Although the flurry of oil and gas exploration has temporarily quietened down, interesting moves are underway in the Falklands to prepare for a radical change to the islands' economy. This is evident from today's financial results from service group Falkland Islands Holdings (FKL:AIM) which beat market expectations and put the £32.7 million cap in a good position to benefit from a forecast seven-fold rise in GDP by 2018.


The service group is in great financial shape, having reported a 1.9% rise in pre-tax profit to £3.3 million and a £11.4 million cash position. Its dividend has been lifted by 4.5% to 7.5p per share, representing a terrific track record of dividend growth. The shareholder payout has been raised every year bar one since 2006.


FKL - Comparison Line Chart (Actual Values)


The market likes the results, sending the shares up 4.4% to 333p. Yet as the chart shows, the shares have suffered from exposure to the oil and gas industry where the anticipated wave of resource discoveries in the Falklands hasn't quite lived up to the hype.


The service group owns 4% of Falkland Oil & Gas (FOGL:AIM) which saw its share price plummet last November after the second of two wells failed to make a discovery.


FOGL - Comparison Line Chart (Actual Values)


To date, only Rockhopper's (RKH:AIM) Sea Lion project can be considered a commercial prospect for the region. Yet this alone is set to revolutionise the local economy.


Premier Oil (PMO) has farmed in to the project and hopes to start construction in the second half of 2014 and begin production in the third quarter of 2017.


Falkland Islands Holdings' chief executive officer John Foster says the islands' government expects to enjoy a 10-fold rise in tax income over the next five years. This is based purely on the financial impact of Sea Lion's development. The region's GDP is forecast to increase from £140 million in 2012 to £1 billion in 2018.


Foster says there's lots of work in the background to prepare for a new oil industry, even though the share prices of any oil and gas company exposed to the region paint a different picture. He says Premier Oil is meeting the islands' government this week to finalise port arrangements for Sea Lion. If construction starts next year, then economic benefits will soon start to feed through to players like Falkland Islands Holdings.


It has interests in ports, construction, retail and transport. The business is cash rich following a fundraising last year. It will extend its DIY product range and retail space for builders merchants' operations. Investments are being made into its general store at the airports; and the group has also improved its motor dealership arm which will rent land rovers to oil workers.


There is competition in the region, but Foster reckons there's plenty of work to benefit everyone. The retail rival is a co-operative owned by a number of fishing companies. Galliford Try (GFRD) is present in the region helping to refurbish schools and upgrade infrastructure hubs like roads, sewers and jetties. Falkland Islands Holdings has a joint venture with Trans Construction to work on infrastructure projects generated by oil development.


The service group clearly offers prime exposure to the emerging oil and gas industry, supported by strong cash generation and dividend income. The latter points are aided by its ownership of museum shipping and storage group Momart. The business has been constrained by space as it is running at full storage capacity, so Falkland Islands Holdings is investigating the cost of adding more storage space.


The group also owns the Portsmouth Harbour Ferry service. It made just shy of £1 million operating profit in the past year on 24% operating profit margin. A new ferry has just been ordered, representing the final stage of modernising the fleet. The group says there is no requirement for further capital expenditure for the next 20 years. Therefore we believe it could easily sell the business to help fund any investment opportunities in the Falklands. Admittedly it is a cash cow for the group, but it is clearly a funding option that could quickly be monitised.


House broker WH Ireland has a 448p price target for the stock. It has today upgraded 2014 forecasts by 10% to £3.3 million. Although this implies no growth on 2013's results, a reflection of making investments to capitalise on future expected gains, the broker does anticipate improvement in 2015. Here it forecasts £3.6 million pre-tax profit.

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Issue Date: 10 Jun 2013