Pennant (PEN:34.5p), an Aim-traded supplier of products and services that train and assist engineers in the defence and civilian sectors, delivered the annual results I had previewed a few months ago (‘Follow the insiders’, 24 February 2020). However, the share price has been hit on concerns relating to the Covid-19 impact on the company’s operations. They are being massively overplayed.
For starters, Pennant has key worker status so has been able to work on its defence contracts and has seen minimal disruption through the lockdown. In particular, the company has two valuable government contracts with the Canadian and Australian defence departments to use its Oracle-based OmegaPS software product that reduces the support cost of major capital equipment. These contracts are worth £6m in annual revenue.
In addition, the company has repurposed its longstanding contract to provide electro-mechanical trainers and computer-based training for the Ajax fighting vehicles to the British Army. The contract value has increased by £1.5m to £13.5m, of which £3.4m is scheduled for delivery this year. Pennant also won a £3.4m award last autumn to design and build a full-size representation of a training aid for Leonardo Helicopters, of which £2m is deliverable this year. Add to that a raft of smaller contracts and the scheduled 2020 order book for delivery is £16.3m, or half the total order book of £33m, and representing a high proportion of the £20.4m of revenue Pennant reported in the 2019 financial year.
Moreover, contracted revenue excludes a contribution from the recent earnings enhancing acquisition of Absolute Data Group (ADG), a Brisbane-based software company that complements Pennant’s existing OmegaPS software business. ADG helps its client base (military aviation, commercial aerospace, and marine, rail, nuclear and automotive sectors) to manage vast quantities of maintenance and training data. Bearing this in mind, chief executive Phil Walker informed me during this morning's results call that ADG has an order book worth A$2m to A$3m (£1m to £2m), and has been “exceeding our expectations”, noting some significant live cross selling opportunities.
Pennant’s contracted order book also excludes any contribution from a potential award (at the final stages) to supply a generic suite of training aids (contract value of £5m of which £3m could be delivered in the second half of 2020) with an existing client in the Middle East, nor any contribution from a contingent award (worth £28m over three years) for the design, build and delivery of training equipment to the Ministry of Defence (MoD). Mr Walker is confident that the huge contingent contract will commence in the third quarter of 2020 as planned, albeit it was pushed back from last year, the reason why the company reduced net operating costs by £600,000.
It’s also worth noting that although Pennant ended 2020 with net debt of £2.2m, it is refinancing its banking lines to increase its facility from £3m to £4m, and has renegotiated £4m of milestone payments (previously loaded to the back end of contracts) on two major awards, of which £3m will be paid in the first half of 2020. Furthermore, Mr Walker says that the company has stripped costs back to realign them with contracted revenues only (it has furloughed 44 of its 120 UK staff) in the short-term. There has been little impact on the manufacturing side of the business to date as the contracts it is delivering in the first half are not yet at the production stage. That’s worth noting.
Admittedly, there is execution risk on the Ajax and Leonardo contracts, but management will be having discussions with the clients later this week. However, what’s clear to me is that Pennant’s strategy is the right one to trade through the lockdown, and with the benefit of strict working capital and cost management, and likely conversion of the two aforementioned contracts, the company is in a far better shape than the market is giving it credit for. I still expect a recovery in underlying pre-tax profits and earnings per share this year, although not the two thirds increase to £2.7m and 6.9p that analysts had expected prior to withdrawing their forecasts last month in light of the Covid-19 uncertainty. The £12.5m market capitalisation company is very undervalued. Recovery buy.
Brand Architekts funded to trade through the crisis
Brand Architekts (BAR:135p), an Aim-traded beauty brands business that has developed a portfolio of beauty product brands is well placed to trade through the Covid-19 crisis.
More than 90 per cent of the company’s sales are made through groceries and pharmacy retailers, both of which continue to trade through the UK lockdown, although international sales to general merchandise and department store customers have been impacted. Online sales have risen sharply, and management is stepping up marketing efforts to tap into this growth segment. Importantly, all bar one of its UK suppliers remain fully operational, and suppliers based in China have returned to normal activity.
True, there has still been a significant impact on sales, but this is being offset by reining in discretionary expenditure, postponing new hires, and the board taking a 20 per cent pay cut until the end of the financial year. Excess working capital is unwinding – net cash has increased from £15.1m to £17.8m (104p a share) since the interims – and there are no bad debt issues as the customer base is made up of major retailers who are experiencing strong cash flows through the lockdown. Net cash could still grow to £19m (111p) by the end of June.
The bumper cash pile means that the directors have ample firepower to target earnings-accretive acquisitions in what is a buyers’ market. The recruitment of finance director, Tom Carter, completes the new boardroom, and it looks a decent hire, too, given his experience at Alliance Boots, and Procter and Gamble.
So, with the brands business in the price for £4m even though it reported first-half underlying operating profit (pre-central costs) of £1.6m, and the shares offering 33 per cent upside to my 180p estimate of fair value, the constituent (at 155p) of my 2020 Bargain Shares portfolio remains on my buy list.
Driver’s Covid-19 action plan
Driver (DRV:41.5p), a consultancy that provides clients in the construction and engineering sectors with specialist commercial management, planning, programming, project management, and dispute resolution support services, has guided investors to expect profits for the six months to 31 March 2020 to be significantly ahead of the previous year. The results will also be in line with internal budgets which were based on full-year adjusted pre-tax profits rising from £3m to £3.7m on revenue of £59.9m to lift EPS from 4.8p to 5.4p.
The pipeline for April and May is “encouraging”, too, but the board is taking a cautious approach in light of Covid-19 economic downturn in case customer behaviour changes in the future. Prudently, the directors have postponed all non-essential operational and capital expenditure, decided to pass the interim dividend and taken a 20 per cent pay cut. Importantly, Driver’s balance sheet is robust. Current assets of £27.7m were more than double total liabilities of £12.1m at the 2019 financial year-end, and the company currently has net cash of £3.3m and access to a £3m revolving credit facility.
I would also flag up that Driver’s dispute resolution business should do good business in the downturn. Priced in line with book value, the laggard of my market beating 2019 Bargain Shares Portfolio is a recovery buy.
Finally, at the end of last week, I published a column highlighting several other small-cap buying opportunities.
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