James Faulkner on WatsHot in the small cap markets: Tristel, H&T and Digital Globe Services

Tristel (TSTL)

Disinfection specialist Tristel (TSTL) is currently riding high on a wave of profit upgrades – in fact, it announced its fifth in a row in July. The shares have already responded with a jump of more than 200% over the past year or so, but there is clearly a lot of trading momentum in the business that could drive the re-rating even further.

Tristel develops proprietary infection, hygiene and contamination control products used by organisations in healthcare, pharma, personal care, and animal care. Its patented chlorine dioxide chemistry is clinically proven and deployed in more than 400 UK hospitals. After a slow few years, sales really began to take off in the first half of FY14, with revenues in the Human Health division (86% of group) soaring by 56.5% to £5.5 million.

Significantly, sales growth was mostly driven by consumables (e.g. wipes), which account for around 97% of group sales. This is really attractive for investors, as it brings great visibility (repeat orders, no lumpy sales) as well as high margins.

Tristel Rinse Wipes

Numbers

For the year ended June 2014, the company announced that adjusted pre-tax profits would come in a whopping 280% higher at £1.8 million on revenues of £13.48 million, up 27.8% like-for-like. Clearly, there is significant operational gearing at play here, which suggests there could be more large jumps in profit on comparatively small increases in sales. There is also a lot of momentum going into the current year, with H2 sales and profit coming in at £7.04 million and £1.08 million respectively,
compared to £6.44 million and £0.72 million in H1.

The bullishness of management is palpable:

“We are experiencing a rise in sales in all three portfolios and across most geographical markets. The pace of growth is higher than previously anticipated and with margins also improving and costs stable, the impact on the bottom line is both significant and immediate. 

“We can conclude that the re-shaping of our business over the past three years has been firmly cemented in place. The growing revenue contributions from the new products and new markets we have invested in have become both visible and predictable, and with an exciting pipeline of new innovations built upon our proprietary chlorine dioxide technology, we view the future with increasing confidence.”   

Tristel has much of the UK market for contamination sewn up. For example, an article titled “Decontamination methods for flexible nasal endoscopes” published in the British Journal of Nursing reported that 60% of respondents used the Tristel Wipes System and 11% used a Tristel liquid disinfectant. Tristel believes the outcome of the survey is representative of the entire UK hospital market.

As Tristel CEO Paul Swinney explains, “One of the great benefits of the Wipes System to a hospital is that it requires no capital investment and has no on-going maintenance cost. For a cash-strapped health system this is a tremendous advantage over the alternatives.” Another advantage for Tristel is that 72% of revenue is derived from proprietary products with patents enforceable until 2028/9.

What’s it worth?

With the UK pretty much in the bag, Tristel is now looking overseas for additional growth avenues, in particular the lucrative US market. With brokers having yet to factor this opportunity into their numbers, this could be a source of further upside in the years to come. But for now, the shares remain on a roll. Consensus estimates place the stock on c.20 times FY15 forecast earnings, with an attractive looking PEG of 0.7 times. There is also net cash of £2.59 million.

H&T (HAT)

Pawnbroker H&T (HAT) is sitting in what looks like value territory, especially if one buys into the ongoing “cost of living crisis” narrative. It is also worth noting that its major competitor Albemarle & Bond almost went under recently, but was bought out of administration by Promethean Investments, which bought 128 of the 187 branches available. This should take some capacity out of the market and ease the competitive landscape for H&T somewhat.

H&T provides a range of options for customers to raise the cash they need, whether using an asset or taking out an unsecured loan. The company claims that the pricing of its loan products is amongst the lowest in the sector, particularly versus larger chains, “and almost without exception the 1.6m customers of pay day lenders would be substantially better off taking a loan with H&T instead.”

At first glance interim results released on Tuesday do not make for pretty reading. Profit before tax was more than halved at £2 million; and the pledge book decreased by 20.8% to £38.5 million. However, the fall in profit was principally a result of reduced profits from its pawnbroking scrap and gold purchasing operations. Cashflow was very strong during the period, with £10.3 million generated from operations (£4.7 million before changes in working capital). This saw net debt cut by 52.6% to £13.5 million, bringing leverage well within financial covenants (1.5x vs 3x limit).

In fact, management seem to be doing a good job of repositioning the business to mitigate the fall in the gold price. In the short-term, this has focused on targeted cost reductions and jewellery retail to support earnings. In retail, sales in H1 2014 were up 49.3% and gross profit was up 20.9% on the prior year. Meanwhile, total direct and administration costs were reduced by £2.1 million to to £19.8 million. Longer term, management believe that the wider alternative credit market is likely to undergo significant changes in the coming year primarily due to the impact of the FCA’s proposed interest rate cap, which should put pressure on some competitors.

Broker N+1 Singer envisages a free cash flow yield of more than 17% for the current year, which makes the shares worthy of further attention. Clearly a further large fall in the gold price wouldn’t do H&T any good, but this seems unlikely in our view.

Digital Globe Services (DGS)

After a promising IPO, shares in customer acquisition specialist Digital Globe Services (DGS) are now almost 50% off of the 272.5p high seen in 2013. This seems to have been down to the firm being (unfairly?) bundled with all the other ‘adtech’ companies, which have been sold off pretty aggressively of late.

What does it do?

DGS uses algorithm-based technology and proprietary databases on behalf of its clients to acquire customers online via paid search advertising. To make money, the firm enters into business partnerships with customers on a fee per sale performance basis. It then helps clients to convert interested consumers into customers via its dgSmart proprietary technology platform, which determines the optimal price to pay for advertising on sites such as Google, Yahoo and Facebook. DGS also adds value by determining the key search terms for advertisers to use.

On Tuesday DGS confirmed that its the financial results for the year ended 30th of June 2014 will be in line with market expectations. On this note, N+1 Singer is looking for revenues of $39.1 million, up over 50% year-on-year, and adjusted EBITDA of $5.8 million, up 45%. At present the vast majority of DGS’s clients are in the telecommunications industry in North America but the group intends to enter the European telecommunications market through initial discussions with firms in the UK, France and Germany. DGS is also planning to diversify its operations into new verticals and has already entered into a partnership with a North American utilities firm. It expects “meaningful revenue generation” from these new areas of the business in the coming year.

At these prices the shares look worthy of further investigation.

For a firm boasting apparently unique proprietary technology and operating in a structural growth market (online customer acquisition), the current rating of 11.8 times and prospective dividend yield of 7.1% (both based on consensus forecasts) looks harsh on the face of it. In addition there is a small net cash balance and a decent track record of organic growth. The PEG is a mere 0.4 times.