New-look Eleco has 46% upside

Last year was a big one for Eleco. The AIM-listed firm had already ditched most of its loss-making building materials businesses to focus instead on its much more exciting, and profitable, software division. A refinancing, further restructuring, and experienced new management team followed, yet despite these distractions, the remaining business still grew profits.

With the legacy operations gone, Eleco is now focused on providing design, planning and cost estimation software to the construction industry.

In 2014, pre-tax profit grew by 10% from £624,000 to £684,000, driven by a small increase in revenue to £16.5 million, and as lower finance costs - net bank borrowing was down almost two-thirds after a £2.9 million placing at 20.75p last July - offset restructuring charges.

Crucially, recurring revenue remained steady at £7.4 million, or 45% of the total, mainly from maintenance contracts - customer support and software upgrades. Services, which includes installation of products, training and consultancy generated 31% of sales, and licenses the other 24%.

The strong pound has had an impact on sales as Eleco does almost half its business in Scandinavia and another 23% in Germany and elsewhere in Europe. This, management tells Interactive Investor, is largely offset by costs in Swedish Krona and Euros.

Eleco's new management, which includes chief executive Nick Caw who rejoins from Microsoft UK, and finance director Andrew Greenwood who moved from Anite in February, are "optimistic" on prospects on the Continent. There are plans to ramp up the fledgling US operation, too, and sales there are tipped to improve through this year.

"2015 has begun well and I believe that the equity raising and the decision to re-bank with Barclays will prove to have been the foundation for a significant and I hope sustained recovery in ELECO's fortunes," says chairman John Ketteley.

Eleco has a new broker, too - finnCap - and it is understandably bullish. "Eleco is now a profitable and growing software group with strong IP and a broad product range addressing key requirements in a growing market," says analyst Lorne Daniel in a 32-page initiation note.

"The improved financial position and huge customer base provides a platform for product and market development in order to exploit real growth opportunities. FY 2015 should see investment and consolidation but with further profitable growth as the group embarks on a very exciting journey."

A higher tax rate and "year of consolidation" ahead mean earnings per share (EPS) will likely remain flat in 2015. Still, finnCap pencils in 43% growth next year to 1.4p, and the broker reckons the shares are clearly undervalued compared to listed peers like Nemetschek AG and Trimble.

"Applying a sector median P/E 25x rating to Eleco's expected 1.4p FD EPS for FY 2016 suggests a price target of 35p for the shares, should they be given the same rating as peer stocks," argues Daniel.

The share price is down almost 10% on Tuesday at 24p, not wholly surprising given the 62% rally since December. But management has to improve its profile among the investment community. "We believe we've got a great story and good long-term prospects," Caw told us. Now he must prove it.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.