Other constituents of my 2016 Bargain Shares Portfolio are of interest too: Minds + Machines (MMX), a company focused on the domain name industry and primarily on the new top-level domain (gTLD) space, has 90 per cent of its assets held in US dollars; and healthcare company Bioquell (BQE) generates 80 per cent of its sales overseas, something worth bearing in mind considering the company is up for sale and in bid talks. I updated the investment case on all these companies online last week ('Bargain shares pricing anomalies', 4 Jul 2016). I also highlighted in an in-depth macroeconomic article the reasons behind the surge in the US dollar denominated gold price and the positive impact it's having on prospects for pawnbroker H&T (HAT), a constituent of my 2015 Bargain Shares Portfolio ('A golden performance', 7 Jul 2016).
Exploiting a pricing anomaly
Another company set to benefit in a major way from the transactional impact on currency movements since the EU referendum is Aim-traded Somero Enterprises (SOM:160p), a Florida-headquartered company that specialises in the design, assembly, and sale of patented, laser-guided concrete levelling equipment for commercial floors. I initiated coverage on Somero's shares at 140p ('On solid foundations', 22 Apr 2015), and reiterated that advice at the current price after the company posted a trading update at the annual meeting that was "comfortably in line with expectations". ('Somero on track for a solid year of growth', 7 Jun 2016.)
The key to the ongoing positive momentum in the business lies in the North American market, which accounts for 70 per cent of Somero's annual sales. In particular, demand from non-residential building construction continues to benefit from customer demand for replacement machines, fleet additions, and product upgrades, too. New product introductions, price increases and a shortage of skilled labour in the concrete contractor industry are all contributing to strong sales in the region, factors that are also driving up margins.
To put this into some perspective, analyst David Buxton at broker finnCap forecasts a rise in full-year revenue from $70.2m (£54.2m) to $75.1m this year to boost pre-tax profit from $17.6m to $18.9m. He notes that the trading update provides "additional confidence to forecasts and augers well for a positive second half". This follows a strong operational performance in the final quarter of 2015, during which time sales hit an all-time high in December. Furthermore, the company reported upbeat news from its European and Chinese markets, both of which account for 8 per cent of revenue.
So not only are segments that represent 85 per cent of annual sales firing, but Somero has lengthy project backlogs for customers in the non-residential construction market that extend well into 2016. Moreover, the impact of the14 per cent fall in sterling against the US dollar, and 12 per cent fall against the euro since my last update ('Somero on track for a solid year of growth', 7 Jun 2016) is to increase EPS estimates from 14.5p to 16.5p for the current financial year. This means that Somero's shares are priced on a modest 9.5 times forward earnings. And even if the shares hit my fair value target of 185p, they would only be trading on the equivalent of 10 times cash-adjusted earnings for 2016, hardly a punchy rating.
That's because, buoyed by robust cash generation, net funds almost doubled to $12.6m in 2015, a sum now worth 17.5p a share, so on a cash-adjusted basis the current forward PE ratio is actually only 8.6. Sterling weakness is also great news for the sterling dividend because analysts at brokerage finnCap predict a rise in the payout per share from 6.9¢ to 7.2¢, equivalent to 5.6p at current exchange rates. That's worth 12 per cent more in sterling terms than a month ago. On this basis, the shares now offer an attractive prospective dividend yield of 3.5 per cent.
According to my models, a fall in sterling to £1:US$1.20, as some currency strategists predicts, would add a further 1.3p a share to the current sterling EPS estimate of 16.5p. Personally I feel that if the Bank of England cut bank base rate and restart printing money, as many economists believe could happen as early as Thursday this week when the central bank's Monetary Policy Committee (MPC) next convenes, then with diminishing yield support sterling could easily fall below this level before finding a floor. According to my models, a fall in sterling to £1:US$1.20 would add a further 1.3p a share to the current sterling EPS estimate of 16.5p.
On a bid-offer spread of 155p to 160p, valuing the company's equity at £86m, and offering 16 per cent upside to my conservative fair value target of 185p, I rate Somero's shares a buy.
Hot property gains in Spain
Somero is not the only company on my watchlist that's been benefiting from sterling's decline. I have been taking an in-depth look at the recently published 64-page annual report and accounts from Alpha Real Trust (ARTL:78p). The company makes its money by investing in high-yielding property and asset-backed debt and equity investments in western Europe that are capable of delivering strong risk-adjusted cash flows. I initiated coverage on the shares just above the current level in February ('High-yield property play', 10 Feb 2016), and reiterated that stance three months ago ('Alpha buy alert', 11 Apr 2016).
The report made for a very good read as the company's net asset value per share surged by 22 per cent, to 138p, in the 12 months to the end of March 2016, including an 11 per cent rise in the second half. In my April article I had predicted a year-end figure around 130p, so this was quite some beat. The fact that the shares have held up incredibly well in the market rout tells a story, too. In fact, by my reckoning the odds favour another sharp hike in net asset value in the first half to the end of September 2016, and one that's not being priced in with the shares trading on a thumping 43 per cent discount to book value.
A key driver in the performance in the last financial year was the 18.9 per cent revaluation of the company's wholly owned H20 shopping centre in Madrid, an asset that's now worth €110m (£94m). The shopping complex comprises 118 retail units with a gross letting space of 51,825 sq metres, a multiplex cinema, a supermarket let to leading Spanish operator Mercadona, and restaurants. Capital improvements made, record visitor numbers, new tenancies, and high occupancy rates have all combined to send the valuation up sharply.
Alpha Real Trust's equity interest in the property had previously been in the books for €29m, but is now worth €39m after accounting for a €71.2m mortgage secured on the property, the only debt it has, and after a debt repayment. The company used an exchange rate of £1=€1.265 to value the equity interest at the end of March 2016, but with the cross rate falling by another 10¢ since that balance sheet date, I reckon that the equity interest is now worth £33.5m, adding £2.6m to Alpha Real Trust's last reported net asset value of £95.6m. Based on 69.3m shares in issue this currency gain adds 3.75p to the March 2016 book value of 138p a share.
It means that the equity interest in H20 now accounts for 48p of Alpha's share price and around a third of its portfolio. It's a solid investment and one that's generating a 16 per cent yield on cost. That reflects the fact that the annual interest charge on €50m of the €71.2m loan is capped at 2.85 per cent, so the asset is generating a hefty cash surplus after interest payments, so much so that Alpha repaid €3.8m of the original €75m loan in the period. In turn, this ongoing cash surplus is accretive to net asset value per share as it increases Alpha Real Trust's equity interest in H20 further, if used to pay down debt, and reduces the loan-to-value ratio (around 64 per cent) on the shopping centre, too.
Seriously undervalued
That's not the only asset that's benefiting from a currency tailwind. The company owns a 47 per cent stake in Europip, an Isle of Man domiciled open-ended investment company that invests in a geared property investment vehicle. Following several disposals, the remaining investment here is one directly owned industrial and office property located in Oslo, which is in the books at NOK50.5m (£4.2m) and has a passing rent of £600,000. Alpha's equity in the vehicle was last valued at £2.5m, but at current exchange rates is worth £2.75m, adding a further 0.4p a share to its net asset value.
It's not as if the company's other investments are of dubious quality. The portfolio is worth £98m, and the main investments are high-yielding equity in property worth £41.4m, including the H20 asset (42.4 per cent of the portfolio); high-yielding debt worth £20.1m (20.5 per cent); ground rent investments worth £20.9m (21.4 per cent); and residential investments in the private rented sector valued at £6.2m (6.5 per cent). The cash flows from these assets enable the board to pay a quarterly dividend of 0.6p a share.
So, with the combined equity interest in the H20 shopping centre, and the value of the freehold ground rents, equating to the market capitalisation of Alpha Real Trust, in effect we are getting a free ride on all its other investments worth 60p a share, virtually all of which are income producing. That's anomalous and worth exploiting especially as the portfolio valuation risk is to the upside. I maintain fair value around 105p and rate Alpha Real Trust's shares a buy at 78p.
