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Investors have got it wrong with these two stocks
He believes you could make a mint buying now as the market has made wrong assumptions about the stocks which should eventually be corrected.
Their shares could trade much higher once investors properly understand each of these businesses and why they are not the same as two particular peers.
Admittedly shares in both Inspired Energy and Smart Metering Systems have already started to rise in price; Donnelly’s argument is that they’ve still got a long way to travel upwards.
What do they do?
The two companies in question both serve the energy market, albeit in slightly different ways. Inspired Energy helps businesses to find cheap energy deals; Smart Metering Systems installs and manages smart gas and electricity meters.
Investors have looked at these two businesses and automatically assumed they are identical to two companies: Utilitywise (UTW:AIM) and Energy Assets Group. The latter was taken over last year and is no longer on the stock market, although investors still remember the business.
Utilitywise has long been criticised for having questionable accounting practices. It quickly recognises revenue from helping a client move to a new energy deal but it can take years for the cash to appear in its bank account. That’s because utility companies can be slow at paying commission for the types of customer Utilitywise brings them.
Energy Assets was a fairly simple business to understand. It installed smart meters for corporate energy users on behalf of utility companies and enjoyed a recurring revenue stream from hiring out these meters.
It was great as an annuity investment, thanks to its reliable cash flow. However, Energy Assets’ growth was reaching a natural end because there are only so many meters to install among UK-based corporations.
Why has the market got it wrong?
Donnelly argues investors have assumed the same negative factors surrounding Utilitywise and Energy Assets also apply to Inspired Energy and Smart Metering Systems, respectively.
That could be why they’ve traded on much lower equity valuations than the analyst believes they deserve.
He says the latter two businesses are different, implying they have unrecognised qualities which make them superior investment propositions.
The lesson from this situation is simple: buy shares in both Inspired Energy and Smart Metering Systems before the broader investment community cottons on to the mistake.
Inspired vs Utilitywise
Inspired Energy helps large companies such as Kwik Fit to save money on energy prices and be more efficient when it comes to energy consumption.
‘People wrongly think Inspired is serving SMEs (small to medium sized enterprises); it isn’t. That’s the domain of Utilitywise,’ says the Panmure Gordon analyst.
‘The pace at which these companies get paid for moving a business onto another energy deal is dependent on the size of the client.
‘Inspired tends to get cash within a year because its clients are big and more valuable to utility providers; Utilitywise often has to wait years for its cash, even when it has already booked the revenue in its accounts.’
How to spot problems
Donnelly recommends looking at the asset part of each company’s balance sheet. He says the ‘non-current trade and other receivables’ line on Utilitywise will have a big number, Inspired will have zero. ‘Non-current receivable is a promise (after more than 12 months) of cash against the booked revenue, but actually money that won’t arrive for many years in the case of Utilitywise.’
The analyst says both companies’ services are very topical as energy wholesale prices have rocketed over the past year. The higher the cost of energy, the more likely a corporate will think about finding ways to switch to a cheaper deal or reduce consumption.
Utilitywise last week confirmed to Shares that the bulk of its business was still in the SME space, despite making an acquisition a few years ago to exploit the larger corporate market.
‘We would never carry the full amount of long dated receivables (owed cash) on our balance sheet; there would be a discount,’ says Utilitywise chief financial officer Richard Laker, adding that some suppliers pay its commission in as little as six months.
He says Utilitywise is expanding its proposition via technology so clients can monitor their energy consumption as well as switch to cheaper deals and potentially provide more immediate cash income for the business. ‘These will be subscription revenues on a recurring monthly basis,’ explains Laker.
How much can you make?
Donnelly believes Inspired Energy’s shares will hit 19p in the next year, implying 20% upside from the 15.89p price at the time of writing. He says that price target is very conservative versus the true potential of the business.
As for Smart Metering Systems, its investment case is considered more attractive than Energy Assets because it has an additional growth driver.
‘Its business is split into two. It enjoys the revenue from the installed smart meter base with corporate customers; that’s very low cost to run and very cash generative. Secondly, it does the same thing again for residential homes.
‘The Government wants all homes to have smart meters by 2020; I think it will be more like 2022,’ adds the analyst.
‘Over the past six years Smart Metering Systems has proved it can secure debt to buy smart meters and generate a big yield. The market thinks it only has limited growth like Energy Assets, not the growth in the years ahead from home installations.’
He believes the shares will hit 868p in a year’s time, implying 43% upside from the current 605.4p share price. (DC)