In fact, both my 2009 and 2010 portfolios soared in value, producing 12-monthly gains of 53 per cent and 46 per cent, respectively, albeit I had the benefit of rich pickings at the start of the 2009 bull market and the back drop in 2010 was equally favourable as investor sentiment improved. My 2011 portfolio underperformed though, producing a nasty 18 per cent drop in the 12-month period. But the key to my balance sheet stock selection process is that the companies I select should have the financial strength to endure any downturn in trading - which impacted the performance of the 2011 portfolio - and will be around to reward followers of this particular investment approach as and when they turn the corner. That certainly happened with the 2011 portfolio which subsequently recouped all those losses and had produced a total return of 26 per cent by February this year.
However, as I always point out each year when I publish my new bargain share selections, this investment technique is designed to reward investors willing to take a longer-term view and is certainly not for those chasing short-term gains. You have to be prepared to be in for the long haul as there is no guarantee that the valuation anomalies I uncover will be corrected in the near-term. That said, both my 2012 and 2013 portfolios soared in value by 31.9 per cent and 36 per cent, respectively, so investors buying shares in the constituent companies will have beaten the market handsomely in four of the past five years of the current bull-run.
But having followed stock markets for over 25 years, I am fully aware that equity investing is not a one-way bet: my 2014 bargain shares portfolio is currently down 8.6 per cent on my advised buy in prices after accounting for dividend income, and 11 per cent on the opening offer prices after market makers hiked their quotes on Friday, 7 February. This is quite a reversal from a month ago when the portfolio was up 1.8 per cent on those opening offer prices when I last updated the portfolio ('Bargain share updates', 9 July 2014).
The main reasons for this reversal lies with Chinese clothing retailers Camkids (CAMK: 51p) and Naibu (NBU: 45p), institutional broker Arden Partners (ARDN: 60p) and share price weakness in solar wafer maker PV Crystalox Solar (PVCS: 17p). The portfolio has also been impacted by a severe share price reverse from one of its top performers, Chinese energy company Fortune Oil (FTO: 9.8p). In fact, having racked up a gain of over 50 per cent by late April, shares in Fortune have retreated all the way back to almost where I advised buying at, wiping four percentage points off the portfolio’s performance in the process.
I still remain optimistic that the lost ground can be made up later this year, but clearly an update is in order to address the investment case of each company in turn.
Fortune favours the brave
Shares in Fortune Oil (FTO: 9.8p), an operator of oil and gas projects in China, were marked down primarily after the company announced future payouts would be dependent on the profitability of each of its core units. The company paid out a special dividend of 2.36p a share last October.
Clearly, the uncertainty on future dividends is not ideal. However, I can understand the board’s need to try to find a balance whereby the investment needs of the business are met to generate the long-term growth while also meeting the desire of shareholders to have an annual payout. The company put in place a £180m bank facility last autumn to support the business and it’s fair to say that prospects certainly look promising.
In the last financial year, Fortune’s Bluesky Aviation business reported fuel sales volumes up 44 per cent to 4.3m tonnes and now supplies aviation fuel to 20 airports. The division plans to supply aviation fuel to an additional 13 new airports by 2020 and a further 13 new airports by 2030 across the five provinces where it operates. The unit is highly profitable too as Fortune’s share in Bluesky net profit increased by almost half to £17.2m in the 15 months to end March 2014.
The company is not a one-trick pony either as following a series of complex financial transactions, Fortune Oil now owns 184m shares directly in Hong Kong listed China Gas Holdings (HK:384), and has a beneficial interest in 732m shares of China Gas Holdings through a joint venture China Gas Group Limited. Combined this means that Fortune Oil has an interest in 916m shares, or 18.36 per cent of China Gas Holdings equity. Having seen its share price surge almost double since last September, China Gas Holdings now has a market value of HK$77.2bn, or £5.9bn at current exchange rates, based on 5.021bn shares in issue and a stock price of HK15.382. This means that Fortune’s direct investment in the company is worth £217m, or 22 per cent more than at its last accounting date of 31 March 2014. To put that into some perspective this investment now equates to 82 per cent of Fortune’s market value of £260m.
To that sum you can add another 366m China Gas Holdings shares worth £433m which Fortune holds through the aforementioned joint venture. Or put it another way, Fortune’s directly and indirectly held shares in China Gas Holdings are now worth around £650m, or 150 per cent more than its own current market value!
It seems an anomalous undervaluation of Fortune’s equity given that China Gas Holdings continues to expand its share of the domestic piped gas market and now has over 10m residential customers and sells 1.1bcm of natural gas to them. The group also supplies over 2.4bcm of natural gas to commercial and industrial customers. China Gas Holdings also has 170 natural gas projects, nine natural gas pipeline transmission projects, one natural gas exploration project, and 44 liquid petroleum gas distribution projects.
It's a highly profitable operation with the group’s pre-tax profits soaring by over half to £286m on revenues of £2bn in the 12 months to end March 2014. In turn, the annual dividend of HK12.06¢, or just under a penny a share, equates to a £1.7m payment to Fortune Oil on its directly owned interests, and a further £6.7m to the joint venture. This means that Fortune is raking in £5m of dividends from its investment in China Gas Holdings, easily enough to pay a modest dividend to placate its own shareholders.
Dividends aside, either the equity of fast growing China Gas Holdings is being massively overvalued on 28 times historic net profits, or Fortune is being chronically undervalued as I firmly believe. Needless to say that my own positive view on Fortune hasn’t changed and I would use the share price pull back as a great buying opportunity on a bid-offer spread of 9.7p to 9.8p.
Naibu share price sell-off
A first half trading statement from Naibu (NBU: 45p), a Chinese maker and supplier of branded sportswear and shoes, has not been taken badly by investors with shares in the company falling 20 per cent in the days following the release. The news was mixed. On the plus side, revenues increased by 8 per cent in the first half, and marketing of the company’s autumn and winter collections has gone well. In fact, sales orders are 5 per cent higher than at the same trade fair last year.
However, labour shortages have driven up labour costs in the coastal regions and the company has been unsuccessful in recruiting enough staff to operate six production lines at its Quangang facility. As a result Naibu is abandoning production at the plant and is in negotiations with third parties to rent it out. It is also being marked for sale.
The net impact is that Naibu’s original equipment manufacturer suppliers will now supply the company’s branded shoes that were due to be produced at Quangang until Naibu’s new Dazhu facility becomes operational in the second quarter of 2016. But there will be a financial cost due to the lower margins earned on the outsourced production.
Analyst Simon Willis at broking house Daniel Stewart now expects the company’s gross margin to decline by two percentage points to 25 per cent this year, and has edged down his volume growth estimate from 7 per cent to 6 per cent. This leads to an 11 per cent pre-tax profit downgrade. Also, a 3 per cent strengthening of sterling against the Chinese renminbi since the spring will impact profits once they are translated into sterling, resulting in a further hit to net earnings. Daniel Stewart now pencils in 2014 EPS of 46.1p on a fully diluted basis, down from 54.2p in 2013. This means with the shares falling from my recommended buy in price of 58p to only 45p, they are trading on less than one times earnings!
That valuation implies the company has gone ex-growth which it has since Daniel Stewart’s hefty 17 per cent downgrade to 2015 profit forecasts means next year’s earnings are now predicted to be flat against the downgraded 2014 forecast. That said, post tax profits cover the 6p a share dividend more than seven times over, so the £3.5m payout looks secure enough especially since the company had net funds of £44.6m at the end December, or the equivalent of 76p a share.
To put the valuation into some perspective, investor distrust of Chinese companies is so acute that the company now only has a market capitalisation of £24.6m, implying a negative value of £20m to the business itself. In fact, Naibu shares have derated to such an extent that its equity is being valued by the market at only 20 per cent of the company’s net asset value of £123m. Furthermore, with the share price bombed out at 45p, the 6p a share dividend equates to an historic yield of 13 per cent.
It’s still my view that on fundamentals, and despite the downgrade, Naibu shares are woefully undervalued. They are also massively oversold from a technical perspective with the 14-day relative-strength indicator (RSI) on the floor, showing a reading sub-20. So although it will take a marked improvement in investor sentiment before the company is valued on a sensible basis, I am not bailing out and would advise taking advantage of the sell-off to average down the cost of your holdings.
Camkids kicked unfairly
The pre-close first half trading update from Camkids (CAMK: 51p), the Chinese designer, manufacturer and distributor of outdoor apparel, was reassuring enough and certainly did not include anything to warrant the subsequent 17 per cent mark down in the share price in the past fortnight.
Firstly, Camkids' board has confirmed that trading is in line with previous guidance. Matt Butlin, head of equity research at brokerage Allenby Capital, currently predicts EPS of 25.8p for the 12 months to end December 2014. On that basis the shares are now trading on a miserly two times earnings forecasts. The chronic undervaluation is even more extreme once you consider that Camkids had net cash of £30.3m, or 40p a share, at the start of this year.
Furthermore, with cash flowing into the business post the year-end as inventories turned into cash and distributors settled accounts, net funds hit £37m, or 49p a share, by the end of February, or almost as much as the company’s market capitalisation now! So just like Naibu, investors are in effect attributing hardly any value to the business itself even though it is profitable and is supporting a full-year dividend of 4.3p a share. It also means that with Camkids’ shares being offered in the market at 51p, the historic yield is 8.4 per cent.
Clearly, some investors are worried that Camkids is investing around £20m of its bumper cash pile between now and the end of 2016 to develop new facilities alongside its current ones. However, at current exchange rates that investment only equates to one year’s net profits, so annual cash flow generation will help protect those net funds. Moreover, this move will support its e-commerce initiatives, and logistics operations, and also enable the company to offer accommodation to staff, which in turn should help it attract and retain highly skilled staff. Given the problems Naibu has encountered, this looks a sensible move in my view.
I also noted that the non-executive directors have now visited 40 of Camkids’ estate of 1,336 retail stores since the company’s IPO. It’s reassuring to have positive feedback on the quality of the estate, dispelling the scare mongering postings on certain retail bulletin boards.
So, although Camkids’ shares are the worst performer in my 2014 Bargain share portfolio, with the business in the price for free, not to mention a further £32m of free assets on the balance sheet, I still believe that there is clearly value in the heavily oversold shares. Interestingly, a break above the June and July lows around 52p to 53p would also shorten the odds that the current correction is coming to an end. On a bid offer spread of 50p to 51p, I am happy to advise averaging down your holding cost on Camkids’ shares too.
Broking for recovery
Institutional stockbroker Arden Partners (ARDN: 60p) reported a poor set of half-year results a few weeks back and ones that were completed unexpected given the strong pipeline at the full-year stage. To compound matters, the board passed the interim 1.25p a share payout.
To recap, the company's operations include an equity division, encompassing equity sales, sales trading, market making and execution of trades for fund managers and dealers primarily in the FTSE 250 index. But the key profit driver has been Arden's corporate finance business which incorporates advisory and broking services to corporate clients, including: public company takeovers, mergers, acquisitions and disposals, flotations, fundraisings and restructurings. And the broker continues to attract new clients having increased its client base to 46 corporate clients, up from 37 six months ago.
However, the major issue in the latest six-month period was a £1m hit from two corporate transactions. The first of which resulted from a client pulling out at the point of delivery and after Arden had completed all its work. This led to a profit shortfall of £500,000. The second transaction related to a pulled IPO and reflected a cooling of the market. As a result, this meant a similar sized shortfall in fees for Arden. Mark-to-market accounting rules on financial assets held knocked a further £300,000 off the bottom line and meant that a £1m pre-tax profit in the first half last year reversed into a loss of £474,000.
The good news is that chief executive James Reed-Daunter reports a “strong second half pipeline of work” and the board is “confident of a satisfactory full-year outcome”. If achieved I would expect the final dividend to be paid. Last year, Arden declared a 1.75p a share final payout.
It’s also worth pointing out that the company has a rock solid balance sheet. Net funds of £4.4m at the end of April accounted for a chunk of its book value of £10.7m. Furthermore, following the share price fall post the half-year results, Arden shares are now being offered at 60p in the market, or 20 per cent less than my buy in price in February, valuing the company at only £13m. If the board can deliver profits for the full-year, and they “report an encouraging start to the second half”, then the shares should recover the lost ground. I would continue to hold the shares for recovery.
Finally, solar wafer maker PV Crystalox Solar (PVCS: 17p) is due to report half-year results very shortly and I will update my view as soon as they are released. Ahead of the announcement, I remain a buyer with the shares priced 15 per cent below the level of the company’s cash pile at the start of this year (‘PV to shine in second half’, 15 May 2014).
■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'
