The aftermath of the Covid-19 pandemic spurred a push towards enhanced energy efficiency and decarbonisation. However, the Russia-Ukraine conflict subsequently raised political awareness regarding the importance of energy security, leading to a recalibration of the rush towards renewable energy in the short to medium term.
For instance, the UK Government has recently acknowledged that delivering decarbonisation on a huge scale needs to be done over a realistic timescale and at a cost that the population can afford. The UK is not an outlier. In the US, although the Biden administration is at the forefront of the global green agenda, the country also operates the largest civil nuclear fleet in the world, producing 30 per cent of the world’s nuclear electricity. The reactors need to be maintained to avoid obsolescence and provide a reliable source of electricity during the green transition. It’s worth noting that almost all the 1GW plus new build nuclear reactor opportunities are in Asia, with the exception of the limited UK programme.
The unprecedented levels of volatility in the energy market since the start of the conflict in Ukraine, and the need for Europe to replace Russian hydrocarbons, is underpinning demand for oil and gas services in the aftermarket and for new equipment, too.
This is a positive backdrop for Avingtrans (AVG: 400p), a maker of critical engineering components and services that has been winning multiple contracts across the nuclear industry, and is experiencing a significant boost from the oil and gas industry.
Trading well below sum-of-the-parts valuations
- Annual revenue up 17 per cent to record £116mn
- Adjusted cash profit and pre-tax profit both up 10 per cent to £13.7mn and £9mn
- EPS of 23.4p and dividend of 4.5p a share
- Net cash of £13mn
The reliable income stream from the energy sector not only provides Avingtrans with defensive qualities in an uncertain economic environment as I highlighted in the summer (‘Two classic small cap value stocks’, 13 July 2023), but the group's order coverage is well diversified.
For instance, the order book includes work on a £70mn contract to provide high integrity steel storage boxes at Sellafield, nuclear life follow-on orders for the Forsmark nuclear power station in Sweden, a Polish nuclear power station owned by energy group Enea, and a contract with South Korea's KHNP, an operator of 21 nuclear power plants and 27 hydro-electric power plants.
Acquisitions are playing an important part in the ongoing growth story, the latest annual results reflecting strong contributions from Boston-based Booth Industries, a maker of fire doors, blast doors and wall systems, and Michigan-based Energy Steel, a maker of machined products to the civil nuclear power industry. Both companies were loss-making when acquired in 2019. Their subsequent turnaround highlights the enviable track record of Avingtrans’ management in identifying underperforming businesses and weaving their magic to create shareholder value.
The point is, if you only value the energy-focused operations on 10 times their projected operating profit of £12mn for the 2023-24 financial year, the valuation backs up almost 100 per cent of Avingtrans market capitalisation of £128mn.
Medical business in the price for free
Effectively, investors are getting the group’s medical division thrown in for free as well as valuable surplus land in Luton that could be worth around £11mn (34p) to a housebuilder.
Specifically, Avingtrans is investing in next-generation helium-free MRI technologies for orthopaedic imaging systems through a 75 per cent stake in Magnetica, an Australian medtech and engineering company, and 100 per cent stake in Oxford-based Adaptix (3D x-ray systems for orthopaedic and veterinary applications).
The addressable orthopaedic imaging market is worth £400mn a year, accounting for 10 per cent of the total MRI hardware and service market, with the veterinary segment a key target area. Magnetica's 'pay per scan' orthopaedic MRI products expect to significantly reduce the total costs of dedicated MRI systems, quadruple the scan rate and free up capacity on the existing MRI system installed base, thus benefiting healthcare providers.
Adapatix has received regulatory approval for its first machine in the US orthopaedic market, providing a blueprint for Magnetica which has a similar commercialisation strategy and is planning to launch in the US in the current financial year, subject to regulatory clearance.
The nascent medical operations have net assets of £9.5mn and will need further investment as they scale. House broker Cavendish is pencilling in divisional operating loss of £6.9mn in the 12 months to 31 May 2024, and £6.4mn the year after. The losses will be covered by forecast annual operating profit of £12mn and £13.3mn, respectively, from the group’s energy division. True, group pre-tax profit will decline from £9mn to £2.3mn in the new financial year as a result of the investment being made in the medical businesses, but the capital upside for shareholders could be huge.
Analyst David Buxton at brokerage Cavendish believes that they are capable of being valued at five to 10 times the inbound investment in the event of a Nasdaq listing within a two to three-year timeframe. Paul Hill at PMH Capital believes they could ultimately “elicit a valuation of around £150mn (465p)”. In other words, buy-and-hold investors adopting a patient approach, could potentially more than double their money again. That’s something they are accustomed to.
The value creation strategy of the group’s astute management has already delivered a 106 per cent total return (TR) in my 2017 Bargain Shares Portfolio, during which time the FTSE Aim All-Share TR index has shed 11 per cent of its value. Buy.
■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com at £16.95 each plus P&P of £3.75, or £25 plus P&P of £5.75 for both books.
