James Faulkner on Utilitywise – the next great small cap investment?

When I think of companies that have really made it big for investors, one word that pops into my mind is scalability. I’m thinking of companies like Domino’s Pizza, ASOS and Telecom Plus: three of the greatest small cap investments of the last decade, all of which benefited from highly scalable business models. These companies were able to replicate their early success by adding relatively small amounts of capital in order to fund growth. High returns on invested capital are what ultimately drive the share price, and the results are there for all to see. Another company that seems to fit the bill is Utilitywise (UTW).

Founded in 2006, Utilitywise (UTW) provides energy procurement and energy management products and services to business customers throughout the UK, designed to assist them in achieving better value from their energy contracts, reducing energy consumption and their carbon footprint. Having established trading relationships with a number of the UK’s largest energy suppliers as a Third Party Intermediary (TPI), the company negotiates rates with suppliers on behalf of business customers, provides an account care service and offers a range of products and services designed to assist customers manage their energy consumption. The group’s customers are based throughout the UK and Ireland, across a variety of industry sectors and the public sector, and range in size from small single site customers to large multi-site customers.

The company’s energy procurement revenues are commission based. Utilitywise receives commissions directly from the energy suppliers and not from customers. In addition, some customers pay for energy management products and services through a premium on their supply contract, and this premium is also paid to Utilitywise directly by the energy suppliers as a commission. Energy procurement revenues are mainly generated through the firm’s account managers who contact prospective customers identified by the company’s bespoke IT search system to offer a potentially reduced energy tariff and various energy management products and services designed to assist in identifying ways to reduce that customer’s overall energy consumption. This income is augmented through the company’s “partner channels”, where organisations refer customers to Utilitywise and commissions generated from those customers are shared between Utilitywise and the referring organisation.

With the Department for Energy & Climate Change (DECC) estimating that non-domestic gas prices will increase by c.11% and non-domestic electricity prices will increase by c.22% by 2020, Energy procurement and management is becoming an increasingly pressing concern for businesses. The SME market in particular has been identified by the company as an area for significant growth. The company points to a Datamonitor survey into the TPI industry showing that the intermediated business-to-business energy market in the UK is highly fragmented with no clear market leader (among an estimated 3,500 TPIs). The survey also showed that, as a percentage of total contracts, TPIs are more prevalent among major energy users, defined as those organisations that spend over £50,000 per year on energy, where 58% of contracts are through TPIs compared to only 9% of contracts for SMEs.

The company’s recent performance has been very strong indeed.

During the six months to 31st January 2014, pre-tax profits (adjusted for share-based payments and amortisation of intangibles) increased by 133% to £4.9 million, on the back of a 105% increase in revenue to £21 million (like-for-like growth of 65%). This reflected the acquisitions of Energy Information Centre Ltd and Aqua Veritas Consulting Ltd and the continued investment in energy consultant expansion with headcount growing by 34% in the six months to 347. Rising headcount also saw gross secured future revenue rise to £23.8 million from £8.5 million at January 2013, a 180% increase, and from £16.6 million at July 2013, a 43% increase.

Approximately 76% of gross secured future revenue as at January 2014 will be recognised over the next 12 months, providing good levels of visibility going forward. The number of contracted customers continued to increase, with the total customer base growing to 17,903 as at 31st January 2014 – an increase of 36% when compared to 31st January 2013. The group also saw a continued improvement in its renewal rate to 74% by meter volume for its SME customers and 89% for its Industrial and Commercial (I&C) customers.

Alongside its interims, Utilitywise also unveiled the acquisition of ICON Communication Centres, a leading international provider of contact centre services based in the Czech Republic, in a move which signals a further increase in the scale of the. The acquisition of ICON also sets the scene for an expansion into Europe, and brings with it a 300-seat capacity call centre with current staff of 150 covering 25 languages across 11 time zones and over 130 countries. Management has initially set its sights on France, Germany and the Benelux after a series of successful trials.

Despite strong growth to date, Utilitywise has still only penetrated less than 2% of the addressable UK market.

In the medium-term, organic growth is likely to remain driven by a continued expansion in the number of energy consultants, which is now planned to more than double to over 700 by July 2016. There is also scope for further bolt-on acquisitions, particularly in the Controls and Demand Management sectors, where the group can add functionality to further differentiate its offering. Even when excluding international expansion from its model, broker finnCap believes that Utilitywise has the potential to almost double profitability over a two-year period from the end of the current year.

Following the recent interims, the broker upgraded its 2014 and 2015 forecast adjusted profit before tax by c.3-4%, to £13 million for 2014 and £18 million for 2015, implying adjusted EPS of 12.6p and 18.2p respectively. It also introduced a 2016 forecast for the first time to reflect the early benefit of the further scaling, implying a move to an adjusted profit before tax of £25 million and EPS of 25.4p.

On these forecasts, Utilitywise shares trade on a P/E multiple of 24.6x (year to July), falling to 17x for FY15 and to 12.2x for FY16. This is against forecast EPS growth of 48.1%, 44.5% and 39.8% respectively. These metrics look highly attractive for a highly scalable business growing as quickly as Utilitywise, especially given the opportunity for a further uplift to these numbers from European expansion. The continued growth and evolution of the group into a one-stop-shop for businesses’ utility management and consultancy needs represents a compelling investment opportunity. With a dividend payment of 5.7p pencilled in for FY15, there is also a prospective 1.8% yield on offer. We see the biggest risks to the investment case being under delivery against forecasts and the reliance on energy suppliers.

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