Category: Stock Tips

Stock of the moment – North Midland Construction The Turnaround

Stock of the moment – North Midland Construction The Turnaround

Stock of the moment – North Midland Construction

NMD: North Midland Construction current stock price: £4.08. Intrinsic value: £7.20. Margin of safety: 76%

The key to a successful turnaround

Peter Lynch said :

“Bottom fishing is a popular investor pastime, but it’s usually the fisherman who gets hooked. Trying to catch the bottom on a falling stock is like trying to catch a falling knife. It’s normally a good idea to wait until the knife hits the ground and sticks, then vibrates for a while and settles down before you try to grab it.”

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Who is North Midland Construction?

North Midland Construction is a civil engineering firm which operates nationally with twelve strategically located regional offices and workshops. They have six operational divisions which provide focused services to customers across five chosen core market sectors: Construction, Power, Highways, Telecommunications and Water.

Legacy costs will disappear

Their results have been turbulent of recent years due to mispricing of legacy contracts which have been incurring heavy losses. Legacy contracts are construction contracts entered into at the height of the recession which carried a high contractual and commercial risk. These contracts have impacted the Group’s income statement in 2013 and subsequent years. Last year the total loss before tax recognised on legacy contracts was £3.85 million which left £2.6m total profit overall.

Last year the group completed all on site works for the one remaining legacy contract, therefore removing any further uncertainty around costs to fulfil the contract. If we know that there will be no legacy hits this year, then we know that all NMD has to do is equal last years adjusted performance to double earnings per share.

The turnaround questions

While looking for investing in potential turnarounds, some points to be considered are:

How much cash and debt does the company have?

NMD has a 0.31 debt to equity ratio with £11m in the bank as of last year. This suits me well however the biggest risk I see with NMD lies in its current ratio which sits just shy of 1. The current ratio is a liquidity ratio that measures a company’s ability to pay short-term and long-term obligations. NMD technically can’t quite do that.

What is the company’s strategy?

The company had a huge shake up mid 2016 with the appointment of a new CEO, John Homer. John was previously with Morgan Sindall and had also worked at Galliford Try. This gives NMD two big green ticks in my box as these companies have delivered tremendous shareholder value. He’s also a self-proclaimed maths nerd which is another big green tick.

Following last year’s major upheaval to address the bottom line, Mr Homer is leading the group towards achieving an ambitious target of a 5 per cent operating margin within five years on top of £500m revenues. That represents a doubling of the business with a much healthier margin than today. Generally you don’t come out saying things like that a week before interims unless you know that you won’t look silly.

Will this make a big difference in earnings?

Well the above plan would give shareholders an EPS of £2.50 in FY22. (Oh that’s another beautiful aspect of this company – it has 10 million shares outstanding so per share calculus is exceptionally simple). The short-term key to this trade is the knowledge that when we add-back this final legacy loss to FY16 then net profits would have been at least £5m last year – essentially doubling earnings per share from 26p to over 50p. 15 x earnings on 50p = £7.50 per share. This means that earnings should double before the above margin improvements are even implemented giving a substantial margin of safety.

Is business coming back?

Business has always been growing It’s simply a case of poor commercial decisions on big contracts which didn’t properly account for risk. Quite a dangerous game with the wafer thin margins in construction. In fact, they have recently won a new joint venture infrastructure contract for Severn Trent Water worth in excess of £100m. North Midland Construction has also been shortlisted for a portion of the £1 billion YORcivil2 project.

The company will release interim results on 10th August 2017 which will provide us with further insight here.

The answers for these questions for NMD are very positive indeed.

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The fundamentals

The above contract wins lead me to believe that revenue growth will continue to at 15-25% per year. If this is the case and net margins achieve 2% (fairly likely given the legacy costs are disappearing) then we are looking at a Net Profit of £5.75 million this year. Across 10 million shares that gives a forward earnings per share of 58 pence. Even by the BREXIT battered construction sector’s standards (an opportunity for us contrarians) it makes the share exceptionally cheap at 7 x earnings. The construction industry’s average forward PE is 16 x earnings so comfortably below its peers. At 15 x forward earnings the shares should be worth £8.70.

So what return can you comfortably expect on this? long-term holders at these prices can expect a return of 14.28% per year (1 divided by a P/E of 7 equates to 14%).  That return comfortably covers the risk of holding NMD.

DCF says yes!

The other valuation metric I use is a discounted cash flow. Lets assume that the average cash flow for the last three years continues at a comfortable £5 million (I expect it will be more but let’s be conservative).

I capped the growth rate at 10% per year for ten years (again very conservative). I set a discount/required rate of return of 14% on future cash flows which provides £36 million in future discounted cash flows. Then I add the perpetuity rate of 2% giving me a further £10 million cash flow into perpetuity. Let’s not forget the cash in bank of £11 million. In total this equates to an EV of £57 million. £5.70 per share for those of you who haven’t got your abacus beside you. That’s 38% upside from today’s price and an inbuilt return of 14% per year.

 money cheers startup hustle startups GIF

The market

I tend not to focus on the market but it’s necessary for cyclical companies such as NMD. The market is certainly pricing in a correction on many construction firms and who can blame them? We have been riding this bull for quite some time and BREXIT did knock us somewhat.

Despite the headwinds facing the UK overall, my overarching theory is that if another correction came then the government has no other option than to revert back to classic Keynesian economics and therefore it may invest heavily in infrastructure. This bodes well for NMD in the long-term. If a correction doesn’t come, well this also bodes well for NMD. I’m not talking about the share price here – I’m talking solid shareholder returns.

My first turnaround

Overall I’m pretty happy to dip my toes into this turnaround. Taking the forward EPS and DCF gives me an intrinsic value of £7.20. The short-term earnings boost now that the legacy contracts have disappeared will build my margin of safety. The general low price relative to earnings potential will continue to be a catalyst to the share price over time. I can quite easily see this being £37 in 5 years if John’s vision comes into fruition.

The one key risk area that I will be keeping an eye on is the current ratio and NMD’s liquidity. If a contraction did occur and our short-term assets couldn’t cover short-term liabilities then money will need to sourced from somewhere. I’m sure that this is an area that John will be addressing.

As per Peter Lynch’s quote – the knife has hit the ground, stuck, vibrated for a while and now settled down so I’m ready to grab it. The upside for North Midland Construction more than compensates for the downside.

Find my other stock tips here.

Book influences:

Disclosure: Long North Midland Construction

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Stock of the moment – Hurricane Energy (AIM:HUR) Buy a Barrel of Oil for $1.60

Stock of the moment – Hurricane Energy (AIM:HUR) Buy a Barrel of Oil for $1.60

Stock of the moment – Hurricane Energy

Hurricane Energy (AIM:HUR) current stock price: £0.54. Intrinsic value: £1.85. Margin of safety: 243%

Buy a barrel of oil for $1.60

If I told you that you could buy 1 barrel of oil for $1.60 would you snap my hand off? Of course you would given that a barrel of oil is worth $52.

What if I offered you 523 million barrels of oil for $1.60 each? or £650 million. The arithmetic is identical but the opportunity is far greater. Obviously, you will still need to raise a wad of cash to drill for the oil and maintain your profitability which is where Hurricane stands today.

Keep talking and take my money gif

What is Hurricane Energy?

Hurricane Energy is engaged in the exploration of oil and gas properties in the United Kingdom so this is one of my riskier and more speculative investment tips.

hurricane energy stock tips

Hurricane focuses on large geological fractures which would ordinarily be too deep to drill but there are some features which have risen to levels due to tectonic movements which allows exploration firms like Hurricane to tap into them.

The company currently holds licences over six fields. These include; Lancaster basement discovery, Whirlwind basement discovery, Lincoln basement, Typhoon basement, Warwick basement, and Strathmore sandstone discovery prospects located to the West of Shetland. Hurricane has drilled and confirmed the commercial viability of Lancaster which is the main prospect and preliminary assessments over the other prospects including the newly acquired Halifax licence are positive. In fact, Lancaster and Halifax might be a whole larger field which would unlock further value.

Exploration firms are highly risky and they are usually an all or nothing investment. It takes a lot for me to recommend such a stock but I think the fundamentals for Hurricane Energy are stronger than the typical exploration firm.

The fundamentals

Hurricane Energy’s greatest strength which sets it apart from other oil exploration firms is that it owns 100% interest in all its resources – no debt or other parties with their own interests. This gives Hurricane the upper hand as it looks for funding to develop an early production system (EPS) which will generate 62m barrels of oil flow and subsequently $192m cash flow from Lancaster from 2019.

The Competent Person’s Report which is written by an independent and competent person suggests a net present value (the value today discounted at 10%) of about $11 per barrel for the Lancaster reserves. A conservative 50% of the 523m barrels could be recovered (although the CPR states 22%), in which case we get a potential value of $2.9bn, or around £1.85 per share. This is subject to oil price fluctuations of course. Remember though, this is one field! The opportunity from the other fields or even a joint Halifax-Lancaster field could mean further upside.

Investors revere the management team highly which adds stability to the future share price. Dr Robert Trice is a strong and capable CEO. He has thus far delivered on his promises and made strong leadership decisions based on his knowledgeable conviction.

Interestingly 97% of the company is owned by ‘smart money’ such as Hedge Funds, VCs and PEs, institutional investors and insiders whilst the general public only owns 3%. It’s the general public who usually distorts these opportunities to extreme heights.

The speculation

Hurricane’s share price is currently being discounted due to the EPS fundraise. This will be to the tune of £394 million. The market is rightly thinking

1) if Hurricane doesn’t raise money then there is no opportunity

2) how will the structure of the EPS financing affect my holding?

The fundraise will most likely be funded through the issuance of new stocks, leverage (remember they currently have none) and/ or by Hurricane selling a share of their field to the likes of BP or some other oil major. I personally believe that it will be a combination of the above which will cause some dilution to existing shareholders. The dilution to shareholders will be offset by the value-added created by de-risking the financials.

Hurricane represents a position of less than 5% of my portfolio due to the speculative nature of the stock. Small speculations with strong convictions and under certain circumstances are fine and this is one of them. It will be a volatile and bumpy ride so hold on tight.

gamble gif

Oil Prices though?

We could sit here and speculate about the price of oil until our nose bleeds. We could also look at the average 30-year inflation adjusted oil price which is $57. The margin between the cost to produce and the price of oil is currently large enough to add value to shareholders.

Whilst oil prices are looking sick at the moment they also offer us contrarian investors an opportunity. Oil prices will be weighing on investors minds so get off the fence and invest whilst prices are relatively low. According to HSBC, the lack of CAPEX and investment in oil will bite us in the ass in the long-term and I agree. If Hurricane can raise cash in a benign oil environment like today then it bodes well for its future.

Time to add Hurricane Energy (AIM:HUR) to your ISA and check back on it in a couple of years!  Disclosure: Long Hurricane Energy.

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Stock of the moment – Taptica International the hidden gem

Stock of the moment – Taptica International the hidden gem

Stock of the moment – Taptica International

TAP: Taptica current stock price: £2.72. Intrinsic value: £3.94. Margin of safety: 44%

The key to successful investing

Charlie Munger, Warren Buffet’s legendary wing-man, once stated that the key to successful investing:

“is the ability to do nothing 99% of the time, combined with an ability to aggressively seize that 1% opportunity, of which the average investor can expect to encounter only a few in their lifetime.”

Well I’ve been waiting for this moment for a while. Never have I seen an opportunity like Taptica.

taptica

What is Taptica?

Taptica is a global mobile advertising platform that helps the world’s top brands reach their most valuable users through targeted ads. Its proprietary technology leverages big data and, combined with state-of-the-art algorithms, enables quality media targeting at scale. It’s customers include Amazon, Disney, Facebook, Twitter, OpenTable, Expedia, Lyft and Zynga.

Essentially, they gather your data for advertisers and consider whether or not you are likely to buy the company’s products. How? Cookies of course.

Cookie monster

If you aren’t a big spender, then they won’t target the ad at you. This is a game changer.

Let’s face it, Facebook, Instagram, Google and Twitter are all top platforms for companies who want to advertise online. At the same time they require pinpoint targeting for campaigns to deliver a strong ROI. Taptica solves this issue.

I’ve worked at a retail start-up where mobile advertising was a key driver for revenue. The company was willing to spend BIG despite its restrained marketing budgets. This advertising shift has been a tidal wave in the last couple of years and companies are only just starting to allocate their marketing budgets to mobile devices. Taptica is therefore very well placed to take advantage of this trend.

The fundamentals

The company released a trading update on the 25th of Jan 2017 however the market has hardly taken any notice of it. On March 20th 2017 Taptica’s full results will be announced – there may be variances to the below which we must consider.

Revenue growth has been strong with an increase to $125 million from $75 million underlining the success of their mobile strategy.

All things equal, Taptica will announce EBITDA for FY17 at circa $25 million compared to $7.4 million last year. That’s an incredible 238% increase in EBITDA.

When you consider that Taptica’s market capitalisation is £166m then the firm is only trading at 8 x EBITDA. That’s a low multiple for a start-up which is in The Deloitte Technology Fast 50™! A conservative multiple would be more like 12 x EBITDA and would value each share at £3.87, representing a 41% uplift from today’s close of £2.72.

What about earnings per share though?

Last year Taptica achieved 11 pence per share. At 15 X earnings (Peter Lynch’s mean reversion earnings multiple) the stock was valued fairly at around £1.65. Analyst’s now expect earnings to be around 22 pence this year which values the stock at £3.30. Taptic and has literally doubled its money.

The stock is therefore currently below the most conservative of values and this is a company which compares to the likes of Shopify. Context alert: Shopify is making a loss and is only generating 2 times Taptica’s revenue. Shopify is valued at $5 billion… now compare that to taptica’s £166 million price-tag.

The intrinsic discounted cash flow value of Taptica at a growth rate of 15%, a discount rate of 11% and a perpetuity rate of 1% values the company fairly at around £3.94

The balance sheet is also impeccable and continues to be highly cash generative. Taptica had a cash balance at 31 December 2016 of ~$21m (30 June 2016: $9.5m), after a $3.5m interim dividend payment in November 2016.

Taptica is the most undervalued high quality growth stock on the market.

The market is sleeping

The sleepy market and Taptica’s under the radar status has allowed me to achieve an average purchase price of £2.36. I began purchasing heavily from £2.oo a share. Taptica’s current fair value is around £3.90. If the market awakens it may be pushed to greater heights.

The Future is bright, the health is strong and the value is low – rarely do these traits emerge in unison.  Earnings are announced in 7 days. This is that 1% opportunity that Munger spoke about.

Disclosure: long Taptica.

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