Shares in Cheltenham-based microcap Pennant International (LON:PEN) dropped by a quarter today as it revealed that revenue expectations for certain projects as well as the slippage of other contracts into FY2020 would have a ‘material’ affect on profits for this year. The share price dropped sharply but has since recovered some:
Pennant are an interesting company and have been around for some time, albeit most of it under the radar, so to speak. They have remained as a niche provider of products, amidst several periods of transformation. They supply training products and services for a variety of users from defence to public transport.
With several iterations of reorganisation Pennant trades out of three divisions: Technical Training, Integrated Logistics Support, and Aviation Skills Partnership. Their list of clients is impressive, from major governments to large transit organisations.
The warning comes in a trading RNS. In some ways we are set up for it:
The Company stated in its 2018 Annual Report (published in March 2019) that it expected 2019 to be significantly weighted in favour of the second half of the year (the “Second Half”, or “H2 2019”), with the majority of revenues for the year (and all profits) anticipated to be realised in H2 2019 upon the achievement of certain performance milestones on the Qatar contract.
Second half weightings are usually a nice way of postponing a warning. We then have a nice note that the first half is ahead of expectations, but then comes the bad news: some contracts are delayed, and the acquisition (Aviation Skills Partnership) speed of expansion has slowed due to Brexit causing knock-on effects to public spend. The warning is expressed as such:
With the change to revenue expectations on the Ajax programme and in the Aviation Skills Partnership business, together with the timeline for the award of certain potential contracts moving into 2020, the Group now expects its results for 2019 to be materially lower than current market expectations and anticipates reporting EBITA for 2019 as a whole of £1.8 million. The Group has more than adequate working capital facilities for the next period and beyond.
It is quite easy to see why investors have not really talked about Pennant as an investment, as it seems there is very little to get excited about. Revenues have been more or less flat across the last 5 years, and aside from 2015 profits have been flat as well, within a narrow band. There used to be a small dividend, but there hasn’t been one paid for a few years, and it doesn’t seem this will change soon with the net cash position being negative.
Whilst there have been profits, and a reasonable 10%+ operating margin, it appears that much of the cash has gone back into the business. Capital expenditures have exceeded cash flow for the last 3 years in a row. Alongside this there have been several equity raises which have diluted shareholders.
Perhaps a sniff of growth could be seen with the acquisition of Aviation Skills Partnership, but this is about as small a bolt-on as you can get, with turnover of just over £300,000. It is fair to say that a good deal of investment may be required into this, and expansion of its services is ambitious but not implausible.
There is little to no debt on the books here, and the company has had net cash at the end of every year in recent history. Should EBITA as a whole be £1.8m as stated it should be the case that this is preserved again. As for debt headroom, it appears as if there is a £3.0m overdraft in place, so in the short term there is no particular worry about solvency.
Not very easy to get excited about this, hence the shorter comments. Of more interest was the broker note released today (available on Research Tree), which shows that the cut in profits as opposed to expectations is quite severe (£1.8m vs £3.55m) which also has knock-on effects for the next year. They also forecast year-end cash to be £0 as opposed to £2.0m which on this sort of market capitalisation has some big effects for people trying to work out potential values.
Playing around with some figures, we can see that perhaps these shares are cheap. The large capex spends of recent years are unlikely to be repeated, and investment into the new Aviation business may be contingent on public spending. If we can accept the broker report and that profits will be almost repaired next year (c.£3m adjusted), then today’s share price represents a very good opportunity.
Trouble is with this type of share, we have seen these excuses many times in that contracts slip, change, or spending is delayed. Where there is concentration in a few customers, the risk of this is quite high and happens with regularity. Defence spending also could be a bit of a political hotbox, in that it would be easier for a government to cut this than something like healthcare or education. So the point that these companies deserve a cheap valuation is pretty valid.
It isn’t a total dog, and the weakness of the pound combined with its international operations could mean that this is a candidate for acquisition by somebody else, either as a bolt-on or outright. But that isn’t enough of a reason to purchase on its own, and as we saw with Bonmarche, a purchase may only arise at a time where it is too late for shareholders. 2/5.