20. Craneware
Craneware (CRW) is engaged in the development, licensing and ongoing support of software for the US healthcare industry. Uncle Sam accounts for a hefty portion of global healthcare spending, which will rise 5.4 per cent annually through 2017-22 to around $10 trillion, according to research from Deloitte.
Consistently strong cash generation has been a feature of group performance, with analysts expecting operating cash flows to rise by 50 per cent in the coming year. Annual earnings growth has run at 13.1 per cent over the past five years and return on equity is estimated at around 33 per cent over the next couple of years. There is also an unusual degree of predictability here – total visible revenue for the three-year period from 1 July 2018 to 30 June 2021 has grown 13 per cent to $196m ($157m of which is ‘Revenue under Contract’) against $174m for the same three-year period at 31 December 2017.
And yet the shares pulled back at the half-year mark, despite metrics in line with consensus forecasts and adjusted cash profits up by a fifth to $11.6m, presumably a reflection of the toppy valuation of 52 times forecast earnings. Hold. MR
19. First Derivatives
A recent update from software group First Derivatives (FDP) revealed it has “continued to trade strongly in the second half of the financial year” to February 2019, and that it expects to meet consensus forecasts for revenues and adjusted cash profits.
For Shore Capital, this news was “short and sweet”. The broker reckons that the shares’ considerable ascent in the year to date reflects “the return on investor confidence” after a bearish report from ShadowFall Capital & Research LLC last autumn.
In any case, First Derivatives will need to continue to demonstrate the growth in demand of its ‘Kx’ data analytics technology across multiple industries. Judging by IDC’s August 2018 Big Data and Analytics Spending Guide, the opportunity for the group’s platform and applications could be worth $260bn in 2022. Its established markets are ‘fintech’ and ‘martech’, but it has made headway in other arenas such as sensor analytics and utilities, and – all being well – we’ll see evidence of further contract wins in these niches over future reporting periods.
That said, following the declines in the stock’s market value in the final quarter of last year, we’re remaining neutral. Hold. HC
18. Keywords Studios
Industry expert Newzoo expects the video games market to expand at a compound annual rate of around 9 per cent between 2019 and 2021. Good news for Keywords Studios (KWS), which provides technical and creative services to companies operating within this arena. The group is also benefitting from a trend towards outsourcing, as – in its words – “video games companies aim to avoid substantially increased fixed costs to handle peaks in activity levels”.
True, Keywords’ growth in 2018 – though robust – was “slightly held back” by both the expected low growth of the acquired ‘VMC’ business, and the “Fortnite effect”. The latter refers to the hugely popular game Fortnite, which has competed with, and reduced the player-base of, some other games supported by Keywords – even contributing to certain clients ceasing trading. But on the plus side, Keywords now does “a considerable amount of work” on Fortnite itself – and it refers to the disruption caused by the game as short-term.
In any case, while the potential for further challenges can’t be dispelled in this fast-moving – and changing – market, the future does seemingly hold exciting opportunities for Keywords. For one thing, there’s been much talk recently of games subscription and streaming platforms. Apple (US: AAPL) announced its ‘Arcade’ subscription gaming service earlier this year, and Alphabet (US:GOOGL) has its ‘Stadia’ streaming service. Keywords says it can’t rule out some short-term disruption as streaming platforms try to become the “Netflix of games” and demand for content increases – but it also reckons it is well positioned to benefit from this trend.
Additionally, the group has seen demand for its services beyond the games vicinity – in areas ranging from film and TV, to education, to architecture and urban planning. This could, ostensibly, bring greater diversification to the top line and perhaps enhance its offering to existing customers.
Looking ahead, it seems highly likely that Keywords will make more acquisitions. Since the start of 2019, it has bought three businesses. Such consolidatory activity against a fragmented backdrop does appear to make sense, though – as with any acquisitive company – we can’t eliminate integration risk from our analysis.
The shares took a dive last autumn and have endured a lacklustre trajectory at the start of this year – but have been on the up in recent weeks. The group’s market value is, ostensibly, vulnerable to broader industry news and updates from video games developers – one of the reasons why it’s a high-risk stock. But based on the cited growth drivers – and notwithstanding a lofty forward PE ratio – we remain cautiously positive. Buy. HC
17. Hurricane Energy
Hurricane Energy (HUR) should soon be a producing entity, with first oil from the Lancaster deep well expected before 30 June. Its fractured basement play, a first for the UK continental shelf, also has the backing of Spirit Energy through a farm-in deal on the neighbouring Greater Warwick exploration area.
If all goes smoothly with its early production system, the current oil price of over $70 (£53) per barrel promises a strong start to cash generation. Even at a more realistic medium-term level of $60 a barrel the company will be generating operating cash flow of $200m a year once ramped up.
Following the buoy installation and the arrival of the Aoka Mizu production and storage vessel in mid-March, Hurricane can thus far boast a safe pair of hands, but buying at this point is a major bet on the field flowing continuously. Hurricane’s shares trade more than a fifth off their 12-month high of 60p – brought on by the Spirit news – as the market waits for more certainty on production. Hold. AH
16. Diversified Gas and Oil
Diversified Gas and Oil’s (DGO) chief executive has a tongue-twisting name but simple strategy: buy assets drilled before 2015 to bolt on to its Appalachian basin portfolio. Rusty Hutson Junior has spent over $1.1bn since mid-2018 and has continued his dealmaking run this year before a possible move to London’s main market.
This spending run saw the company’s production climb by a factor of five over the course of 2018, averaging 41,000 barrels of oil equivalent per day (boepd) and hitting 70,000 boepd by the year-end. This year’s purchase of the Huckleberry gas portfolio has added another 21,000 boepd. That epic acquisition run was done with a $1.5bn revolving credit facility and $439m in equity-raisings. As per the company’s preference for sprinting, it announced a $70m share buyback programme at the end of April.
Broker Mirabaud thinks shareholders should be ready to keep backing purchases. “With the wider US shale industry increasingly focused on spending within cash flow and looking at ways to monetise non-core assets... this represents a huge opportunity set for a proven acquirer such as DGOC,” its analysts wrote in a note following the most recent deal.
In this rush, normal touchpoints on company performance, such as return on capital and production guidance, have gone by the wayside, and a fair investor concern is the strain on management time and energy, particularly with corporate activity being compressed into ever-shorter timeframes. That explains the reliance on identifying all and any accretive opportunities from the vast numbers of personnel DGO is snapping up. “Because we’re bringing all those employees over with us for the most part, operationally we’re able to pretty quickly identify things that they know of that are out there that can be done to improve production [and] be more efficient in the operations of the assets,” Mr Hutson told analysts in February.
Shareholders have already leapt onto this M&A train, backing the two $200m-plus fundraises and sending the share price up more than a third over the past 12 months. Despite some dilution, the deals have been billed as earnings-accretive, and Mirabaud has already upgraded its 2020 dividend forecast by 15 per cent to 16¢ a share since the Huckleberry purchase. The broker also reckons the stock should sit at a slight premium to its sum-of-the-parts-derived core risked NAV of 163p – itself already a healthy premium to the current share price. Buy. AH
15. James Halstead
James Halstead (JHD) makes and distributes commercial floorcoverings, and is by all accounts a well-run company. The latest half-year dividend was the highest ever paid, well covered by after-tax earnings. What’s more, there is no debt on the balance sheet, just £62.8m of net cash. Investors may have taken fright after a bad month of trading in December, which was blamed on larger customers exercising stock control. However, sales in January bounced back, and even with a soggy December, sales in the last six months of 2018 were up 3.9 per cent from a year earlier. Overall turnover has shown little growth, but gross margins have risen thanks to a shift in the product mix towards higher value-added products. This margin improvement comes despite raw material inflation running at around 3 per cent. Investment in new production included a new sheet vinyl range, which helped to improve its market share. The company also has extensive geographical reach, operating as far afield as Peru. Buy. JC
14. Gamma Communications
Gamma Communications (GAMA) – a tech-based provider of communications services – operates via an indirect business, through channel partners, and via a smaller direct business. Both segments enjoyed double-digit revenue upticks during 2018 – at 13.9 per cent and 24.2 per cent, respectively.
The group is now focusing on four strategic areas “to ensure growth” over the next five years. These include taking its cloud telephony offering into the ‘UCaaS’ (Unified Communications as a Service) market – facilitated by the launch of its UCaaS product ‘Collaborate’ on 19 March 2019 – and expanding its European footprint.
To the latter point, Gamma has bolstered its presence in the Netherlands with two acquisitions in the past year – telecoms company DX Groep, and internet, cloud-telephony and IT services company Nimsys. It seems likely that further deals will ensue; management reckons branching out onto the continent will complement its UK organic growth.
Gamma’s 90 per cent-plus recurring revenues should engender good visibility – helpful if macroeconomic conditions take a turn for the worse. But, in any case, the shares still look steep for new investors – trading at around 30 times forecast earnings. Hold. HC
13. GB
GB’s (GBG) technology helps companies to “validate and verify” the identity and location of their customers. Its client base spans e-commerce giants, banks and household brands. And business appears to be running smoothly. The group recently revealed that revenues and adjusted operating profits will land ahead of market expectations for the year to March 2019, with chief executive Chris Clark citing a “good performance across all regions and all our core propositions”.
When the official results emerge in June, we’ll be looking for continued signs of international expansion. Overseas sales constituted more than a third of the top line at the half-year stage. Such diversification could come via new acquisitions; last year, the group acquired VIX Verify Global, operating in Australia and New Zealand, and US-based IDology.
That said, these acquisitions have also engendered a sizeable net debt position – something for management to bear in mind as it considers further transactional activity.
House broker Investec expects a revenue CAGR of 21 per cent from FY2018 to £212m in FY2021, with adjusted pre-tax profits growing at a similar rate of 20 per cent. We remain buyers. HC
12. Breedon
Breedon (BREE) arose from the ashes of Ennstone with a mandate to consolidate the highly fragmented UK aggregates sector where there were more than 200 independent operators. That was back in 2010, and since then Breedon’s market capitalisation has risen from under £100m to over £1.1bn.
The biggest contributor to this came with the acquisition of Belfast-based building materials group Lagan in April 2018 for £455m. This followed the 2016 purchase of Hope Construction, which at that time more than doubled group turnover. Breedon’s assets now include more than 170 ready-mix concrete plants, 80 quarries, 40 asphalt plants as well as nearly 900m tonnes of aggregate in the ground.
Brexit worries have instilled a note of caution, though – especially on how it could affect the Irish market. However, a hard exit would almost certainly prompt an injection of cash into infrastructure projects.
Breedon also operates in a sector where it is virtually impossible for new competitors to enter, as it remains extremely difficult to gain permission to dig new quarries. The latest acquisitions included Staffs Concrete in the West Midlands and Blinkbonny Quarry in Scotland, along with an asset swap of 23 of its ready-mixed concrete plants and £6.1m in cash for four quarries and an asphalt plant from Tarmac. Such acquisitions take time to integrate, but Breedon will benefit from cost synergies at some point.
Breedon’s business model is highly cash generative, and management prefers to plough funds back into the business at the expense of not paying dividends. This has shown results because, although net debt has risen from £74m in 2012 to £310.7m in 2018, gearing has come down from 93 per cent to 40 per cent. In that time, the share price has more than trebled.
Trading conditions were tough in 2018, with construction output broadly flat from a year earlier, but Breedon still managed to deliver revenue growth of 32 per cent, while adjusted operating profits exceeded £100m for the first time. On a like-for-like basis, excluding acquisitions and the impact of the disposal of 23 ready-mix concrete plants to Tarmac in July 2018, aggregates and asphalt volumes were up by 4 per cent and 2 per cent, respectively, while ready-mixed concrete volumes were flat.
Rising input costs meant that there was no material increase in underlying cash margins at 12 per cent, although the medium-term target is to achieve margins of 15 per cent. Given the prospect of further growth both organically and through acquisitions, we still rate the shares a buy. JC
11. Blue Prism
With great growth comes great expenditure – a neat precis for Blue Prism (PRSM). The robotic process automation (RPA) specialist has enjoyed rapid revenue expansion since its 2016 IPO. However, it has also continued to plough money into sales and marketing, weighing on the bottom line. And this pattern looks set to continue. Broker Panmure Gordon anticipates a sales CAGR of 65 per cent between FY2018 and 2021, reaching £247m – but it also expects the group to remain lossmaking over the same three-year period.
That said, one can assume that investors aren’t buying into Blue Prism in the hope of near-term profitability. Beyond its projected top-line momentum, the market opportunity is – by various estimates – colossal, with research house HFS expecting it to reach over $3bn by the year 2022.
Still, RPA is a competitive arena in which Blue Prism operates alongside major players Automation Anywhere and UI Path. And it seems feasible that the group might ask shareholders for more cash in the coming months. First, it will need to demonstrate the fruits of the £100m fundraising implemented in January 2019. Until then, the heavy losses keep us neutral despite the potential. Hold. HC
