Surveillance and security specialist Petards issued a profit warning today, although despite reducing expectations termed the overall result ‘satisfactory’. The share price saw an immediate fall:
As with many profit warnings recently (see results) the share price has since recovered a little and as of this afternoon halved its losses.
For longer-term holders, this might seem like business as usual. The price of shares has regularly gone up and down, and two years ago was nearly at 40p. Today’s reduction takes us to a low not seen in 2 years.
Petards specialises in ‘ruggedised’ security systems, such as in public transport or military operations. This is quite a niche market, and this is evident in the financials: this is a small company and a market cap of under £10m now. Despite listing relatively recently, profit growth has been slow: from £0.77m in 2014 to £1.18 in 2018.
The warning comes as the company publishes its half-year report. We have some operations figures to start with an a decrease in order book values. In financial terms there is mixed news: margins have gone up, but revenues have decreased, which has led to a loss and a swing in the debt position from net cash to net debt.
The outlook is also mixed:
There is also a strong pipeline of new contracts under negotiation which it is anticipated will add to the Group’s order book in due course. The Group continues to secure the majority of opportunities available to it, although more recently the timing of expected orders has been later than originally envisaged.
The Board remains confident in the Group’s future prospects and expects to return a satisfactory, albeit lower than previously anticipated, performance for 2019 weighted towards the second half of the year.
Timing slip of contracts seems to be a familiar issue nowadays. No figures are given for what this lower performance is, but Stockopedia estimates £1.52m net profit for the next year.
Petards have an impressive list of clients. Most of the major rail franchises and manufacturers use them in some way, and their latest EyeTrain product is designed as a bespoke solution for trains, integrating into the design and offering weatherproof solutions.
They also specialise in air defence and surveillance systems, as well as using technology for civilian use, such as ANPR (Automatic Number Plate Recognition).
Given this, we might expect that contracts would be large and lumpy. And the company has had form for this before, with contract delays being responsible for profit warnings in the past. As with many contracting companies, margins are small, but not disastrous, although they have slipped to 5.8% in 2018. Competitors are not mentioned, but we must presume with the pedestrian growth and smaller margins that the environment must be pretty tough.
One of the main problems facing the company is gearing. Their type of products would need constant capex to keep them relevant, and this is not matching up with money generated:
In many years capex was bigger than cashflows, and this is apparent when examining other aspects of the finances. It comes as no surprise that no dividends have been paid. 2017 saw a capex spend of £1m larger than cashflow. Because the accounts are merely a snapshot of what happens at the end of the year, it doesn’t reflect that this was financed by a debt, which was then converted to equity for 2018, diluting existing holders.
Cash has decreased in this period to £815k, although not helped by a heavy working capital movement. Whilst prior to working capital movements the company was profitable overall, we can see that it would not take much to go wrong and there may be financial distress. And in this kind of macro-environment we can easily see that, Brexit offering companies the chance to delay or cancel their spending.
Balance sheet wise, they appear in a relatively good position with net tangible asset value of around £3m at the last report. However, almost half their tangible assets lie in inventory, which may not have the same value in a fire-sale.
On a valuation basis, this is fairly cheap I suppose. The market cap equates to roughly £9m, and if we assume that profits are only slightly below the £1.5m slated earlier, we can see that the valuation is not very demanding at all.
There are many things going against this, the primary one being that contracting companies should be cheap. They have small margins, can be interchanged with other companies relatively easily, and in the case of downturns many of their costs are fixed. Even better performing ones like TClarke (LON:CTO) which are clearly executing strategy very well are cheap relative to earnings.
Operational gearing is something Petards could be looking to exploit, a very successful period of winning contracts would contribute disproportionately to the bottom line, as many costs are already sunk into their capex. For whatever reason, it does not seem that this is the case, with the order book smaller than it was last year.
Financially, I feel that smaller shareholders will be vulnerable here. The spread will be relatively large, and it does seem that a successful turnaround might require cash the company does not have currently. A debt-for-equity deal has been seen in the past, and could be seen again. 2/5.