Amino Technologies - Bite the Bullet?

http://www.aminocom.com/


Stock markets at the moment appear to be at a pivot point, where momentum appears to have faded and the number of low valuations has fallen. If investors take a 'wait and see' stance on the market, then there are two common options: stay out of the market pending a direction to appear, or to buy small cap shares whose price movements are nearly entirely down to corporate news, rather than what the wider markets are doing. In line with a falling number of attractive valuations, the site portfolio has around 40% in cash pending clarity on the likely next direction of the UK markets. Occasionally it makes sense to take a short-term step back and watch the market without taking multiple new positions, and that has recently been the case.

Amino Technologies (LSE:AMO) is one company that I have been mulling over as to whether it still deserves a Buy tag. Over the past year, the share price has been stagnant to the extent the bulk of a circa 6.5% gain has been registered in the form of dividend payments. The share price now stands at 94.5p - the market cap is £52m. Is it time to bite the bullet and cut the portfolio position?

This article is a follow-on from the below post. For full context and information, read this article first:
http://www.theel1tetrader.com/2014/01/amino-technologies-growth-stumbles.html


The technical position for Amino remains fairly neutral since the shares are trading in a consolidation pattern off the highs back in late 2013. Whilst news since has not exactly been stellar, with growth rates previously slowing, the fact that the shares remain trading towards the top of their historical range is thanks to the progressive dividend policy that Amino has been adopting, that goes quite far to supporting the share price. Schroders have reduced their holding over the past six months by several percent (to sub-14%), whilst Kestrel Opportunities have increased their stake from below 10% through to ~12%. More positively, Chairman Keith Todd purchased around £107,000 worth of shares over the period at a price of 89p.

There is a slight underlying uptrend, but the direction of any sustained breakout is highly important - the next trading update (based on last years timeline) may be released in late November, which is beyond the symmetrical triangle implied lifetime, so a breakout could materialise beforehand. The recent narrowing of the trading range suggests that the pattern is being followed, but also that interest in the stock is falling.

I last covered Amino back in January when I decreased my target price down from 130p to 106p on the back of growth stumbling. Whilst the share price has since increased by just over 10%, a raft of news has been released that makes it important to reconsider the investment opportunity and whether Amino remains a convincing hold.

In the previous review I noted how, at 83.5p, the forward PERs were around 7.5 once cash was stripped out, and that once a rising dividend yield was factored in, the "downside should be fairly well protected against at the level". That has held up as being true, although the share price has failed to make real progress against the initial review price, and it still remains below the crucial 100p level, and also below the 95p level. The revised 106p target price took into account a cash pile discount plus a range of price-earnings ratios. Those valuation metrics are undoubtedly attractive, but it's important to consider other aspects of the financials and update the viewpoint using new information.

The problem that Amino has faced over the past few years is that growth has stuttered because the main reason has been that sales have been concentrated to a few large customers - the latest setback was the result of a customer in the Netherlands slowing their set-top box purchases from Amino. Whilst the reasons are difficult to identify, there is no escaping that Amino operates in a competitive environment, and does not carry a household name in developed economies. The focus in the past has been on selling to larger customers such as hospitals, rather than to individuals where freeview boxes are just one example of the fierce competition faced. Amino packs together a wide range of content into a range of set-top boxes to address each part of the technology spectrum, with lower specification boxes catering for emerging market opportunities such as Latin America, and higher specification boxes for more developed economies.

Whilst set-top boxes are often considered to be on a downtrend, Amino is seeking to change that through a renewed product offering. For example, Smart TVs are an obvious method in which the set-top box is bypassed. The product offering therefore has to be strong, and Amino has decided to try and do that through incorporating slightly separate market opportunities. One of those is the home automation market whereby the set-top box acts as a central control for a wide range of household products. Amino hardware for door sensors, cameras and lights can all be brought together onto the set-top box interface through plugging in a USB stick. That allows the user to set times for a light switch to turn on, for example, but importantly it all connects to mobile devices. That means that you could be miles away from your house, but through the use of a mobile, able to view in-house cameras and control the hardware.

It is cutting-edge technology that is taking hold in North America, but the likely headwind that Amino will face is through seeking entry pathways into the market. The brand is not established within the target markets so much work will need to be done on that front - potentially partnerships with distributors will be a key method of market penetration. Despite that, the company is hoping that this, alongside other factors, is sufficient to restart faltering revenue growth and has noted an increasing in tendering activity heading into H2.

Full-year 2013 results came out in-line with market expectations with an operating profit of £3.3m, gross margin up 3.2% to 45.3%, and revenues down by 14% to £35.9m. Despite the falling revenues, increased operational efficiencies and sensible cost-cutting exercises, kept the profitability of Amino on an upward trend, and cash flow strongly positive.


It has been far from plain sailing over the last few years though. Revenues have been unpredictable due to the reliance on a small number of large customers, and that is shown through the revenue fluctuations experienced in recent years. That does ultimately mean that it will be tricky to value Amino on a premium rating for the near future - a more modest rating seems much more sensible. Notwithstanding that, the profitability has been on an upward trend, which does highlight the strong underlying business and the ability to withstand revenue shocks through various re-structuring efforts.

Within the results, Chairman Keith Todd commented, "Amino has seen continued success in 2013 and has delivered growth in profits and cash whilst meeting the diverse needs of its global customer base. Due to the continued focus on margin enhancement and cash generation, I am pleased that we have been able to increase our improved final dividend. Looking further out, we are making significant progress with a number of new product initiatives which will expand our addressable market.  The Board remains confident in the outlook for the Group's profitability and cash generation in the year ahead and the positive impact on revenues of the new enhanced offering from 2015."

There have been a number of positive indications that growth might start getting back on track:
- First IPTV roll-out contract in Albania
- Amino signed up a new vice-president of global sales
- High performance Live Advanced Media Centre in a number of 'key' US trials
- New opportunities arising as a result of regional deregulation in Latin America, and further broadband roll-outs. First orders were received from Argentina during H1 2014
- Supplying a subsidiary of Cable and Wireless with set-top boxes to support a pay-TV roll-out in Cayman Islands & Barbados
- Chosen by C Spire (US' largest privately held wireless communications firm) for the roll-out of an IPTV platform as part of an 'ultra-fast' offering in Mississippi


However, that was somewhat dented in by unsuccessful attempts to penetrate the Russian market where revenues continued to slide, apparently due to "industry consolidation". That underlines the competitive market that Amino finds itself in, especially for the lower specification set-top boxes.

It was the H1 results that provide greater insight into the financial performance of the company. Whilst results were received in-line with market expectations, the company noted that the financials would return to the traditional second half weighting, but also that there were "growing levels of engagement in Latin America and Eastern Europe." Furthermore, the company pledged to increase its progressive dividend policy for an additional two years up to and including the year ended November 2016, albeit at a reduced minimum rate of +10% as opposed to +15%. That still provides investors with an interesting yield play, especially since the dividends are currently well covered by earnings, and almost 'ensured' by the large cash pile on the balance sheet.

I did note in the initial review that "Most of the market is watching to see if they will utilise their cash pile, and for what" plus that "Growth has stumbled, and management need to restart it using the funds at their disposal." Unfortunately, that has not yet happened with any special dividend, share buyback scheme or acquisition undertaken over the past year. The bottom line is that it is highly disappointing - text from the company does not hint that any of these value creation are in the pipeline so the cash pile that Amino sits on will continue to be discounted by the market, and it is difficult to see what, apart from an upturn in organic growth, will act as a catalyst for the share price. For example, a share buyback of even a couple of million GBP would boost EPS figures and give confidence to the market, but that has not been forthcoming to date, and it is difficult to understand given that there is the healthy progressive dividend policy.

These were the key points from the interim report:
- Revenues lower at £16.4m
- Gross margin of 44.9%
- Basic EPS of 3.29p. Based on forecasts, 3.5p in EPS is required during H2, so forecasts look achievable
- Substantial net cash balance of £19.7m
- Interim dividend up as per guidance, to 1.15p

Those figures are once again attractive on an absolute basis. The stated dividend policy means that the 2015 dividend will amount to circa 5p, which would give a forecast yield of over 5%, which is highly attractive for yield seekers. However, the earnings story is equally important and the market is sceptical as to whether sales growth will return. Analysts are forecasting that scenario with 6.8p EPS in 2014, rising to 7.3p in 2015. If that occurs, then the shares look far from expensive, as it would validate the growth story. However, there needs to be a transition away from dependency on a few customers before the market starts to back Amino at much higher valuation levels. In addition, that cash pile needs to be utilised to convince the market that steps are being taken to further boost shareholder returns. Dividends are forecast to be 4p in 2014, rising to 4.6p in 2015, which still gives attractive yields.

The cash is not there to cover a debt either as current assets are well over 300% of total liabilities - that gives Amino a balance sheet, which is amongst the strongest on AIM. However, once again, that is not entirely useful unless the fundamental business model is intact. There is a valuable bank of tax losses that amount to £37m plus a deferred tax asset, which enhances the attractiveness of Amino as it means that taxes will not need to be paid for the foreseeable future.

Looking closer at the results, there are a few reasons to be slightly sceptical. Although profits were sound, they were helped by a fall in operating expenses and amortisation. In particular, selling and general administrative expenses fell - if Amino are to crack the home automation market, for example, then there is likely to be a need to increase marketing expenses at which point profits may be squeezed.

Value investors may choose to look more closely at the numbers, and factor out certain cash levels. Without stripping out any cash, price-earnings ratios (PERs) for 2014 and 2015 stand at around 13.9 and 12.9 respectively. Underlying earnings growth is forecast to be around 13% this year, falling to circa 7.4% next year, giving uninspiring PEG rates of 1.07 and 1.76. Stripping out 50% of the cash pile, the adjusted share price falls to 76p so the 2014 PER drops to 11.2. PEG rates now stand at 0.86 in 2014 and 1.42 in 2015. Stripping out 75% of the cash (i.e. discounting the cash pile by 25%), and the adjusted share price falls to 68p. The 2014 PER falls to 10 whilst the PEGs are now 0.77 in 2014 and 1.27 in 2015 respectively. That underscores the need for growth, either organically or acquisitively. The EV/EBITDA stands at a modest sector discount of around 5.

There are two notable risks for shareholders going forward. The first is that the growth hoped for does not kick in, but in that scenario the balance sheet still provides very good protection. The second is more material and relates to the number of large customers. Whilst this works in both directions, if there are a number of large customer exits, either as a result of increased competition or for other reasons, then the revenue figure could be hit again. The interims highlighted the customer dependency with revenues from Serbia contributing £3.2m in revenues, Netherlands £1.8m, USA £7.3m and rest of the world £4.2m. If the Serbian customer, for example,  were to slow or delay orders, then the financials would be hit. Of course, on the other hand if they can onboard a large customer, then the financials can quite quickly spring upwards, but the customer dependency is a clear risk.

In light of the results, FinnCap upgrade their target price by around 10% to 133p whilst N+1 Singer slightly upgraded their target price to 93p, and Northland Capital retained their 100p target price. Those prospective targets are not particularly exciting, except in FinnCap's case. In my opinion, the lack of movement with respect to deploying the cash balance is disappointing and the company does not appear to be giving off encouraging signals in that respect. In the absence of the cash pile deployment, the forecast growth rates are not attractive enough considering the customer dependency risk, even in light of the expected dividend growth. Therefore, whilst the downside is relatively limited (unless there is a major financial change), the upside would appear to be capped for now until the market is more convinced of the growth case. I reckon it is now best to wait for either plans for the cash pile to be announced, or for the growth situation to become clearer, before reassessing.

I have therefore banked a 6.5% gain in Amino and moved the company from a Buy tag to a No Rating tag on the site portfolio. It's not a straightforward decision, but it makes sense at the current point in time.

6 comments:

  1. Hi el1te.

    Is there a reason why the company has not bought back shares or done something? Interest rates are a piddly 1 or 2 or 3 percent so whats the reason to sit on money? A review by cambridge private punter said that working capital is £7m but there is too much money to just keep in the bank.

    CraigJ

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  2. Still beat the market :-). Ftse 100 only rose by 3% in the period

    M.

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  3. Thanks for the update

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  4. Excellent write-up as always Elite.

    I saw AMO present last year, and it was made clear that (from memory) £10m of the cash pile had to be retained to bolster the Balance Sheet and the confidence of potential customers re working capital etc.

    This makes it fairly clear imo that buybacks etc are not on the agenda, since the balance is needed to finance growth, pay a steadily rising dividend stream et al.

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    1. Thanks - it makes sense that they should keep a large amount of cash on the balance sheet even if only to convince customers that any large orders could be met in a prompt manner.

      However, even if you allowed £12m as working capital requirements, there is nearly £8m surplus and the dividend payments should be covered on top by cash generation. They could easily complete a £2m-£4m share buyback scheme and if nothing else that would interest the market and could take the share price over 100p. Mulled it over, and it would probably spark initial liquidity but a higher market cap may counter any decreased liquidity over time.

      The only reason why I could think that it's not an attractive option is if they need to up marketing spend. As noted in the review, Amino is hardly a household name so it will be interesting to see how they go about selling the home automation products - it doesn't look to necessarily be a product that they can see through their entire existing client base.

      El1te

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  5. The cloud of an excessive cash pile is now slowly moving away as the co has begun share buybacks. Shares shoot up 30% as a result. If top line direction can be addressed, how far will this go?

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