Two that have popped up on my radar lately appear to be trading far below their fair value. That’s always a good place to start but it’s no good if they don’t have strong growth potential.

So I decided to dig deeper.

An up-and-coming IT firm

Redcentric (LSE: RCN) is a managed services provider, offering the usual IT mix of remote access, networking and cloud support. With a £187.5m market cap and 659 employees, it’s an up-and-coming company listed on the AIM marketplace.

It’s been unprofitable for the past two years and the shares have fallen 22% since late May. But future cash flow estimates remain high and the current price is estimated to be undervalued by 48% using a discounted cash flow model. That suggests there could be decent growth potential — if the forecast earnings growth of 63.8% materialises.

Could that happen?

Well, in its full-year 2024 results released in August, revenue was up 15%. It still posted a net loss of £3.4m but earnings per share (EPS) improved from a 5.9p loss to a 2.2p loss. Overall, performance has been improving over the past few years.

However, it’s treading a fine line with debt. At £43.5m, it looks like its operating income only covers debt interest by 0.6 times. That puts it at risk of defaulting if earnings come in lower than expected.

For now, it’s sufficiently covered by equity but it will need to drop a bit before I consider the stock a buy for my portfolio.

A confident electronics firm

TT Electronics (LSE: TTG) hit the news last week when it rejected three takeover bids — two from fellow electronics firm Volex and a third from an anonymous source. The shares skyrocketed 54% on the news, which looks great until we zoom out.

The price is actually down 30% this year because the company reported potential profitability issues in September.

Following news of the rejected bids, Deutsche Bank put in a Buy rating on the stock.

TT Electronics manufactures electrical components for critical industries like healthcare, aerospace and defence. It operates across Europe, providing solutions for wireless connectivity, motion sensors and power management. It’s a relatively small company, with a £198m market cap and fewer than 5,000 employees. Revenue in 2023 came in at £613.9m.

In September, it delivered a trading update revealing operational issues in North America. As a result, it reduced its expected revenue and earnings for the second half of 2024. The price fell 37% following the news, prompting the takeover bids I mentioned above.

That’s where the risk comes in. If the issues in North America aren’t resolved, earnings could take a further hit. It’s already a small company operating in a fairly competitive industry. As a much larger firm, the jilted Volex could try to elbow in on its market.

However, the rejections of the takeover bids reinforce the company’s faith in its true value. With confidence that strong, it may well recover, making the current low valuation an opportunity worth considering.

The post I found two small-cap UK tech shares with bargain-basement valuations appeared first on The Motley Fool UK.

Virolens is a Covid test, which TT is the exclusive manufacturing partner for. The test is developed by a company called iAbra.

But after the share price jump, would I add TT Electronics shares to my portfolio? Could there be further for the share price to rise?

It’s worth noting that over the last five years, the share price has risen by 55%, over the last 12 months the rise has also been 55%. That 55%, over the longer timeframe, is far less than many FTSE 100 shares and quite low growth for a company with a market capitalisation of only around £400m. 

Reasons for the rise in TT Electronics shares 

TT itself has said that there’s no certainty, even after the approval, of the financial impact of Viorlens. So in itself, it may not add much to the company and is dependent upon iAbra’s sales. On top of that, much of the interest in Virolens so far has been outside Britain. Other regions will also have to give regulatory approval.

More worryingly, iAbra’s integrity and test accuracy has been called into question before, when a release last year contained factual and data errors. In an increasingly competitive marketplace, that lack of transparency or accuracy might really sway the regulator or future customers. To invest in TT Electronics based on this contract, I’d want to be very certain that iAbra’s test is vastly superior to other saliva swab tests. So far, I don’t know if it is, despite today’s approval.

I think that in the long term, TT Electronics’ share price will be determined more by its core business and so that’s what I’ll focus on when deciding if the shares are worth adding to my portfolio.

One for the long term? 

So, stripping out speculation over the Covid test, which may or may not add significant revenues in the future, is TT a good business? 2020 understandably was a difficult year with operating profit falling 27% and operating margin falling to just 6.4%. Net debt has risen to £83.8m.

Looking back to growth the previous year between 2018 and 2019, it was lower than I’d like. While revenue growth was good, profit and earnings per share growth wasn’t. The latter went from 8p to 8.5p, if you only look at continuing operations. Gross profit went from £110.7m to £116.6m, an increase of only 5.5%.

On the flip side, the company has customers in growth markets, spends heavily on R&D, invests in growing by making acquisitions and does have strong cash conversion of 130%. Leverage, or the level of debt, is also within management’s preferred range at only 1.6x, which is very comfortable.

A final word on the shares

For me the shares don’t deserve to be on a P/E rating above 15, let alone around 18 where they sit now. That looks expensive given the growth rate of the company. For me, the  jump in the share price has made the shares even more risky and I won’t be adding them to my portfolio.

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Why I think this is one of the best shares to buy now

The company earns its living as a global provider of engineered electronics for performance-critical applications. And the directors reckon the business benefits from “enduring megatrends” in high-growth markets such as healthcare, aerospace, defence, electrification and automation.

From day to day, TT Electronics designs and makes things such as sensors, connectors, hybrid microcircuits, power modules and sensors. And it does so from its facilities in the UK, North America, Sweden and Asia. On paper, the business is just the sort of thing I like to invest in. The set-up seems relevant in today’s world and it’s easy for me to imagine the enterprise growing over time as I hold the shares.

Another thing I like is the small market capitalisation near £375m. The company resides in the FTSE Small Cap index, suggesting there’s plenty of room for the business to grow. However, a glance at the 20-year share price chart shows me the stock has essentially moved sideways this century. TT Electronics may be a small-cap, but it’s been little for a long time. And the undulating chart is a testament to the long-term volatility in the record of earnings.

Right now, the company looks and sounds like a business recovering from the pandemic with tempting growth prospects ahead. But I suspect there’s a lot of cyclicality in the enterprise that could go on to unhinge a long-term investment in the stock. Nevertheless, I remain interested and consider it to be worth my further research time.

A positive outlook

Today’s full-year results report shows the damage caused by Covid. Constant currency revenue slipped by 9% in 2020 compared to the prior year and adjusted earnings per share plunged by 34%. But the directors reckon recovery is “well underway” and there was an increasing intake of orders and improved production capacity in the fourth quarter.  

Free cash flow was “strong” through the period and the directors have restored the shareholder dividend, “reflecting good recovery and a positive outlook.” Looking ahead, chief executive Richard Tyson reckons the positive structural trends in the company’s markets will likely accelerate. He thinks the longer-term effects of the pandemic could cause that situation. So the directors’ outlook statement is positive in both the short and long terms.

But there’s still much that could go wrong for new shareholders from today. One risk is that a downturn in the industry could pull the rug from anticipated earnings. City analysts expect a robust double-digit rebound in earnings during 2021. But progress beyond the current year is uncertain.

Meanwhile, the stock isn’t particularly cheap. The forward-looking earnings multiple for the current year is running just above 14. And the anticipated dividend yield is around 2.9%. I’m late to the opportunity. It would have been better to have bought some of the shares just under a year ago when they crashed. Nevertheless, I’m tempted to pick up a few now to hold for the long haul while being mindful of the risks in the post-lockdown world.

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The television group’s stock has fallen by 50% since the start of 2016. Is this share price collapse reflected in the company’s performance? I don’t think so. Here’s how the group’s earnings have changed over the last few years:

Back in 2015, ITV shares were priced for growth, thanks to several years of rising profits. Now that picture has changed. The firm’s profits have stagnated for several years and are falling.

Behind this stock market action is a general fear that ITV will end up being unable to replace lost profits from traditional television advertising. That’s a valid concern. The group’s adjusted operating profit from broadcast and online, which includes advertising, fell by 7% last year.

Although profits from the ITV Studios production business remained stable, overall group profits fell.

Why I’d buy

There’s no doubt this business is changing. Chief executive Carolyn McCall plans to return the business to growth by focusing equally on three areas — advertising, content production and “direct consumer relationships”. I guess this last category includes online voting and competitions, plus a rumoured streaming service in the future.

This business is still delivering revenue growth. I’m fairly confident that Ms McCall, who previously ran easyJet, will be able to find a way of stabilising and improving the group’s profit margins.

If I’m right, then ITV shares could be too cheap to ignore at the moment. Trading on nine times 2019 forecast earnings and offering a 6.1% dividend yield, I see ITV as a top FTSE 100 buy.

A small-cap turnaround buy?

ITV isn’t the only company that’s working hard to adapt to changing conditions. Woking-based components manufacturer TT Electronics (LSE: TTG) is also transforming itself after the acquisition of Stadium Group last year.

The TT Electronics share price was 4% higher at the time of writing after the company said plans to cut costs by combining the two groups were being delivered faster than expected.

The firm also revealed new plans to restructure its UK manufacturing and warehousing operations and shift some production to China. According to the firm, this will help to cut costs and meet customer demand for cheaper parts.

Good and bad news?

Chief executive Richard Tyson appears to be delivering on the potential of the Stadium acquisition. In today’s statement Mr Tyson confirmed that 2018 trading was “positive” and that the group had a strong order book for 2019.

Analysts expect the group’s adjusted earnings to rise by 20% to 17.6p per share in 2019, putting TT shares on an attractive forecast P/E of 11, with a 3.5% yield. With the shares down by about 25% from last year’s highs, now could be a good time to buy more.

My only real concern is that the profitability of this business may always be limited by pricing pressure from customers. I’d want to do a bit more research into the firm’s competition before deciding whether to buy.

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While it would be foolish to attempt to call the short-term direction of the FTSE 100, I believe these two companies are well-positioned to deliver higher returns than London’s flagship index in 2019 and beyond.

Things in common

The two companies have a number of things in common. They’re both in the FTSE SmallCap index, but are far from being minnows. TT Electronics has a market capitalisation of £346m at a share price of 212p, and XP Power is valued at £477m at a price of 2,480p.

They’re also both in the Electronic & Electrical Equipment sector. TT designs and manufactures things such as sensors and connectivity devices for performance-critical applications. XP designs and manufactures power controllers, which convert power from the electricity grid into the right form for equipment to function. Both have diverse end markets, including medical and various industrial segments.

Good geographical diversification is something else they have in common. TT generates over 70% of its revenues from outside the UK, and XP over 80%.

Time for TT

Turning to valuation, both businesses have strong earnings and dividend growth outlooks. And I reckon their shares are currently undervalued.

TT said in today’s trading update: “Following a first half with good revenue growth and significant margin improvement, momentum has strengthened into the second half of the year.” This should put the company on track to meet (if not beat) City analysts’ earnings forecasts for the year. The resulting price-to-earnings (P/E) ratio of 14.4 isn’t screamingly cheap. However, the full benefits of two acquisitions made during 2018 will kick-in in the coming year bringing the P/E down to 11.7.

With acquisitions having expanded TT’s addressable market, and management also investing in areas that will support the future growth of the business (including an exciting joint venture opportunity, announced today), I believe the company has good prospects of delivering above-average returns for investors well beyond 2019.

XP powers on

XP’s latest trading update was similarly bright, with the company saying it believes it’s continuing to grow market share, as its products are increasingly designed-in to new equipment by its target customers. Like TT, two recent acquisitions help underpin earnings growth forecasts. In XP’s case, a current-year P/E of 14.1 falls to 13 for 2019.

This is another company where I see good prospects for investors beyond 2019. Again, it has a larger addressable market after recent acquisitions. XP also has significant design wins under its belt that will “translate into orders as our customers’ projects move to production phase over the coming years.”

Finally, TT and XP both pay dividends that are well-covered by earnings. And with good earnings growth prospects, their dividends are expected to increase strongly, too. TT offers a current-year yield of 3%, rising to 3.4% for 2019, while XP offers 3.3%, rising to 3.5%. The sparky dividends add to what I see as strong candidates for big capital gains. As such, I’d be happy to buy both stocks today.

The post Why I believe these 2 growth stocks could smash the FTSE 100 in 2019 appeared first on The Motley Fool UK.

Strong underlying gains

When a company is going through a major period of change, adjusted accounts showing only continuing operations can be very useful for investors. These numbers provide a snapshot of progress that strips out all the ‘noise’.

Today’s 2017 accounts from TT Electronics (LSE: TTG) are a good example. This £350m electronic component manufacturer sold its transportation division last year in order to focus on its higher margin product lines such as current sensing, circuit protection and signal conditioning.

TT’s figures for underlying performance show sales from continuing operations rose by 8% to £360m last year, while operating profits measured on the same basis rose by 18% to £24.3m. Adjusted earnings per share were a whopping 40% higher, at 10.9p.

When profits rise faster than sales, this usually indicates rising profit margins. That certainly seems to be happening here. The group’s operating margin from continuing ops rose from 6.2% to 6.8% last year. Return on invested capital, one of the company’s preferred measures of profit, rose from 9.2% to 10.6%.

More change coming

Last year’s disposal left the company flush with cash, and this hasn’t been left idle for long. In February, TT announced it had made a successful offer to acquire specialist electronics maker Stadium Group for a cash payment of £45.8m, plus net debt of £11.8m.

Today’s accounts show net funds of £47m, suggesting that the acquisition will leave the firm with a modest net debt position. That doesn’t concern me, given the group’s stable profits and the potential for cost savings when Stadium’s operations are integrated.

Analysts’ forecasts for 2018 put the stock on a P/E of 18, but I expect these estimates to rise when the Stadium acquisition completes and TT’s management provides updated guidance. I’d rate TT Electronics as a long-term buy at current levels.

A stealth growth stock

One company you may not have heard of is Cohort (LSE: CHRT). The group owns a selection of engineering, software and consultancy businesses which operate mainly in the defence sector.

Areas in which the group operates include cyber security, electronic warfare, communications and surveillance. The logic behind Cohort’s expansion seems to be that the companies it buys will enjoy cross-selling opportunities and access to new markets as part of a larger group.

I can see the case for this, although the evidence so far is somewhat mixed. The group’s operating profit margin has fallen from 11.8% in 2013 to just 0.9% last year. Return on capital employed has slumped from 14% to 1.2% over the same period.

A turning point?

In fairness, I think these isolated numbers probably mask a more attractive picture. The group’s acquisitive growth has been funded without issuing a lot of new shares, and while maintaining a net cash balance.

However, there’s no doubt that progress will be required to justify a higher share price. Analysts expect the group’s adjusted earnings to rise by 6% to 29.1p per share this year. That puts the stock on a forecast P/E of 12.7. There’s also a prospective yield of 2.2%.

This valuation seems about right to me, but if you view this as a long-term growth story, then the shares could be worth considering.

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Evolve and prosper

The company completed the sale of the largest of its four divisions last month. Following the disposal, as management rightly says, “TT will be a higher margin, higher quality business, more balanced across markets and geographies and with increased financial capacity to accelerate growth through capital investments and acquisitions.”

In today’s update, it reported “strong growth” in the continuing businesses, with like-for-like revenue up 6% and the order book across all three divisions continuing to be “strongly ahead” of the prior year. Despite the loss of the disposed division’s revenue and profit, I calculate little change in group earnings, assuming an elimination of finance costs (the company has moved to a net cash position) and lower tax (due to the change in geographical mix).

TT’s share price is little moved following today’s update and at 216p this FTSE SmallCap firm is valued at £350m. With net cash of over £50m, I put its cash-adjusted forward earnings multiple at around 15 and see the stock as very buyable at the current level.

Exciting oil play

Another stock I see as having huge potential is AIM-listed Hurricane Energy (LSE: HUR), which has a market cap of £524m at a current share price of 26.75p. This oil play has 37m barrels of 2P reserves at its Lancaster field and 760-786m barrels of 2C contingent resources across all its fields/prospects — and there’s potential for these numbers to increase by a large amount.

Impressively, for an AIM oiler with no currently producing assets, Hurricane has retained 100% ownership of its licences. This has meant rounds of dilution for shareholders, the latest being a $520m fundraising in June, which included $300m ordinary shares at 32p and the remainder in convertible bonds.

However, retaining full ownership of its licences will reap bigger rewards in the longer term and, for new investors, I believe now could be a great time to buy a slice of the business. The reason is because the fundraising means Hurricane is funded for an Early Production System at its Lancaster field, for which its was given consent in September. First oil is targeted for H1 2019 and planned production is 17,000 barrels a day. This would provide revenue to fund the move to full production. So, if all goes to plan, new investors today shouldn’t experience the level of dilution seen in the past.

Some commentators are deeply sceptical about this. But with Hurricane having the potential to become a major player in the West of Shetland region and also now looking to move from London’s junior AIM market to a premium listing, the risk/reward proposition here leads me to rate the stock a ‘buy’.

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TT Electronics

£350m market cap TT Electronics (LSE: TTG) is a global provider of engineered-electronics for applications in the industrial, transportation, defence, aerospace and medical industries. The company develops products such as semiconductors, sensors and magnetics that can withstand harsh environments.

After a tough few years, today’s half-year results suggest TT is heading in the right direction. The company recorded revenue of £180m, growth of 13% on last year, while operating profit rose a significant 31% to £10.9m. Impressively, earnings per share doubled to 4.6p. Chief Executive Richard Tyson sounded particularly upbeat about the results, stating “we have been delighted with the performance of the business in the first half. We have reported strong organic revenue growth, an improved operating margin with excellent profit growth and cash conversion. Our first half performance and order momentum reinforce our confidence of making further progress in 2017.”

After trending sideways for the best part of two years, TT Electronics’ share price has roared back into life since November, surging over 50%. Is there more to come?

The company recently disposed of its transportation (TS&C) division, and this should place the company in a much stronger position to focus on its strategy of investing in structural growth markets. Indeed, management stated today that the disposal will make TT “a higher-margin, higher-quality business, with significantly improved financial capacity.”  

City analysts currently forecast it to generate FY2017 earnings of 13.6p per share, a 13% increase on last year. At the current share price, that places the stock on a forward P/E ratio of 15.9. A dividend yield of 2.6% is also on offer. With demand for connected devices, more data and improved precision in the industries that TT services likely to remain robust, these metrics look attractive in my view.

Keller Group

Another company that looks to have considerable long-term potential is £600m market cap Keller Group (LSE: KLR). It is the world’s largest independent ground engineering company, specialising in providing advanced foundation solutions for complex projects. While over half of its revenues are generated in the US, the company has operations in over 40 countries across five continents, employing over 10,000 people. 

Half-year results, released in late July, saw revenue increase 17% to a record £991m, and underlying earnings per share surge 28% to 35p. The group had a year-end order book of £1.1bn, an all-time high, 20% above last year on a constant currency basis. The performance in the US was a little lacklustre, but with US President Donald Trump planning to spend significantly on infrastructure in coming years, Keller could benefit.

The company has appealing dividend growth prospects, having increased its dividend payout from 22.8p to 28.5p per share over the last five years. Analysts expect dividend growth of 5.2% this year, taking the payout to 30p, a yield of a healthy 3.6%. Dividend coverage is forecast to be almost three times.

Revenue growth of 13% is anticipated this year, and consensus earnings estimates place the stock on a forward looking P/E ratio of just 9.4. After a 13% pullback in the share price since mid May, I believe value is on offer for long-term investors.

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The tech titan was last 11% higher after advising that it had hived off its Transportation Sensing and Control (or TS&C) division to US giant AVX Corporation for $118.8m on a cash-free, debt-free basis. The Woking firm advised that it will use the proceeds to cut debt and to fund capital investments and acquisitions to facilitate future growth.

Celebrating the deal, chief executive Richard Tyson commented that “this is an important step for TT. Having returned the TS&C Division to growth and profitability faster than expected, we believe it will be better positioned to achieve its full potential under the ownership of AVX.

“Following the disposal, TT will be a higher margin, higher quality business, with an improved geographic and market balance.” Tyson added that “we will continue to focus on structural growth markets where there is increasing electronic content.”

Broad approval

The news has been widely welcomed by those in the City. Harry Philips of Peel Hunt commented that “the disposal itself is not unexpected but the price is far better than the £65m we had in our model.”

He added that “[the deal] leaves net cash at around £50m, which is a terrific platform to build off and this represents relaunch of the company. The management team have done a great job and they will be strongly supported in the next phase of the company’s development.”

Meanwhile David Larkham of Numis advised that “the transaction will… materially improve the quality of earnings since operating margins in this division were particularly low at 1.3%.”

Strong trading

News of the disposal was not the only cause for cheer, however, with TT Electronics also putting out a short — but reassuring — commentary on current trading, the firm advising that the “pattern of trade across the remaining business has been good,” and that the “order book remains strongly ahead.”

The company’s decision to concentrate on structural growth markets with improving electronic content is clearly producing the goods, and prior to today’s results the City had been expected earnings improvements of 15% and 9% in 2017 and 2018 respectively.

I reckon the firm is worthy of serious attention, particularly given its very-unassuming current forward P/E ratio of 14.8 times.

Medical marvel

While Smith & Nephew (LSE: SN) may not be expected to generate eye-popping earnings growth in the near future — rises of 1% and 9% are anticipated in 2017 and 2018 — I am convinced profits should explode in the years ahead as rising healthcare investment across the globe powers demand for the company’s artificial joints and limbs.

The FTSE 100 giant has been pressured in recent times as demand from China has moderated and economic pressures in the Middle East weighed. But sales at the company seem to have picked up in 2017, and particularly in emerging territories (underlying sales growth in these regions returned to double-digits during January-March, rising 13%).

These figures underlined the huge potential of these highly-lucrative regions. And I believe the huge investment Smith & Nephew has made in growth arenas like sports medicine and robotics could also lay the base for stunning revenues growth in new and established markets alike.

I reckon Smith & Nephew’s slightly-heady forward P/E rating of 20.4 times is decent value given the company’s robust long-term outlook.

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Improving outlook

Global provider of engineered electronics, TT Electronics (LSE: TTG), released an upbeat update. Trading for the four months to the end of April has been in line with expectations. Revenue has risen by 10% versus the same period of the prior year, while it is 1% higher on an organic basis.

Encouragingly, the company’s order book is strongly ahead of the previous year. This provides the business with better visibility over the medium term. It also indicates that the strategy to reposition the business in structural growth markets where there is increasing electronic content is working well.

The acquisition of Cletronics in 2017 provides TT Electronics with further capabilities in North America. This should help to improve its earnings growth outlook. In fact, in the current year the company’s bottom line is expected to rise by 13%. Next year, further growth of 10% is forecast, which could lead to improving investor sentiment.

Since TT Electronics trades on a price-to-earnings growth (PEG) ratio of only 1.3, it appears to offer a wide margin of safety. This could limit its downside risk in the short run and lead to a higher level of capital gain in the long run. As such, now could be the perfect time to buy it.

Better-than-expected performance

Also reporting on Friday was designer and manufacturer of microwave electronic products, Filtronic (LSE: FTC). Trading during the fourth quarter of the year in the Wireless business was better than previous guidance. While impressive, some of this was offset by short-term weakness in trading in Broadband. However, when the performance of the two segments is combined, the company’s management now expects total revenue to be around £35m in the year to the end of May 2017.

This better-than-expected top-line performance has caused the company’s share price to rise by 30% on the day of its update. It is also expected to boost profitability in the current year. Filtronic’s earnings are due to rise by 225% in financial year 2017, followed by further growth of 17% next year. This puts the company’s shares on a PEG ratio of just 0.5, which suggests they offer a wide margin of safety, despite their improving outlook.

Clearly, Filtronic is a relatively small company which lacks the size and scale of many of its larger peers. As such, it could prove to be a relatively risky buy. However, with high potential rewards, its risk/return ratio suggests that now could be the right time to buy it.

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