Pennant International is a very familiar company to me, which I have been covering and also investing in for many years now.
During that time, I have witnessed some highs such as the £1..40p touched in 2018, along with submerging lows such as the 28p seen over the last twelve months.
The company, which has been around for decades now is very much in the micro-cap field, so naturally won’t appeal to some investors, particularly as there is also a degree of illiquidity.
That said, PEN is one of those companies that is pretty specialist and to a degree niche in what it does, serving largely the defence, aerospace and rail markets and can prove a highly rewarding play when things come right
Historically, the company’s revenue often served by significantly large contracts relative to its market cap have been lumpy, which has resulted in periods of feast and famine, hence the volatility in its share price.
I last covered PEN here just over a year ago now and the shares are basically at the same price today as they were then, although there has been some movement either way of that during the period.
To give a brief overview, PEN has very strong and established relationships with partners and customers including the MOD along with likes of BAE and more latterly Boeing, where it is a provider of distinct training technology products and services that in part serve distinct defence programmes or projects.
Over the last couple of years the company has certainly endured a down period, which, as with other industries, was compounded by the pandemic and the freezing of projects and spending along with a troublesome project aligned to General Dynamics.
Within that period though, there has been an ongoing and determined shift in strategy and focus, where the emphasis has been to drive further into the software element of its business, which brings with it more predictable and recurring revenue as opposed to being skewed to the more lumpy nature of the historic business.
This, it has to be said, was not a knee jerk reaction to the pandemic, rather, CEO Phil Walker highlighted the shift as a priority back in 2018, where he had a vision of driving the software offerings as the main revenue generator.
The election to embark on that road now appears to be bearing fruit as evidenced by PEN’s full year 2022 results, which has seen a welcome move back into profitable territory after a difficult period.
Also importantly and of significance, is the much improved margins across its business that has delivered a positive result on what was reduced revenue. Gross margins achieved for the period registered at 42.3% as opposed to the 27.3% recorded in the previous year, which is a real positive take away.
Full year 2022 revenue came out at £13.7m which in turn saw a small adjusted pre-tax profit of £0.2m against both last years and the previous year's losses.
More importantly though, the trend looks set to continue with positive numbers pencilled in for the current and subsequent year, which should provide a pathway to continued and ongoing growth and profit improvement, as opposed to the historical lumpy swings.
In the past I have caught up with management on a number of occasions and following the results release, I was able to do so again in order to learn more of the progress achieved and what may be in store ahead.
My first question to CEO Phil Walker, is focused on an update regarding the legacy contract with General Dynamics which whilst out of PEN’s hands had caused it major headaches with payments for work produced being delayed.
Walker tells me that everything provided to General Dynamics is now complete and has been accepted on site where all that remains with the contract is the formality of signing off some paperwork.
In terms of moving forward in this area, the CEO adds that whilst the defence secretary has announced that the Ajax programme is continuing, PEN is not contracted as yet at all, but this is, at the current stage, the company’s choice.
Given the previous issues that PEN endured, it is understandable that they have taken this stance.
However, Walker goes on to say that the desire is very much there for PEN to be on board, but before committing to any contract, the CEO wants to get everything absolutely right for the company.
There is, he adds, a real desire for its training aids to be aligned to the product, but that PEN will only take that work at the right price and terms.
Given the speciality and history of the company’s product and service in this area there could well be a deal struck that is very much in PEN’s favour, so it could be worth watching the space on this front.
In relation to the previous part of this programme aligned to General Dynamics, PEN received the delayed and outstanding invoice payments in February of this year and although there is a remaining £600k remaining relating to closed out milestones, that is due to drop in very shortly.
Moving on, I wanted to ask about the recent acquisition that was announced and which looks to be a good bolt-on-buy at a very nice price. Walker confirms that the actual figure paid is £585k, which wasn’t particularly clear when the announcement was made, as the purchase, Track Access Productions (TAP) brought with it cash on the book.
Expanding on the buy, the CEO says that as a business, PEN has historic core work themes, including technical training and software but that they had been looking to add a third aspect which they identified as rail.
This made strategic sense with its being highly regulated with a high barrier to entry, so in 2019 they purchased a company called Track Access Services which was at one point part of the same company as TAP before splitting.
Walker adds that they had been looking at TAP for some time and the purchase has effectively brought the two rail focused businesses back together under PEN’s group umbrella.
He sees this latest buy as a very good purchase which brings with it subscription services where TAP already serves eleven out of thirty train operating companies in the UK.
Whilst TAP is profitable, cash generative and has growth potential, Walker points out that due to its size a lot of its development programmes were outsourced, but that these can now be brought in house at PEN, which in turn will save on costs.
Services provided by TAP cover driver training and route mapping related to rail infrastructure and are complementary to the wider business of PEN
As mentioned earlier, there has been a concentrated effort on expanding the business on the software aspect of the business, so Walker filled me in on what progress has been achieved and where things are moving to.
He says that back in 2018 technical products/ training accounted for some 80% of group revenues with software and technical services providing for the other 20% and it was at this point that they embarked upon really changing the model.
The result is that today, there has been a complete turnaround with the software and technical services now accounting for some 75% of revenues with the training aspect bringing up the other 25%.
The really positive aspect of this is that the software element, although smaller in terms of individual contracts than the historic business, is more lucrative and importantly growing with an increasing element of predictable recurring revenue.
Regarding the more historic technical training aspect, Walker says that they are certainly keeping that despite the lumpy nature, but where they can perhaps focus on contracts which are of particular appeal, which can provide for improved margins.
As the name Pennant International implies, the company operates across multiple territories and Walker sees that accelerating with its now more diverse range and software offerings.
On this aspect he says that they already have customers in Australia, India, Europe and a lot in the US where over a third of revenue as it stands is now generated from N. America.
It is only more recently though that the US has featured at all on the map and Walker says that with an established arm based in Boston, the US is now a very active market for PEN.
It is, he believes, going to be incredibly important for the company over the next five years and across all aspects PEN is focused upon.
With a £13m order book already in place for the current year, the company also talks of a significant pipeline, which I have mentioned in previous articles is often open to interpretation, as I like to see firm confirmed orders as opposed to what might or may not occur.
In PEN’s case it does have a good track record of delivering on prospects identified in the pipeline so it was an area worth touching on.
The CEO says that internally they always break it down into firm contracts and those that are expected to land, so they are pretty realistic on what is achievable in both the near term and what is on the horizon, hence confidence in the current expectations.
In the past there was a skewing to some of those large multi-million but lumpy contracts, but Walker says that they have now deliberately avoided or been more picky on that area. The result is a much broader pipeline of opportunities but with the range running between £1m to £12m.
Interestingly in the results announcement, the UK appeared to be something of a laggard in revenue terms, particularly compared to what has been happening in the US and Walker is happy to enlighten.
The answer is, he says, largely down to the last two years of little in the way of firm decisions or spending across defence, but he sees that as changing due in part to the Russian invasion of Ukraine and other global uncertainties.
Also and importantly, with a shifting mix the quality of earnings derived from the UK should show improvement going forward and there appears to be a confident mood on home turf prospects.
In terms of the balance sheet, some good cash payments that have come through from the likes of the Boeing contract and a property sale has resulted in a much improved look, where the company is forecast to be in a net cash position by the end of the current financial year of £1.6m rising to around £2.5m next year.
Walker is happy with the balance sheet strength and says that they are a world away from where they were twelve to eighteen months ago and can probably do another small acquisition now if they choose.
Looking at the broker forecasts, WH Ireland has expectations for full year 2023 revenue of £16.6m with adjusted pre-tax profits of £1.3m giving EPS of 3.5p. For next year pre-tax profits of £1.6m has been pencilled in with EPS of 4.2p, which sees the stock at the current price of 37.5p trading on a PER of under 11 falling to 9 next year.
On that basis, with a market cap of just £14m where cash generation and earnings are improving along with growth potential the shares look decent value to me.
Additionally, given its increasing broadening reach along with defence spending shackles being eased, then there could be potential for upside risk from PEN, which in turn could see the share head northwards once again.
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