- First-half revenue up 25 per cent to $11.6mn
- Adjusted pre-tax profit up 59 per cent to $5.8mn
- EPS up 74 per cent to 10.8¢
- $4.4mn cash generated from operations
Aim-traded Spectra Systems (SPSY:167p), a leader in banknote authentication, brand protection technologies and gaming security software, has delivered eye-catching interim results that cover three-quarters of house broker WH Ireland’s full-year pre-tax profit estimate of $7.9mn.
It not only “increases the probability of upgrades for the year”, but materially de-risks earnings risk. Moreover, with the benefit of a lower-than-expected tax charge, reflecting the unwinding of tax losses, first-half earnings per share (EPS) cover 86 per cent of analysts’ 12.6¢ (10p) conservative-looking full-year forecast. The directors have a record of outperforming, having smashed WH Ireland’s 2022 EPS estimates by 21 per cent (‘Two high-tech small-caps with positive earnings momentum’, 20 March 2023).
Bank authentication accounts for the majority of Spectra’s revenue, mainly from the supply of covert security features to central banks – highly engineered material for inclusion in banknotes and sophisticated hardware to detect the materials in banknotes. In addition to material and royalty revenues, Spectra makes and supplies high-grade phosphors, the key customers being central banks.
Spectra provides customers with a range of other services to protect the security of banknotes in circulation, too. Its highly sophisticated sensors are embedded in sorting machines to detect fakes and taggant materials are embedded in banknotes, making this a closed loop. The group has also developed the world’s first banknote-cleaning technology system to eliminate pathogens on banknotes and protect processing staff and users from hazardous materials.
Outperformance is set to continue
The first-half outperformance was partly driven by greater demand for the group’s materials to meet demand for banknotes at one of its key central bank customers. It also reflects income from pre-production development contracts, one of which is with a long-standing central bank customer that is targeting pre-production delivery of a new generation of banknote authentication sensors in late 2024 ahead of actual deliveries in 2025.
WH Ireland anticipates that the hardware revenue element of this contract is worth $50mn over a three-year period, commencing towards the end of 2024, and the service contract could generate revenue of more than $8mn a year. Spectra will also earn ongoing high-margin material sales, too. This explains why analysts expect a step-change in Spectra’s revenue and profit in the coming years, forecasting more than 50 per cent growth in both revenue and pre-tax profit to $32mn and $12mn by 2025. On this basis, expect 2025 EPS of 19.2¢ (15.5p), implying a sharp reduction in the current-year price/earnings (PE) ratio of 17 to 11 in 2025.
A prodigious cash generator
Spectra is a prodigious cash generator as its asset-light business model enables a high proportion of profit to be converted into cash. Despite paying out $5.2mn of cash dividends in the first half, net cash only dipped from $17.5mn to $16.6mn, a sum equating to 18 per cent of Spectra’s market capitalisation. That’s good news for a continuation of the progressive dividend policy, as highlighted by WH Ireland’s payout forecasts of 11.8¢ (2023), 12.3¢ (2024) and 13¢ (2025). On this basis, the current-year prospective dividend yield of 5.7 per cent rises to 6.3 per cent in 2025.
The holding is 30 per cent ahead since I initiated coverage 13 months ago (‘Alpha Research: Don’t miss out on the authentication boom’, 22 August 2022), during which time the FTSE Aim All-Share Total Return index has shed 16 per cent of its value. The shares have also outperformed since I covered the annual results in March. I expect that to continue and maintain my 200p target. Please note that Spectra has two classes of shares and the unrestricted ones (AIM:SPSY) are the most liquid and the ones to focus on. Buy.
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