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OPINION

Set sail for gains

Set sail for gains
April 10, 2014
Set sail for gains
IC TIP: Buy at 30p

I have noted this recently in a few of the companies I have been following with the offer price little changed, but the bid price shareholders are being offered to sell their holdings well below previous levels. In effect, this is a method of market makers buying in stock on the cheap in preparation to offload it at a far higher price as and when buyers return during more normal market conditions. It’s also why I always look at the average bid-offer spread a share has traded at over a number of weeks, or indeed months, in order to gauge what the ‘normal’ spread actually is during normal market conditions. I would advise any investor to do the same before buying into any company.

That’s of interest to me now because shares in Aim-traded Plymouth marina and property company Sutton Harbour (SUH: 30p) are trading modestly below a 12-month high of 31p, but the bid-offer spread is currently 27p to 30p. That’s a hideously wide margin and means that the share price would have to rise by 10 per cent alone just to cover the spread. As a rule, my general cut off point is a spread of 5 per cent. Moreover, I only recommend companies when the spread is that wide when the upside potential on the investment is large enough to compensate for the immediate hit taken on the spread. In the case of Sutton Harbour, at the start of this week the shares were actually trading on spread of 27p to 28p, so the market makers have widened it dramatically. Furthermore, a look at the bargains that went through the market show that some investors were actually trading between the spread.

The point to note here is that if you are in for the long-term, as I am having last recommended buying Sutton Harbour shares when the bid-offer spread was 27p to 28p (‘Small cap plays’, 5 December 2013), then in pays to ignore market maker shenanigans and focus on whether the investment case still holds and the likely catalysts to spark the much overdue re-rating that prompted the recommendation in the first place.

On that score, the company is clearly making progress and a pre-close trading statement ahead of results in the latter part of June confirmed as much. Indeed, Sutton Harbour continued to trade steadily through the second half of the financial year to end March and not even the widely publicised storms during January and February sent it off course. As a result analyst Chris Thomas at broking house Arden Partners expects the company to return to profitability in the 12-month period by reporting adjusted pre-tax profits of £300,000 and EPS of 0.24p. These numbers incorporate the disposal of an acre of land at the former airport site in Plymouth, with planning consent for a care home facility.

 

Valuation uplifts to drive Sutton Harbour’s share price

Ahead of the results, what is apparent to me is that if the UK economy continues to recover as economists predict - the UK is expected to have the highest growth rate amongst the G7 countries this year - and assuming the recovery in regional residential and commercial property continues to benefit from the recovery too, then this can only be good news for Sutton Harbour.

In fact, in the first half of the last fiscal year the company was already seeing some upward moves in valuations. These helped drive up its net asset value per share from 38p in March 2013 to 40.3p per by the end of September, reflecting a £400,000 net valuation surplus on Sutton Harbour’s investment property portfolio and a £2.3m surplus on the owner occupied portfolio following an independent revaluation by surveyors Jones Lang LaSalle. It also reflects a general improvement in market sentiment and quality of the asset base.

It’s worth noting that the initial net yield applied in the valuation on the investment property portfolio was a hefty 9.07 per cent, so any improvement in investor demand for commercial property in the regions (as seems to be happening now) is likely to feed through to a contraction in the yield used to value the company’s properties. I would also expect some valuation uplifts even without factoring in yield compression. That’s because the 171-berth King Point Marina, in the Millbay regeneration area of Plymouth, was valued at cost in Sutton Harbour’s last set of accounts as it had not completed at the reporting date. However, the new season commenced on 1 April and the marina is now open for business.

At the end of last year a fifth of the berths had already been sold at the £4m development, and enquiry levels were good at the time, so I will be looking for an uptick in occupancy rates to drive up the valuation being placed on this particular property asset. The company is in no need to take anything other than top dollar for these prime berths, having renegotiated a new £22m banking facility to June 2016. True, net debt was £20.2m at the end of September, up from £17.4m in March, but this reflected the capital expenditure on King Point which is now complete. I would expect borrowing levels to start falling. In case, they only represented around half of the company’s net assets of £39m.

Assets with hidden value

Kings Point is not the only asset with valuation upside since Sutton Harbour has already outlined its own proposal to develop the 113-acre former Plymouth Airport site, in Derriford. Plymouth City Airport Limited, a wholly owned subsidiary of Sutton Harbour, ceased airport operations on 23 December 2011, and in accordance with its legal obligations, is working with Plymouth City Council (PCC), to achieve best value from alternative use of the site whereupon net proceeds will be split 75:25 in favour of PCC which is also the freeholder of the site.

The local council has stated that it wants to create a sustainable mixed-use urban centre at the heart of the North of Plymouth. Sutton Harbour's plans encompass a business park, education facilities, new district centre, commercial and retail units, hotel and housing. It’s therefore worth flagging up that the former Plymouth airport site is in Sutton Harbour's books at only £11.5m, or just over £100,000 per acre, a valuation that offers significant upside if the development plan gets the go ahead.

Admittedly, we are some way off a final outcome there, so in the short-term investors will be focusing more on the improving market conditions to enhance net asset value. In my opinion, with the company set to return to profitability, it’s only reasonable to expect the hefty 25 per cent share price discount to net asset value to narrow over the medium term. So ahead of the full-year results in the latter part of June, I continue to rate Sutton Harbour shares a medium-term value buy. Please note that a move through January’s high of 31p would be a positive signal and would open up the possibility of a return to the December 2012 highs around 36p. Beyond that the summer highs of 40p in 2011 are the next target.

Please note that I am working my way through a long list of companies on my watchlist that have reported results or made announcements recently including: IQE (IQE), Pure Wafer (PUR), LMS Capital (LMS), Communisis (CMS), Eros (EROS), Inland (INL), Netplay TV (NPT), API (API) H&T (HAT), Air Partner (AIP) and Record (REC).