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Poised for a profitable recovery

An Aim-traded supplier of products and services that train and assist engineers in the defence and civilian sectors is winning new orders, has cut costs and moved back into profit.
Poised for a profitable recovery
  • Order book up from £22mn to £32mn since start of 2022 with £13mn scheduled for recognition this year
  • Post year-end disposal of surplus property for £2.1mn to slash borrowings
  • Cash neutral position forecast at year-end

Pennant (PEN:36.75p), an Aim-traded supplier of products and services that train and assist engineers in the defence and civilian sectors, is now delivering a sustainable move into profit on the back of a growing order book.

In March 2022, the group was formally awarded a £8.8mn contract by Boeing to supply simulated training systems for the British Army’s new 50 Apache AH-64E helicopter fleet. Chief executive Phil Walker says that £1.8mn of the award will be delivered this year, a further £4.5mn in 2022 and £2.5mn in 2024. Walker also points out that Pennant is gaining real traction from the 2020 acquisition of Absolute Data Group (ADG), a Brisbane-based software company that assists clients to manage vast quantities of maintenance and training data (military aviation, commercial aerospace, and marine, rail, nuclear and automotive sectors). 

ADG not only earns a high margin (90 per cent gross margin on software license sales, and 50 per cent on maintenance work), but is enabling Pennant to grow beyond its defence base and widen its geographic footprint, too. Recent awards include a $1.8mn (£1.44mn) contract with a new customer in the North American commercial aerospace market. 

Since the start of the year, the software and services business has grown its annual revenue by 25 per cent to £7mn and Pennant is in “active dialogue with seven major operators across commercial, shipbuilding, space and rail industries.” Around 80 per cent of divisional revenue is recurring, including valuable government multi-year awards with both the Canadian and Australian defence departments to use Pennant’s Oracle-based OmegaPS software product (reduces the support cost of major capital equipment).

The momentum could be seen in the second half of last year when Pennant reported a small underlying operating profit of £0.2mn, so reversing a first half operating loss of £1mn which reflected the impact of a legacy contract with the MoD. That contract is expected to complete by September with no further financial impact anticipated. Furthermore, having taken £0.9mn costs out of the business, Pennant is now in leaner shape, hence why house broker WH Ireland expects last year’s adjusted pre-tax loss of £0.8mn to turn into a pre-tax profit of £0.6mn on six per cent higher revenue of £17mn.

The balance sheet is strengthening, too, as a surplus freehold warehouse and office property located in Cheltenham is being sold for £2.1mn, or 40 per cent above book value. Cash inflows from contract assets and property sale proceeds should move the group into a cash neutral position by the year-end, thus wiping out net debt of £3.5mn. Also, Walker expects to rationalise a further six freehold properties worth a combined £3.1mn, so there is potential for more disposals as the cost base is realigned to reflect higher levels of remote working.

The disposal of the Cheltenham property alone will wipe a further £0.25mn of annual overheads, adding further weight to WH Ireland’s forecast that pre-tax profit will rise to £1mn on revenue of £18mn in 2023. Reassuringly, Pennant already has £12.9mn of orders booked for delivery in 2023. It’s worth noting, too, that £6.7mn of unused tax losses will benefit future taxable profits and accelerate the earnings recovery. 

Pennant’s share price has risen five per cent since my last buy call (‘Pennant’s recovery on track’, 25 January 2022), highlighting strength relative to the FTSE Aim All-Share Total Return index which has lost 12 per cent of its value in the same four-month period. Expect the outperformance to continue. In fact, if contract momentum continues to build, as seems highly likely, then Pennant could even move into an earnings upgrade cycle, a possibility that is certainly not embedded in the group’s modest £13.5mn market capitalisation nor a 2023 price/earnings (PE) ratio of 14. Buy.

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