Join our community of smart investors
OPINION

Value judgments

Value judgments
August 3, 2015
Value judgments

The consideration of £82.5m is being funded from the £98m net proceeds the company raised when it listed almost six months ago. The placing was backed by some heavyweight investors including star fund manager Neil Woodford, whose fund management group, Woodford Investment Management, invested £20.5m for a 19.5 per cent shareholding in the company. Invesco Asset Management, his former employer, made a similar sized investment, Legal & General has a 4.75 per cent stake and Marathon Asset Management owns 5.36 per cent.

Led by the former chairman of subprime consumer lender Provident Financial (PFG: 2,953p), John Philip de Blocq van Kuffeler, Non-Standard Finance's business model is to create a company focused on this niche area of the finance sector through acquisitions that generate an annual return on equity of between 20 per cent and 30 per cent. Companies being targeted must have potential to grow lending balances by at least 20 per cent a year, offer strong yields underpinned by APRs of between 50 per cent and 100 per cent, and with impairment levels implying an attractive ratio of risk to the APR. The company's first acquisition certainly fits these criteria.

Having increased its profit before tax by almost 8 per cent to £8.4m on revenues up 10 per cent to £38.3m in 2014, Loansathome4u's pre-tax profit return was 24.5 per cent of its average receivables in the 12-month period, up 130 basis points on the previous year. On this basis, the purchase price equates to 12.5 times net profit and 2.5 times tangible book value. That seems fair, but it's the potential to boost returns by investing in the business that will provide the upside for Non-Standard Finance's shareholders.

 

A platform for growth

For instance, the company intends to expand Loansathome4u's staff of 530 self-employed agents who provide a home credit service to its 100,000 customers. Non-Standard Finance will also invest in IT systems and technology to enhance the underwriting process to support further growth in Loansathome4u's loan book and customer base, including the use of mobile technology across the agent workforce to improve efficiency. Senior management will be appointed in the business to support a much larger operation, including commercial director, finance director, risk director and compliance officer.

In terms of growth potential, the UK home credit market services the needs of 3m individuals, of whom between half and two-thirds are actively borrowing at any one time. The three largest lenders - Provident Financial, SFS/Morses and Loansathome4u - account for three-quarters of the overall market, with the remainder being served by smaller, local credit providers. There are currently around 100 non-standard lending companies across all segments of the UK market.

But the introduction of the new Financial Conduct Authority (FCA) regulatory regime has put greater pressure on smaller competitors and is driving market share gains for the larger incumbents. For instance, increased capital requirements on lenders - due to EU regulatory reforms and the initiatives introduced by the UK's financial regulators, Prudential Conduct Authority and FCA - has helped contribute to a 30 per cent decline in new loan advances since 2007. As a result, there is an increasing focus by peers on rationalising their customer bases. In turn, this should provide an opportunity for both organic and acquisitive growth for Loansathome4u, especially as the tighter lending criteria in mainstream loan markets and the impact of a wage squeeze since 2007 has increased the size of the overall market.

The outlook is certainly positive: Loansathome4u's last reported collections were up 12 per cent year on year on a 7 per cent rise in customer loans.

 

A profitable niche lending market

I would point out that I am under no illusions that this business services a segment of society shunned by the mainstream banks that would be far better served by low-cost lending by credit unions, churches and a government-backed bank. Customers of Loansathome4u typically borrow two or three unsecured weekly loans per year, with each loan averaging £300 advance and £480 repayable over an average term of 35 weeks. This gives an APR close to 400 per cent!

But that's not to say that the needs of these 3m individuals would be better served in the market as it stands if the likes of Loansathome4u were excluded from lending to the poorest segment of society. Indeed, whether you find it morally right or wrong to prosper from the hardship of these customers, the alternative is far worse: forcing cash-strapped individuals to seek loan sharks charging astronomical APRs. The APRs charged by Loansathome4u may be unpalatable to some, but it provides a service and operates legally.

And if it can take advantage of the growth opportunities I have outlined above, I expect shareholders in Non-Standard Finance to be richly rewarded over time. I also anticipate further similar bolt-on deals to create the scale to drive down Loansathome4u's cost-to-income ratio from 56 per cent to below a 50 per cent target and enable the strong cash generation from the lending operation to be recycled back to shareholders through regular and growing dividends, and to fund future lending and acquisitions, too.

Trading on a bid-offer spread of 106p to 107.5p, marginally above the level at which I initiated coverage ('A non-standard investment', 2 March 2015), I continue to rate Non-Standard's shares a medium-term buy.

 

New orders for Software Radio Technology

Software Radio Technology (SRT: 27.5p), the Aim-quoted provider of maritime domain awareness (MDA) technologies and products, has received an order for AIS Class A transceivers worth $700,000 (£450,000) for deployment on Philippine fishing vessels over the next seven months.

The Philippines is a sensitive area for illegal poaching by foreign vessels and the authorities recently announced the purchase of nearly 100 new boats to better patrol its waters. The initial order is for the Class A device, which will use both terrestrial and satellite AIS networks to track fitted vessels. Although this is a relatively small order compared with the potential size of the country's maritime market, it nonetheless gives the company access to a new market and one that was not factored into analysts' revenue estimates when I initiated coverage on the shares at 31.25p ('On the radar', 3 March 2015). The contract equates to about 4.5 per cent of analysts' current-year revenue estimates.

This could be a pivotal year for the company if it moves into sustainable profitability as I believe will be the case. I continue to rate the shares a speculative buy at 27.5p.

 

Running profits on a playful investment

Shares in the fourth largest distributor of toys in the UK, Character Group (CCT: 500p), have risen by about 20 per cent in the two months since I initiated coverage ('Playtime', 1 June 2015), and are now approaching my 525p target price.

The price move is fully justified, too, as I strongly feel that the company will at the very least increase full-year pre-tax profits by more than half to £11m, based on a 15 per cent rise in sales of £113m in the 12 months to end-August 2015, as forecast by analysts Peter Smedley at Charles Stanley Stockbrokers, and Myles McNulty at Allenby Capital. On this basis, expect adjusted EPS to rise from 25.2p to 41.9p in the 12-month trading period and underpin a 35 per cent rise in the divided to just shy of 9p a share.

So with the shares priced on a bid-offer spread of 485p-500p, the prospective PE ratio is 12 and the forward yield is 1.8 per cent. That's hardly punchy for a company that has developed a portfolio of long-lasting iconic toy brands, both organically and by acquisition, targeting the niche pre-school market. Character may even surpass those estimates when it releases a pre-close trading update around Tuesday, 8 September. I am not the only one thinking this way as at the time of the half-year results Mr Smedley at Charles Stanley noted that "we have a high and increasing level of confidence that our 2015, 2016 and 2017 estimates can be upgraded over the next three to 12 months, giving further scope for continued substantial share price outperformance".

The launch of a range of toys to coincide with the return of cult children's classic The Clangers to the BBC on CBeebies after 43 years, is just one product that could lead to an earnings beat. Character's product range for Yummy Nummies, an innovative new children's 'food play' collection, whereby ingredients are used to make mini versions of everyday food, such as pizza and cookies, is another. And it will be interesting to find out how sales of Character's range of Teletubbies toys have fared since launch in June. CBeebies has been airing repeats, but a new series of 61 episodes has been commissioned by the Teletubbies brand's owner, DHX Media, and Character has been appointed 'Global toy partner'.

So ahead of the pre-close trading update, I would continue to run your bumper profits. Charles Stanley has a target price of 540p and Allenby Capital has a target of 575p, but I can see scope for both to be raised if Character beats its aforementioned profit estimates. Run profits.

 

Communicating a change in investor perception

Shares in marketing services company Communisis (CMS: 50p) are trading at around the same price as when I last updated my view ('A slick investment', 25 June 2015), but are down 28 per cent in the 16 months since I reinitiated coverage when the price was 69p ('Making the right communications', 3 Feb 2015). The question is why?

The headline figures in the latest half-year results showed adjusted pre-tax profit up by 19 per cent to £5.3m and EPS ahead by 15 per cent to 2p, albeit the impact of sterling's strength against the euro had held back growth by around 7-8 per cent. Factoring in the second-half weighting, N+1 Singer still expects the company to hit its full-year EPS estimate of 6.2p based on full-year pre-tax profits of £17.2m.

Liberum Capital, the company's new broker, initiated coverage post results with fiscal 2015 full-year pre-tax profit and EPS estimates of £15.8m and EPS of 5.7p, up from £12.4m and 4.6p, respectively, in 2014. Ordinarily investors would still be reacting positively, with the shares priced on a little over 10 times historic earnings.

One reason for the lacklustre reaction is that half-year adjusted profits have been stated after adding back exceptional items once again, mainly ongoing restructuring costs and acquisition-related expenses, and the figures also benefited from the contribution from acquisitions, the latest being Life Marketing Consultancy. This is an award-winning, research and insight-led shopper marketing agency which was acquired for an initial consideration of £14m at the start of 2015.

Of course, Communisis' management will rightly point out that they are now three years into a strategy to rationalise and exit the commodity printing business and shift the emphasis towards digital services. This has delivered success, with non-print revenues now accounting for about 40 per cent of revenues. I don't doubt the rationale for making these ongoing bolt-on purchases, nor for taking costs out of the legacy businesses, but clearly some investors are wary of the one-offs, especially after hefty goodwill writedowns in the full-year numbers in March, otherwise the shares would not be trading on nine times earnings estimates. Liberum's forecast above is after adding back £2.5m of one-offs this year and the broking house is pencilling in another £2m of exceptional costs in 2016, too.

 

Investment in new business

The company also highlights a major new six-year contract with AXA UK, which went live in April, a two-year extension of an existing contract with EE, and its aim to raise overseas revenues from a fifth to a third of the total. Three new European hubs were opened in the latest six-month trading period to cater for new clients in the drinks, food, pharmaceutical and technology sectors. This makes complete business sense given that the pipeline of new business is strong, and Communisis' client base encompasses a growing number of leading global brands in the consumer goods sectors, including Procter & Gamble.

But the flipside is that new contracts require investment and although they are very profitable based on the strict criteria Communisis adheres to when it tenders for work, it's only when they have been successfully delivered that investors can see the returns being made. The fact that the company has been replacing low-margin legacy business with higher-margin contract wins has cash flow implications, too. That's because there is a mismatch between cash flow performance and cash profitability due to the investment needed in new contracts, capital expenditure and the ongoing one-off restructuring costs. This explains why the company went to such lengths to highlight the fact that it generated free cash flow of £6m in the half-year from operating cash flow of £9.98m and cash profits of £12.8m. That said, operating cash flow is still lagging cash profitability, albeit it's moving in the right direction.

The company also highlighted a £1.8m reduction in net debt year-on-year. But once £9.3m-worth of promissory notes issued to the vendors of Life Marketing are factored in, net borrowings actually rose by more than £7m to £43.4m at the end of June 2015. Still, interest cover is comfortable at four times, and the company is operating well within its borrowing facilities.

The bottom line is that the low rating attributed to Communisis' shares is down to investors' perception of the company. This is only likely to change when the company starts reducing borrowings, its cash conversion ratio improves, and one-offs no longer weigh so heavily on the income statement. If the management team at Communisis can deliver, and guidance for second half trading is postive, then perhaps the long awaited re-rating will finally start. So if you followed my previous recommendations I would hold onto the shares.

 

MORE FROM SIMON THOMPSON...

At the end of April, I published an article with all of the share recommendations I have made this year. Since then I have published articles on the following companies in the past 13 weeks:

Marwyn Value Investors: Buy at 220p, target price 260p ('Exploiting a value play', 5 May 2015)

Pure Wafer: Buy at 113p, target 140p to 150p; Paragon: Run profits at 440p, but buy on a confirmed breakout above the 445p and new target of 500p; 600 Group: Buy at 16.5p, target 24p; Fairpoint: Buy at 127p, target 190p; AB Dynamics: Buy at 207p, target 230p ('Repeat buy signals', 11 May 2015)

Globo: Buy at 56p, target 69.5p; Greenko: Hold at 70p; Pittards: Buy at 128p ('Breakout looms for mobile wonder', 12 May 2015)

Macau Property Opportunities: Buy at 214p; Dragon-Ukrainian Properties & Development: Hold at 28p; Raven Russia: Hold at 53p ('Overseas property plays', 13 May 2015)

Trakm8: Run profits at 135p; Redde: Buy at 120.75p, target 140p; STM: Run profits at 45p, but conditional buy on close of 48p and new target of 60p ('Smashing target prices', 14 May 2015)

Bilby: Buy at 75p, target 100p ('Buy to build' growth play, 18 May 2015)

Bioquell: Buy at 148p, target 170p to 185p; Somero Enterprises: Buy at 140p, target 185p; KBC Advanced Technologies: Buy at 109.5p, target 165p; Inspired Capital: Hold at 14.25p ('Three value plays', 19 May 2015)

Renew Holdings: Buy at 315p, target range 350p to 375p; Manx Telecom: Buy at 198p, target 210p ('Renewing old acquaintances', 20 May 2015)

Marwyn Value Investors: Buy at 228p, target 260p; Charlemagne Capital: Hold at 13.5p; Bloomsbury Publishing: Hold at 178p ('Lights, camera, action', 21 May 2015)

Anite: Buy at 91.5p, target 110p ('Testing a breakout', 26 May 2015)

Character Group: Buy at 415p, target 525p ('Playtime', 1 Jun 2015)

Tristel: Run profits at 96p; Pure Wafer: Buy at 123p, target range 140p to 150p; Crystal Amber: Buy at 153p ('Hitting target prices', 2 Jun 2015)

B.P. Marsh & Partners: Buy at 150p, target range 170p to 180p; Moss Bros: Buy at 110p, target range 120p to 130p; SeaEnergy: Sell at 15p ('Exploiting a valuation anomaly', 3 Jun 2015)

Globo: Buy at 59p, target 69.5p; London & Associated Properties: Buy at 38.5p; Greenko: Hold at 44p ('Catalysts for share price moves', 4 Jun 2015)

Burford Capital: Buy at 148p, target 190p ('Legal eagles', 8 Jun 2015)

Market strategy ('Financial Market Watch', 9 Jun 2015)

Software Radio Technology: Buy at 29.5p, target 40p to 43p; Tristel: Run profits at 92p; Creston: Buy at 136p, target 150p; Sanderson: Buy at 69p, target range 80p to 85p ('Blue sky potential', 10 June 2015)

1pm: Buy at 67p, target 80p; Vislink: Buy at 58p, target 70p ('Small-cap growth stocks', 11 Jun 2015)

Elegant Hotels: Buy at 105p, target 135p to 140p ('Checking into an elegant investment', 15 Jun 2015)

First Property: Run profits at 45p; AB Dynamics: Run profits at 225p and target 250p; Inspired Capital: Sit tight at 20p (Bargain shares updates', 16 Jun 2015)

Trakm8: Run profits at 159p, new target 180p; Anite: Sit tight at 126.75p; Trifast: Run profits at 129p, target 140p; Record: Buy at 37p ('Small-cap wonders', 17 Jun 2015)

Inland: Run profits at 71p, target 80p; KBC Advanced Technologies: Buy at 110p, target 165p; Caretech: Buy at 237p, target 300p ('Riding an earnings upgrade cycle', 18 Jun 2015)

Ensor: Buy at 97p, minimum target 125p ('Building up for a takeover', 22 Jun 2015)

GLI Finance: Buy at 54p, target 80p; Pittards: Buy at 128p; Netplay TV: Buy at 9.5p ('A triple play of small-cap picks', 23 Jun 2015)

Bilby: Run profits at 97p; Safestyle: Run profits at 220p; Epwin: Run profits at 134p ('Soaring small-caps', 24 Jun 2015)

Faroe Petroleum: Buy at 86p, target 100p; Greenko: Hold at 65p; Communisis: Buy at 48p ('A slick investment', 25 Jun 2015)

Mountview Estates: Buy at 12,250p; Inland: Run profits at 71p, conservative price target ('Running bumper profits', 29 Jun 2015)

Redde: Run profits at 138p, target range 150p to 155p; Trakm8: Buy at 175p, target 200p; Cohort: Buy at 312p, target 365p; Burford Capital: Buy at 175p, target 190p; Flowtech Fluidpower: Buy at 135p, target 155p ('Riding earnings upgrade cycles', 7 Jul 2015)

Crystal Amber: Buy at 161p; Stanley Gibbons: Buy at 258p; Somero Enterprises: Buy at 150p, target 185p; Globo: Buy at 49p, target 69.5p ('A quartet of small-cap buys', 8 Jul 2015)

H&T: Buy at 200p; STM: Buy at 47p, target 60p; Stadium: Buy at 113p, target 140p ('Exploiting upgrades', 9 Jul 2015)

Cambria Automobiles: Buy at 57.5p, target 75p ('Driving a re-rating', 13 Jul 2015)

Walker Crips: Buy at 47p, target 60p; 600 Group: Buy at 18p, target 24p; Henry Boot: Buy at 235p, target 260p ('A trio of small-cap value plays', 14 Jul 2015)

Bilby: Buy at 90p, target 120p; 32Red: Buy at 67.5p, ('Exploiting a valuation anomaly', 20 July 2015) target 90p; Marwyn Value Investors: Buy at 244p, target 275p (‘Acquisitions drive earnings upgrades’, 15 July 2015)

Vislink: Buy at 53p, target 70p ('Awarding success', 16 July 2015)

SPARK Ventures: Buy at 4.5p (‘Exploiting a valuation anomaly’, 20 July 2015)

W.H. Ireland: Run profits at 120p, target 140p; Safestyle: Run profits at 235p; Charlemagne Capital: Sell at 11p (‘Cash rich small-caps’, 21 July 2015)

Amino Technologies: Buy at 150p, target 180p; Arbuthnot Banking: Buy at 1,530p; Globo|: Buy at 49p, target 69.5p ('Primed for major re-ratings', 22 July 2015)

SPARK Ventures: Buy at 4.5p; Entu: Buy at 115p, target 165p ('Cashed-up for gains', 23 July 2015)

Capital & Regional: Buy at 60.25p, target 70p ('Hot property', 27 July 2015)

LMS Capital: Vote against proposals at EGM; Marwyn Value Investors: Buy at 238p, target 275p to 280p ('Game changers, 28 July 2015)

Stadium Group: Buy at 130p and take up open offer, new target range 155p to 160p; 1pm: Buy at 68p and take up open offer at 60p, new target 90p (‘Powered up for gains’, 29 July 2015)

CareTech: Buy at 245p, target 300p; Burford Capital: Buy at 170p, target 190p; K3 Business Technology: Run profits at 275p; Trakm8: Buy at 178p, target 200p ('Hitting the right numbers', 30 July 2015)

Non-Standard Finance: Buy at 107.5p; Software Radio Technology: Buy at 27.5p, target 40p; Character Group: Run profits at 500p; Communisis: Hold at 50p ('Value judgements', 3 August 2015)

■ 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 £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'