20. ITM Power
After a mid-year crash and a horror-show half-year results release in September, hydrogen electrolyser company ITM Power (ITM) once again scared off investors in October with a sales downgrade and a warning of rising warranty provisions.
Its struggles this year have seen off its long-term chief executive and brought a change in company communications – now it is all about resetting expectations for both investors and customers.
It’s not a terrible sign that orders have overwhelmed capacity, but the company has also cancelled a new factory, so scaling rapidly is not on the cards any longer. The low-end of the revised sales guidance for the 12 months to 30 April is £23mn, still well ahead of the £5.6mn seen last year. But it is clear all is not well.
“The timing of [forecast] revenue will be weighted towards the final quarter of the current financial year, and will be dependent on the success of the current work to resolve [manufacturing] issues,” ITM said last week. Cash burn of £53mn and high inventory levels in the first half show this is a company in a tight spot. It has cash reserves, but it is unclear what the future is if existing orders cannot be delivered. Hold. AH
19. Kape Technologies
Kape Technologies (KAPE) owns several different virtual private networks (VPNs) – apps for browsing the internet privately. VPNs are useful because they are secure, but they also mask users’ IP addresses. This capability has been particularly useful in Russia of late, with the country trying to ban users from accessing particular sites on the internet.
In the six months to June, recurring revenues jumped 354 per cent to $268mn (£231mn) year on year and now make up 89 per cent of total sales. With most of the revenue coming through auto renewed subscriptions, cash conversion is an impressive 101 per cent. That growth has helped reduce the net debt pile from $458mn to $392mn. This substantial amount of debt is largely due to recent acquisitions, but strong cash generation means it should be manageable.
The company has around 7mn customers, the majority of whom are between 20 and 45. Tech-savvy younger users are more interested in VPNs, so demographics should provide useful tailwinds. With a forward PE ratio of just 6.1, in part thanks to a hefty fall this year, it seems investors aren't recognising the value available. Buy. AS
18 Breedon
In July, we moved Breedon's (BREE) shares back down to hold given concerns about the outlook for its end markets. The company provides aggregates from a network of quarries, plus asphalt, concrete and cement from a network of plants across the UK and Ireland. It generates around a fifth of sales from a residential market that’s beginning to look rockier as mortgage rates climb, and about 50 per cent from an infrastructure market where promised government funding has been slow to materialise. Yet after a near-halving of its share price since the start of the year, the obvious question to ask is whether the sell-off has been overdone. The company’s market cap has fallen below £900mn, which isn’t much greater than the £800mn book value of its physical assets. Earnings (for now at least) remain strong, with its underlying Ebit margin nudging into double-digit territory in the first half. For a long-term investor, it looks like good value at just over eight times forecast earnings. Back to buy. MF
17. Learning Technologies
We argued in September’s look at corporate education company Learning Technologies (LTG) that it is “reasonably recession-proof” given its client base is focused on listed corporations. Demand looks safe, and the significant enlargement of the business through the 2021 acquisition of GP Strategies is bearing cash flow fruit.
This was in evidence in the results for the six months to 30 June. GP Strategies contributed 66 per cent of total revenues, which accordingly boomed by 241 per cent to £282mn, and helped pre-tax profits soar by over 300 per cent. Notably, the deal gives the business significant exposure to the American market.
Goldman Sachs' analysts raised their forecasts on the back of the results and said that Learning Technologies “continues to deliver macro-resilience”. The shares trade at 11 times forward earnings estimates, according to the consensus position per FactSet – well below the five-year average of 28 times. Analysts expect sales to hit £622mn for the year ended 31 December 2023, a 58 per cent uplift on 2021. Buy. CA
16. Serica Energy
In every life a little rain must fall. So it is for Serica Energy (SQZ): the company has seen its earnings soar this year as it receives full cash flow from its North Sea oil and gas holdings for the first time. But some of the sheen was taken off in September when it announced delays at a new well. Chief executive Mitch Flegg said technical delays at the North Eigg test well were “extremely frustrating”, clearly mindful of the earnings potential of a new site in the current environment.
But 2022 has really been a landmark year for Serica – fuelled by a deal to take on stakes in the Bruce, Keith and Rhum fields (collectively known as BKR) from BP (BP.) in 2018. Serica partly paid for them using a profit-sharing deal that meant it held onto 60 per cent of net cash flow in 2020 and 2021, and then 100 per cent from this year onwards. That, combined with soaring gas prices, will see free cash flow almost quadruple on last year to £431mn for the full year, as per the consensus estimate compiled by FactSet. That is despite capital spending doubling to over £108mn.
The boost in earnings and the newfound interest in North Sea production in general means Serica has been involved in some interesting corporate moves this year, most notably the standoff with Kistos (KIS) over who might buy the other out. It ended in stalemate; both agreed a merger could work but did not come to actual terms.
Serica added in its September trading update that its North Eigg well and broader expansion plans were “designed to help increase the UK's security of supply and reduce its reliance on imports”. That might indeed happen, but this is an extractive company looking at economic deposits. Capital investment is done with the aim of making money for shareholders.
Happily, Serica has also been very good at that. Current conditions won’t last forever, but Serica is in a good position to maintain strong earnings. Buy. AH
15. YouGov
All change at YouGov (YOU) – at least at the top. Stephan Shakespeare, co-founder of the research and data analytics group, announced last month that he will step down as chief executive next August and take up the role of chair. That’s hardly a hammer blow on the continuity front, but he has guided the group through a period when its business model had to evolve in response to widespread digital adoption.
At any rate, the news seemed to draw attention away from an impressive set of figures for FY2022. Sales and statutory profits were both up by around a third, while the adjusted operating margin increased by 130 basis points to 16.4 per cent.
The evolution of the business model continues apace with the recent launch of YouGov Survey Direct in the UK and US, a do-it-yourself tool which allows users to build targeted surveys and receive detailed results within an hour. It is not difficult to appreciate the commercial potential, although we will have to wait to see initial take-up levels.
The group isn’t immune to the economic uncertainties gripping the global economy, but management pointed to better sales visibility on the back of strengthening renewal rates and new longer-term deals. The shares have been caught up in the general tech sell-off, but the long-term business case remains very much intact. Buy. MR
14 Ceres Power
'Work in progress' was the term used when we last featured Ceres Power (CWR) and, like a lot of companies that are still in the development phase and not yet generating earnings, its shares have experienced a sharp sell-off – they are down almost 70 per cent this year. Its solid oxide fuel cell technology is gaining traction – an agreement with Shell to provide fuel cells for an electrolyser project to develop green hydrogen in India was a recent breakthrough. But a joint venture with Bosch and Weichai that was supposed to bring in upfront licence fees of around £30mn, plus ongoing royalties, is no longer likely to be finalised this year, chief executive Phil Caldwell said in September.
While it isn’t short of cash, with £222mn on its books at the end of June, higher interest rates have diminished the present value of expected future earnings and there doesn’t seem to be any immediate reason to tie in funds that would earn a better return elsewhere. Hold. MF
13. Gamma Communications
It’s easy to switch off when companies start talking about “cloud-based connectivity” and “unified-communications as a service”. Fundamentally, however, Gamma Communications’ (GAMA) purpose is simple: to help people communicate at work, be it via voice call, video or written message.
Lockdown forced small- and medium-sized businesses to update their IT systems and Gamma was an obvious beneficiary. Sales and profits jumped as small companies quickly embraced a distributed telecoms model, and Gamma’s share price climbed.
Since September 2021, however, its shares have lost all the ground they gained during the pandemic. This decline has coincided with a series of robust but unspectacular updates. In the first half of 2022, for example, it reported revenue growth of 8 per cent and Ebitda growth of 13 per cent, while gross margins remained steady at 51 per cent.
A big addressable market, good cash generation, and strong recurring revenues make Gamma an attractive proposition. However, it is struggling to maintain the momentum it built up during the pandemic and management has warned that a recession could weigh on revenue growth. Hold. JS
12. Fever-Tree Drinks
Fever-Tree Drinks (FEVR) has a poor record of hitting its own margin guidance, its capital-light business model is struggling with cost increases in this high-inflation era, and it has a very expensive rating. Not the most appealing combination.
The company now forecasts gross margins of 33-35 per cent for its year to 31 December, having guided at the start of the year for a flat performance against the 42 per cent margin posted in 2021. Cash profit guidance has also been slashed. Revenue forecasts have been maintained at £355mn-£365mn.
When it comes to driving profitability in the future, the company’s foray into the US market looks unappealing as things stand. Broker Peel Hunt thinks that cash profit margins sit in the low single-digits and will only reach a 20 per cent level over the long term.
Goodbody analysts reiterated their sell recommendation in their latest note and said that “it is difficult to have comfort on the stock given our concerns on the near-term challenges and pressures on costs and profitability”. We moved our own recommendation downwards in September and see no reason to change tack. Sell. CA
11 Smart Metering Systems
Smart Metering Systems (SMS) has performed admirably this year, as both sales and profits rose by more than a fifth in the first half.
Then again, if a company that literally made its name from installing smart meters to help people curb energy costs can’t prosper in a market such as this, what hope is there?
SMS has been stepping up the rate of meter installations, which are expected to increase by 450,000 this year. It has also been spending more on energy storage – it owns and runs grid-scale batteries that can store power from intermittent sources like wind or solar. The increased investment was a drain on cash, however, as it spent more than £74mn on new meters, batteries and battery sites in the first six months of the year. Broker Peel Hunt forecasts earnings per share growth of 37 per cent this year and 12 per cent next. Based on its 2023 earnings outlook of 14.6p a share, the company is valued at nearly 49 times earnings. Healthy prospects but at a big price. Hold. MF
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