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Riding positive earnings cycles

Our small-cap stock-picking expert has been targeting technology focused companies in positive earnings cycles, and successfully so
July 21, 2022

The FTSE SmallCap Technology index may have shed 41 per cent of its value in the first six months of 2022, but that’s not to say all technology companies have suffered in the savage bear market environment. Indeed, to skew the odds of a profitable outcome, I have been seeking out companies in earnings upgrade cycles.

For example, in the second quarter, I produced lengthy analyst reports for IC Alpha subscribers on Aim-traded fintech payments group Equals (EQLS:94.5p), and Brave Bison (BBSN:2.25p), a London-based social and digital media company that has undergone a dramatic transformation since a board room clear-out two years ago. Equals upgraded guidance earlier this month (‘First amongst Equals’, 6 July 2022), hence the 20 per cent share price gain since I first suggested buying (Alpha Research: ‘A high tech fintech payments opportunity’, 8 April 2022).

Brave Bison's share price performance is even better, rising 23 per cent since I initiated coverage (‘Alpha Research: A social marketing profit play for the digital age’, 10 May 2022). The small-cap company has upgraded guidance, too, and released a bullish first-half pre-close trading update that suggests the earnings momentum has some way to run.

 

Brave Bison upgrades guidance

  • First-half operating profit up 200 per cent to £1.2mn on 101 per cent higher revenue of £14.7mn
  • Net cash up 66 per cent to £4.8mn in the past 12 months
  • Analysts upgrade full-year pre-tax profit forecasts by 10 per cent to £2.2mn

Brave Bison’s outperformance reflects a combination of a restructuring by its experienced management team that has significantly reduced the cost base, upside from astute acquisitions to scale up the business, and a digital focus that is driving organic growth across four pillars: search engine optimisation (SEO); social advertising; transactional websites and platforms; and a portfolio of owned and operated social channels.

The group is unique in that it is both a digital media owner, as well as a digital media agency, acting as a broadcaster for the digital age: publishing content on its own channels like The Hook (on Instagram), The Wave House (on TikTok) and Slick (on Snapchat), and on behalf of channel partners like PGA Tour and US Open (on YouTube). Brave Bison also buys media across advertising platforms such as Google, and Facebook, as well as directly from creators, and manages transactional platforms for customers. In total, the group operates over 700 social media content channels which delivered 1.74bn average monthly views from 164mn total followers and subscribers in 2021.

The digital focus is a key differentiator. That’s because digital advertising is now the dominant medium for advertising, accounting for two-thirds of global advertising revenue, according to GroupM, with mobile adoption a key driver as more people purchase smart devices. This means that Brave Bison’s focus on online video and social media advertising will benefit from ongoing structural underlying growth even if the overall advertising market is impacted by a global economic slowdown. Analysts at Zenith forecast that these two segments will generate average annual revenue growth of at least 14 per cent until 2024.

In fact, the ongoing economic slowdown is likely to accelerate the shift away from traditional advertising methods towards digital channels where it is much easier to demonstrate how marketing campaigns are driving client sales. In the first half, the group won two notable contracts (worth £1.7mn of revenue in 2022) and added new accounts with Rapyd, Asus, Lloyds Direct, Paperchase and the World Economic Forum. Moreover, the launch of a new Brave Bison trade brand is driving customer cross-selling opportunities, both Rapyd and Autoglym, another new client, are now using services from multiple divisions across the business.

House broker Cenkos Securities has taken note, raising its full-year adjusted pre-tax profit estimate by 10 per cent to £2.2mn on expectations that annual revenue will rise 35 per cent to £29.2mn. Brave Bison has over £50mn of historical tax losses (a result of previous management failure) that can be used to offset tax liabilities on future profits, so more cash flow can be recycled back into the business to support organic growth initiatives as well as further bolt-on acquisitions. Cenkos expects the group to generate £1.8mn of cash from operations this year and is pencilling in net cash of £5.9mn (6p a share) at the year-end, up from £4.8mn at the end of the first half. 

On this basis, net of cash on the balance sheet, the £24.9mn market capitalisation company is priced on nine times forecast post-tax profits this year, a deep discount to sector peers. My 3p a share target price could prove conservative. Buy.

 

Dial into Fonix’s free cash flow yield

  • Annual cash profit rises 16.3 per cent to £10.3mn and pre-tax profit likely to be up 17 per cent to £9.7mn
  • Analysts forecast 8 per cent cash profit growth in 2022/23 financial year
  • International expansion under way

The fact that Fonix Mobile (FNX:158.5p) has emerged unscathed from this year’s technology sector crash is testament to the strength of a business that continues to outperform management’s expectations. The group’s main business is a mobile payments service that enables merchants to charge customers' mobile phone bills for products or services. Effectively, carrier billing turns the mobile device into a cash register while offering convenience for consumers.

In the 12 months to 30 June 2022, Fonix increased total payment volumes by 11 per cent to £258mn, a reflection of organic growth across all verticals and the contribution from 12 new client additions. The group now has 123 active corporate customers who use its payment processing platform as an alternative to traditional cash transactions which have a high cash processing cost.

By providing an alternative payment method to consumers who may otherwise forgo purchasing, Fonix’s payment platform is an important customer acquisition tool, too, acting as a product differentiator to traditional payment methods, such as credit cards or ApplePay. Importantly, the group has experienced no churn from major clients in the past six years, so enjoys a high level of recurring revenue.

Furthermore, a focus on more profitable verticals, such as payments for car parking, cinema tickets, pay-and-go gyms, gaming and even public transport, continues to drive profit margins higher. Fonix’s gross profit increased from 4.9 to 5.1 per cent as a proportion of total transaction value, thus driving both gross profit and cash profit up 16 per cent to record levels (£13.2mn and £10.3mn, respectively). Cash profit was £0.2mn above house broker finnCap’s expectations even though analysts at the firm had already pushed through a 5 per cent upgrade in January 2022.

The business is hugely cash generative, too. Analysts at finnCap estimate the group produced annual free cash flow of £7.7mn (7.7p a share), a sum that easily covers a forecast full-year dividend per share of 6.1p, up from 5.2p in the 2020/21 financial year. There are decent prospects of the board lifting the dividend again in the 2022/23 financial year as pre-tax profits and earnings per share (EPS) are expected to rise 9 per cent to £10.6mn and 8.8p, respectively, to support a higher payout per share of 6.6p (covered 1.2 times by forecast free cash flow of 8p a share). On this basis, the prospective dividend yield is 4.1 per cent, well underpinned by a 5 per cent free cash flow yield.

Those projections looked well supported, especially as ongoing domestic organic growth is set to be supplemented by international expansion. In the past month, Fonix launched interactive services with a major media broadcaster in the Republic of Ireland, has contracted with all major mobile operators in the country, and already has a number of clients ready to go live on its platform.

The holding has produced a 18.5 per cent total return since I initiated coverage last summer (Alpha Research: Bargain opportunity to play the mobile payments boom’, 5 August 2021) during which time the FTSE Aim All-Share Total Return index has shed 27.8 per cent of its value. The shares have also posted a 5 per cent total return since I covered the annual results (Tapping into a fast growing mobile payments play’, 14 March 2022), during which time the benchmark Aim index has lost 10 per cent. I expect the outperformance to continue and maintain fair value at 190p.

Please note that a concert party including the founders and directors sold £10mn of shares, at 150p, last month that equates to 6.67 per cent of the 100mn shares in issue, but still retain a 42.5 per cent combined stake in the business. I view this in a positive light as it has diversified the shareholder base, improved liquidity and is likely to stimulate more interest form institutions in the tightly held shares. Buy.

 

Simon Thompson was named Journalist of the Year at the 2022 Small Cap Awards.

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