“It was a case of errors, sloppiness and bad judgement”, the chief executive cleared his throat and surveyed the room. “To be honest, it could get worse”.
These were the words uttered by JP Morgan’s Jamie Dimon in May last year. He’d just announced a rather surprising $2bn loss. And one man was very much to blame – a young French trader, Bruno Iksil, later nicknamed ‘the London whale’ had accumulated a massive loss on a complex energy trade.
It turned out that this trader worked in the chief investment office – the very place that was supposed to be mitigating risk at JP Morgan!
But JP Morgan hasn’t been the only one to make such an embarrassing disclosure. Does the name Yasuo Hamanaka ring a bell? It should. His ferocious copper trading style lost Sumitomo Corporation $2.6bn. And it’s likely that we will see more expensive errors like this.
Global trading turnover in energy, metals and agriculture is huge. With trillions of pounds at risk and so much volatility in the market most banks are looking to take serious measures to improve risk management. And today I want to tell you about one company that aims to do exactly that.
Helping companies contain the risk
Brady (BRY) aims to help many of the world’s leading companies manage their risk. Its order management system provides a web-based platform that allows clients to send orders for both physical and derivative commodities.
Its focus is on servicing traders in soft commodities, metals, energy and recycling materials. It is the number one European supplier and the fourth largest globally in a market estimated to be growing by 11% a year. With huge costly mistakes like the ones I mentioned above, I was surprised by Brady’s interim results.
At the half year stage, sales had grown by 24%, though this was due to a number of acquisitions. If we assume the acquired companies had been in the group last year, then sales would have fallen by 8%. Although underlying costs were kept under control, the revenue shortfall meant that margins fell to 9% from 15%.
As a result Cenkos has cut its earnings per share (EPS) forecast by 40% this year to 3.5p, well below last year’s 5.9p. And the share price duly fell 15%, bringing a long run to an abrupt end.
But it isn’t all doom and gloom for this solution software company. Here’s why.
How Brady could come roaring back
There is another side to the Brady story. Selling software licences can be a lumpy business with the timing of large contracts impossible to control.
Brady states that it has several significant deals in the pipeline and is very hopeful of signing some of these in the second half of the year. Historically, its largest licence deal was for £800,000; it is currently negotiating one of similar size – and even two larger ones. These big deals are over and above the normal flow of business. This gives management confidence in delivering a bounce back to profits in 2014, encouraging Cenkos to leave its forecast for EPS of 7.0p unchanged.
Another factor supporting a recovery in earnings is a £2.2m cost cutting programme. Brady has made several acquisitions and is in the process of cutting out duplication and unnecessary overheads. It aims to add resource to the sales function at the same time. The balance sheet looks good with net cash. Shares have been issued to pay for acquisitions in the past which has acted as a drag on EPS but at least it means there is no debt to worry about.
The quality of earnings should also improve over time. More than half of group revenues are recurring and this proportion is increasing as Brady moves towards a cloud-based rental model from selling traditional software licences. This will help the visibility of earnings in the future. It might also help bring in customers, as a $10,000 monthly rental fee is an easier pitch than a $300,000 licence payment.
Another positive point to bear in mind is the attraction of Brady to a potential acquirer. Most of the competitors have made acquisitions in the last couple of years and larger transactions have been conducted at much higher valuations than Brady is trading on.
Waiting for the final piece of evidence
If Brady is suffering from a temporary blip and we take Cenkos’ 2014 forecast on face value; then at 62p the shares trade on a mere 8.8 price/earnings ratio. The price to sales ratio would be similarly modest at 1.4.
At the same time the company would have regained its sales momentum and in a year’s time could easily be selling for twice its current depressed level. On the face of it this looks like a good company that looks very cheap.
Now that said, I wouldn’t recommend buying now. Brady’s track record at the eps level doesn’t yet convince that it is a quality company that can be bought with confidence on a share price setback like the current one. That 7.0p forecast for 2014 could be made, but it looks a bit demanding. In cases like this I prefer to wait for more evidence. I would want to see an announcement in the next few months regarding one or more of those large contracts. But this is one company I’ll be watching with great intrigue…
• This article is taken from our free twice-weekly small-cap investment email, The Penny Sleuth. Sign up to The Penny Sleuth here.
Information in The Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. The Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd. Fleet Street Publications Ltd is authorised and regulated by the Financial Conduct Authority. FCA No 115234. http://www.fsa.gov.uk/register/home.do
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