Aviation and energy

Esken is a UK infrastructure company. It has two divisions, which are aviation and energy. Its aviation division helps manage airports and run day to day operations. It currently manages London Southend Airport. Other aviation services include baggage, checking-in, and other logistics solutions. The energy division helps provide fuel to biomass plants.

Penny stocks are those that trade for less than £1. As I write, Esken shares are trading for 14p. This means it is one of the cheapest shares on the FTSE index right now. A year ago shares were trading for 21p. The pandemic has affected the share price. Aviation and travel stocks have had a turbulent 18 months due to restrictions and the pandemic.

For and against investing

FOR: Despite the current issues in the aviation industry, I like that Esken’s business has a diversified offering. Aviation may eventually pick up if the pandemic eases but it continues to operate its energy division, which has seen growth recently. I especially like penny stocks that have a diversified offering and don’t rely on one form of revenue stream.

AGAINST: Aviation is the larger division. The well documented issues that the aviation industry has faced since the pandemic started put me off. With the threat of new variants, which could result in more restrictions and less travel, the aviation industry’s woes may continue for a long time. There is a school of thought that living with the pandemic is the new normal and there will be peaks and troughs of travel.

FOR: A half-year report announced in November for the six months ending 31 August showed me signs of recovery for Esken. It reported that revenues increased by close to 8% compared to the same period last year. This was mainly driven by its energy division and its growth. Furthermore, aviation losses had declined less than the same period last year. Esken also managed to make a profit based on an earnings before interest, taxes, depreciation, and amortisation (EBITDA) basis for the half-year period.

AGAINST: Esken shares are still way off pre-pandemic levels which is understandable but still an issue for me. Furthermore, it was reporting consistent losses prior to the pandemic which is usually a red flag. If aviation woes continue and energy cannot pick up the slack, Esken may not report a profit for some time.

Contrarian penny stock option

Every now and then I like to pick a contrarian stock for my portfolio. This is usually a stock that has potential and is currently dirt-cheap so I am not risking lots of my hard-earned cash.

I place Esken in this contrarian bracket. Despite some credible risks and issues, for 14p per share, I would be willing to buy a small amount of shares for my holdings and keep an eye on developments. I see some potential in Esken in the longer term. If this potential doesn’t materialise, I wouldn’t have lost a substantial amount of money buying this penny stock.

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The cheapest FTSE-listed penny stock

I decided to look at the cheapest FTSE-listed penny stock. The stock in question is Esken (LSE: ESKN), which is priced at 14p. Formerly known as the Stobart Group, the company operates energy and aviation businesses. Within aviation, it manages London Southend Airport. It also runs Stobart Aviation Services. Under this, it provides services like baggage handling, check-in and other logistics solutions for both airports and airlines. Its energy business, called Stobart Energy, supplies fuel to biomass plants. 

Why did Esken’s share price drop?

It was already a penny stock before the coronavirus crisis started, but its share price has dropped dramatically since and is down by almost half in a year. Further, its descent has gathered speed since May this year. It is now trading almost 85% below its pre-pandemic price, even though it still maintains a fairly decent market capitalisation of over £140m. 

So is there any possibility of a rise in Esken’s share price, especially now that the pandemic appears to be largely controlled? Given the nature of its business, it was impacted significantly last year. Its aviation business in particular was significantly reduced and its energy segment also saw a small drop in revenue. 

Recovery visible

However, for the first six months of its current financial year (the period that ended on 31 August), the company showed a fair degree of recovery. It revenues increased by 7.7% from the same time last year, largely due to growth in its energy division. The aviations arm’s revenues also declined far less so far this year than they did for the last full financial year. 

The company managed to make a profit on an earnings before interest, taxes, depreciation and amortisation (EBITDA) basis. It also has a somewhat optimistic outlook, especially based on the opening up of travel. 

My takeaway

This is all quite encouraging. But I have to point out that the company was loss-making even before the pandemic started. And combined with the fact that there is still some uncertainty about Covid-19 and the economic recovery, I have my doubts whether it will swing back to net profit any time soon. 

I expect other investors feel this way too, which could explain why its share price is presently trading at such abysmal levels. I do, however, think that the company has potential. Other aviation-related stocks, including FTSE 100 biggies like International Consolidated Airlines Group and Rolls-Royce, are also still trading at pre-pandemic levels. Unlike them, however, it does not have the benefit of a big size. That makes it more vulnerable if another big challenge were to arise. For that reason, I am putting it on my watchlist and intend to see how things shape up for it in the future.  

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The Esken share price has plummeted on Monday too. Down 17% on the day, it’s now trading at 25.9p per share.

Stobart Air falls to earth

Esken announced on Monday its flying division is to be officially wound up. This follows news over the weekend that partner and IAG-owned Aer Lingus had to cancel flights from Belfast as Stobart Air ceased operating.

In late April, Esken entered into an agreement to sell Stobart Air to Ettyl Limited. But the financing of the deal encountered subsequent problems. And Ettyl had been seeking alternative methods of stumping up the cash.

However, Esken said today it’s “now clear that Ettyl is unable to conclude the transactions on the original terms or to obtain an alternative funding package” within the necessary timescale. The small-cap has therefore decided to end its agreement with Ettyl with immediate effect.

Esken added that will not continue to finance Stobart Air in the absence of other buyers for the division. Consequently the company “has terminated its franchise agreement with Aer Lingus, will cease trading and is taking steps to appoint a liquidator”.

Cash outflow forecasts upgraded

Following the move Esken has “undertaken certain contingency planning measures”. And it will continue to fund lease obligations on eight ATR aircraft until they expire in April 2023 under existing arrangements. Esken also said it’ll take immediate steps to sublease these planes to other operators.

Esken added it “also remains responsible for certain obligations” to Aer Lingus, under its franchise agreement.

Finally, Esken said it expects to endure a cash outflow of £34m in this financial year (to February 2022) if it’s unable to sublease the planes. This compares with the £16m outflow that was predicted back in April. Outflows for fiscal 2023 and 2024 have also been upgraded to £22m and £26m respectively.

Other big news from Esken

In other news, Esken is in the “final stages” of agreeing strategic funding for London Southend Airport. This would “release significant liquidity into the group while underpinning the funding requirement of the airport in the medium term.” The financial partner “has significant investment experience in the airport sector globally,” Esken said.

Trading at Esken’s Aviation division continues to be troubled by travel restrictions as the pandemic rolls on. This has caused a “slower recovery” at London Southend Airport. But trading at its Global Logistics Operation has been more resilient.

Elsewhere, Esken’s Energy unit is still operating at expected levels as the availability of waste wood from the construction sector has returned to pre-coronavirus levels.

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Could a company like Stobart Group (LSE: STOB) be a way into the sector without taking such risks? Shares in Stobart (it’s the one that owns Southend Airport, not the trucking firm) have lost almost half their value over the past 12 months, as the firm has been through a traumatic period.

Dividend

Stobart also did something that often sends shareholders rushing for the exits, when it slashed its dividend last year. And, it is cutting the dividend further in the current year, as it sees more demand for cash and better reinvestment opportunities in an expansion programme.

I think that’s exactly the right thing to do. Last year’s dividend was partly funded by debt, taking net debt up to £83.1m, so it wasn’t sustainable at such levels. It’s also nice to see a company that isn’t stubbornly holding on to its dividend until the very last minute, as so many have done to their shareholders’ ultimate cost.

A first-half update on Wednesday reported a 42% rise in passenger numbers at Southend Airport, boosted by the commencement of Ryanair flights in April, the start of Loganair flights in May, and further growth of easyJet‘s schedule. The expansion of rail services from Liverpool Street, coupled with WizzAir‘s move to reach three new destinations starting November, add to my feeling that we could be at the start of a profitable growth phase for Stobart.

The shares are very hard to value, but I think I’m seeing a tempting growth investment opportunity that deserves closer examination.

The other one

While I’m at it, I thought I’d take a look at the other Stobart, the trucking one with the famous green livery, Eddie Stobart Logistics (LSE: ESL).

ESL (as I’ll call it here to avoid confusion) has had its shares suspended since 23 August after a £2m accounting error in its 2018 accounts was revealed, providing a fresh blow to Neil Woodford. Woodford, whose Equity Income Fund remains suspended after further confirmation was released this week, owns around 23% of ESL’s shares.

The firm has since told us that full-year operating profit will be significantly below its previous expectations, that it is in talks with lenders, and is looking at plans for a new equity issue. The dividend for 2019, which had been predicted to yield 9.3%, has been scrapped.

Too cheap now?

The shares had a price-to-earnings ratio of only around five, though I expect the share price to drop further when trading restarts. Could we be looking at a recovery prospect at a bargain price? Several major investors seem to think so, with DBAY Advisors the first to show its hand with a takeover approach.

The ex-CEO of Stobart Group (the airport one, not the trucking one) Andrew Tinkler has also made an approach, though there’s no guarantee that anything will come of either. But I think ESL is definitely one to watch, and will be interest in whatever the short-term throws up.

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In a shock announcement at the end of August, the company said it was suspending its shares following a review of the accounts. Management believes this ongoing review will lead to a substantial readjustment in reported earnings before interest and tax, according to the company’s press release on the matter.

As a result, management also warned it will be reviewing Eddie Stobart’s dividend policy. Immediately following the announcement, the shares were suspended from trading, and have remained so.

However, today, the story took another turn. Responding to media speculation over the weekend, the company announced it had received a “preliminary expression of interest” from the private equity group DBAY Advisors Limited regarding a possible issue for the business. As of yet, there’s no certainty an offer will be made, but DBAY now has until 5pm on 7 October to make a final decision.

If it does decide to acquire Eddie Stobart, this could be a boon for shareholders. This time last year, shares in the logistics business were changing hands around 123p, 76% above current levels. I think it’s highly likely an offer, if it does emerge, will be substantially above the current share price.

An FTSE 100 dividend champion

If Eddie Stobart is taken off the market, an excellent replacement in your is portfolio could be Johnson Matthey (LSE: JMAT). I think this is one of the best in the FTSE 100 for a couple of reasons.

First of all, the business is a leader in the speciality chemicals business. This is a highly regulated and niche company, where reputation counts for everything. Johnson has been in business since 1891, giving it a substantial competitive advantage over smaller, younger competitors.

Secondly, management has been pursuing a conservative dividend policy. For example, the company’s current dividend per share (89p) is covered 2.7 times by earnings per share, and it’s been that way for roughly the past 10 years. The dividend has grown at a compound annual rate of around 5.5% over this time, roughly in line with earnings growth. Net gearing — a gauge of balance sheet strength — was just 33% at the end of its fiscal 2019. So it appears the firm has a moderate level of borrowing and a strong balance sheet.

These numbers tell me that while Johnson Matthey’s current dividend yield of 2.9% might not be the highest around, it’s exceptionally safe. Earnings would have to fall by more than 50% for the dividend to come under pressure. Considering its reputation and competitive advantage, I think that’s unlikely.

Still, even if it earnings do fall 50%, Johnson Matthey has plenty of financial headroom on its balance sheet to borrow money and make up for any short term cash shortfalls. That’s why I think this could be one of the best dividend stocks in the FTSE 100.

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Meanwhile, the Woodford Patient Capital Trust (LSE: WPCT) said that after revaluing one of its largest holdings, the trust’s net asset value will be cut by 3.4p per share.

Here, I’ll explain why today’s news could mean investors in the Woodford Equity Income fund will face further delays getting their cash back. I’ll also look at Patient Capital Trust and explain why I’m staying away, despite the stock’s discounted valuation.

What’s gone wrong at Eddie Stobart?

Eddie Stobart’s famous lorries are green and red. But shareholders are likely to be seeing only red after today’s news. The company says that after reviewing its half-year accounts with its auditors, it needs to apply “a more prudent approach” to certain accounting items.

Among the changes that will be made are fresh assessments of “the recoverability of certain receivables.” This suggests the group could be forced to write off some significant bad debts.

The impact of these changes is that adjusted operating profit for the half-year will be “significantly lower than anticipated.” Chief executive Alex Laffey has been replaced, with immediate effect.

Stobart is not yet able to provide updated figures, so its shares have been suspended to prevent a disorderly market. An amended set of accounts is expected to be ready in “early September,” when we can expect the shares to start trading again.

Bad news for Woodford

As I’ve said, Woodford is Eddie Stobart’s largest shareholder. His fund’s 22.9% shareholding was worth about £60m before today’s news, following a stock sale I estimate at £5.8m in early July. Stobart shares are likely to fall heavily when they return from suspension in September.

Woodford may find it difficult to find buyers for further large chunks of stock. I think these problems could add to his difficulties in reopening his Equity Income Fund in early December, as currently planned.

Patient Capital cuts valuation

Woodford’s other problem child is the Woodford Patient Capital Trust, which invests in early-stage companies. These are mostly loss-making businesses, hoping to commercialise new technologies or medical treatments.

Valuing investments of this kind is difficult and valuations are subject to regular revisions. That’s what’s happened today. In a statement this morning, the WPCT board said the trust’s valuation of Industrial Heat, a firm that aims to harness “cold fusion”, would be cut.

As a result, the WPCT net asset value will fall by 3.4p per share. The last reported net asset value for the trust was 78.96p, on 21 August. Today’s update suggests NAV could fall to about 75p when it’s next updated.

The Patient Capital Trust share price is currently about 42p. Although this represents a discount of nearly 50% to NAV, I think there’s a real risk further revaluations are likely over the coming weeks. In my view, WPCT looks like a potential value trap and remains a stock to avoid.

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However, so far, the share price has been sinking and the current 98p or so leaves it almost 40% down from where it started when first listed. The valuation looks tempting with the forward-looking price-to-earnings rating for the trading year to November 2019 just above seven and the anticipated dividend yield a little over seven too. But that’s not the whole story.

Strong growth

Such a bargain rating suggests lacklustre business performance but there’s no sign of that. City analysts following the firm predict that earnings will grow around 17% in the current trading year and by 11% in the year to November 2020. Not only does Eddie Stobart have apparent value, it also appears to enjoy decent growth prospects.

I find today’s full-year report to be encouraging. It revealed that revenue grew a little over 35% compared to the previous year and adjusted earnings per share moved a little more than 16% higher. However, the figure for net debt moved almost 46% higher to almost £160m, which I’m not so keen on. But the directors expressed their confidence in the outlook by slapping almost 9% on the total dividend for the year.

The growth in revenue in the period came from a mix of organic advances, new contract wins and contributions from the firm’s prior acquisitions of iForce Group, The Pallet Network Group, The Logistic People and Speedy Freight. The directors explained in the report that the net debt figure rose because of the acquisition of The Pallet Network Group and due to “working capital investment,” which is “expected to normalise in 2019.”

Reasons to be cautious

I think the debt situation is the one thing that takes the shine off the low valuation and exciting-looking growth prospects. Adjust for the debt, and the valuation doesn’t look as attractive any more. The current figure for net borrowings runs at more than five times the year’s operating profit. I’d want the company to make serious inroads into getting the debt burden down going forward.

Chief Executive Alex Laffey said in the report the company made “significant progress” during the year in delivering its strategy to become “a full-service logistics and supply chain organisation.”

I reckon there’s bound to be a big element of cyclicality in the company’s operations and Laffey said the directors are “mindful of the current political and economic uncertainty,” but he is “confident” the firm’s “unique” operating model will deliver the “flexibility to respond rapidly to changing market conditions.” 

Eddie Stobart is cheap, the dividend yield is high, and the immediate growth prospects look good. But I think that risks can be found in the way high debts combine with the cyclical operations. I see the stock as tempting, but I’d approach with caution and watch any investment closely.

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These companies are both major players in essential sectors. Unlike some sexy tech stocks, I’m pretty certain that the services provided by these companies will still be needed in 10 or 20 years’ time.

Keep it rolling

When Edward Stobart took over the running of the Eddie Stobart haulage business from his father in the 1970s, he realised that customers would pay more if he could combine transport and warehousing services. This insight helped him to build the group into one of the UK’s largest logistics operators.

After several changes of ownership, Eddie Stobart Logistics (LSE: ESL) floated on London’s AIM market last year. Share price performance has been disappointing so far and the stock is down about 17% since its flotation.

However, today’s half-year results suggest to me that the firm’s share price could soon find some support. Revenue rose by 25% to £359m during the first half, thanks to a mix of acquisitions and major contract wins. Underlying operating profit rose by 7% to £18m, cutting the group’s underlying operating margin from 5.9% to 5%.

The company says that profit growth lagged behind sales growth due to the costs involved in setting up several major new contracts. That’s understandable, given that these new contracts are expected to deliver annual revenue of £158m, or around 20% of forecast sales for this year.

My view

Chief executive Alex Laffey expects the investments made in the first half of the year to support strong profits growth during the second half. That sounds reasonable to me.

However, the group’s net debt has now risen to two times EBITDA (earnings before interest, tax, depreciation and amortisation). That’s at the upper end of what I’m comfortable with for a low-margin business of this kind.

When Stobart’s full-year results are published in 2019, I’ll be looking for evidence that cash flow and margins have reversed recent declines. I’d also like to see a reduction in borrowing levels.

Despite these concerns, I believe this could be an attractive long-term income pick. Trading on less than 12 times forecast earnings and with a 4.9% yield, Eddie Stobart’s valuation seems reasonable to me.

Making money from muck

Collecting and managing waste is an essential function in any modern society. I don’t see that changing in my lifetime.

With this in mind, I think that waste management firm Biffa (LSE: BIFF) could be an interesting investment. 

Biffa’s revenue rose by 8.8% to £977.7m last year. This increase was split evenly between acquisitions and organic growth. The group’s profit margins were maintained, lifting underlying operating profit by 10% to £81.2m.

Cash generation was also encouraging, with underlying free cash flow improving from £28.8m to £44.4m.

Growth opportunities

As one of the largest firms in this sector operating in the UK, Biffa enjoys economies of scale not available to smaller firms. I feel that this should allow management to expand profitably in areas such as energy from waste and recycling.

Overall, the stock looks quite good value to me, on 12.8 times forecast earnings with a well-covered yield of 2.8%. In my view, Biffa could be a good long-term buy for UK investors.

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The company reported that for the 13 weeks to the beginning of April, total group sales increased 10.4% on an organic basis, excluding the impact of acquisitions or disposals. Including the effects of these portfolio changes, total sales grew by 18.3% year-on-year, a significant jump helped mainly by a rise in international sales from £4.5m for the period last year, to £25.6m this year. 

Total sales in the UK and Republic of Ireland increased 10.4% on a reported basis and 7% on a like-for-like basis in the UK alone.

Pizza rush 

These figures show that despite concerns about saturation in the fast food market across the UK, customers are still flocking to Domino’s offering. 

CEO David Wild believes that customers are attracted to be group’s “clearer value proposition,” a conclusion based on customers’ “strong scores for value for money and overall satisfaction.” As long as Domino’s can maintain this reputation, the company’s growth is unlikely to slow any time soon, especially in the international market. Here the enterprise is still fairly underrepresented in the markets where it has exposure. In fact, only around 150 of the firm’s 1,203 outlets are overseas.

City analysts are currently forecasting earnings per share growth for 2018 of 25%, followed by growth of 11% next year. Based on these earnings targets, shares in the company are trading at a forward P/E of 21 falling to 19 by 2019. This might look expensive at first glance, but shares in Domino’s have always commanded a high valuation. The firm’s double-digit earnings growth rate, coupled with its franchise business model (and the high-profit margins that come with the franchise model) are certainly worth paying a premium for in my view. That’s why I would buy and hold the stock for the next two decades.

Growing industry 

Another potential long-term investment I like is Eddie Stobart Logistics (LSE: ESL).

Logistics is a low-margin, tedious business, but it is also an essential one and demand for logistics services is only going to grow as the world’s population expands and consumers do more shopping online and less in stores. 

Among other businesses, Eddie Stobart, which has one of the most recognisable names in the industry, provides e-commerce fulfilment and logistics services to a range of retailers.

However, this business has only been independent for around a year, and it is still, in my opinion, finding its feet. Over the next few years, as management leverages the group’s reputation for building its independent offering, I believe the shares could be set for a substantial re-rating. 

City analysts seem to agree with earnings per share growth of 116% pencilled in for 2018, the group’s first full year as an independent company. For 2019, earnings per share are expected to grow by a more sedate 11% as the firm settles into a more sustainable growth trend. 

It seems as if the market is overlooking this as, at the time of writing, the shares are trading a forward P/E of only 12.1, and are projected to yield 4.5% for 2018. With this being the case, I believe now is the perfect time to make the most of the opportunity.

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The BCA share price has fallen by 20% over the last six months, as investors fretted that a slower UK market and rising debt levels could limit the group’s profitability. So today’s news should mean that shareholders such as fund manager Neil Woodford can breathe easy, for a while.

I’d like more detail

BCA provided very little detail in today’s trading update. Strong trading seems to have been driven by “a number” of new remarketing contracts plus “continuing renewals”. Remarketing is the group’s main auction business and accounted for around three quarters of operating profit during the first half of the year.

The company didn’t provide any indication of how far profits had risen ahead of forecasts. And while net debt is now expected to be “lower than market forecasts”, there was no indication of what this might mean.

I’m not convinced

I’ve been cautious about BCA in the past, due to what I see as a weak balance sheet. The group’s half-year accounts showed total liabilities of £1,026m versus tangible assets of just £637.1m. This left the group with a negative net tangible asset value, a situation I prefer to avoid.

My view is that recent years’ profits have been boosted by rising volumes of nearly-new cars and add-on services such as “Partner Finance”, which provides credit for customers. With new car sales now falling, maintaining this rate of growth could soon become difficult.

I may be overcautious, but I’m not sure that this is a good time to invest in this business. I’ll be staying away, for now.

Trucking ahead

Another relatively new arrival on the stock market is Eddie Stobart Logistics (LSE: ESL). The trucking and logistics group has a strong brand and works with a wide range of blue chip customers.

Former parent company Stobart Group spun out this business into its own stock market listing back in April last year. Since then, the group’s operational performance has been good, but the shares have flopped. Is this a buying opportunity?

So far, so good

This week’s full-year results contained a fairly large number of adjustments. But if we accept the group’s picture of underlying performance, last year was quite good. Revenue rose by 13.6% to £623.9m, while adjusted pre-tax profit climbed 57.5% to £37.8m.

Thanks to IPO proceeds totalling £118m, Eddie Stobart was able to reduce net debt from £165.5m to £109.5m in 2017 and spend £43.2m on acquisitions. Alongside this, the group paid a maiden dividend of 5.8p per share, giving the stock a trailing yield of 4.6%.

The right time to buy?

My concern is that the business went through a number of changes last year. Seeing through these isn’t that easy, so I’d like to see a ‘clean’ set of accounts before investing.

Despite this, the picture looks reasonably positive to me. Broker forecasts suggest that earnings should climb 22% to 12p per share this year, putting the stock on a forecast P/E of 10.5, with a prospective yield of 5.1%.

I think there’s a good chance that this week’s results will mark the low point for Eddie Stobart’s share price. I’m going to keep this one on my watch list.

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