below risked net NAV of 38p a share based on 2P proven reserves of 23.18m barrels and cash in the bank.
So, although the massively oversold shares are likely to remain volatile in the near term, my medium-term investment case still holds and I feel the risk:reward ratio is skewed to the upside at this depressed level. Buy.
■ 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.
