The fundamentals certainly support another leg to this re-rating, a point I made when I anticipated a bumper first half trading performance seven weeks ago (‘Revaluation to drive re-rating’, 9 October 2014). I have not been disappointed.
In yesterday’s interim results Daejan reported a 10 per cent rise in net asset value per share from 6,815p to 7,504p in the six months to end September 2014. This means the shares are now trading on a 33 per cent discount to book value. Even after factoring in a structural share price discount to reflect the Freshwater family control of over 70 per cent of the share capital (through direct interests, beneficial holdings and shares held in trust), this seems extreme.
It’s not as if the business is not doing well either: in the six month period the company reported a £108m uplift on its £1.6bn investment portfolio, reflecting net gains in both the UK and US commercial and residential property markets. A chunk of that increase was down to a revaluation of the Grade II-listed Africa House near the Aldwich, London, a property offering 118,000 sq ft of prime London West End space. As I noted last month, legal firm Mishcon de Reya has taken a lease on the whole of the property giving a rent roll north of £7m for Daejan. Add to that a strengthening of the commercial property generally in London - capital values in London’s West End now exceed £1,100 per sq ft for prime office space – and I estimate that Africa House accounted for between a third and half of the valuation uplift.
As property watchers will be all too aware the London and Home Counties residential market has been flying this year. This is clearly supportive of Daejan’s UK property book given that three quarters of its real estate is located in the prosperous areas of London and south east England. Moreover, demand in the commercial market – accounting for over half of the value of the £1.2bn UK portfolio – has been equally strong. Add to that high occupancy rates and a rent roll north of £110m that covers the interest charge 10 times over and Daejan’s finances are in fine fettle too. In fact, net borrowings of £246m equate to only 20 per cent of shareholders funds. In turn, this enables the company’s board to maintain a progressive dividend policy which has seen the payout lifted by half since 2003. The current dividend yield is around 1.7 per cent.
It goes without saying that I rate Daejan shares a strong buy on a bid-offer spread of 5,100p to 5,125p and have a short-term target price of 5,800p.
Buy-to-let winner
Shares in the UK’s largest buy-to-let lender, Paragon (PAG: 406p) have surged in the past month and got a nice kick off a bumper set of results this week to take them above my 400p target price. It was difficult to find fault in the results announcement and from a technical perspective if the share price can break above the spring high of 426p, then a run up to a former support level at 488p looks firmly on the cards. That’s reason enough to run your bumper gains if you followed my advice a month ago to buy at 347p (‘Riding the buy to let boom’, 27 October 2014).
The fundamentals are supportive too. Buy-to-let completions increased by £300m to £656m in the 12 months to end September, but not at the expense of credit quality as loans in arrears are miniscule and contracting at just 0.25 per cent of the loan book. Furthermore, with pre-tax profits surging by more than a sixth to £122m, and net cash generation increasing a fifth to £157m, shareholders have been rewarded with a 25 per cent lift in the dividend to 9p a share. Paragon has also set aside £50m for an earnings enhancing share buy-back programme.
Moreover, with appetite for this type of lending only likely to increase given the changes in pension regulations next spring, the general recovery in the housing market, and the increase in rental demand due to a growing UK population, then medium-term prospects look sound.
For the year ahead, broking house Numis Securities expects to upgrade its conservative looking EPS estimate of 32.8p, but if the momentum can be maintained I can see further potential for upgrades as the year progresses. So although it may be tempting to bank a quick-fire 17 per cent gain in just a month, I would run your profits for now.
Marketing a recovery
Marketing services provider Communisis (CMS: 55p) has proved a frustrating holding this year and is currently below my recommended buy in price of 69p (‘Making the right communications’, 3 February 2014).
However, after a sell-off during the economic growth scare which saw Communisis’ share price fall from a summer high of 70p when I last updated the investment case (‘Communicating a break-out’, 20 August 2014), to an autumn low of 51p last month, it appears that a base is being formed and one which could be the platform for a solid share price recovery back to the summer highs. A close in the share price above 58p would be confirmation that a base is in place.
Moreover, with the share price trading above the 20-day moving average (54p) and testing the 50-day moving average (56p), and the chart pattern highlighting a successful retest of that autumn low, then I feel the negative share price momentum has now run its course. The 14-day relative strength indicator is currently around 50, and rising again, so offering scope for a multi-week rally to emerge.
It would be fully warranted by the company’s operational performance. In a trading update a couple of weeks ago, Communisis’ chief executive Andy Blundell confirmed that the robust revenue growth seen in the first half has been maintained into the third quarter, reflecting new contracts including a major one with banking giant Lloyds Banking Group (LLOY: 79.5p), new acquisitions and geographic expansion. And with a strong sales pipeline in place, guidance from the company is inline with analyst high expectations for the full year. Support services analyst Andy Brown at brokerage N+1 Singer predicts a 20 per cent rise in fiscal 2014 revenues to £326m to lift pre-tax profits by a quarter to £14.6m and produce EPS of 5.6p, up from 4.7p in 2013. On this basis, expect an 11 per cent increase in the dividend to 2p a share, covered 2.6 times by post tax profits.
Furthermore, as legacy contracts are replaced by higher margin contract wins, and given the board’s keen focus on cost control, Mr Brown expects another step change in profitability next year too. For 2015, N+1 Singer forecasts pre-tax profits of £18.8m on revenues of £332m to produce EPS of 7.1p and a dividend per share of 2.2p. On this basis, the current year forward PE ratio of 10 drops sharply to 8 for 2015, and a prospective yield of 3.6 per cent rises to 4 per cent for next year.
There is of course execution risk, but with the board stating at this late stage of the year that trading is on course to hit those 2014 numbers, then that risk is already being factored into a modest stock market valuation. Indeed, I think investors are starting to warm to the growth story once again, so ahead of a pre-close trading update in January I would be taking advantage of the depressed share price. Importantly, the company is fully funded to deliver on the multiple contract wins it has been awarded.
Offering more than 50 per cent upside to my fair value target price of 85p, I rate Communisis shares a very decent buy on a bid-offer spread of 54p to 55p.
Engineering growth
Shares in 600 Group (SIXH: 16.5p), a small-cap engineer of machine tools and precision-engineered components, have been drifting since late summer and are now back to where they were in the spring, having traded as high as 24p after I initiated coverage at 19p (‘Tooled up for a strong recovery’, 19 April 2014).
I feel the pull-back is unwarranted for a number of reasons, all of which became apparent when the company released what appeared to be a flat set of interim results yesterday. If you ignore a £2.19m pension credit which flattered the reported numbers, adjusted pre-tax profit rose 10 per cent on flat revenues of £21m in the six months to end September 2014. This may have disappointed some investors, but given the second half weighting the company still remains on course to hit the full-year forecasts from analyst David Buxton of broking house finnCap. Mr Buxton predicts a rise in revenues from £41.7m to £44.5m for the 12 months to end March 2015 to drive adjusted pre-tax profits and EPS up by 5 per cent to £2.1m and 2p, respectively. The EPS estimate has been clipped by 0.1p to reflect the extra shares in issue following the strategic purchase of a 26 per cent stake in Aim-traded Prophotonix (PPIR: 4.25p). I discussed that acquisition when I last updated the investment case (‘A strategic buy’, 5 August 2014).
Those forecasts look credible to me because once you drill down through the numbers it becomes apparent that the factors that weighed on the first half performance have now gone into reverse. Indeed, the currency headwind which clipped £100,000 off operating profit in the six month period, and primarily in the laser marking division which originates 44 per cent of sales from North America, has now become a currency tailwind. That’s because at the end of March the sterling:US dollar exchange rate was £1:US$1.66, it subsequently rose to £1:$1:72 by mid-July and ended the six month trading period at £1:$1:62. However, since the end of September, sterling has fallen sharply against the greenback and is now trading at £1:$1:57, a hefty 10 per cent depreciation since mid-July.
That not only makes UK exports far more competitive, but there is a positive currency effect on dollar earnings once translated back into sterling. It’s no coincidence either that the company ended the period with a North American order book at a two-year high, underpinning expectations of a stronger level of deliveries in the second half and beyond. This prediction is given more credence by industry forecasts which point to growth of around 7 per cent next year in global machine tool consumption, according to Oxford Economics, buoyed by growth of over 6 per cent in the Americas and 9 per cent in Asia.
Admittedly, conditions in Europe remain “patchy”, and the UK market is showing signs of levelling off after a buoyant 18 months of trading. But with North America rebounding strongly, and the far more benign currency environment a major positive, I feel that finnCap’s estimates are not out of place.
Sound financials
I also note that 600 Group is selling its former head office in Leeds and its former freehold premises in the US for around £500,000 in total. The rent on the new US facility will be completely offset by savings on utilities and other overheads, so expectations that net debt will fall by £2m to £4.7m by the March year-end seem sensible to me once you factor in around £1.6m of operating cashflow in the second half, up from £1.1m in the first half. That cash inflow covers the annual interest bill of £400,000 almost seven times over.
Current net borrowings of £6.75m represent less than 30 per cent of net assets of £22.9m, so the balance sheet is hardly overgeared. That’s worth bearing in mind as 600 Group’s board have indicated that “we continue to explore acquisition opportunities and anticipate progress from this activity in the second half of the financial year.”
Trading on less than 8 times earnings and on a 43 per cent discount to net asset value of 27p, the shares are far too lowly rated in my view given that the order book, currency tailwind and industry outlook favour a far better second half performance. So although 600 Group’s share price has drifted back to support around 15.5p, I am happy maintaining a buy recommendation with the shares trading on a bid-offer spread of 15.5p to 16.5p and feel a target of 24p is achievable on a six month basis.
■ Simon Thompson's 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 stockpicking'
