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OPINION

Running bumper profits

Running bumper profits
August 27, 2015
Running bumper profits

Firstly, FTSE Small Cap constituent and shopping centre owner Capital & Regional (CAL:67p) released the bumper set of interim results I had anticipated when I suggested buying the shares at 60.25p. The share price duly hit my 70p target price ('Hot property', 27 July 2015), so it's hardly surprising that some investors were tempted to bank a 16 per cent short-term profit.

I am inclined to run profits though with the shares currently trading on a bid-offer spread of 66.5p to 67p. That's because in the first six months of this year valuation gains lifted the company's net asset value (NAV) per share by 12 per cent to 67p a share, prompting analysts to see potential for upgrades to their end 2015 NAV forecasts of 70p. Moreover, with occupancy rates up too, and balance sheet gearing comfortable, the interim payout was lifted more than four-fold to 1.5p a share. A full-year expected payout of 3p a share implies a decent prospective yield of 4.5 per cent.

Importantly, the key reasons for my initial buy recommendation still hold. Namely, the business offers strong exposure to a benign environment for consumer spending and one that is benefiting retailers at Capital & Regional's six wholly-owned Mall shopping centres; a mix of yield compression and income growth are driving valuation gains, a positive trend that is expected to continue; and the company's development programme guarantees a minimum return on investment, so is value accretive to shareholders. So, if you followed my previous advice, I would run profits.

A blockbuster share price rally

Shares in one of Europe's leading cinema chains Cineworld (CINE:578p) have now risen by 72 per cent since I recommended buying 10 months ago at 336p ('Lights, camera, action', 28 October 2014). As anticipated, half year results made for a good read with pro-forma revenue up by over 11 per cent in the six-month period and growth being reported in all territories apart from Slovakia. Prospects for the second half look well underpinned by a slate of movies including potential blockbusters: Star Wars: Episode VII; the final Hunger Games film: Hunger Games; Mockingjay Part 2 and the next James Bond film: Spectre.

But this is not being lost on investors with the shares rising by almost 10 per cent since my last update three weeks ago when the price was 530p ('Acquisitive growth drives re-ratings', 6 Aug 2015). This means that Cineworld's shares are now rated on 20.5 times fiscal 2015 likely earnings, falling to 18.5 times 2016 forecasts. The key question is how much of the future growth is now being discounted in the share price?

Analyst Sahill Shan at brokerage N+1 Singer, who has a 650p target price, offers some insight here as he believes that Cineworld's current market capitalisation is still not yet fully discounting the 18 per cent screen expansion that will take place in the 2016 to 2018 fiscal years. Mr Shan estimates this three-year roll-out is worth 80p per share and is leaning towards fair value nearer to 700p using free cash flow valuation techniques. A prospective dividend yield of almost 3 per cent for 2016 is attractive too. On balance, I would therefore run the 75 per cent total return including dividends on this holding with a view to the recent 599p post results high being taken out. Run profits.

Cohort hits target price

Aim-traded shares in small-cap UK defence company Cohort (CHRT:375p) have now hit my upgrade target price of 375p, hitting a high of 390p on 10 August, so it's decision time. I first advised buying the shares at 215p ('Blue-sky buy', 6 October 2014), so the price is now 74 per cent ahead in the past 10 months or so. I last recommended running profits three weeks ago at 357p ('Acquisitive growth drives re-ratings', 6 August 2015), since when the company has announced a contract worth £11.2m with the Ministry of Defence (MoD) to provide the armed forces with tactical hearing protection systems for the dismounted close combat user.

The contract has been awarded for four years, with an option to extend it for a further three years. The win follows on from a previous UK MoD contract earlier in the year, supplying Cohort's Tactical In-Ear Protection Plugs as part of the tactical hearing protection system for the basic user soldier.

Factoring in the contract award, analysts now expect Cohort to report revenues of £117m in the 12 months to end April 2016, rising to £131m the year later to drive up pre-tax profits from £10.2m to £12m in the current fiscal year and to £14.1m in fiscal 2017. On this basis, the shares are rated on 14 times future earnings estimates. However, there may be scope for more gains if, as seems highly likely, Cohort continues to win new work that is currently tendering for.

Potential contracts being pursued include submarine communications work; roadflow traffic enforcement systems in the UK and for export, including the red light system developed for rail crossings; and communications systems for surface vessels. In my view, any of these contracts could be the catalyst for additional share price upside if Cohort is successful. Run profits.

Acquisitions drive earnings upgrades at Redde

Redde (REDD:152p), one of the UK's leading providers of accident management and legal services to insurance companies, insurance brokers, motor dealerships and large national fleets, has announced the acquisition of FMG Group, a provider of outsourced fleet management, specialist rapid response and vehicle recovery management, and legal services.

In addition to supporting Redde's strategy of widening its range of services, the acquisition is expected to be immediately earnings enhancing and cash generative, and will support the company's dividend policy of distributing as much of net profits by way of dividend as it can, taking account of prevailing circumstances and other requirements and commitments. The £43.2m consideration consists of £38.2m of cash and £5m worth of new Redde shares and looks a sensible use of Redde's net funds of £40.4m. It's earnings enhancing too because FMG generated cash profits of £3.8m on revenues of £69.2m in the nine months to end June 2015 and management's guidance is that the business will make cash profits of £5.4m in the 12 months to end September 2015. This implies a reasonable take-out price of 8 times cash profits.

Moreover, analyst Andrew Watson at broking house N+1 Singer believes there is "an opportunity to deliver revenue benefits through the provision of accident management services to FMG's existing customer base. FMG's customers include leasing companies, car hire providers and large direct fleets - including local authorities and the Highways Agency." Mr Watson adds that "there are also likely synergies from increased scale such as the ability to service FMG cases from Redde's existing fleet and repair network." N+1 Singer upgraded its EPS estimates by 8 per cent to 9p for fiscal 2016 (June year-end) and by 17 per cent to 9.6p for the year after, up from 8.3p in fiscal 2015. This means that last year's dividend of 9p a share is fully covered by net profits.

The combination of a sustainable 6 per cent yield, and potential for outperformance on delivery of revenue synergies, are reasons enough to run profits your 41 per cent paper profits on this holding. Please note that I initiated coverage on the Aim-traded shares at 108p ('In the fast lane', 23 March 2015) and last advised running profits last month at 138p targeting a 150p to 155p price range ('Riding earnings upgrade cycles', 7 July 2015). That price level was hit yesterday, but there is potential for the share price rally to continue as I see additional upside to the aforementioned EPS estimates from revenue benefits not factored into the upgrades. Run profits.

Cashed up for recovery

Pawnbroker H&T (HAT:195p), a constituent of my 2015 Bargain shares portfolio, has reported a 30 per cent increase in half-year profits to £2.6m and is well on course to deliver full-year profits of £7.1m, up from £5.5m in 2014. On this basis, analysts expect EPS of 15p and a payout up by over half to 7.5p a share, forecasts that look sensible in light of the fact that the board have just having ramped up the interim payout from 2.1p to 3.5p.

Having stabilised the pledge book at £37.4m, and lowered net debt by a third to £8.9m, well within banking facilities and representing gearing of less than 10 per cent of shareholders funds of £91m, H&T has ample scope to grow the pledge book through selective acquisitions as well as organic growth as competitive pressures ease. Priced on a 22 per cent discount to book value, and underpinned by a prospective dividend yield of almost 4 per cent, I continue to rate H&T's Aim-traded shares, up 11 per cent on the 174p entry level in this year's portfolio, a value buy on 11 times fiscal 2016 EPS estimates of 17.2p. Buy.

Mandate loss hits Record on Black Monday

Another constituent of my 2015 Bargain shares portfolio, currency manager Record (REC:33.5p) have fallen to just below my 34.3p entry point in this year's portfolio after the company announced on Black Monday this week that a client has reduced the size of its tactical bespoke currency return mandate by $2.8bn (£1.8bn). The shares are also down on my most recent update last week ('Bargain shares updates', 17 August 2015).

Admittedly, Record had previously announced in the first quarter this year that the mandate could prove volatile as the company was effectively managing currency positions on behalf of a client who could at any time alter their size and direction. Record's other currency for return mandates are less transactional than this mandate, so are far less volatile.

Nonetheless, there is a negative impact on full year revenues of about £1.7m for the remaining seven months of the fiscal year to end March 2016. Record was earning a fee of around 16 basis points on the mandate so analysts have reined back their full-year pre-tax profit estimate from £8m to £6.7m, implying a 10.6 per cent profit fall on the prior year, based on revenues of £20.5m. On this basis, expect EPS of 2.42p, down from 2.66p in fiscal 2015. However, it's worth remembering that these estimates do not factor in any new mandate wins, and with client interest in Record's currency hedging strategies likely to benefit from the increased volatility, there is still scope for the profit shortfall to be made good over the remainder of the financial year. Moreover, Record's multi-strategy currency for return products now have a three-year track record, meaning that many investment consultants can recommend the product for the first time to clients looking to make positive returns in a market not so closely correlated with equities.

It's also worth pointing out that the company's 1.65p a share dividend is covered almost 1.5 times by net profits, so looks very solid. This means that the shares currently yield about 5 per cent. And with net funds of £30m on its balance sheet, a sum worth 13.6p a share, expected to rise to £32m by the end of March 2016, or 14.5p a share, then Record's shares are being priced on only 8 times cash adjusted EPS estimates too.

So although a reduction in a profitable mandate is never good for any asset manager, in this case I feel it's a 'one-off' event given the nature of the account rather than a precursor to further mandate losses. I am therefore maintaining my positive view and continue to rate the shares a buy.

Drug busters

Shares in Bioquell (BQE:137p), a provider of specialist microbiological control technologies to the international healthcare, life science and defence markets, are slightly down on the price at the time of my last update ('Three value plays', 19 May 2015), but are still 10 per cent up on the price when I initiated coverage on the shares at 124p ('Bug busting potential', 20 April 2015).

This looks like another buying opportunity to me as I still maintain a fair value range of between 170p to 185p a share for the company's equity. In fact, the downside risk looks very limited. That's because Bioquell's board initiated a strategic review of its operations following the disposal in May of its specialist testing services subsidiary, TRaC. A business combination, joint venture, a distribution deal, or a co-promotion agreement, are all being considered as is an outright sale of the company.

Bearing this in mind, and given that Bioquell has £47.7m net funds on the balance sheet, a sum equivalent to 112p a share, this means that its retained biocontamination control technology products business is being attributed a value of only £11m based on the company's market capitalisation of £58.7m. Including that bumper cash pile, Bioquell has a book value of £64.7m, or 152p a share, so in effect the biocontamination control business is being valued on a 35 per cent discount to its carrying value of £17m in the accounts. That's harsh for a business that has just reported a near trebling of cash profits to £1.4m on revenues of £12.5m in the first six months of 2015.

Positive outlook

Importantly, the outlook statement is positive as Bioquell's chairman Nigel Keen noted in yesterday's half-year results that "the underlying demand for our products and services around the world is strong and increasing. The US biotech market is well funded and growing which is helping our Life Sciences business." Mr Keen also added that "world hospitals and public health bodies are increasingly worried by the clinical threat and attendant financial consequences of antibiotic resistance, hospital acquired infection and the rapid spread of viruses such as MERS-CoV and Ebola." He has a point as Bioquell's healthcare revenues shot up by 22 per cent in the first half and guidance for the second half and beyond is very promising too.

In addition, the geo-political stresses within the Middle East and elsewhere mean that interest in Bioquell's Chemical, Biological, Radiological, and Nuclear (CBRN) defence products remains robust. Indeed, revenues here surged from £800,000 to £2.2m in the six-month period.

Quantifying a bid premium

Admittedly, there is no guarantee that a larger rival will snap up Bioquell, but I still see a takeover or sale of the unit as the end game especially as a purchaser could take out substantial costs from the business, not least £1.5m of annual central costs, so it has obvious value to a larger rival way above the implied £11m value in the company's market capitalisation. To put the potential bid premium into perspective, at the lower end of my 170p to 185p price range, this implies a valuation of £25m for Bioquell's biodecontamination business, or 6.5 times the cash profits the unit made last year. Please note that the board are in the process of considering "a number of different pathways" and the planned capital return of a significant part of the TRaC proceeds has been deferred until the outcome of the strategic review has been completed.

On a bid-offer spread of 133p to 137p, and offering 24 per cent share price upside to the bottom end of my valuation range, I continue to rate Bioquell's shares a buy.

MORE FROM SIMON THOMPSON...

I have published articles on the following companies in August:■

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 Aug 2015)

Fairpoint: Buy at 138p, target 190p; Creston: Run profits at 155p; Sanderson: Buy at 71p, target 80p to 85p; Renew Holdings: Buy at 340p, target 375p ('Break-outs looming', 4 Aug 2015)

Globo: Buy at 42.75p, target 69p; Cambria Automobiles: Run profits ('Short sellers in for shock treatment', 5 Aug 2015)

Cohort: Run profits at 357p, target 375p; Cineworld: Run profits at 530p; Paragon: Buy at 412p ('Acquisitive growth drives re-ratings', 6 Aug 2015)

PROACTIS: Buy at 93p, target 117p ('Procuring growth', 10 Aug 2015)

Town Centre Securities: Buy at 310p, target 350p ('Equity market watch', 11 August 2015)

Equity market strategy ('Equity market watch', 11 August 2015)

KBC Advanced Technologies: Buy at 122p, target 165p; Getech: Buy at 59p, target 80p ('Fuelled for strong growth', 12 August 2015)

Pure Wafer: Run profits at 162p, target 178p; Inland: Run profits at 71.5p, next target 80p; Macau Property Opportunities: Take profits at 189p ('Bumper cash returns', 13 August 2015)

Inspired Capital: Accept cash offer of 21.5p; Record: Buy at 40p; Pittards: Buy at 128p; Netplay TV: Buy at 9.5p ('Bargain shares updates', 17 August 2015)

■ Equity market strategy ('Stay calm', 25 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'