Newmark Security - Results Date Approaches

http://www.newmarksecurity.com/


I first looked at Newmark Security (LSE:NWT) back in February after the company had announced half-year results above market expectations. I concluded that the financial state of the company should ordinarily demand a higher market cap than the circa ~£7m boasted when the shares were trading at 1.58p, and that certain exceptional charges on the books, obscured the underlying performance of the company, which was positive and improving. However, Newmark's shares have not managed to gain any real traction since, now trading at 1.68p - a lack of news releases has not helped, although the company has never been news-rich. Despite the lack of price appreciation to date, Newmark will be gearing up to release its full year results in late July to early August, and anticipation of the results numbers could well spark the market back to life. At 1.68p, Newmark is valued at £7.54m.

This article is a follow-on from the below post. For full context and information, read this article first:
http://www.theel1tetrader.com/2014/02/newmark-security-underlying-performance.html


Unsurprisingly, with the lack of price movement since the original review, there is not a great deal more to comment upon. However, there has been one crucial change, which is that the share price has conclusively broken free of the 1.38p-1.60p horizontal range that the shares traded in throughout the vast part of 2013. That is an important change as it now gives Newmark the platform to move higher, and could signal the end of any overhang that was present during 2013. There is an underlying uptrend still in place, which is also positive. It does remain difficult to predict Newmark's price movement given the period of stagnation, but also the sharp rise that took place in 2013. The technical picture has a positive bias at present.

Newmark has maintained it's favourable spread, particularly for a small cap company. It currently spans 1.65p - 1.70p, which is much narrower than the reported 1.60p - 1.75p that most websites publish. There remain a couple of price targets within the market. Broker Cantor Fitzgerald has increased its target price since the initial review, from 2.00p to 2.50p, which implies circa 67% upside. Edison Research has kept their 3.60p 'fair value' price target, which implies circa 114% upside.

Since I have covered most of the fundamentals in the initial review, and there is not a great deal to add on top, it is worth performing a comparison of Newmark to other London listed security firms. Those firms cover a variety of security sectors, including managed security, cybersecurity and physical security.


As per the table above, the five comparator companies chosen are Croma Security Solutions Group, Corero Network Security, Security Research Group, Falanx Group and Accumuli. With the exception of Security Research, all of the four other companies are up significantly over the past year, with increases ranging between 72% percent and 249%. Unsurprisingly, Security Research has not performed well since it is experiencing falling revenues and weak financials. Newmark Security has on the other hand been experiencing revenue growth (of 39.9% to FY 2014), and above market expectations - however, it is only up 10% over the past year. Newmark is valued towards the lower end of the peer comparison and, as noted in the initial review, has both an electronics (Grosvenor Technology) and physical security division (Safetell).

Newmark is forecast by Edison to report underlying EPS for both the full-year ended April and the next full-year of 0.39p, reflecting future dilution rather than a flattening of growth. That suggests that Newmark trades on a price-earnings ratio of just 4.3, which is particularly low, especially compared to the peer group. A fair PER in my opinion, would range between 9 and 11, given the nature of the company, and the fact that it operates in a competitive market, where contracts can be lumpy. Taking the lower value, it would suggest a share price of 3.51p, compared to 1.68p currently. That said, Croma trades on a higher multiple at present. On this single metric, Newmark is trading on a multiple of earnings that is particularly low.


Along with many of the peer companies, Newmark boasts a healthy cash balance - it totals 21.8% of Newmark's current market cap. As you would expect, that percentage falls as the market cap of the company increases, as is the case with both Accumuli and Falanx. That cash balance is important as, with the company being cash generative, it means the chance of insolvency is minimal. That is a critical point that needs to be considered with very small cap companies. Indeed, if we strip out 50% of the net cash balance (as being surplus) the ex-50%-cash share price drops down to 1.49p. Taking the forecast 0.39p EPS reading again, the adjusted price-earnings ratio drops back even further to 3.82, which is exceptionally low for a bull market, and for a company that has a narrow spread. Even assuming that Newmark significantly miss expectations and book 0.25p of earnings, it translates through to a PER of 5.96. In H1, pre-exceptional earnings were 0.15p, so a purely symmetrical estimate would be 0.3p - on a PER of 9, that equates to 2.70p. In the current market it is difficult to find companies (that have net cash and are UK-based) trading on such low multiplies. The reason, as outlined in the initial review, is that previous years performances have predominantly been overshadowed by impairments.

Looking back at the table, Newmark has a tangible assets/total liabilities multiple of 1.45, which is robust, especially since almost all of those tangible assets are current. Stripping out the non-current assets and the current assets/total liabilities multiple is 1.30. Whilst that is lower than most of the other peers, it is still a very healthy position to be in, and combined with the superior earnings forecasts, still highlights Newmark as being seriously undervalued. Newmark also had superior cash generation for the last set of six months available, at £1.87m, albeit that was bolstered by certain advance payments by customers (payables increased by £600k over receivables + inventories). That said, operational cash generation for the previous full-year stood at £2.96m, so it is clear that the company is generating very material amounts of cash compared to its market capitalisation.

That is reflected in Newmark's ability to pay a dividend, which is reinstated last year. The dividend gives a trailing yield of 1.98%, with it forecast to be rise to 2.20% this year. Most of the peers don't issue a dividend, with the exception of Accumuli who now have a trailing yield of 1.39% - that was previously much higher, but their share price has appreciated materially. Croma Security has also announced its intentions to issue a dividend this year, and whilst no range has been given, I'd predict is to be around 1.2% to 1.6%.

The strong cash generation of Newmark is a key point. It should allow them to either boost future dividends, but more likely fund more aggressive organic growth. As the market is so competitive, there is the need to have a continued R&D focus, and that has meant that Newmark has spent roughly £600k per half-year on research and development. Admittedly, the past it has not always worked, with the cash in transit box being a great example of an impairment obscuring results. However, the company has to continue to innovate. 2015 revised forecasts are for revenues to be higher at £20.3m with fully diluted EPS of 0.39p as noted earlier. Forecast price/cash flow multiples are less than 2.5.

One of the more recent products was launched by Safetell through a partnership with Acsys. The product contains patented technology that uses a password key, physical lock and code generator to develop wireless remote site control. In the scheme of things, it's a small development, but it underlines the need for Newmark to innovate and keep ahead of the competition. Newmark has done well so far, with a very respectable 35% blended margin across the electronics and physical security divisions. The security sector, particularly physical security, is also highly fragmented as a result of the competitiveness and low barriers to entry. There is thus scope for Newmark to use a portion of the cash it generates to acquire complementary assets or companies, similar to the acquisition of Gunnebo's assets in early 2014. The one restriction should be that bank overdrafts or loans are not required - the company should ideally stay cash positive, hence acquisitions would likely be on the smaller side for now.

One way in which the company should stand to benefit is from an improving UK construction sector (the UK accounts for well over 80% of Newmark's revenues). Whilst Newmark's physical products are not widely used in the construction of buildings, they are implemented at a later date dependent upon the building use - primarily for banks and building societies. The electronic security division is likely to be more heavily impacted. The company's focus has been to roll out their access control platform, SATEON, more widely. The SATEON system is already in use at 30 St Mary Axe (The Gherkin) and 99 Bishopsgate [very useful reference sites]. Aside from direct improvements in the construction sector, it is fair to assume that increased economic growth will assist Newmark with boosting revenues, albeit this may be counteracted by bank branch closures. In the half-year results, the chairman commented: "The Board is delighted to announce recently that, in view of the results for the first half of the year and a healthy order book, full year revenues are expected to be substantially ahead of expectations."

Outside of the UK, the company continues to focus upon increasing revenues from both the US and Eastern Europe. Sales in the US over the period were up 122% year-on-year, but that number is relatively immaterial since it was from an extremely low level. The geographical expansion is for the electronics division since it has been developed to be stand-alone and not requiring ground-presence apart from for marketing. Furthermore, additional revenues should not require high additional costs, so once critical mass is reached, increased revenues will flow through more cleanly to profits.

The one risk that is applicable to most small companies such as Newmark, is that they often process large contracts periodically, that can skew results from time to time. In addition, should gaps open up in their order book, then they can be prone to issue profit warnings. That is not something that has affected Newmark recently, but it is worth being acutely aware of. The large contracts can of course work both ways, and lead to earnings upgrades above market expectations - that is what occurred earlier in 2014. Therefore,  diversifying revenues into the electronics security division is imperative. That division should have a more recurring revenue stream, thereby making future earnings predictions more accurate. The division is seeing growth with revenues up 18% at the last reading, and it is continuing to form an increasing proportion of total revenues at 43% at the half-year (versus 40% at the same point last year). Further shifts towards this direction should be welcomed, and if acquisitive growth is pursued, the balance could be improved in the future.

Therefore, whilst it is relatively easy to see why market interest has failed to pick up since February (no RNS'), the fundamental picture remains strong at the current price. If the shares were trading at circa 2.75p, a discount to normal metrics could be justified, but at 1.68p the market is factoring in a dismal future for the company - a future that is not forecast and that would require a collapse in operations. Furthermore, that collapse would still probably justify the current price, so major downside seems improbable. The shares trade on a 50%-ex-cash PER of less than 4 and significantly shy of both Edison and Cantor's price targets. I would suggest that an initial price target of 2.50p, in line with Cantor's target, is sensible pending the company's results, which are to be released in late July or early August. There is a further penny of upside up to a modest PER of 9 on top of that.

Should the results show the improvement that the market expects, without impairments, and with a positive outlook, then the shares will probably move substantially higher than the current price. At the current level, the potential rewards are very attractive given the risks, and it is difficult to find a company at the moment that is trading at a very low forecast PER. The balance sheet is sound enough, cash generation is strong, and with a recently re-commenced dividend, Newmark should be gearing up to re-rate as the results date approaches and passes. I have retained a Buy tag on Newmark at 1.575p.

UPDATE (19/09/14) - I moved Newmark Security from Buy to No Rating at a price of 2.175p, which includes 0.075p of accrued dividends. I have concluded that it makes sense to see progress on the investor relations front first as progress is tangible. The lack of liquidity combined with the weak newsflow leaves the shares open to retail investor movements until the next results of trading update, that may well be in January at the earliest

10 comments:

  1. Hi El1te
    Thanks for a great update
    Who was the client for the big order that Newmark have been processing this year?

    CraigJ

    ReplyDelete
    Replies
    1. Hi Craig,

      The large orders were from both the Post Office and a foreign embassy, as noted in the early 2014 trading update.

      El1te

      Delete
  2. Thanks again el1te. I look forward to the next two months :0)

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  3. Good piece elite. I enjoy reading your site as do a number of other investors. I feel that Newmark could do more to tell investors about them selves and I will be intrigued to see whether newmark decide to release a preclose trading sstatement this year. They did last year but that trend does not follow further back. I have done a filter search on stockopedia, and this is amongst the lowest on a forward pe value next to chinese naibu and camkids. I know you are not interested in those any more so for a uk holding company this looks good value for the price!

    Regards,
    RT

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  4. Thanks for the nice update. I think a p e ratio os 12 to 14 is better to be honest, but one step at a time I suppose

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  5. does anyone know a place where you can trade really small companies like this, I tried Saxo, Barclays and Capital Spreads but none of them have this listed...

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  6. Weird. I can buy shares through Barclays. Give them a ring?

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  7. Very helpful review - seems that the market is now taking a bit more notice of Newmark !

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  8. Hi RT

    I am the newly appointed Group Marketing Manager for Newmark Security and I am tasked with improving investor relations. We hope that you will see a marked improvement in communications over the coming months but feel free to contact me with any questions you may have in the meantime and I will be happy to help.

    Thanks for your feedback and do let me know if you have any queries.

    Dale Kaszycki- dk@gtl.biz

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  9. Is there any reason for the sudden drop in share price today, especially given the large trades (buys ?) 8 days ago - crikey this isn't Naibu !

    ReplyDelete