Indeed, I made the point that the heavily asset-backed and lowly rated UK car dealers were being seriously undervalued. They still are. Shares in Cambria Automobiles (CAMB:60p) are little change since my article and are rated on just 7.5 times earnings for the year to end August 2016 even though 60 per cent of the share price is backed by leasehold and freehold property, and a number of acquisitions will help drive profits up in the current financial year. It’s a similar story at Vertu Motors (VTU:43p) which has freehold and leasehold property worth £174m on its balance sheet equating to 43p a share, and net funds of more than £12m, worth a further 3p a share. This means cash and property exceeds its market capitalisation.
Importantly, the strong recent trend in household spending growth suggests that consumers coped well in the lead up to the EU referendum. Despite a slight dip in August, retail sales volumes have continued to rise robustly after the vote and consumer confidence readings have bounced back to pre-referendum levels. If UK consumers are seriously worried about the future they have yet to show their hand as record interim results from Vertu Motors clearly highlighted.
True, underlying pre-tax profits of £19.5m for the six months to end August 2016 have been buoyed by acquisitions, but like-for-like used car volumes still notched up their 10th successive year of growth, up 8.5 per cent, and at higher margins too. The UK used car market remains robust despite an increasing supply of new vehicles that have been purchased over the past three years. Vertu’s service revenues have been motoring too, ahead by 6.6 per cent, and at improved margins. Moreover, aftersales revenues look set to remain on an uptrend driven by the ongoing increase in the UK car parc.
That’s important because even though Vertu reported a strong September for new car registrations, and one that clearly supports analyst full-year pre-tax profit estimates of £31.5m in the 12 months to end February 2017, up from £27.4m the year before, the outlook is less clear for next year. The Society of Motor Manufacturers and Traders recently cut its calendar 2017 forecast by 6 per cent for new car registrations, although this would still represent the fifth highest new car market on record. Weaker sterling relative to the euro and Japanese Yen may also have a bearing on car dealers’ trading prospects as OEM hedging strategies will start to unwind in the first quarter of 2017, so car makers may decide to introduce price rises to offset the impact of sterling weakness.
That said, this is all relative as car dealers make most of their profits from the used car market and aftersales. In fact, new car registrations only contributed 22 per cent of the company’s £161m gross margin in the first half whereas aftersales and used vehicles accounted for 72 per cent of gross profit, areas in which Vertu has demonstrated outperformance historically. Contributions from acquisitions made by recycling the proceeds of a £35m equity raise in March 2016 will also benefit the bottom line next year which is why analyst Mike Allen at brokerage Zeus Capital predicts Vertu’s pre-tax profits and EPS can both increase in mid-teens to £36.8m and 7p, respectively, and support a raised payout of 1.5p a share in the 12 months to end February 2018.
He rightly points out that a forward PE ratio of only 6 discounts earnings downgrades of “in excess of 30 per cent if we apply a “normalised” sector PE ratio of 10 through the cycle”, adding that “while we see scope for a softer new car market next year, we anticipate further progress in aftersales as an attractive recurring revenue stream with the used car market remaining robust for now”. I wholeheartedly agree with this assessment and still hold the view that Vertu’s shares are pricing in a collapse in profits that’s highly unlikely to occur.
Trading on a forward PE ratio of 6, offering a prospective dividend yield of 3.5 per cent, rated 26 per cent-plus below the last reported net asset value of 58.25p a share, and with the value of property and cash backing in excess of the share price, Vertu’s shares remain a recovery buy in my book. I have not changed my positive stance either on Cambria which is due to report its full-year results on Tuesday 22 November and is rated on around 6.5 times forward earnings for the 12 months to end August 2017. Buy.
On solid foundations
I also feel that investors are being overly cautious in their assessment of some housebuilders. I made a strong case to buy shares in east London builder Telford Homes (TEF:285p) at around the current level in late summer and last week’s trading update hasn’t altered my positive stance ('London property trading play', 22 Aug 2016).
The board revealed that since the start of September it has seen greater interest levels and more visitors to its central sales centre which has led to an increased number of reservations. This includes the sale of three of the remaining penthouses at the Horizons development in London’s docklands which have achieved an average price of over £1m, well in excess of the company’s usual price point. The average anticipated price of open market homes in Telford’s future pipeline is £517,000.
Given this focus on the lower end of the London housing market, profit expectations for the 12 months to end March 2017 are well underpinned. In fact, with over five months of the financial year still to go, Telford has already secured 95 per cent of the open market home sales for the 12 month period, prompting analyst Gavin Jago at brokerage Peel Hunt to maintain his pre-tax profit and EPS estimates at £33m and 35p, respectively, and pencil in a 10 per cent hike in the payout to 15.7p a share. Analysts Mark Hughes and Hannah Crowe at Equity Development have similar forecasts, having just initiated coverage. On this basis, the shares are rated on 8.25 times earnings estimates and offer a prospective dividend yield of 5.4 per cent.
The next significant site launch is at the company’s City North scheme in Finsbury Park, a joint development with The Business Design Centre in Islington. The 355-home development is now underway and is being funded by a £110m loan facility with LaSalle Residential Investment Fund. The scheme also includes 140,000 sq ft of commercial and leisure space and a new entrance to the underground station. It’s well worth noting then that around 150 of the units have already been pre-sold and form part of Telford’s £650m sales pipeline which underpins over half of its revenues for the next three financial years. At an average selling price of £800 per sq ft, and given its attractive location, I would anticipate solid sales demand at City North when the site is launched next month.
I would also flag up that the chronic supply shortage of housing in London reflects a significant gap between the need for homes and the numbers being built each year, an imbalance that will not ease anytime soon given the predicted population growth in London over the next decade. Furthermore, the collapse in sterling – buyers with euros and US dollars now get more than 20 per cent more UK property for their money than before the EU Referendum – has already stimulated interest at the top end of the London market and could attract rich overseas investors to the high rental returns from Telford’s offering.
Institutional demand for PRS growing
Another positive is that Telford is currently in discussions with a prospective purchaser for the sale of its third private rented sector (PRS) development this year. The company has already offloaded around 300 homes in its pipeline with a development value of £130m to M&G Real Estate, and a subsidiary of L&Q, one of the UK's leading housing associations and one of London's largest residential developers. These deals reflect increasing institutional demand for high-quality, well-located developments to be 'built for rent'.
There is decent financial upside from PRS sales because assuming Telford achieves close to its target operating margin of 15 per cent, it will earn huge profits on the £130m of revenue generated from the two schemes. Profits will be recognised earlier because under contract accounting standards it is based on a percentage build basis rather than on legal completion of the schemes. Furthermore, Telford has no debt finance on its PRS developments, has recouped its land costs and is fully carried on funding, so will make a higher return on capital employed that on a normal housing development. Admittedly, it forsakes net margin to secure the sale of a complete development, but it’s good business as this mitigates risk.
Frankly, with Telford’s shares priced on 8.25 times earnings estimates, rated on a 5 per cent premium to end March 2017 book value estimates and offering a forward dividend yield of 5.4 per cent, investors are pricing in a sharp reversal of house prices at the more affordable end of the London market despite the strong supply-demand dynamics of the market segment Telford is targeting. And with analysts forecasting cumulative EPS of almost 140p over the next three financial years even in a flat London market, of which over 50p a share is earmarked for dividends, this progressive earnings profile is simply not being reflected in the current valuation.
Offering more than 30 per cent share price upside to my 370p target price, I continue to rate Telford’s shares a buy.
Currency plays that pay
I have been making a concerted effort to focus on companies benefiting from the collapse of sterling as this currency tailwind is set to drive earnings higher and create a favourable back drop for investor sentiment.
Amino Technologies (AMO:149p), the Cambridge-based provider of digital entertainment solutions for IPTV, internet TV and in-home multimedia distribution, is a good example as the company has significant overseas exposure. Indeed when I last updated the investment case in the summer I noted that “with more than half of first-half revenue derived from North America, and almost a third from Europe, sterling's sharp devaluation since June is likely to provide a strong currency headwind on translation of overseas earnings” (‘Taking profits, and running gains’, 8 Aug 2016). And that’s exactly what has happened as the company has just announced that favourable exchange rate markets, and record order intake in August, means that it will beat earnings expectations for the 12 months to the end of November 2016.
This news prompted analyst Andrew Darley at broking house finnCap to raise his revenue estimates by around 5 to 6 per cent to £73m and hike pre-tax profits and EPS estimates by 9 per cent to £9.5m and 12.2p, respectively. The forecast 10 per cent rise in the dividend per share to 6.1p is covered two times over by likely earnings, and also by expectations of a higher end of year cash pile of £5.2m, implying a prospective dividend yield of 4 per cent.
And with these positive effects feeding through to later years, Mr Darley has also upgraded his 2017 revenue estimate by 6 per cent to £77.4m and lifted his pre-tax profit and EPS forecasts by 9 per cent to £10.5m and 12.9p, respectively, to support a dividend of 6.7p a share. On this basis, Amino’s shares are rated on a forward PE ratio of a little over 11 and offer a chunky 4.5 per cent prospective dividend yield, a very attractive rating for a cash rich company benefiting from strong orders inflow and a currency tailwind.
In fact, I feel that a much more reasonable rating is 13.5 times next year’s earnings estimates, implying a new target price of 175p a share, or well over double the 83p price level at which I initiated coverage ('Set up for a buying opportunity', 10 Jun 2013). Buy.
Value in Elegant Hotels
It’s not often you get the chance to check into a luxury hotel at half price, but that’s what’s on offer at Elegant Hotels Group (EHG:64p), the largest hotel operator in Barbados, the Caribbean island that attracts 520,000 long-stay visitors each year.
I last rated the shares a hold for recovery at the current price (‘Insiders check into Caribbean hotelier, 9 Aug 2016), and though the company cautioned on the outlook for next year reflecting the impact sterling’s devaluation is having on affordability of its offering - the UK market accounts for 70 per cent of Elegant’s bookings - there is clear value on offer here.
The luxury hotel operator operates six high end hotels on the island - Colony Club, Tamarind, The House, Crystal Cove, Turtle Beach, and recent acquisition, Waves Hotel & Spa - all of which are situated along the prestigious west and south coastlines. The portfolio of hotels was valued at $235m by commercial property valuers CBRE in April 2015, since when the company acquired The Waves Hotel & Spa resort on the island and which was valued at $22m in the interim accounts. Using these valuations, the company's properties have a combined valuation of $257m, implying an adjusted net asset value (NAV) of $202.7m and a NAV per share of 228¢ which, based on an exchange rate of £1:$1.21, equates to 188p a share. This means Elegant Hotel's shares are rated on a thumping 66 per cent discount to book value. Or put it another way, with the company’s equity being valued at only £57m, or US$70m at current exchange rates, and net debt around $57m, then $257m worth of real estate is being effectively valued at half price.
Furthermore, it’s not as if the company isn’t profitable. Analyst Mike Allen at brokerage Zeus Capital still expects the business to turn in cash profits of $17.2m on flat revenues of $58m in the new financial year to end September 2017 based on a reduced occupancy rate of 60 per cent, down from 68 per cent previously forecast, and lower room rates too. These estimates take into consideration the 20 per cent fall in sterling against the US dollar since the EU Referendum which is impacting bookings from the UK market. In the past six weeks, these have been tracking about 5 per cent below the same period last year.
True, even if Elegant’s management team achieve those revised estimates the performance will be well down on the $20m cash profit analysts expect in the year just ended, and well shy of the $22.2m earned in the 2015 financial year. But with the company being valued on a miserly 7.4 times cash profit estimates to its enterprise value, then the subdued performance looks priced in which explains why the shares are little changed since last Friday’s trading update.
Investors have probably taken note that Elegant has won a management contract to run a new 120-room hotel on Antigua when it opens its doors in mid to late 2017. For an investment of $1.5m, the contract is expected to generate cash profits of $500,000, implying a three-year pay-back period. It’s a significant deal and paves the way for the company to enter into more management contracts of this nature.
Another factor worth considering is that the surge in the greenback has helped to support the sterling value of Elegant’s overseas earnings despite the earnings downgrades. Based on adjusted pre-tax profits falling to $11.7m from $14.8m in the 12 months to end September 2017, the company will still report EPS of 8.2p based on 10.1 cents worth of dollar earnings. The board are also keeping to their guidance to pay a full-year dividend of 7p a share for the year just ended, of which half was declared at the time of the interim results. This means that the shares offer a 10.5 per cent prospective dividend yield.
So, although demand for Elegant’s luxury holidays are being impacted by sterling’s weakness, it’s more than factored into the current valuation. In fact, I feel that at this level the company could become a bid target given its real estate assets are effectively in the price for half their open market value. Hold for recovery.
Finally, my next column will appear on my home page at 12pm on Monday, 24 October.
