Newmark Security - Underlying Performance Obscured

http://www.newmarksecurity.com/


Over the past year, Newmark Security (LSE:NWT) has been a slow burner for investors with the share price seemingly stuck in a 20% trading range. Despite this, the underlying financial position of the company has improved greatly and that improvement is even more stark on a three-year timescale. Newmark is a UK-based, micro-cap security solutions provider, tackling both the electronic and physical security sectors. Valued at £7.09m, Newmark is far from being overpriced and currently trading at 1.575p, it could offer good upside for investors, based on the current metrics alone.


The technical position for Newmark is an interesting one. The shares have been trapped within the 1.38p - 1.60p range as shown for the past year following a very sharp move up during early 2013. Over the period when volumes were high, that move took the shares up from ~0.90p to ~1.60p. It is therefore understandable for the share price to enter a horizontal range. The recent spike out took the shares to a high of 1.85p, which is a considerable break of the range, so for it to retrace to this extent is certainly a little surprising. Therefore, the price movement over the next couple of weeks will determine the medium-term outlook for the share price.

One issue with Newmark is that its shares can be fairly illiquid. That has not been the case over the last few months though, with a decent spread attainable. In light of the recent results, that spread has narrowed such that it currently is 1.55p - 1.60p. That is a very decent spread indeed for a company of Newmark's size. There are 450m shares in issue and a large proportion of these are tightly held by directors. 29.9% of shares are held by the Chairman and his family, with a further 3.7% held by a non-executive director. A further ~30% of shares are held by Investec and the Reid family (an independent investor who was previously a non-executive director of the company before passing away a few years back). There are a total of ~36m options outstanding so that could prove dilutory in the future (given the less than testing exercise price!), but that is not an issue for now and the potential dilution is less than 10%. Non-executive Rapoport has bought a total of 4m shares over the course of the past year.
http://sateon.com

As commented earlier, Newmark Security is a provider of electronic and physical security systems and has operations separated into these two divisions. Remarkably, the company has been listed on the London Stock Exchange since 1997, yet the price performance to date has been less than stellar to put it mildly. The electronic security division is mainly comprised of Grosvenor Technology. Grosvenor's flagship product is SATEON having upgraded their legacy JANUS system (which had a blue-chip client base including BAE Systems and Morrisons).

SATEON is an access control system which can control a whole array of systems for firms, including door controls, CCTV and fire alarms. Hardware from Newmark is integrated into various building locations that interact with the software in order to provide a fully functional interface. Aside from the interface itself, the USP that Newmark continues to push is that the software does not require installation, and it is a fully browser based tool. That has numerous advantages, one of the most significant being that when the software has an upgrade, only the central server needs upgrading as opposed to each individual computer.

Last year Grosvenor released SATEON 2.6 which allowed for the company to compete in larger project tenders. The following version, 2.6.1, included a multi-tenancy feature and this helped them secure the contract for winning the Gherkin's (building in London) access control. That should prove to be an important reference that they can use to sell their SATEON system to other businesses. Further upgrades to SATEON are planned. The managing director of Grosvenor resigned in September 2013 but ensured it was an orderly handover. Having spent 24 years at the firm, it is probably misplaced to read too deeply into the move.

Newmark's physical security system comprises two companies; Safetell and ATM Protection. Safetell sells products such as security screens and services such as lock and CCTV repair. Safetell's clients include the Post Office (for which it has received large orders over the past couple of years) and the Metropolitan Police. ATM Protection (ATMP) is a much smaller part of the wider group, and it was bought back in 2010. It specialises in unique Cash-In-Transit (CIT) systems and the protection of ATMs, although one of its main products has not been nearly as successful as hopes. One of the main reasons why ATMP was bought was for its CIT boxes. These CIT boxes are the boxes that cash is carried around in when it is being transported. Historically, the way to deter thieves from stealing these boxes has been to include a system whereby blue dye is released upon tampering, and that means it cannot be used. The problem with this is that the dye does not always penetrate each and every note, as they are bundled, and some cash machines are not designed to be able to detect the dye. The result is that the dye method is only a partial solution.

A much more comprehensive solution was to use chemicals to bond the notes together. Instead of dye, upon tampering an adhesive is released that damages the notes beyond repaid within a matter of seconds. This method is more clever though, as the identification numbers on the bank notes are not obscured by the adhesive. Seeing as these CIT boxes are GPS tracked, upon retrieval of the notes a refund can be sought from the Bank of England. However, there has been a problem with this, that I will outline later. To add to the product range of the group, Newmark undertook a small scale acquisition of Gunnebo Security Installations (GSI) for £118,000 back in November. The tangible value of GSI mainly consisted of inventory and tools although the intangible value is the enhanced product offering and introduction of new clients, and this gives cross-selling opportunities. It appears a good fit for the portfolio, although don't expect it to materially contribute to the overall group performance.

Looking at the FY 2013 performance, it becomes clear that impairments have materially skewed past financial performances. The CIT box had to be impaired to the tune of £483k because it needing re-developing, and this underlines the problem with capitalising costs - if those costs later turn out to not have generated as much value as on the balance sheet, then they have to be written down. A large impairment was against goodwill on the acquisition of Grosvenor Technology. These impairments knocked down the profit from £2.48m to £0.2m. It's important to remember though that these impairments are non-cash charges. Earnings take a hit, but the company does not actually have to outlay any cash - it's purely a case of writing down the value of an asset. Thus, Newmark reinstated a 0.0333p dividend which is a 2.1% dividend yield (currently) at a cost of £150k. The chart below shows the state of Newmark's financial performance since 2006.

* = Figure is before exceptional items, finance costs and tax

Part of the problem with Newmark is that its revenues have behaved erratically, and consequently so have operational cash generation and profit from operations. Nevertheless. the 2013 performance shows a clear step forward with revenues rising sharply past £18m, operational cash generation reaching a new period high of £2.97m and profit from operations tracking to a new high of £2.58m. Brokers forecast that revenues for the next two years are expected to be broadly similar to that of 2013, which is reassuring given that it indicates the revenue increase will prove to be an anomaly. What is equally important though, is the cash position of the company and this is not shown on chart. In fact, there has been a significant underlying improvement in that figure with the net cash position having been transformed from -£1.4m in 2008 to £0.65m in 2013.

In January 2014, Newmark delivered a trading update ahead of the interim results. Take note that broker expectations for this year were ~£17.2m in revenues. The update told investors that revenues are above market expectations for the interim period, due to orders for the asset protection division from the Post Office being received earlier than expected. Newmark went on to add that FY revenues would also be substantially above market expectations due to recent further orders from the Post Office, the finalisation of a substantial one-off contract for a foreign embassy together with a healthy order book. That's encouraging as substantially above market expectations usually means at least 10% above.

However, there was a negative side to the update. The company announced that it would impair the remaining £0.8m associated with the CIT box. That was due to budget cuts from the intended client, competitor movements (e.g. G4S have developed a similar box), and the planned introduction of polymer notes in 2016 being sooner than anticipated. That write-down hit the EPS figures for H1.

The interim results were released shortly after. These were the main points:
- Revenues up 8% Y.O.Y to £8.8m
- Profit before exceptionals of £893k vs. £799k. This was almost entirely wiped by the CIT impairment of £826k
- EPS pre-exceptionals of 0.15p. Post-exceptionals of -0.03p which was a £122k loss
- Cash flow from operations increased to £1.87m but benefited from certain advance payments. Cash inflow during the period of £894k
- Gross margin lower at 35%
- Cash & Equivalents of £2.02m with borrowings lower at £375k
- Net payables of £1.035m although inventories of £1.40m were booked
- R&D expenditure steady at £541k

http://www.safetell.co.uk/
The EPS figures are particularly interesting as it tells investors that had the impairment not occurred, the company would be trading on a PE ratio of around 10 based on H1 alone. Stripping out the cash and it falls to single digits. Taking the EPS forecast before impairment (0.26p) and factoring in results being above expectations, probably means that adjusted EPS for the year will come in around 0.30p. Looking in greater depth, the electronics division saw strong revenue growth, up 18% to £3.9m which was above expectations - the result aided by strong growth in US-based workforce management divisions. The asset protection division saw revenues up 2% to £5m. Previous FY estimates for this division were around £10m, so this looks to be trading in line with expectations although this could change during H2 (i.e. above expectations due to the Post Office orders).

Another point to make is that a large follow-on contract for a supermarket was delayed during the period, thus the company expects that most of it will be delivered during the next financial year. Whilst that is disappointing on the surface, it actually makes the estimate-beating announcement all the more impressive and should mean that the outlook for next year is improved. It effectively counter-acts the Post Office orders being brought forward.

Looking ahead, Newmark is looking to further diversify its revenue streams primarily through the electronic division. The multi-linguistic functionality of SATEON means that it can be sold overseas without the need for significant further developments. Indeed, management are planning to market SATEON once technical support in attendance is not required. In other words, develop it to the stage such that a worker does not need to travel to the business to install it or provide support. In essence, this means that future costs through this expansion model are relatively small and operational gearing can take place on a small scale.

Taking the current share price, Newmark's underlying PE ratio is therefore just 5.25 which is extremely low in the current market. The reality is that the true performance is being obscured by the impairments and that is an inherent risk when looking at companies who deal with technology and who have a large amount of intangible assets - a sudden change in the market can lead to those assets needing to be written down to fair value. In the case of Newmark, all of the CIT costs have been written down so that could spell the end of those major impairments. If Newmark was a £500m company, the market would probably not take great notice of the impairments and look at future EPS, future PE ratios and adjust the share price accordingly. That is not the case though, so the market seems to be taking a very (and probably over) cautious stance.

The underlying performance of the company is sound with it being highly cash generative and having a much improved cash position. The dividend this year should be increased (albeit not materially) and that should help the share price push towards house-broker Cantor Fitzgerald's initial 2p target. I reckon that if momentum builds, and the share price can break out of the current range, that target should be easily surpassable on a medium-term timescale. A question that it's good to ask is whether you can see the market cap of the company falling to £Xm. In the case of Newmark I'd set that to be £5-6m. In my opinion, the answer is no and in that case I'd be inclined to think that the downside is fairly limited. For those reasons I have put a Buy tag on Newmark Security at 1.575p.

4 comments:

  1. As usual excellent research, thanks El1te

    ReplyDelete
    Replies
    1. Agree. Very good find el1te. this website is one of the best researching resources out there

      CraigJ

      Delete
  2. Great write up, El1te. Mrkt seems to have taken notice as well

    ReplyDelete
  3. Newmark is now almost back at the level at which you put a buy tag on in February - so perhaps worth looking at again by all those who missed the previous rises.

    ReplyDelete