Whilst market sentiment certainly doesn’t get any better, particularly across the smaller and micro-cap space, there nonetheless appears to be an increasing number of opportunities emerging for potential future returns.
Being sector specific can arguably assist in the stock selection process in such a bearish climate, which as a result sees my returning to Pennant Intl a company that has big exposure to the defence, aerospace and rail markets, with defence in particular seeing markedly increased spending.
The Pennant share price however appears to suggest that the stock hasn’t got too much going for it at present, where the depressed 27.5p share price sees the market cap now standing at little more than £10m.
This comes, despite the recently delivered Interim Results that demonstrated continued progress of a turnaround situation, which also saw management reaffirming a belief in delivering full year numbers in-line with market expectations.
Following that release, I have once again caught up with the Pennant CEO Phil Walker in order to hear more on what has been going on at the company and importantly, what the future may hold for the business and holders of the shares.
Given the Ukraine war backdrop and increasing global security concerns, it is little wonder that the area of defence is continually being marked out as a sector for investors to focus on and that sentiment looks likely to remain in focus for the foreseeable future, in light of the ongoing global security concerns.
To this end, Pennant, as I have written in the past should prove to be a beneficiary, where although somewhat niche, it is nevertheless extremely well placed to gain on the contract front that should translate into improved profitability over the next few years.
As a reminder, this now long-established Cheltenham based business is a provider of technology systems and services that takes in key high end training aids and product support, where it serves major blue-chip names.
These include BAE, Boeing, Babcock and Lockheed amongst others, which also sees it enjoying a long-established relationship with the MOD here in the UK.
It isn’t merely on home soil that the business generates its revenues though, as it is extremely active further afield on a global basis, hence the International aspect noted within its title.
Speaking with CEO Walker earlier this week on the current activity across the areas it serves, he was quick off the mark to make the point, “I don’t think I’ve ever experienced a period quite like it in all my time at Pennant, we have never been so busy on bidding work.”
Of course, when it comes to pipelines of potential business, I am as sceptical as the next investor regarding that and the ultimate delivery and my caution wasn’t lost on Walker.
He accepts that it is all about the actual securing of deals and that ultimate serving up, but given the level of activity referred to, there is clearly a positive mood in the camp with what is perhaps best described as cautious optimism.
The CEO tells me that following the outbreak of the war in Ukraine, he was often asked about the prospects for the business on the back of the inevitable increased defence spending that is subsequently playing out.
To this end, Pennant, I am told, is very much in the frame for new opportunities and business wins, but given the nature of its products and services this tends to come further down the chain.
“We don’t do assets in the theatre” explains Walker, “so the benefit to us is in the mid-long term as we provide the training and safety upgrades, although we are now starting to see these come through.”
Given the time lag outlined, it appears that Pennant is now witnessing activity converting and that trend is likely to continue and accelerate where it has a number of opportunities across differing areas on which to concentrate.
In the past, the company was extremely reliant on big lumpy contracts with what was then a more hardware concentrated business as opposed to recent years where it has migrated and accelerated towards software and services, bringing with it an increasing element of recurring revenue.
Confirmation of this can be seen in the mix bias where software and services now account for the bulk of revenue having increased to circa 75% of the total and which importantly brings with it stronger margins and recurring subscription-based revenue.
Finding the right balance is key though and Walker tells me that whilst the software and services strategy certainly isn’t going to change and is key, there are clearly also strong opportunities in other areas of the business given the highly promising bidding activity.
To this end, whilst he points out that he doesn’t expect the company to win everything it is currently bidding for, he nevertheless expects a few of those in the pipeline to land in the current period.
This all sounds pretty bullish and positive, where if the past can be a reliable guide, Pennant’s shares usually respond postively on the back of meaningful contract wins.
At the larger end of the contract spectrum, Walker says that they would certainly be announcing any such wins to the market, given the sizes concerned being of a material nature.
Typically, he says, these fall into the £2m-£10m bracket, although he adds that some of the bigger ones are actually north of the £10m figure.
Interestingly and pleasingly, he stresses that a lot of these potential contracts are now concentrated in the UK as opposed to the past, where there had been quite a focus from the Middle East.
That could see the company in a sweet spot given its firmly established presence and relationship with the major blue-chip sector names along with the MOD, where its products and services operate in an arena that has a high barrier to entry.
At this point, I have to inquire as to whether Pennant has been involved in any Submarine related business, not least, as BAE recently announced a massive £3.95bn contract award for the next phase of the AUKUS Submarine programme.
Commenting on this area, Walker says, “historically, we have been involved in submarine projects, but in a more recent Navy programme we unfortunately partnered the wrong team with Lockheed and Babcock, which proved unsuccessful as it went elsewhere".
Although it missed out on that occasion it is perhaps worth noting that Pennant has very recently struck up a partnership with Aquila, whose software I am told is used on the Dreadnought Submarine that was designed and built by BAE.
Therefore, given that tie up with Aquila and an already long- established relationship itself with BAE, there is clearly potential for an opportunity across this space going forward.
In our catch up, Walker informs me that he has only recently returned from a business visit to Canada where he was catching up with parties related to two N. American aviation contracts that were signed eighteen months ago, along with discussions on a Canadian Defence contract that has been running since 2003.
On the latter aspect, the CEO tells me that the contract is actually changing from its previous structure, which although this sees Pennant dealing with less in total revenue terms, it is able to take the segments it wants which will provide increased margins.
This, Walker explains, results in achieving the same contribution in profit terms for less overall input, although Pennant will still be dealing with some fourteen tasks across Canadian defence support.
The US is of course also an important revenue contributor, accounting for £2.2m during the first half period and the company has an operation there with a team close to ten. Walker says that this arm operates as a Pennant America business as there is a high barrier to entry for outside players, where being well established and connected, it remains ideally placed to win new business.
One US company that it has partnered in the past is major player General Dynamics, which was the developer of the AJAX armoured vehicle programme.
Unfortunately, that project ran into some technical issues, although this wasn’t down to Pennant which was providing training aids to the project. Nevertheless, it proved troublesome to the business on the back of delays that were well out of its control.
As a result, in a previous conversation relating to the next phase of AJAX, Walker had informed me that Pennant would only put pen to paper if it received the right offer and assurances that it required.
Catching up on the current state of play here, Walker says that a potential follow-on contract is still very much alive, but that nothing has been signed yet.
“We are digging our heels in here until we get the price that we want” Walker explains, adding that within the key training aids the IP is wholly Pennant’s and he doesn’t believe anyone else could deliver what is required.
Although he says that there isn’t any immediate urgency, the clock appears to be ticking here, as Pennant’s aids are now actually disconnected from the vehicle, which requires an uplift for 2025-2027.
On that basis, I am told that a decision needs to be made by June of next year to ensure continuity, so it appears that it would be somewhat complex and late in the day for GD to find an alternative option at such a late stage.
In monetary terms, the contract if signed would be worth a handy £2m to Pennant and it is actually joined by other bids in the frame including the Leonardo Wildcat and Challenger 3.
Looking at the numbers recently released from Pennant, revenue came out at £7.1m which delivered EBITDA of £0.8m on the back of gross margins increasing to 47% from 41%.
Importantly, net debt reduced sharply from the previous £4.1m to £1.9m which sees the company on track to move into a small net cash position for the full year end.
Although the half way numbers may not look particularly inspiring, Walker is confident of hitting the full year expectations where the forecast is for 2023 revenue of £15.5m with an adjusted pre-tax profit of £1.3m giving EPS of 3.5p.
Next year the pre-tax profit is expected to increase to £1.6m on revenue of £16.1m which sees EPS rising to 4.2p, implying a PE of 8 falling to little more than 6, which looks extremely cheap for what is a niche tech player with exposure to buoyant end markets.
On the cash front, Walker acknowledges that in an ideal world he would like to have more on the balance sheet to further assist in ongoing development and working capital, alongside additional complementary acquisitions, of which there appear to be potential targets in sight.
However, for now major milestones on contracts should, the CEO says begin to flow through, with development costs reducing, whilst he also points out that cash through next year should be strong.
Investors may be interested to know that there are currently no plans for a raise and they certainly wouldn’t entertain that anywhere around the current levels.
Rather, given the strength of the pipeline and expectation of landing some wins coupled with the strength of its markets, Pennant should be in a decent spot next year.
Additionally, Walker says that there is another freehold property on the book that isn’t currently being used, but it isn’t on the market as if they land any of the big orders currently in the pipeline, it would very much be required in order to deliver.
Within the overall mix, the company also has increasing exposure to the rail market which has been upped with its acquisition earlier this year of TAP, which provides driver training, route mapping and route services to UK rail operating companies and infrastructure firms.
This has opened the door for synergies across Pennant’s existing business and Walker sounds highly upbeat on prospects going forward, particularly given the recent news on the change of direction around HS2.
This should see regional Northern railways receiving various and significant upgrades across a number of areas which plays to Pennant’s strengths and sees it well placed given limited competition in the areas it serves.
The CEO says that whenever there are structural changes across rail, be it signalling, stations or infrastructure, there is a requirement for various upgrades which is where Pennant comes in through its modelling product.
He adds that there are only four players in the UK providing the services required across this space and two of those, now that TAP has been acquired, are Pennant owned.
Given that Network Rail insists on two suppliers, the company is clearly in a very good spot to gain on the expected increased activity and spending. Further on rail, I am told that there are opportunities overseas, the business not confined to the UK.
As what is essentially a technical focused operation, Pennant has been investing heavily into its new GenS software product that although not officially launched until next April has already seen its first sale.
In addition to that, the company has already migrated seven key customers across to the product which provides for the seamless management of equipment and data across the likes of tablets and laptops.
Walker says that it is going well and customer feedback has been very positive with comments that the product is ahead of the field with its unique integrated approach.
The beauty of the product being that it brings together various offerings under one umbrella, which will see all customers migrated across next year.
This should provide scope for both increased and recurring revenue to Pennant, further highlighting the ongoing commitment to driving software and services as the main contributor and accelerator for growth.
One aspect of the recent share price performance that investors or watchers will have noted is evidence of a seller in the market.
Raising this issue, Walker is happy to explain. “We did have a seller who sold 325k a week or so back and that was Stonehage Fleming.”
That fund is now completely out with the shares taken up Walker confirms, where it appears that BGF also exited back in the summer. On the positive side, there have been other funds buying, including Rockwood (Harwood Capital) CRUX and one other.
All of these are very supportive, says Walker, which also sees Gervais Williams Miton on board with a sizeable stake.
Funds sell for various reasons, be it a change in its strategy or fund manager, so whilst it is always disappointing to see one or two exit, it is also reassuring to see familiar and respected names build a position.
For now, Pennant’s shares remain decidedly unloved, arguably mirroring the general small cap market sentiment.
However, given the current paltry market valuation against the positive prospects and forecasts ahead, I have added at these levels for what I hope will provide a decent return further down the line.