Northern Bear is James Faulkner’s Small Cap of the Week

Few small caps are trading in bargain basement territory right now – especially those that are exposed to the cyclical upswing of the UK economy. However, for investors prepared to look off the beaten track, the ‘micro cap’ end of the market offers a pretty fertile hunting ground, even for some of the more cyclical plays.

With a market cap of just under £10 million, Northern England building services group Northern Bear (NTBR) is just about as ‘micro cap’ as you get. It can be considered a late-stage cyclical play in that it is highly geared towards a recovery in construction activity in the North of England, which has experienced a much slower recovery than London and the South East. This, along with the fact that it has announced a positive set of results covering its financial year ended 31st March 2014, means that the shares are worth a look.

Bullish numbers…

In a year where trading significantly exceeded management’s forecasts, revenue increased by 4.8% to £36.8 million in 2014 and gross profit jumped by 21% to £9.2 million as margins improved across the majority of the group’s companies. Operating profit doubled to £2.2 million despite a £0.5 million increase in administrative costs to £7 million (mostly due to higher operating costs in certain areas, including semi-variable costs such as insurance expenditure increasing with revenue in the year, and the recruitment of additional senior management).

After a £0.5 million finance expense, pre-tax profit came in at £1.75 million, with diluted earnings per share rising from 2.7p to 7.5p. Crucially, profits were matched by strong cash flow, with a net £1.55 million generated from operating activities. After consuming £0.26 million in investing activities, this enabled a £1 million reduction in net debt during the period, to £5.4 million. This lower level of indebtedness has left the company feeling confident enough to reinstate the dividend, initially through declaring a final dividend of 0.75p.

Northern Bear reports having seen positive movement in several sectors during the year, particularly the new house building market, and continued strength in the Social Housing sector for most group companies. Current order book levels are said to be “very encouraging” and, although the roll out of these orders remains difficult to predict, “point to the likelihood that the upward trend in performance should continue through the new financial year”. The strong pipeline of orders, coupled with a brighter outlook for both the national and local construction sectors, bodes well for the firm’s specialist building and support services businesses. 

This looks like a landmark set of results from Northern Bear, with the return to the dividend list a key positive and an indication of management’s confidence in the future outlook for the business. The firm has been benefiting from the growing UK economy feeding through into the building sector, especially in the area of housebuilding. Particularly pleasing is the continual reduction in net debt (see historic figures below). Although debt reduction remains a core goal, management now appear to be moving from a focus on stabilising the business towards looking for growth opportunities. In particular, management is monitoring the opportunities for other uses of funds generated, including capital investment, bolt-on acquisitions and capital repurchases. 

Un-bear-ably cheap?

Northern Bear shares have continued on their strong bull run and currently trade at a mid-price of 55.75p, just shy of multi-year highs, to capitalise the business at £9.85 million. Despite the recent rise the shares are still being valued at a low level by the market, especially in view of the strong cyclical recovery in the sector that seems to have taken hold of late.

At the current price the shares trade on a multiple of just 7.4x earnings for the year to March 2014, which looks cheap given that the results pointed to a strong pipeline for 2015. The investment case is also improved by the return to the dividend list – this year will be the first time a payment will have been made since 2009.

Overall, Northern Bear appears a good way to gain exposure to the improving UK economy and the UK construction industry. In that respect I note the recent Markit construction Purchasing Manager’s Index for June, which stood at 62.6. This was up from 60.0 in May, its highest level since February and well above the forecast for a fall to 59.5 (anything above 50 indicates growth).

Elsewhere, there has been further positive readings for the sector, with official data released last month showing that Britain’s construction output rose by 1.5% in the first three months of 2014, putting output 6.7% higher than a year earlier – the biggest annual rise in three years. The PMI figures pointed to ongoing momentum in the sector, with new orders coming in at the fastest rate since January.

In terms of risks, investors must remember that this is a cyclical stock, with the shares having fallen significantly in the economic crash of 2008/09. Northern Bear also retains a certain level of debt and is exposed to execution risks on contracts.