- Cost savings drive a 49 per cent pre-tax profit upgrade
- Net cash estimates lifted by five per cent for both 2023 and 2024 financial years
- 100 per cent recurring license fee income
- Shares trade on cash-adjusted PE ratio of 2.5 for year just ended
Aim-traded financial software provider Arcontech (ARC:66p) has materially increased earnings guidance for the financial year to 30 June 2023.
The news prompted analysts at house broker FinnCap to raise their adjusted pre-tax profit and earnings per share (EPS) estimates by 49 per cent to £1mn and 7.3p, moving up 11 per cent from £0.9mn and 6.5p in 2022, on slightly lower year-on-year revenue of £2.7mn. On this basis, expect a hike in the full-year dividend per share from 3.3p to 3.6p, implying the shares are rated on a modest price/earnings (PE) ratio of nine and offer an attractive dividend yield of 5.5 per cent.
Arcontech makes its money by providing software products and solutions for collecting, processing, distributing and presenting time-sensitive financial markets data. It doesn’t deliver any market data, but it provides the means for its clients to do so. The company’s customer base includes a roll call of blue-chip financial organisations including Barclays, Citi, JPMorgan, Lloyds, Morgan Stanley, Santander and the Bank of England. It is a high-margin asset-light software business that boasts a high recurring revenue stream from multi-year contracts and earns an incremental operating profit margin in excess of 60 per cent on new contract wins. The business is highly cash generative, too.
Highly cash-generative business model
Analyst Michael Hill at Finncap estimates Arcontech generated £0.8mn of free cash flow in the latest 12-month period, a sum that equates to nine per cent of its market capitalisation of £8.8mn and covers the cash pay-out of the dividend 1.65 times. The impressive cash generation explains why Hill upgraded his net cash estimates by five per cent to £6.4mn in 2023 and £6.6mn in 2024. The implication being that 73 per cent of the current share price is covered by net cash on the balance sheet.
On this basis, Arcontech’s enterprise valuation of £2.4mn equates to a minuscule 2.5 times post-tax profit estimates for the year just ended, a bargain basement rating that could spark interest from larger rivals. A price-to-book value ratio of 1.2 times highlights the scale of the undervaluation, too. Furthermore, the burgeoning cash pile provides the board with ample funding to continue making organic investments in Arcontech’s technology platform or consider making earnings accretive bolt-on acquisitions.
So, although the shares have drifted slightly since I covered the interim results five months ago (‘This cash-rich, high-yield stock is also a takeover target’, 27 February 2023), the better-than-expected financial performance and improving end market conditions suggest that a material re-rating is more than warranted. The shares are worth buying ahead of the annual results in early September. Buy.
