Chief executive Phil Walker of Pennant (PEN:84p), an Aim-traded supplier of products and services that train and assist engineers in the defence and civilian sectors, was pretty confident that his company would deliver a strong rebound in profits in the second half when I interviewed him at the time of the half-year results (‘Pennant on track for strong second-half profit recovery’, 24 Sep 2019).
True, contract delays and timing of revenue recognition on major work programmes led to a pre-tax loss of £1.8m for the first six months of 2019 on revenue down 45 per cent to £7.25m. However, Pennant has £12.75m of work slated for delivery in the second half of this year, which analysts estimate will produce a pre-tax profit of £3.6m. Bearing this in mind, £7m of that second-half revenue figure is set to come from a contract to supply training aids in the Middle East. Therefore, it’s reassuring that the directors confirmed that all four training devices achieved acceptance for Pennant’s Qatar programme, thus enabling the associated revenue and profit to be recognised in the current financial year, and two further devices are on schedule for acceptance testing in December 2019.
Furthermore, Pennant has been awarded a major new contract by a UK original equipment manufacturer (OEM) valued at £3.4m for the design and build of a helicopter maintenance training aid to enable UK military training on ‘anti-surface’ weapons systems. The contract is an engineered-to-order programme, whereby revenue will be recognised on a ‘percentage of cost completed’ basis, as the programme runs across 2020 and 2021, with final acceptance due in the fourth quarter of 2021.
This takes Pennant’s total order book up to £40m, a figure that excludes a significant contingent contract (worth £28m in revenue over three years, according to Mr Walker) for the design, build and delivery of training equipment to the Ministry of Defence (MoD). Pennant was down-selected as supplier of training solutions by the US prime contractor in 2018, but the contract start date was pushed back to 30 June 2020, a contributory factor in the first-half loss as Pennant was carrying an additional £1m costs in preparation of work commencing.
It’s worth noting, then, that Pennant has achieved £430,000 of annualised operational cost savings, and is aiming to make a further £170,000 in savings, all of which will be seen in the 2020 budget. Factoring in these cost savings, and a budgeted record contribution of £6.6m of revenue from Pennant’s integrated logistic support (ILS) division, WH Ireland is predicting Pennant will produce 2020 revenue of £22.3m, pre-tax profit of £3m and earnings per share of 7.7p. The contribution from ILS reflects valuable long-term contracts with the Canadian and Australian defence departments to use Pennant’s Oracle-based software product that reduces the support cost of major capital equipment.
Taking into account the latest contract win, Pennant's contracted order book now covers around 60 per cent of next year’s revenue budget. However, if Pennant lands a £5m contract to supply trading aids to a new academy in Saudi Arabia that is scheduled to open in September 2020 – the prime contractor is a longstanding partner of Pennant – and three other smaller government contracts worth £2m that were deferred until 2020 due to budgetary issues, then order book cover rises above 90 per cent, thus derisking 2020 forecasts even further. Also, the £3.6m of revenue that Pennant expects to earn in 2020 from a contract to provide electro-mechanical trainers and computer-based training for the Ajax fighting vehicles to the British Army doesn’t factor in a likely [multi-million pound] increase in its overall value in light of the contract’s rescoping.
Pennant's shares have rallied since September's interim results, but still only trade on a 2020 price/earnings (PE) ratio of 11. That's a modest rating and one that offers 50 per cent plus upside to my short-term target price of 130p, and even higher still if work on the aforementioned delayed contingent contract starts next year as planned. On a bid-offer spread of 82p to 86p, I rate the shares a buy.
■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £3.25 [UK]. Postage and packaging is only £3.95 for purchases of both books.
Details of the content of both books can be viewed on www.ypdbooks.com. They include case studies of Simon Thompson’s market beating Bargain Share Portfolio companies outlining the investment characteristics that made them successful investments. Simon also highlights many other investment approaches and stock screens he uses to identify small-cap companies with investment potential, too.
Simon Thompson has been named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards, a prestigious event celebrating the best and rewarding the finest professionals and companies that work within the AIM and NEX communities. It is attended by institutions, fund managers, brokers and advisors operating in the sub-£100m market cap quoted company sector.
