Earnings upgraded by 44% – but there's more to come from this stock

Aim-traded financial software provider Arcontech (ARC:93p) delivered an eye-catching 45 per cent increase in pre-tax profit to £0.54mn in the six months to 31 December 2023. This reflected a 7 per cent increase in revenue to £1.45mn (mainly from last autumn’s client win – see below), below budget operational costs and an additional £0.11mn of interest income on a burgeoning cash pile.

The company makes its money by providing software products and bespoke solutions for the collection, processing, distribution and presentation of time-sensitive financial market data. It is not a software house as it doesn’t deliver any market data, but instead provides the means for clients (mainly large banks) to do so. Arcontech’s blue-chip client base includes Barclays, Citi, JPMorgan, Lloyds, Morgan Stanley, Santander and the Bank of England.

Arcontech has been extending the length of these multi-year contracts with several large clients, thus de-risking its 100 per cent recurring revenue stream which more than covers a relatively fixed cost base and means that incremental contract awards have an accentuated impact on profits.

Significant pipeline of contract opportunities

Bearing this in mind, Arcontech signed a multi-year agreement in late October 2023 with a [undisclosed] Tier-1 global institution, which needed to upgrade its existing market data infrastructure to cope with the frequency and volume of updates for its critical business needs. Following initial deployment in New York, the contract could be expanded to cover the client’s operations in both Europe and Asia.

Furthermore, analyst Michael Hill at house broker Cavendish notes that Arcontech has “several active opportunities with both existing and prospective Tier-1 clients which have installed the company’s software for testing”. Hill adds that “some individual contracts [in the pipeline] could exceed the entire revenue uplift we expect in 2024 and 2025”. True, chairman Geoff Wicks points out that “lead times are longer than before we signed the October contract”, but he also notes “we have the start of growth at existing customers and are confident about this continuing”.

That’s worth noting given that Arcontech has invested in its sales team to exploit the market opportunity, having appointed two full-time seasoned and highly experienced sales professionals in London, a consultant in Asia, and two part-time sales consultants. The additional cost explains why, even after a 44 per cent earnings upgrade, Cavendish’s full-year pre-tax profit estimate of £0.8mn is still shy of £1mn profit reported in the 2022-23 financial year.

However, there is material upside to forecasts if the company lands more major contracts. I wouldn’t bet against it, especially as competitors have been pushing through price rises, thus making Arcontech’s offering an even more compelling proposition.

Bumper free cash flow generation

In the meantime, the capital-light business remains a prodigious cash generator. Net cash has risen from £5.7mn to £6.8mn (51p) since the 31 December 2023 half-year end, a sum that equates to more than half the company’s market capitalisation of £12.5mn. It means that Arcontech’s enterprise valuation of £5.7mn equates to only nine times full-year operating profit estimates, or two-thirds less than the average rating of peers in Cavendish’s financial information technology space.

The cash pile not only offers firepower for Arcontech to make complementary earnings-accretive acquisitions, such as a trading platform which could be integrated into its solutions, but the cashed-up company could itself become prey to a larger predator. Shareholders can expect another hike in the progressive dividend, too, with Hill pencilling in a full-year payout per share of 3.7p.

Arcontech’s share price is modestly up since I suggested buying the shares at the annual results (‘Larger predators will soon notice Arcontech's smart strategy’, 6 September 2023) and offers almost 100 per cent upside to Cavendish’s target price of 180p. Buy.

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