Three under-the-radar recovery plays

That was certainly the case with small-cap niche packaging engineering business Mpac when I suggested  investors were underestimating both the likely pick-up in second-half orders as lockdown restrictions eased (thus reducing the 2020 profit shortfall) and potential for a stronger than forecast earnings rebound in 2021 (‘Deep value buys’, 13 July 2020). That call has played out neatly, which is why Mpac’s share price has almost doubled even though its pre-tax profit declined by ‘only’ 16 per cent in 2020, far less than pessimists had been factoring in. The other dynamic I feel is likely to come into play is earnings multiple expansion as more investors cotton on to Mpac’s robust growth prospects and higher levels of profitability as operating margins expand. With the shares rated a third below sector peers on a price/earnings (PE) basis, that is simply not in the price.

Corporate broker Cenkos Securities is another recovery play that’s exhibiting similar characteristics. At the current entry point, the shares are priced for a highly profitable outcome, too.

Mpac’s growth potential prompts upgrades

• Closing order book up 6 per cent year on year
• Second-half order intake surges 75 per cent
• Free cash flow of £10.3m and strong net cash position to fund further acquisitions

Annual results from Mpac (MPAC:510p), a small-cap niche packaging engineering business that offers customers digital solutions for artificial intelligence-enabled equipment and robotics in their production facilities and warehouses, have prompted analysts to push through hefty target price upgrades. They are more than justified. In fact, I am following suit, raising my target price to 600p (550p previously), in line with Equity Development’s new fair valuation (445p), but shy of house broker Panmure Gordon’s new target of 650p (550p).

Mpac’s focus on higher-margin health and personal care, pharmaceutical and food & beverage market segments, a strong international footprint (88 per cent of customer revenue is generated overseas) and exposure to secular tailwinds (automation, e-commerce and the use of recyclables and biodegradable materials in packaging) are all driving a strong recovery. The Covid-19 pandemic is also accelerating the move by manufacturers to use robotics. These dynamics explain why order intake was 75 per cent higher in the second half of 2020 than in the previous six months, and the closing order book of £55.5m was 6 per cent up year on year. Importantly, no orders have been cancelled and only a few are still on hold.

Moreover, last autumn’s $13.3m (£10.2m) acquisition of Ohio-based Switchback is performing far better than management had expected. Switchback’s product offering adds breadth to Mpac's carton and end-of-line solutions, and the business provides access to a wider potential customer base to build sales in North America (56 per cent of group revenue). The US economy is surging ahead, one reason why Mpac booked significant fourth-quarter orders.

Mpac’s board remains on the hunt for more acquisitions, and has the firepower to do so. Buoyed by bumper annual free cash inflow of £10.3m, Mpac’s net cash position (excluding £4.2m of lease liabilities) only dipped from £18m to £14.6m last year, despite spending £10.3m on the Switchback acquisition.

Having pushed through three earnings upgrades since last autumn, Panmure Gordon expects 2021 underlying pre-tax profits to increase to £8m, up from £6.3m in 2020 and exceed the 2019 high water mark of £7.5m, based on revenue rising 16 per cent to £96.9m. On this basis, expect adjusted earnings per share (EPS) to increase 15 per cent to 36.1p. Mpac’s forward PE ratio of 14.1 compares favourably with the UK engineering sector average of 20.8 even after factoring in the group’s pension deficit.

In addition, Mpac is well on course to lift operating margins to 10 per cent over the medium term, so there is scope for earnings multiple expansion as EPS increases, driven by the twin factors of rising profitability on higher sales and recycling surplus cash into complementary acquisitions. Panmure’s forecast is based on an 8.5 per cent operating margin, up from 7.8 per cent in the 2020 financial year.

Mpac’s share price has more than trebled since I included the shares, at 156p, in my market-beating 2018 Bargain Shares portfolio, and is slightly higher than when I covered the pre-close trading update (‘Three high growth small cap plays, 11 January 2021). My 600p target still values the equity on a 20 per cent ratings discount to the UK engineering sector average. Buy.

Cenkos makes hay in small-cap bull market

• Underlying pre-tax profit almost trebles to £4m
• Healthy pipeline of corporate transactions for 2021
• Dividend hiked 17 per cent to 3.5p a share

Corporate broker Cenkos Securities (CNKS:77.5p) almost trebled its underlying pre-tax profit to £4m last year on 23 per cent higher revenue of £31.9m, highlighting the operational leverage of a business that benefits from a relatively low fixed cost base and a remuneration structure highly geared to performance.

The headline figure excludes one-off costs of £0.7m as the board completed its headcount reductions as part of a restructuring plan which has now cut £3m from the annualised fixed cost base. There was also a £0.9m charge for a one-off incentivise and retention plan for key members of staff that was funded using shares already held by the Cenkos’ Employee Benefit Trust.

The strong bull market in small-cap stocks has clearly been beneficial for Cenkos which raised £944m for clients, up from £644m in 2019, across 29 corporate transactions including four IPOs. Corporate finance fee income of £22.3m was 28 per cent higher year on year. Three-quarters of the broking house’s 94 corporate clients are listed on Aim and Nomad, and broking and research fees chipped in £6.2m. As one would expect, market-making income has soared, up 75 per cent to £3.5m – a reflection of the high volumes of trading, a trend that has continued into 2021.

Outgoing chief executive and co-founder Jim Durkin notes the firm has a healthy pipeline to build on last year’s performance, so his replacement, Julian Morse, formerly head of the Growth Companies Team, has a decent platform to build on. Last month Cenkos raised £100m for safety and regulatory compliance specialist Marlowe (MRL).

The possibility of another year of growth is simply not being priced in even after the holding has produced a 37.5 per cent total return since I included the shares, at 56p, in my market-beating 2020 Bargain Shares portfolio. That’s because the company’s bumper cash pile of £32.7m (57p a share) backs up almost 75 per cent of its £44m market capitalisation, effectively meaning that an operational business benefiting from substantial operational leverage and a reduced cost base is priced on less than three times 2020 pre-tax profit. The 17 per cent hike in the 2020 payout to 3.5p a share is another attraction for income seekers looking to lock into a 4.5 per cent dividend yield. Since listing on Aim in December 2008, the board has paid out 178.3p a share, highlighting the importance of rewarding its shareholder base.

It’s not beyond the realms of possibility that given Cenkos’ solid cash backing, the positive equity market environment, and potential for profit growth in 2021, the share price could rally a further 50 per cent to 120p, the high water mark in 2017 and 2018. A chart breakout above the March 2021 high of 81p would be a significant technical buy signal and one worth following. Buy.

A Brexit winner

• 2020 pre-tax profit surges 38 per cent to £7.2m on modestly higher revenue of £221m
• Pall-Ex franchise reports record volumes in March 2021
• Benefiting from greater post-Brexit administration to transport freight across Europe

Braintree-based international freight management services group Xpediator (XPD:59p) has more than justified my decision to initiate coverage, at 45p (Alpha Report: Profit from a Brexit winner’, 19 February 2021).

The group shrugged off some initial weakness following the outbreak of the Covid-19 pandemic to recover strongly in the second half and deliver a robust fourth-quarter result. Operating from 38 offices in the UK and nine central and Eastern European (CEE) countries, Xpediator offers more than 14,000 clients integrated freight management within the supply chain logistics and fulfilment sector in three main areas: freight forwarding, logistics and warehousing, and transport services. Demand for these services is well-underpinned in Xpediator’s key markets – the Baltic states and CEE account for 63 per cent of revenue –which offer superior growth prospects compared with the rest of Europe.

Lithunia, Bulgaria, Serbia and Estonia were standout performers in freight forwarding. Accounting for 61 per cent of group profit, the division is benefiting from increased online customer demand and upside from consolidation of new service lines. Another eye-catching contributor is the group’s Pall-Ex (Romania) franchise, a fast-growing palletised freight distribution network offering 24-hour delivery across the country. Average monthly pallet volumes increased 13 per cent to 68,000 in 2020, and hit a record 87,000 last month.

Although there has been post-Brexit disruption for hauliers transporting freight, this is playing into Xpediator’s hands as the group has been winning additional business to help clients deal with the post-Brexit administration and compliance required to transport freight across Europe. Moreover, as the UK agrees more trade deals with countries outside the EU, this will have a positive impact on demand for freight volumes at key ports handling non-EU trade, Felixstowe and Southampton being two major ones. Xpediator has a presence at both and planned expansion and rationalising of its facilities at Southampton could reap £0.25m to £0.5m of annual cost savings, notes chief executive Robert Ross.

Xpediator is a consolidator in a fragmented sector, having made six acquisitions since IPO in August 2017. Last autumn’s earnings-enhancing acquisition of Ripon-based international freight forwarder and operator, Nidd Transport, was an absolutely cracking deal. Nidd's focus on western Europe not only complements Xpediator's focus on CEE, Italy and Germany, but the directors have already recouped the £4.6m outlay and retain a business making £0.5m operating profit. Ross highlights an active pipeline of acquisition opportunities to deploy some of the £6.8m (4.8p a share) net cash pile . A new £18m bank facility is in place, too.

Ross is confident of achieving house broker Cenkos Securities’ 2021 pre-tax profit forecast of £7.7m. It looks an easy beat from my lens given that £0.5m of operational savings will benefit the 2021 result, and Xpediator sold off its business-to-consumer logistics service EshopWedrop at the tail-end of 2020, thus removing a further £0.35m of operating losses.

On a cash-adjusted forward price/earnings (PE) ratio of 11, offering a 2.5 per cent dividend yield and with the earnings risk skewed to the upside my 70p target price is looking increasingly conservative. Buy.

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