The other benefit of wading through what admittedly is a substantial document is that you can get a real feel for how each segment of a company's activities is performing. This is relevant to me right now because I have been carrying out this task for one of my 2015 Bargain Shares, Aim-traded activist investment company Crystal Amber (CRS: 162p). The company's annual report and accounts for the fiscal year to the end of June 2015 was a real eye-opener and I would strongly recommend you read it as part of your own research. The depth of detail attributed to each of the component companies in Crystal Amber's investment portfolio is mightily impressive, as is the breakdown of how the company managed to achieve its returns.
True, the fund's total return of 5 per cent in the 12-month period was nothing to shout about, being three points less than that of the FTSE Small Cap index, and that was after the benefit of banking substantial gains on holdings in Irish airline Aer Lingus and chocolate retailer Thorntons, both of which succumbed to takeover bids. However, the relative underperformance looks to be a thing of the past. Indeed, during the market rout in August, Crystal Amber's portfolio actually rose in value by 0.5 per cent, which compares rather well with the 6.8 per cent fall in the FTSE 100, the 3.2 per cent decline in the mid-cap FTSE 250 index and the 2.5 per cent drop in the FTSE Small Cap index.
Having analysed the investment merits of each of the fund's 10 largest holdings, which between them accounted for 127p of the end-August book value of 165p a share, I feel this relative outperformance could continue for some time to come. I have good reasons for taking this stance.
Grainger shares primed for re-rating
Firstly, Crystal Amber recycled a chunk of the cash from those takeovers into the residential property sector, having picked up a 3.4 per cent stake in the UK's largest listed residential property owner and manager, Grainger (GRI: 236p), a FTSE 250 constituent with a market value of £981m. It's a substantial investment, accounting for 36.1p a share of Crystal Amber's equity portfolio worth 151.7p a share. Crystal Amber also holds 13.2p a share of cash on its balance sheet to capitalise on further investment opportunities.
What interests me about Grainger is the robust cash generation the company looks set to enjoy over the next 13 years. That because its traditional reversionary business is based predominantly on regulated tenancies, which provide substantial, high-quality, predictable and resilient cash flows. The company's portfolio of 7,400 reversionary assets has a carrying value of £1.5bn, but when these properties revert to vacant possession after an average period of about 10 years, Grainger sells them on and reaps their full open market value. Grainger's board estimates that they will generate a surplus of £500m, equivalent to 120p a share. But it could be far more because this embedded value is the difference between open market value of the tenanted assets and their higher vacant possession values at today's prices, and does not reflect any future benefit from house price inflation. This reversionary portfolio alone is expected to generate £120m of gross cash each year until 2030.
Bearing this in mind, Grainger highlighted in last month's pre-close trading update that sales of vacant properties achieved prices on average 8.3 per cent above September 2014 vacant possession value. It also outlined a pipeline of vacant reversionary assets worth in aggregate £213m of sales that have either completed, exchanged or are in solicitors' hands. That's important because the cash generated from the reversionary business is being recycled into private rented sector (PRS) residential developments. Grainger owns 8,400 properties as part of a market rented portfolio valued in excess of £1.1bn, including 3,400 homes in the UK where it is the market leader in equity release schemes principally for retired home owners. The company expects to complete around 1,070 market rented units over the next two years.
Catalyst for re-rating
It's therefore worth noting that Grainger has just appointed investment bank Lazard & Co in Frankfurt to advise on the disposal of its wholly owned residential property assets in Germany, which are non-core to the company's UK-focused strategy. Grainger held around 5,600 homes with a market value of £311m in Germany at its last balance sheet date, so if this capital was released it would help accelerate the company's strategic and financial focus on its UK residential activities to enhance shareholder value while taking advantage of the currently strong market for residential property in Germany.
I strongly feel that a disposal of the German properties, combined with the release of Grainger's full-year results in late November, could provide the catalyst for the company's share price to make a decisive breakthrough the 250p level, which has acted as a glass ceiling to previous rallies in March 2014 and also this year. A chart break-out would be justified, too, as analysts predict Grainger's triple net asset value will be around 250p by the end of this month, and that figure excludes the reversionary surplus of 120p a share I have mentioned above.
Dart on the right plight path
Another reason why I believe shares in Crystal Amber could do well in coming months is because it holds a 1.4 per cent stake in Aim-traded Dart (DTG: 490p), the parent company of leisure airline Jet2 and distributor Fowler Welch. Around 90 per cent of Dart's annual revenues of £1.25bn and 93 per cent of its operating profits are generated from leisure activities.
The airline side really interests me right now. That's because since 2004, Jet2 has increased seat capacity by 16 per cent on average each year, rising from 1.2m to 6m, by adding more planes and departures and using larger planes. Around half of its UK flights go to Spain, followed by destinations in Portugal, Italy and Turkey. The airline's UK hubs are all based in the north of England, Scotland and Ulster.
The business model is distinct from other low-cost airlines like Ryanair (RYA: €13.84) and easyJet (EZJ: 1,771p). Whereas most budget operators purchase new fuel efficient aircraft, Jet2 has bought inexpensive but fuel inefficient second hand planes. Many competitors fund their fleet with operating leases; for instance, all of Monarch's fleet is leased. In contrast, Jet2 has grown its 59 strong fleet mostly by buying the planes outright, and now owns 44 aircraft. The average age of Jet2's fleet is much older as a result, nearly 22 years, versus only five years for Ryanair. So, given its fuel inefficiency, Dart sensibly hedges out almost all of its fuel requirements at the start of each year.
Clearly, the fuel inefficiency of the fleet is a challenge when oil prices are high, but with Brent crude at very depressed levels, having fallen by a further third since the summer, this is providing a tailwind at current prices.
That said, as part of its planned fleet replacement, the company has recently entered into an agreement with Boeing to purchase 27 new Boeing 737-800NG aircraft to be delivered between September 2016 and April 2018. The total value of this transaction is approximately $2.6bn (£1.7bn) and will be funded through a combination of internal resources and debt.
Riding an earning upgrade cycle
Dart certainly has the financial strength to upgrade its old fleet as financial results for the 2015 fiscal year were accompanied by a sharp upgrade to the current year's earnings forecast. Moreover, in a half-year trading update last week, the company announced that its performance for the financial year ending 31 March 2016 is likely to be materially above those upgraded market expectations. This news prompted analyst Chris Thomas at broking house Arden Partners to raise both his pre-tax profit and EPS estimates up by 25 per cent to £75m and 41p, respectively. The company will provide a further trading update in mid-October following the half-year-end.
The trading statement should make for a good read because the additional capacity taken on by Jet2Holidays, the company's packaged holiday business that supports and feeds off the airline, as it only uses Jet2's aircraft, is helping to drive load factors and ticket yields. This higher-margin part of the business has grown to carry one million passengers in the year to March 2015, or a third of Jet2's capacity. The goal is to reach 50 per cent of its capacity.
That target looks achievable. With the UK economy growing strongly again, real wages at their highest level since the 2008 financial crisis, and sterling buoyant against the euro, foreign holidays are once again affordable. That's augurs well for the next trading update from Dart in mid-October and I have a positive outlook on Dart's shares which only trade on 12 times earnings estimates.
Turning over a new leaf
The third reason why I believe Crystal Amber's shares have mileage is the fund's holding in Aim-traded clean energy investment company, Leaf Clean Energy (LEAF: 41p). Crystal Amber owns 29.9 per cent of the shares in issue, so the stake accounts for 15.4p of the fund's net asset value of 164p.
Following engagement with the board, Leaf Clean Energy has adopted a policy of asst realisation and capital return to shareholders. Operating costs have been slashed and the company has just sold four investments for a total of $8.4m (£5.5m) which almost doubles the cash pile to $17.4m, or a sixth of its pro forma book value of $105.2m, or 53p a share. That cash sum is worth about 9p a share, or over a fifth of Leaf Clean Energy's share price.
It's worth pointing out that there could be upside to Leaf Clean Energy's book value too as asset sales progress. That's because well over half the value of the portfolio is invested in Invenergy Wind LLC, North America's largest independently owned wind power generation company. Leaf Clean Energy originally invested $40m in Invenergy and the company continues to execute on its capacity expansion plans and development initiatives across its core markets.
The company is evaluating options for monetising its investment in this well-performing asset, although this "is not expected prior to 2016". However, it's still worth noting that Invenergy sold 930 mega watts of wind power capacity for $2bn (£1.3bn) in July this year, highlighting the attractions of so called "yieldcos", entities that acquire and operate income generating assets from developers and operators such as Invenergy. Crystal Amber's investment advisers are of the opinion that the book value of the Invenergy stake in Leaf Clean Energy's accounts understates its true worth.
So, although I am not suggesting you buy shares in Leaf Clean Energy, I feel that if the company can realise a higher value from its investment in Invenergy than the current book value, then the recovery in its share price could well continue. In turn, this could provide additional upside to Crystal Amber's own share price.
The bottom line is that the odds favour an outperformance of Crystal Amber's share price over the rest of this year, both in absolute and relative terms, driven by likely investment gains on its portfolio as the catalysts I have outlined come into play. There is also a decent 5p a share dividend too. On a bid-offer spread of 157p to 162p, I continue to rate Crystal Amber's shares a buy.
Please note that my next column will be published online at 12pm on Tuesday, 22 September 2015.
MORE FROM SIMON THOMPSON...
I have published articles on the following companies this month:
■ Equity market strategy ('A sense of perspective', 1 Sep 2015).
■ LMS Capital: Buy at 73p ahead of tender offer; STM: Buy at 53p, target 60p; Entu: Hold at 65p ('Shareholder activism works', 2 Sep 2015).
■ Henry Boot: Buy at 235p, target 260p; Amino Technologies: Run profits at 162p, target 180p; PV Crystalox Solar: Hold at 9.5p ('Planning for success', 3 Sep 2015).
■ Vertu Motors: Buy at 66p, target range 80p to 85p; Cambria Automobiles: Run profits at 68p ('Poised for a strong rally', 7 Sep 2015).
■ Avation: Buy at 127p, target 200p; Fairpoint: Run profits at 177p, target 190p, Redde: Run profits at 158p ('Get ready for take-off', 8 Sep 2015).
■ Stadium: Buy at 132p, target 155p to 160p; Somero Enterprises: Buy at 145p, target 185p; Flowtech Fluidpower: Run profits at 151p ('Switch on for gains', 9 Sep 2015).
■ Tristel: Run profits at 95p, target return to 110p; BP Marsh & Partners: Buy at 145p, target 180p; Character: Run profits at 505p; Greenko: Hold at 80p ('Small caps priced for gains', 10 Sep 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'
