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Synectics – a buy for recovery

By Tom Winnifrith & Steve Moore | Wednesday 10 October 2018

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

Having been over 600p in 2013, shares in Synectics (SNX) were heading towards 100p towards the end of 2014 following a “Trading Update and Board Changes” announcement, which included from Chairman David Coghlan; “In the board's view, and I'm sure that of other shareholders, a third profits warning in a year for Synectics is unacceptable, even after five years of solid profits growth. Some of the factors behind this poor performance have been outside the company's control, but others were not. Action is being taken to ensure future profitability is not dependent on the timing of revenue recovery in certain sectors”. Such action looks to have been taken, but the share price has only recovered to a current 220p offer – and this looks a recovery story with more to go…

Operations: The company describes itself as “a leader in the design, integration, control and management of advanced surveillance technology and networked security systems”.

Its ‘Systems’ division “provides specialist electronic surveillance systems, based on its own proprietary technology, to global end customers with large-scale highly complex security requirements, particularly for oil & gas operations, gaming, transport & infrastructure protection, and high security & public space applications”. A ‘Integration & Managed Services’ division - of Systems division and third party offerings - includes a nationwide network of service engineers, UK government security-cleared personnel and facilities and an in-house 24-hour monitoring centre and helpdesk.

Management Incentive: In January 2015 Paul Webb became CEO. He has a degree in Physics from Imperial College London and joined the company in 2004, subsequently overseeing the growth of its industrial systems activities and then leading the consolidation of all of its proprietary technology systems activities into a single operation. His remuneration last year totalled £374,000 (including a £90,000 bonus) and he has 36,322 shares in the company.

Finance Director Mike Stilwell took on the role in December 2015 though is leaving at the end of the company's financial year. His replacement is Simon Beswick - a fellow of the Chartered Association of Certified Accountants and with previous industry experience including European Finance and Legal Director of Rohm & Haas (a Fortune 500 specialty chemicals company at the time listed on the NYSE) and Finance Director and subsequently Managing Director of Tritech International, a subsidiary of FTSE 100 constituent Halma. Stilwell’s remuneration last year totalled £183,000 (including a £36,000 bonus) and he has 6,910 shares in the company.

Chairman David Coghlan was formerly a partner at strategy consultants Bain & Company and is an experienced non-executive. His remuneration last year totalled £86,000 and he has 1,521,303 shares in the company. We also note that on just Thursday Business Strategy Director David Lowe bought £20,600 of shares at 206p each.

Recent Financials & Trading: Results for the company’s half-year ended 31st May 2018 showed pre-tax profit up 12% on the corresponding prior year period, at £1.5 million, on revenue 3% higher at £34.7 million. This was despite currency impact – “on a constant currency basis, underlying profit and profit before tax were both up 31% to £1.7 million”. Due to an increased proportion of profits generated from the US and a resultant projected higher effective tax rate, earnings per share were down slightly to 5.9p.

However, after particularly a more than £4 million net working capital inflow, net cash increased by £5.2 million to £9.1 million and the dividend per share was increased by 20% to 1.2p. The company did though note “the high cash inflow in the half was in part a function of an unusually positive reduction in working capital requirements due to the timing of payments on major contracts. The current average net cash is around £5 million, and this balance more accurately reflects the underlying position”. Current assets over total liabilities increased by £1 million to £16.8 million and it also emphasised “order book up 18% since the year end to £28.8 million”. It has since also announced a “multi-million pound project” from Serco to replace CCTV systems at six UK-operated custodial sites.

Risks: As earlier noted, there were some prior profit warning factors outside the company's control and others not. There remains some sector risk – the latest interims, for example, including “underpinned by a very strong performance in the gaming sector”. However, there does look a decent spread now – the overall performance delivered despite the UK bus and coach market “remained weak” and a lower Integration & Managed Services contribution, for example. Additionally, on the latter it was emphasised “this is primarily a timing issue… order book, up 23% since the year end, which supports management's expectation that the division is poised to produce much improved revenue and profits in the second half”, whilst “in the Oil & Gas surveillance sector, the level of enquiries and quotes has picked up significantly… this increased activity is expected to feed through to growth in Synectics' revenues from 2019”.

There is also technological risk, but the company has increased its investment in product and business development, seeing “opportunities to capitalise on emerging software technology applications”. There is also risk in project delivery and it notes exchange rate and Brexit risk, though that these are closely monitored.

Valuation: House broker to the company, Stockdale, is forecasting full-year earnings per share slightly down on last year, below 15p, but, noting the order book and pipeline of high probability expected new business, is looking for heading towards 20p next year and more than 25p the year after – and calculates a discounted cash flow-derived 315p target price.

Of course, some scepticism needs to be attached to house broker targets but the above suggests the numbers realistic – and we note 300p for example, equates to less than 12x soon-to-be the next year’s forecast earnings. As such, at the current 220p offer and up to 240p, the shares are a Recovery stock buy.

This article first appeared on the Nifty Fifty website which Tom Winnifrith runs with Steve Moore & Lucian Miers. To access the website - where another new tip has just gone live & there is a new tip EVERY DAY DURING THIS WEEK and a new shorting piece from Lucian later in the week - click HERE

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