There was a lot to like about the first half trading performance from Gresham House (GHE:320p), a specialist asset manager and a constituent of my 2016 Bargain shares portfolio. The company has been making great strides in scaling up the business, so much so that in the first eight months of this year it has increased assets under management (AUM) by more than half to £360m. Gresham House won the £86m mandate as investment adviser to investment company LMS Capital (LMS:59.5p) over the summer, and plans to adopt the same Strategic Public Equity (SPE) investment strategies it has been pursuing as investment manager of Gresham House Strategic (GHS:830p) since winning that mandate in August last year.
In fact, having seen GHS’s net asset value rise by almost 9 per cent in the 12 months since taking over the mandate, a performance that’s three times better than the return on the FTSE SmallCap index excluding investment trusts, the skills of Gresham House’s investment team are clearly in demand as it has just raised £24m for a new Strategic Public Equity Limited Partnership fund. It’s not the only fund launch as Gresham House's new forestry fund should have its first close in the second half this year with subscriptions north of £12m and a final target fund size of between £25m to £40m. The fact that the company’s forestry funds increased AUM from £205m to £223m in the eight months to end August 2016 highlights the ongoing attractions of this alternative asset class.
The point being that these funds are now generating annualised AUM of £3.7m and with the company set to earn a 1.5 per cent annual management fee on new forestry fund, and a 2 per cent transaction fee, then annualised AUM are set to rise above £4m later this year. That’s well ahead of the £3.8m run rate that analyst Justin Bates at Liberum Capital had previously factored in for Gresham House’s 2017 financial year.
Move to breakeven ahead of schedule
Moreover, Gresham House owns a legacy property in Speke, Liverpool, known as Southern Gateway, a fully-let office and industrial complex that is being marketed for sale at £7.6m on an initial yield of 10 per cent. It’s in no rush to sell unless the price is right, so the cashflow from this property is making a useful contribution to covering the company’s annual administration costs of around £4.8m while the board scale up the asset management operation. It’s hardly surprising then that Mr Bates says “we shall have to review forecasts in light of this progress as it seems profitability will be achieved ahead of our original expectations of 2018. We expect to see more organic and acquisitive growth in AUM and reiterate our target price of 381p”.
I think that target price could be on the light side as Gresham House has rock solid asset backing including property assets worth £9.9m; deferred consideration from Persimmon of £6m on a land sale, of which a third is due for payment in March; a holding in GHS shares worth £6m; and the £4.3m initial investment in forestry asset manager Aitchesse. Net borrowings were only £1.9m at the end of June, representing 8 per cent of shareholders funds.
In other words, strip out £22m worth of property and legacy assets from Gresham House’s market capitalisation of £33m, and its fund management businesses, which have a combined £360m of AUM and will shortly be generating annualised management fee income north of £4m, are being valued on less than three times annual management fee income. That valuation is way too low for a business that could easily breakeven next year, and is scaling up for profitable growth on the back of some lucrative mandate wins. The shares are modestly up on my buy-in price in this year’s portfolio and rate a clear buy.
Lights brightening at PV Crystalox
Shares in solar wafer maker PV Crystalox Solar (PVCS:19p) have rallied 40 per cent since I recommended buying them a month ago at 13.5p ('A quartet of small-cap buys', 30 Aug 2016) and are now back to the entry level of my 2014 Bargain Shares portfolio.
A recovery in spot prices for wafers, the company's primary product, and softer prices of polysilicon, the key raw material used in photovoltaic wafers, helped PV Crystalox deliver a pre-tax profit of €4.7m in the first half of 2016. But wafer prices have since plunged by around 15 to 20 per cent to historic lows, and polysilicon prices have surged at the same rate, the net effect of which is to make wafer production uneconomic once again and force PV Crystalox's board to consider measures to protect shareholders' interests.
Bearing this in mind the company made an important announcement at the tail end of last week in relation to one outstanding long-term polysilicon purchase contract with a supplier at prices considerably in excess of market prices. By mutual consent it has agreed to end the contract with immediate effect and all obligations of the parties to buy and sell polysilicon under the terms of the agreement have ceased. PV Crystalox will forfeit a significant portion of the pre-payment outstanding on the contract and will receive the remainder in cash. To put this sum into perspective the company had €2.55m of pre-paid expenses at the end of 2015 mainly in relation to polysilicon feedstock deposits.
Adjusting for that sum in its entirety, but excluding operating losses since the end of June 2016, this implies the company has a proforma net asset value of €43m (£37m). Based on current exchange rates of £1:€1.16 and a diluted share capital of 160.2m shares, book value per share equates to 23p, around 90 per cent of which is made up of inventories of €12.7m, worth 6.8p a share, and net funds of €24.8m, or 13.3p a share.
So, on the face of it the shares are fair value at this level. However, there is a potential catalyst on the horizon which could see the share price re-rate significantly: the resolution of a contract dispute between PV Crystalox and one of the world's leading photovoltaic companies. The evidentiary hearing for arbitration will be heard by the International Court of Arbitration of the International Chamber of Commerce at the end of this year, and a judgment is expected in early 2017. PV Crystalox has one outstanding long-term sales contract in place with the photovoltaic company which failed to purchase wafers in line with its obligations. Despite extensive negotiations PV Crystalox's board has been unable to reach an agreement.
If the claim is upheld, PV Crystalox's board believe compensation "could be a multiple of the company's market capitalisation". So, with PV Crystalox's share price trading in line with cash and stocks on its balance sheet, and the company in cash conservation mode having extricated itself from its last remaining long-term polysilicon purchase contract, then any upside from the International Court of Arbitration (ICC) ruling is in the price for free.
Of course, this is a speculative recommendation, but I still feel the shares are worth buying given the potential upside could be more than 100 per cent if the ICC ruling proves favourable. Speculative buy.
Bowleven seriously undervalued
The decision by OPEC to cut production for the first time in eight years sent Brent Crude oil prices rallying by more than 8 per cent from $46 per barrel to $50 per barrel in the past week. The new production target represents a decrease of between 240,000 barrels of oil per day (bopd) and 740,000 bopd from the 33.24m bopd that the cartel pumped in August, and is well short of the 1m bopd production cut that will be needed to have a meaningful impact on global supplies and prices, according to analysts.
But it’s a step in the right direction as any cut in global supply ahead of peak demand season can only be supportive of the oil price. And it’s no surprise that the share prices of small cap oil companies got a boost after the announcement as it raises the potential for profitable production again for operators whose cost of production is below the current oil price.
Bearing this in mind, Bowleven (BLVN:25.5p) a constituent of my 2016 Bargain share portfolio, is one such beneficiary. That’s because its Etinde Permit off the coast of Cameroon, in which the company has a 20 per cent non-operated interest having completed a farm out deal with Lukoil and New Age at the start of 2015, has been valued using a long-term oil price of $65 a barrel for a project which has gross 2C contingent reserves of 290m barrels of oil equivalent. On this basis, it has a carrying value of $168m (£130.5m) in Bowleven’s accounts, a valuation that equates to 40p per share. The company also has a 100 per cent equity interest in the Bomono project, offshore Cameroon, which is valued at $36.6m (£28.4m) and reflects a gas price of $7 per million cubic standard feet of gas.
Clearly, investors are being very cautious as to whether the oil and gas price can recover to levels at which these projects are commercially viable. In fact, the company's market capitalisation of £83m is only marginally above its $100m (£78m) cash balance at the end of September 2016 as highlighted in a trading update today. That figure is calculated after accounting for the receipt of $15m deferred consideration on the Etinde farm-out deal, and after factoring in the cost of 2.4m shares repurchased in the past month or so pursuant of a US$10m (£7.8m) share buy-back programme announced in August. The board has authority to repurchase up to 14.99 per cent of the 327m shares in issue under this authority.
This means that in effect the upside of the oil price recovering further is virtually in the price for free with the company being valued on a 70 per cent discount to its last reported net asset value of $367m (£285m). It also means that the share buy backs are hugely accretive to net asset value per share as the company is only paying 25.5p a share in the market to get its hands on 87.75p a share of net assets. If the full $10m is deployed, and a further 28m shares are bought back at an average of 25.5p each, then I estimate that it will add 6.25p a share to Bowleven's net asset value per share.
So, with the company’s shares trading below cash, the board buying back shares, and Opec’s producers taking production off the market, I maintain my buy recommendation ahead of full-year results in November, having first advised buying around 19p in this year’s portfolio. Buy.
