Stockwatch: An AIM tech share to tuck away

Is £116 million AIM-listed payments solutions group Eckoh poised to break out of a stubborn three-year trading range?

Over 2013-14, Eckoh soared from 14p to over 47p as QE forced investors up the risk curve, the annual average historic price/earnings (PE) ratio on hot-house multiples around 200 times.

The market has justifiably been excited: Eckoh's patented technology facilitates secure payments for client organisations, via whatever device a customer chooses; aiding efficiency, protecting data and reducing the risk of fraud.

It's highly pertinent when hackers can inflict serious reputational damage. Also, regulation is tightening, hence organisations increasingly look to secure themselves.

Eckoh's clients range from governments to retailers, utilities and financial services, whether dealing with their customers directly or via an outsourced contact centre. But, as ever with a promising story, the market seeks underlying proof, thus Eckoh's consolidation range from 30p to 55p.

Lately, the price jumped from about 40p to 46p in reaction to an 8 May trading update, citing revenue and operating margin growth over 20% for the fourth year in succession, helped by US operations.

UK is main contributor but US is growing fast

Latest prelims to end-March 2017 show the UK representing 67% of the group's 29.5% revenue growth to £29.1 million, and 87% of recurring revenue. US operations jumped 145% from a relatively low base, to £9.7 million.

But, although the US saw gross profit jump from £1.6 million to £4.2 million equivalent, its gross margin was 43% versus 83% in the UK, hence the domestic market contributing £16.1 million of £20.3 million gross profit. This disparity relates to closing one division of an acquired US business which had a large loss-making contract.

It also reflects a move from "capex pricing" (in the US from April 2014) where customers used to pay a large initial fee for service implementation, then an annual service & maintenance contract representing 15-20% of the initial fee, to a Software as a Service "opex pricing" approach where revenues are recognised over a three-year period.

This makes for better quality revenues in terms of smoothing receipts and also increasing contract size, rising from $53k (£42k) to $173k to $918k over the last three years. So, although US contributions can look modest in context, they are pregnant for growth.

In the last financial year, US contracts won have soared from just one worth $1.5 million to nine worth $8.3 million in the year to end-March 2017, with over 90% using SaaS pricing model.

Contact centres (or call centres) are an important aspect of group marketing in both territories. With 87 UK clients, Eckoh still has addressed only 3% of this domestic market. Meanwhile, the US contact centre market is five times larger than the UK, yet its implementation of secure payment technologies remains a long way behind the UK and Europe. As yet, Eckoh has 41 US clients and engages less than 1% of this market.

Currency translation is a further benefit: the income statement shows a strong dollar enhancing sterling revenues by £316,000 or 17.7% of operating profit, and which looks likely to maintain a boost given deteriorating UK politics further weakening sterling.

A strong start to the new financial year is declared, with a three-year contract for services to HM Passport Office and a five-year contract with Carters Inc for Secure Payments.

Mixed income/cash flow statements check the stock

Eckoh's price is broadly unmoved around 48p, partly because the income statement spoils the presentation somewhat. Despite a 29.5% revenue advance, the gross margin has slipped from 7.5% to 7%, although administrative expenses as a percentage of revenue have improved from 5.7% to 5.5%; and yet normalised operating profit is up only 4.2% to £4.3 million.

It's not exactly flagging growth as you glance down the numbers. After a 38% rise in amortisation of intangibles and modest exceptionals, statutory operating profit falls 27.8% to £1.8 million and the £162,000 net interest charge clip pre-tax profit to £1.6 million.

Also, net operational cash flow is down 52.6% to £2.5 million, which doesn't wholly support £2.7 million investment nor, effectively, the rise in dividends from £0.8 million to £1.1 million. Working capital was hit with significant payables being settled early in the financial year. Management took out a further £6.5 million in loans after £5.0 million last year, said to assist with acquisition financing, although the cash flow statement shows £5.4 million borrowings redeemed (after £3.0 million last year).

More positively, the end-March balance sheet shows total debt of £5.9 million debt offset by £6.1 million cash, hence all-considered it is fair for the board to provide shareholders with a return, while retaining ability to invest for growth.

To truly assert itself in the growth stock league, however, Eckoh needs to show better drop-through from revenue to profits/earnings growth, backed by strong cash generation.

Thematic long-term 'buy'

Despite the financial statements creating pause for thought, with the stock on a forward PE approaching 30 times and yielding only 1.5%, these results are worth noting because they affirm Eckoh as well-positioned in a growth industry that should buck risks within the UK and US economies.

Organisations need to protect their reputations to ensure customer confidence, thus the technology has plenty roll-out potential. The move to SaaS accounting created initial uncertainty and a stock price plunge from about 50p to 33p last September. But it is improving earnings quality and client retention is nearly 100%.

Altogether, this makes for an attractive risk/reward profile operationally in uncertain times, and US upside offers potential for upgrading the 2018 profit forecast of £5.1 million.

Eckoh looks likely to regain its 50-55p highs in the short to medium term and offer useful capital growth thereafter. Despite the inherent risk of rival technologies, this is a relatively small yet well-established business with a major opportunity.