Thursday, 4 July 2013

Pennant growth portfolio candidate


Pennant International provides a range of services that extend across e-Learning, Computer Based Training, Emulation and Simulation, Technical Documentation, Media Services, Cartography, Supportability Engineering Software products and related services. I have no holding in this company (epic code: PEN) 

Software & IT Services
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Est. 2013 growth
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5 yr BV + Div return
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PEN was one of the recent additions to the growth portfolio candidates list here.  It is a small company listed on AIM, that amongst other services & products provides training and simulation to the defence industry.  It operates through three divisions - Training Systems (57% of sales), Data Services (18%) and Software Services (25%).

Its most recent announcement on 19 June stated that it had received a £1.3m export order for the supply of a software based training capability, but more importantly the directors stated that they expected to exceed current market expectations.  This had the effect of moving the SP from 64.5p  at the time I produced the candidate list to 75.5p and their brokers WH Ireland (the only broker that follows them), increased their price target to 99p up from 90p; since then the price has moved back a little.  It should be noted that there is a low level of free float in the shares, with the directors holding just over 50% of the shares in issue.

Pennant has shown good growth over the past three years as more companies outsource their training needs.  Sales have grown by 15% pa and EPS by a substantial 53%.  Operating margins have increased over the past year to 11%, but there should be more to go at here for this type of business, as the switching cost for the customer can be prohibitively expensive.  Return on equity is good at 23.1% and is probably indicative of a company with an economic moat that I would ascribe to switching costs and their intellectual property (see description of economic moats here).  This narrow moat has the ability to be widened, as their training and simulation systems become more widely adopted and they benefit from network effects within their customers.

Free cash flow (FCF) was weak last year, as receivables increased by over £1m.  This would normally be of concern, but the directors state that only £7k is past due, so I'm assuming this is a timing issue.

The majority of their sales are within the UK (77%) and 57% of sales are from the Training Systems division.  The customer base is somewhat concentrated, not unusual for a small company, with just 4 customers representing 71% of turnover and one of those customers represents 29% of total revenues.

Expectations are for 6.6p this year and 7.1p next year and the dividend yield on the current price is forecast to exceed 3%.

Interims are due to be announced on the 5 August, opportunity to check on those receivables and the outlook, so should make interesting reading.  I would judge the current intrinsic value for the business at about 90p.  I have used the average free cash flow for the past 3 years (see comment above on FCF) and assumed growth of 20% pa for 2 years, 10% pa for the following 8; 2.5% pa in perpetuity and a discount rate of 12%. 

A small company in an interesting growth niche, with the directors owning a good stake in the business, that should ensure an owners' mentality with respect to strategy and execution.  There are some risks attached though that may be summarised as - size, concentrated customer base, current high level of receivables, company not widely followed by analysts and a 4-5% bid/offer spread in the SP.


  1. Hi Jeff,

    Well done on an informative blog I have found it very useful. PEN released their results on 5th August. My concern has always been their free cash flow levels. They state that their net cash generated from operating activities stands at -£550k whereas last year it was +£280k. Any comments on this?


  2. Thanks for the comments. I would agree with your concern over PEN's cash flow. It was weak at the full year stage and the interims have done nothing to improve the situation.

    They state in their interim announcement that:

    "...Cash was used during the period mainly to fund the start of some major contracts. It is expected that this requirement for working capital will reduce during the second half as stage payments are received..."

    The largest use of working capital was a £1.9m increase in receivables and, since there was no corresponding increase in deferred revenue, I am assuming that these receivables were traded as sales. It is therefore likely (deduced from their comments above) that they have traded stage payments on some of their recently awarded contracts and have yet to receive the cash.

    This is not unusual for this type of work, but in a small growing company has a distorting effect as they trade milestones early on.

    On the positive side, it is likely that the margins in the early stages of a contract are weaker than the later stages, so higher margins may be expected later on. It's worth noting the much lower GM% in the half year than both last year's interims and full year. This would only be worrying if it continued in to the second half, but it is concerning that there was no mention made of such a large deterioration, especially if there is a likely positive outcome, as I am suggesting.

    All of this is conjecture at this stage, as the disclosure in their interims is minimal.

    Young growing companies can often be cash consumers in their early years, but a bit more disclosure from the company might be helpful in determining when the cash burn might turn to accumulation. So I have this as one to watch at this stage for me.

    Hope this was helpful. If you disagree, or do not understand any of my comments I would be interested to know.


  3. Thank you for your insight. I agree and think this one will be one to watch and get in once news is more comfortable regarding the cash position.

    I will probably post again to keep discussion live if we have meaningful news.