Stockwatch: does this spectacular bull run have further to go?

Despite a wider relief rally as Middle East fears temporarily abate, and a strong first-half update yesterday from telecoms’ billing software group Cerillion (LSE:CER), its share price eased around 2% to 1,470p.

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It is among the best example of perturbing news of how, in the past 12 months, the number of AIM-listed companies has fallen by 70 to 738, a jump on the 25 that went the year before. In 2007, there were nearly 1,700 AIM shares but the dominant reason now for de-listing is raising money from private equity. While some investors curse AIM for flaky companies, Cerillion has more than ten-bagged from around 150p back in 2018 to a Christmas 2023 high at just over 1,600p.

Source: TradingView. Past performance is not a guide to future performance.

The forward price/earnings (PE) multiple is 31x current financial year expectations (affirmed by the update), easing toward 27x for September 2025. This, I believe, partly reflects scarcity of growth shares despite softening in Cerillion’s growth rates.

After earnings per share (EPS) growth tested 150% in 2021 it eased to 69%, then 21% last year. Around 7% is implied for this September’s EPS outcome and 12% in 2025. With the company currently citing 10% growth rates, at least it implies scope for modest upgrading for this financial year.

Headline numbers are softening somewhat

I drew attention to Cerillion as a “buy” at 820p two years ago after a similar first-half update. Better late than never, and it was quite easy to distinguish attractions in revenue growing at mid-20% rates plus operational gearing manifest in the way EBITDA (close to operating profit) was up 48%.

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Compared to this, revenue in the six months to 31 March this year is up nearly 10% to £22.5 million with EBITDA up similarly to near £11 million. An impressive margin still, but this aspect of gearing is gone – as if costs have risen or the business is reaching scale where it no longer applies. Net cash is up nearly 13% towards £27 million, making the dividend look quite meagre – given nearly four times’ earnings cover – although with return on equity around 40% it makes sense to retain earnings, assuming it gets invested well.

Revenue is still at a low base arithmetically (able to benefit the growth rate) and the operating margin has soared from 5% to 39% over seven years (see table below).

Cerillion - financial summary
Year-end 30 Sep

Source: historic company REFS and company accounts.

In a situation like this – a “growth” type rating versus underlying numbers that barely support it – the question is whether a slew of contracts could turbocharge them again. This is still a small company testing £50 million revenue and its financial dynamics can easily change.

A strong pipeline is cited with “a number of substantial potential new contracts at various stages of negotiation” as if news can be expected, with Cerillion “well-placed to meet expectations for the current financial year and beyond”.

The business is clearly doing well, amid full-fibre broadband and 5G roll-out. But it’s unclear quite whether it consolidates in due course before 6G adds a new dimension.

A tepid response to this latest update

If you respect “technical analysis”, charts which reflect the balance between buyers and sellers, you would regard guessing fundamentals as less significant than what is before your eyes.

Of concern, therefore, is the tepid response to this latest update, although a 4% slip did recover to less than 2%. True, management did not express a “beat” of expectations to justify a further rise, and the chart shows a particularly strong run from 1,080p last October to 1,600p by Christmas. But there has definitely been a consolidation-downwards trend this year, relative to sideways for the AIM 100 index.

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Mind, as regards the validity of technical analysis. Cerillion fell last October from 1,325p to 1,050p in a matter of days – a 20%+ drop that should have triggered a stop-loss for investors minded to place one. Or perhaps this simply shows a stop-loss approach is too crude, given a 24% rebound to 1,600p promptly followed.

A fair observation seems that the story on Cerillion is well known and its shares exhibit a long bull run. Investors likely to buy, already hold it. “In line” updates therefore, at best, sustain a high valuation where it is.

Can Cerillion leverage greater scale?

The company originated as a 1999 management buyout of the in-house customer care and billing product division of Logica, so it has existed a good while, if yet to achieve £50 million annual revenue. There are around 80 customer installations in 45 countries.

This is not a Microsoft Corp (NASDAQ:MSFT) leveraging massive scale via cloud applications for global businesses. Cerillion is a relatively specialist software company serving telecoms, finance, utilities and transportation. Admittedly, that should offer good scope for growth.

Nor is it akin to Sage Group (The) (LSE:SGE), which extends very broadly in enterprise resource planning software, being the world’s third-largest supplier. Sage shares have soared from 4p in 1990 to a 1,265p all-time high last March, and is an example of why not to sell down a dynamic, well-managed software group just because it looks pricey.

Sage is similarly on a 30x forward PE, albeit yielding nearer 2% than Cerillion near 1%. Sage shares are likewise undergoing something of a correction currently – 10% down from the high - yet both remain well above a 200-day moving average.

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Possibly, Cerillion could make a strategic acquisition with its cash in a perceived new area for growth and back it also with organic investment. That was not entertained in the 2023 annual report. The story was “numerous factors continuing to drive software that connects their network to customers” with attempted reassurance how “in a slower growth environment for telcos, the need to exact more revenue from existing assets and improve operational efficiency are as important drivers...as investment in new 5G and fibre infrastructure.”

Management proclaimed “a huge marketplace” in which its brand is rising, and the outlook statement was bullish. First-half revenue/profit growth of around 10% is down, however, on 27% and 39% reported a year ago, hence the interim results due 13 May will need to substantiate further growth relative to the share’s high rating. Might a contract or two be declared simultaneously?

Low yields mean software shares can ‘fall between two stools’

A common dilemma for Cerillion and Sage is that if growth-driven investors (likely their majority holders) get restless with any aspect of slowdown – in the business or shares – and look to switch into something more exciting, there is no material yield prop.

Such shares would have to de-rate to attract income investors to more worthwhile yields than 1% to 2% currently. This is despite consistently strong, free cash-flow profiles.

To my mind, therefore, such risk/reward profiles are not as strong as the proclaimed narratives. Managements must deliver on what they say, otherwise if the underlying growth rate slows then shares de-rate. In terms of 12-month forward “PEG” ratios (PE ratio divided by forecast EPS growth), both Sage and Cerillion are on pricy multiples of 2.5 and 3.0 respectively.

This puts quite some pressure on Cerillion to flesh out more progress and prospects. I retain a “hold” stance (as last October at 1,150p), but further profit-taking could follow the 13 May results – so be attuned.

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.