TIPS

Buy Northern Bear at 96.5p
Says James Faulkner of WatsHot.com - 09/04/08

Being a northern git, I'm partial to a good solid Northern company, which is precisely what Northern Bear is. Although the phrase solid northern company may not be too endearing to investors given the recent Northern Rock fiasco, and the name Northern Bear might seem like the worst possible name for a company, there are plenty of reasons to feel bullish about Northern Bear. Based in the North East of England, the company operates in the building services sector and has a proven track record of extracting value from consolidating small privately run businesses. Although the shares have suffered recently along with the rest of the construction sector, much of the punishment has been unfair given the group's repositioning of its business mix towards the less cyclical public sector.

Business Overview

Founded in 2006, Northern Bear has established a niche in acquiring small private businesses ranging from asbestos disposal to roofing and general building services at bargain basement prices. Acquisitions are generally made on EBIT multiples of no more than 3.5 times, which reflects the value to be had from pursuing private rather than publicly listed companies in this respect. These are generally small, well-run companies that throw off cash and have an established customer base. Northern Bear typically extracts very favourable terms indeed with these acquisitions, and its increasingly impressive track record, along with the weakening of sentiment surrounding the building sector, should ensure that these terms become even more favourable in the future. It is generally the case that vendors are offered at least 25% of the consideration in equity, to ensure that their interests remain aligned with the continued success of the acquired company, which is important given the often personal nature of these businesses. The rest is made up of debt, which is available to Northern at 2 times EBITDA, and cash generated internally. Going forward, it is anticipated that these acquisitions will have to become larger in order to have a comparable effect on earnings.

We all know that the commercial and residential building sectors aren't looking too rosy at the moment, but the market seems to have simply aligned Northern solely with these interests and neglected the group's considerable and increasing exposure to the public sector. Public sector and local authority projects are less volatile than those in the private sector and are not subject to the vagaries of the economy. However, while it is true that the company has been placing increasing emphasis on beefing up its public sector presence, it is by no means seeking an entry from or neglecting its private sector operations. Instead, the company is seeking to balance its operations between both sectors in order to create a more stable business model that can reap the benefits of an upswing but also be resilient in a downturn. The company's long-term target is to have around 60% of its customers in the public sector and local authority arena, compared with around 50% currently, and Northern's most recent acquisitions have brought it further towards this goal.

Chirmarn and Chirmarn Surveying, acquired in May 2007, specialise in dealing with asbestos removal and disposal. Government legislation compels owners to manage asbestos in non-domestic properties and Chirmarn's main customers include health authorities and government establishments as well as commercial building firms. Meanwhile, General building contractor Hastie D Burton, acquired in June 2007, focuses on providing building services to local authorities, housing associations and schools. It is likely that more earnings enhancing acquisitions oriented towards the public sector are on the cards for the near future to bring the company further towards its target.

Northern Bear was co-founded by Jon Pither and Graham Forrest in 2006. Pither worked as managing director of engineering and building products company Amari until it was acquired by Glynwed International in 1988. He is now Executive Chairman of Northern and also holds positions with numerous other public and private companies. Graham Forrest is CEO of Northern and has previously served on the boards of four public companies. Both Pither and Forrest have substantial shareholdings in the company, totaling more than 30%. The board is well balanced between people with hands-on industry experience and those with expertise at the corporate level.

Recent Trading

During the six months to 30 September 2007, the company posted pre-tax profits of £1 million on turnover of £13.7 million pounds. Notably, the company decided to declare a maiden dividend of 1p per share, a year ahead of its initial expectation. The group had no problem raising funds on the market during the period, which included a placing of 275,000 shares at a price of £1.40 in May 2007 to raise £0.4 million, and another on 30 August at £1.45 which raised a further £3.2 million to help finance acquisitive growth - both of which were well above the listing price of 88p and the current share price. In addition to this, the company also negotiated a new banking facility with Yorkshire Bank, which further increases the company's scope and flexibility in terms of growth.

Forecasts and Valuation

During the year to March 2008, the company is forecast to achieve pre-tax profits of c. £2.2 million on the back of sales of just under £30 million, giving earnings per share of 9.8p. These figures should rise to c.£3.5 million, c.£36.8 million and 14.9p, respectively in 2009. On this basis, the shares are trading on a current year earnings multiple of 10 falling to just 6.5 in 2009, which suggests the market is currently valuing the company in line with pure construction plays. I reckon the shares deserve a rating that is more in line with the mid teens multiples commanded by the support services sector, which would reflect its increasing earnings diversity and exposure to the public sector. Add to this the company's superior growth rates and the proposition becomes even more tempting. Of course, the stock is not without its risks. These include the possibility of some bad debts being incurred if the situation in the building sector deteriorates rapidly, but the high proportion of blue chip private sector clients would suggest that any impact will be minimal. Northern Bear, like any acquisitive company, carries a net debt burden which also needs to be considered. However, at £4.4 million the debt level is by no means excessive and interest cover of 4.8 indicates that it is eminently manageable.

Northern Bear is a company that is currently misunderstood by the market. With the shares at 97.5p, potential investors are getting both value and growth. Further acquisitions could also potentially lead to upgrades in these earnings estimates. My stance is buy with a 1-year price target of 179p based on a reasonable 12 times 2009 earnings estimates.

Key Data

EPIC: NTBR
Market: AIM
Spread: 93p - 100p (7%)

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