In our previous post we highlighted Adacel as one of our key picks. Since then Adacel has notched up its fifth upgrade and reported an outstanding 1H16 result with a 612% increase in EPS on pcp. With the share-price having reached $2.50 before the 1H16 result and after the recent profit upgrade, we think the result has been missed by the market this reporting season.

In our previous post we highlighted Adacel as one of our key picks. At the time we said “we have noticed the company has a tendency to under-promise and over-deliver. Over the last twelve months, Adacel has issued a whopping four profit upgrades”. Since then Adacel has notched up its fifth upgrade and reported an outstanding 1H16 result with a 612% increase in EPS on pcp. The two highlights of the result were the cash conversion and increase in recurring revenue. Free cash flow was $5.7m vs NPAT of $5.7m which confirms the quality of the profits being generated. Adacel also commented that the cash flow in the second half of the 2016 financial year is anticipated to be higher reflecting the benefit of receivables generated in the first half.

We have seen a number of companies punished this reporting season for poor cash flow conversion and making various add-backs to arrive at underlying earnings, none of which apply to Adacel. Adacel also ended the half with a net cash balance of $11.3m and is looking at ways to give more cash back to shareholders in Australia.

The other highlight of the result was the increase the services revenue from $10.4m in 1H15 to $14.7m in 1H16. The services revenue is largely recurring and gives the company more clarity on the outlook going forward.

Adacel gave the following outlook statements: “We are confident that the solid growth platform we have now established will continue to deliver improved results for the full 2016 year and beyond” and whilst it is too early to provide specific guidance for the second half of FY2016, the combination of a strong order book to commence the calendar year, good visibility of opportunities for each of the business segments and disciplined operating systems provides confidence that the guidance for FY2016 of profit before tax being 70% higher than the previous period is achievable.

We believe this guidance again is inherently conservative given the outlook comments from the company. In FY15 the 1H:2H PBT split was 24%:76% while the current guidance implies a 63%:37% split. Adacel is also a benefactor of having substantial historical tax losses such that the amount of tax paid will be minimal for the foreseeable future.

With the share-price having reached $2.50 before the 1H16 result and after the recent profit upgrade, we think the result has been missed by the market this reporting season. One reason for this might be the fact there is still no research coverage on the company. We think it is only a matter of time before the research analysts pick up coverage, which will see the market recognise Adacel for what it is - the global market leader in air traffic control simulation and air traffic management technologies.