Three high growth small-cap plays

It’s an exercise well worth doing as I found with niche packaging engineering business Mpac over the summer (‘Deep value buys’, 11 July 2020). At the time, the directors had withdrawn guidance due to the Covid-19 pandemic, but I noted that Mpac continued to win new orders with original equipment manufacturers (OEMs) and service orders, too, highlighting resilience in the healthcare sector (accounting for three-quarters of annual sales), and in the Americas region (almost two-thirds of sales). I concluded that analysts were being far too bearish on 2020 profit estimates and overly cautious on 2021 numbers. The fact that estimates have been upgraded three times since then tells a story as does the 77 per cent share price rise. The upgrade cycle is not over yet.

It also pays to number crunch ahead of trading updates as I have regularly done with Sylvania Platinum, a South African producer and developer of platinum, palladium and rhodium. Another buying opportunity has presented itself right now as the forthcoming half-year numbers are going to be eye-popping and will prompt significant analyst upgrades, the scale of which is simply not being priced in.

Mpac on the upgrade again

• Third earnings upgrade since September.
• Net cash position double analyst estimates due to exemplary cash control.

A bullish trading update from Mpac (MPAC:490p), a small-cap niche packaging engineering business that offers customers digital solutions for artificial intelligence-enabled equipment and robotics in their production facilities and warehouses, has forced analysts to push through their third earnings upgrade since September.

The Covid-19 pandemic is not only accelerating the move to automation as more blue-chip clients reappraise their manufacturing efficiency, but Mpac’s focus on higher margin health and personal care, pharmaceutical and food & beverage market segments means that profits are recovering far better than analysts had anticipated even in a global pandemic. Indeed, Panmure Gordon raised its 2020 pre-tax profit by 7 per cent to £6.2m on annual revenue of £83m, implying 25 per cent revenue growth in the second half. Moreover, with Mpac’s closing order book unchanged at £55.5m year-on-year, and no orders cancelled due to Covid-19, analysts at both Shore Capital and Equity Development expect 2021 pre-tax profits to at least match the 2019 high water mark of £7.5m based on revenue rising to £95m.

Panmure is even more bullish, pencilling in 2021 pre-tax profits of £8m and earnings per share (EPS) of 36.1p, up from 27.2p forecast in 2020, noting that last autumn’s US$13m (£9.6m) acquisition of Ohio-based Switchback is performing better than management had expected. The range of products offered by Switchback adds breadth to Mpac's carton and end-of-line solutions, and access to a wider potential customer base to build the business in North America. The region accounts for half of revenue and more than 80 per cent of sales are international, so the group is well placed to benefit from the global economic recovery.

Bearing this in mind, Paul Hill at Equity Development notes that “in addition to pent up demand [from delayed projects], several FMCG brands are now planning to expand manufacturing capacity particularly in America to satisfy greater home worker consumption of treats such as coffee pods. Similarly, Mpac’s medical grade packing expertise is ideally suited for boxing Covid-19 test kits and vaccine vials/ampoules.” Although the Covid opportunity was not mentioned specifically by the directors, Mr Hill reckons it could offer substantial potential upside. I agree.

It’s also worth noting that analysts have significantly upgraded Mpac’s net cash projection. Panmure doubled its estimate from £7m to £15m (75p a share), a reflection of Mpac’s “exemplary cash control”. On this basis, the shares are priced on a price/earnings (PE) ratio of 13 for the 2021 financial year, an unwarranted discount to the UK engineering sector average PE ratio of 18.

Mpac’s share price has more than trebled since I included the shares, at 156p, in my market beating 2018 Bargain Shares portfolio and has achieved the 461p target price I outlined after the last earnings beat (‘Technology stocks for the new normal’, 26 October 2020). I now feel that Panmure Gordon’s upgraded 550p fair value estimate is a realistic target to value the equity in line with the engineering sector average after taking into account net cash and the pension deficit. Buy.

Rhodium rally to propel Sylvania profits

• Rhodium price has trebled since July.
• Spot basket price 23 per cent ahead of analyst estimates.

Shares in Sylvania Platinum (SLP:91p), a cash-rich, fast-growing, low-cost South African producer and developer of platinum, palladium and rhodium, have been on a tear since I last highlighted a cracking buying opportunity at 64p (‘Five small caps for value and more’, 2 November 2020). In fact, the share price got within pennies of achieving the 100p target I outlined and is now 528 per cent higher than the 14.5p entry point in my 2018 Bargain Shares portfolio.

The rally is more than justified as I now expect analysts to push through eye-watering earnings upgrades when the company releases its first half results at the end of January. That’s because the price of rhodium, a mining by-product used as a catalyst in three-way catalytic converters in cars, has surged from US$6,000 per ounce (oz) at the start of July to a record high of US$18,200 per oz as car manufacturers scramble to get their hands on a commodity in a tight market to comply with new government emissions standards. Rhodium is two to three times more effective than platinum in an auto-catalyst, hence its appeal to car makers. 

The recent introduction of stricter emissions standards for passenger cars in China, new EU legislation limiting nitrogen oxide emissions in on-the-road driving tests (comes into force in September 2022) and rebounding China car sales are the main drivers behind the booming rhodium price. Furthermore, the lack of investment in new mines means that the global rhodium market is heading towards a supply gap whereby annual demand could exceed output by around 25 per cent within the next five years.

Bearing this in mind, rhodium accounted for 12.5 per cent of Sylvania’s PGM prill split in the 2019/20 financial year and 46 per cent of group revenue of US$115m. It’s going to be an even higher percentage of revenue in the financial year to 30 June 2021. To put the scale of likely upgrades into perspective, analysts at house broker Liberum Capital have only embedded an average rhodium price of $10,000 per oz into their forecasts of annual revenue of US$145m, up from US$115m in 2019/20. The broker’s revenue estimate also factors in an average price of US$2,100 for palladium (spot price of US$2,310 per oz); and US$925 for platinum (spot US$1,084 per oz). Palladium accounts for around 25.5 per cent of the PGM prill split and platinum about 61.7 per cent.

In other words, I reckon Sylvania’s average spot basket price is US$3,500 per oz or 25 per cent higher than in the first quarter to 30 September 2020 when the company posted net revenue of US$41.5m and cash profit of US$29.7m on output of 18,000 ounces. Based on annual production of 70,000 ounces, and assuming PGM prices hold as seems highly likely, then Sylvania’s annual revenue could come in US$30m higher than current forecasts, almost all of which will drop through to operating profit.

To put the likely profit windfall into perspective, Liberum are pencilling in (pre-upgrades) pre-tax profit of US$99m and a net profit of US$71m. By my reckoning, Sylvania could make a post-tax profit closer to US$93m (£68m) and almost double its net cash to US$105m (£77m) by the June 2021 year-end.

Strip out net cash from Sylvania’s market capitalisation of £250m, and my financial models suggest the shares are trading on a forward cash-adjusted PE ratio of 2.7. I raise my target price to 145p and rate the shares a strong buy.

BigBlu on the upgrade

• Four broadband grants won since autumn 2020.

• Quickline targeting 100,000 premises.

Aim-traded BigBlu Broadband (BBB:110p), a provider of alternative superfast satellite, fixed wireless and 4G/5G broadband products, has announced yet another contract win for its 56.9 per cent-owned Quickline subsidiary, a business that is building its own fixed wireless access networks, supported by increasing amounts of fibre infrastructure, to target the ‘digital divide’ in the UK.

North Yorkshire Local Authority has awarded Quickline a £14.5m contract to extend its fibre-backed wireless technology and provide superfast, ultrafast and even gigabit speed broadband services to a further 15,800 premises in rural areas. Quickline is investing £2.2m of its own capital in network infrastructure with the £12.3m balance of the funding required coming from government subsidies. The UK government has committed to a £1.7bn superfast broadband programme, a £200m 'rural gigabit programme' and set aside £5bn to fund gigabit-capable technologies to the hardest hit 20 per cent of households.

It’s also Quickline’s fourth contract win since the autumn and almost doubles cash subsidies and network investment to £27.4m and £33.5m, respectively. It also doubles the premises covered by these grants to 32,000. Importantly, the limited connectivity currently available in the contracted areas (West and North Yorkshire and North Lincolnshire) should result in a strong take-up of broadband services, further increasing Quickline’s addressable market and customer base. In due course, the directors see scope to target over 100,000 premises and are aiming to deliver a minimum 15 per cent return on capital over the life of the contracts.

The raft of awards also explains why analysts at house broker finnCap expect BigBlu to report organic sales growth of 22 per cent in the 12 months to November 2021 and deliver pre-tax profit to £4.8m on revenue of £33.7m. On this basis, expect EPS of 7.3p, up from 4.4p in 2020. The brokerage has introduced 2021/22 estimates which point to revenue rising a further 15 per cent organically to £38.9m to produce pre-tax profit to £6.2m and EPS of 8.5p. On this basis, the shares are rated on a forward PE ratio of 13, hardly exacting for a cash-rich company that is primed to win more earnings accretive contracts.

Interestingly, a chart break-out above October’s high of 114p looks firmly on the cards, and one that could prompt a swift move towards my target price of 165p to bring BigBlu’s valuation in line with peers on an enterprise valuation to cash profit multiple basis. 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, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £3.25 [UK].

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Simon Thompson was named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards.