Each month Richard Beddard trawls through annual corporate results for his Watchlist and the ShareSleuth portfolio of companies that satisfy key valuation metrics such as earnings yield and return on capital – and profiles the most interesting candidates.
Watch: Air Partner (AIR)
Air Partner has made good profits over the last decade, but it hasn’t grown convincingly. Its principal business providing air charters, was heavily reliant on government contracts to move people and equipment in support of military and humanitarian interventions in other countries. As budgets have tightened and foreign policy ambitions have been reined in, the company has had to put more emphasis on commercial markets, ferrying around rich people, football teams and companies launching products; jets provided by Air Partner flew Hillary Clinton’s team around the US last year to campaign for the presidency. It also supplies planes to tour operators.
As the customer base changes, so too is new technology having an impact on the business. Automated online charter platforms are eating into routine charters, leaving Air Partner, which sees itself as a concierge, to focus on customers with more unusual, complicated and specific requirements.
Under the circumstances, Air Partner has done well to remain comfortably profitable, but it is, perhaps, because conditions in the charter market are difficult that it is investing its profits more broadly.
In recent years Air Partner has acquired Cabot Aviation, which sells and leases planes rather than chartering them, and two consultancies: Baines Simmons and Clockwork Research.
Baines Simmons provides a broad range of regulatory and safety services to the aviation industry, and Clockwork Research specialises in managing pilot fatigue.
Partly due to the acquisitions, profit grew 14 per cent in the year to January 2017, despite the expiry of a large contract that ran throughout the previous year.
Air Partner believes services like these will differentiate it from competitors. It can supply a charter with a safety audit, for example. If it succeeds in its ambition to become a global aviation services group, the shares are probably good value. But these are early days yet. Services only earned the company about 7 per cent of profit last year.
A share price of 130p values the enterprise at £75 million, about 17 times adjusted profit. The earnings yield is 6 per cent.
Watch: Augean (AUG)
Augean has increased revenue and profit every year for the last eight years. In 2009, the company was just about breaking even, but in the year to December 2016 it earned a healthy 11 per cent return on capital.
These encouraging headlines may lend a somewhat sanitised perspective to Augean’s performance, though. In 2016 and the year before, the company arrived at its adjusted profit figure having ignored substantial costs; it deemed them accounting figments or one-off expenses that mask the underlying performance of the business.
Augean operates hazardous waste disposal plants, incinerators and landfill sites dealing with toxic materials such as oil, asbestos, and radiation. It owns valuable assets – essentially land, or the right to use it, plant, laboratories and expertise – which it’s using to service industries where hazardous waste management is essential. It expects to profit, perhaps more reliably in the future than the past, as customers enamoured with its specialist services increasingly enter into contracts instead of paying as they go.
What could go wrong? The strategy passes the sniff test, but the execution has not been so straightforward. In 2016, Augean wrote off £3.3 million of investment in a high-temperature incineration facility. Reliability problems and inefficiencies while it was operating below capacity mean the incinerator will not be as profitable as the company anticipated.
Augean also reached a legal settlement costing over £1 million with a customer. In 2015, it wrote off the value of plant used in its North Sea Oil business after the oil price collapsed.
Augean’s less profitable past and big accounting adjustments put investors in a glass half-full or glass half-empty type of quandary. If its operational and legal problems are history, it may have a very profitable future. But waste disposal plants require high levels of commitment up front in capital investment, while demand might not be there in future due to changes in regulations, the economy and the type of waste that must be processed. Although Augean has diversified revenues across five sectors, it’s currently heavily dependent on one division, Energy and Construction, for profit.
A share price of 65p values the enterprise at £85 million, about 14 times adjusted profit. The earnings yield is 7 per cent.
Watch: Dillistone (DSG)
Recruitment software provider Dillistone continued to pedal furiously in the year to December 2016 without increasing revenue or profit very much. Over the last six years, Dillistone has acquired three firms and ramped up spending on software development, yet profit growth has been inconsistent and return on capital has declined.
Dillistone earns 72 per cent of revenue in the UK, where recruitment is subdued following the vote to leave the EU. The company says recurring revenue covers much of its costs, which gives it confidence in the future; and incoming data protection regulation ought to stimulate demand for software like Dillistone’s over the medium term. But a slow start to the new year, the impending loss of a major contract and heavy investment all mean profit is likely to fall in 2017.
Dillistone needs to raise funds to continue the development of a secret new product it says addresses a global need. Instead of being expensed immediately, some of the cost will be capitalised, which means it will be treated as an investment and charged to profit over a period of five years, starting when the company begins selling the product in 2018. But some costs will impact profit this year.
A share price of 75p values the enterprise at about £15 million or 12 times adjusted profit in 2016. The earnings yield is 8 per cent. This valuation is by no means extreme, but the combination of a turbulent recruitment market and the necessity of heavy investment makes Dillistone a difficult share to recommend.
Even though the company believes its FileFinder software is used by more executive search firms than any competitor worldwide, and Voyager is a market leader in the UK recruitment industry, these are fragmented markets in which Dillistone must vye with cheap generic software and other specialists who leapfrog each other by adding new features to their products. The imperative to diversify into services and new products in search of profit shows how competitive the core business is.
Sprue Aegis (SPRP)
Profitability at Sprue Aegis collapsed in the year to December 2016. The company made a 6 per cent return on capital, compared to an average of 34 per cent over the last decade.
The severity of Sprue’s reversal puts shareholders in a bind. Although profitability fluctuated before 2016, the trajectory of revenue and profit seemed clear. Sprue was a growth stock. The question is whether 2016 is an anomaly, or whether we can expect more inconsistency in future.
On the face of it, Sprue is an attractive investment. It claims to be a market-leading European supplier of smoke and carbon monoxide alarms, which are protected by over 100 patents and sold under increasingly famous brands like FireAngel in the UK and AngelEye in France and Germany.
A year ago Sprue launched SONA, a trade brand, and it’s developing a whizz-bang connected home system that will allow people to monitor alarms, and potentially other devices supplied by Sprue, using their smartphones. Sprue has international aspirations beyond its three major markets, and it was selected in 2016 by Warsaw City Council to supply all its social housing.
But revenue fell 35 per cent in 2016, primarily due to a collapse in demand in France. New legislation mandating alarms there caused an unsustainable surge in revenue and profit in 2014 and 2015. With much of the nation newly equipped in 2016, Sprue’s distributors were left with too much stock and not enough customers. The company also sold fewer alarms in Germany than expected. A problem with the batteries in some alarms required it to find a new supplier, delaying the registration of FireAngel in Germany (now completed).
German states are also mandating alarms, but although Sprue missed out on some business, each state has its own schedule, so demand should be spread out over many years.
A share price of 195p values the enterprise at about £80 million or about 53 times adjusted profit, but profit is almost certainly depressed and the shares could be good value.
Everything depends on the extent of Sprue’s recovery, and risks abound. The company, which outsources manufacturing, is switching to a new manufacturer. An agreement that allows Sprue to distribute a rival brand is ending, although Sprue didn’t derive any profit from it in 2016. And the much-heralded coming of connected devices is attracting new competitors.
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