I analysed the interim results in an online-only article a month ago ('Currency winners', 28 Nov 2016), and had no hesitation reiterating my buy advice and my target price of 56p, having first recommended buying at 18.5p in my 2011 Bargain Shares Portfolio. After factoring in total dividends of 7.265p a share, the holding is up 204 per cent. At the time of the interim results the board noted that its mandate for the Shipbuilding Industries Pension Scheme (SIPS) fund had recently been increased from £125m to £170m, which could add £200,000 to profits in a full year once fully invested. First Property's fund managers have wasted no time in deploying the additional funds as they have just completed on a portfolio of supermarkets and a retail warehousing scheme in Southampton. This means the SIPS fund is 95 per cent invested and the portfolio of 24 properties is producing an annualised yield of 6.3 per cent. I would flag up that chief executive Ben Habib “hopes to announce additional fund mandates very soon”.
Furthermore, this is not the only factor supporting profit growth as the company also owns a portfolio of 11 high-yielding commercial properties in Poland and Romania that are worth a combined £170m, including five properties worth £67m held by 74 per cent-owned subsidiary, Fprop Opportunities. These properties contributed £5.65m to First Property's first-half profit before central overheads, reflecting an attractive yield differential between the weighted average interest rate of 2.59 per cent on the €141m (£122m) debt secured on the €199m (£170m) portfolio, and the 9.8 per cent rental yield being earned. Bearing this in mind, the plunge in sterling this year has not only boosted the sterling value of overseas profits earned, but has enhanced the sterling balance sheet value of the assets, so much so that First Property's last reported net asset value of 46p a share is 20 per cent higher than 12 months ago.
Analyst Chris Thomas at house broker Arden Partners only assumed the company would replicate its first-half pre-tax profit of £4.57m in the second half when he increased his full-year pre-tax profit estimate by £2m to £9.2m at the time of the interim results at the end of November. He has also based his estimate on an average £/€ rate of 1.217. However, with the current cross rate well below that level, and the SIPS fund now 95 per cent invested, this offers potential for earnings upgrades, as does the possibility that First Property's board will use some of the £14m cash available on its balance sheet to make further earnings-accretive debt-funded acquisitions of high-yielding eastern European commercial property.
Trading on a modest premium to book value, rated on less than nine times EPS estimates of 5.6p, falling to only eight times EPS estimates for the financial year to March 2018, and offering a 3.2 per cent prospective dividend yield based on a forecast payout of 1.55p a share, First Property's shares still rate a great buy in my view and with further earnings upgrade potential in the price for free. Buy.
Arbuthnot's portfolio buys
First Property is not the only constituent of my annual Bargain Shares portfolios to be making the news. Last week, Arbuthnot Banking Group (ARBB:1,459p) acquired a private banking loan portfolio worth £44.9m from banking group Duncan Lawrie. The loans are secured on property worth £104.4m, so have a low loan-to-value ratio, but still offer a decent yield of 5.21 per cent and that's before taking into account the £2.2m discount Arbuthnot negotiated on the acquisition price.
The company also announced the acquisition of Renaissance Asset Finance (RAF), a provider of finance for a range of specialist assets including vintage cars. RAF has customer assets of £68m. Arbuthnot is funding both deals from its own cash resources, which got a £148m boost earlier this year after it sold down its stake in Secure Trust Bank (STB:2,249p). Its remaining holding is still worth £77m, a significant sum in relation to its own market capitalisation of £220m. Arbuthnot used £53m of the cash windfall to acquire a prime property in the West End of London, comprising 22,500 sq ft of office space and 7,000 sq ft of retail space. The premises will in time enable its private banking arm, Arbuthnot Latham, to develop a presence in the West End, but in the meantime it's generating annual rental income of over £1.8m.
The plan is to use the balance of the cash from the Secure Trust share sale to develop Arbuthnot Latham. The unit posted half-year pre-tax profits of £4.5m on a 15 per cent hike in operating income to £19.4m. It's well funded, as customer deposits cover loans and advances more than 1.4 times over and this significant liquidity and balance sheet strength supports the bank's ongoing growth in loan balances. Moreover, assuming Arbuthnot Latham can continue to recycle its £1bn of customer deposits into high-quality lending - impairments represent a tiny 0.12 per cent of loans on an annualised basis - and at an economic net interest margin, it will be value accretive to shareholders. This anticipated ramp up in lending explains why analysts at Hardman & Co expect Arbuthnot's adjusted EPS to increase from 24.4p in 2016, to 55.4p in 2017, rising again to 93p in 2018.
It's proved a rewarding holding since I included the shares in my 2015 Bargain Shares portfolio at 1,459p as the company has so far paid out total dividends of 383p. So, having last advised running profits around the current price ('Riding small-cap bumper gains', 24 Oct 2016), I still feel that Arbuthnot's shares should be trading closer to book value of 1,552p. Run profits.
BP Marsh on a roll
Aim-traded and cash rich insurance sector investment company BP Marsh & Partners (BPM:200p) has acquired a further 6.87 per cent stake in Nexus Underwriting Management, an independent specialty managing general agency (MGA) for £4m, taking its stake to 18.8 per cent. Nexus is one of the largest independent specialty MGAs in the London market, operating across a number of specialist insurance sectors including Trade Credit & Political Risk, Surety, Bond, Marine, and Accident & Health.
BP Marsh made an initial investment in Nexus in August 2014, acquiring 5 per cent, and since then has acquired additional interests through follow-on investments. Since BP Marsh's original investment, Nexus has doubled its premium income from £56m to a forecast in excess of £120m for this year, and boosted commission income from £13m in 2014 to a forecast of £20m. It's proved a successful holding for BP Marsh's shareholders too, as the company's aggregate investment of £4.57m was valued at almost £7m in the last accounts. Including the latest £4m investment, it's now one of the company's largest holdings, accounting for 15 per cent of BP Marsh's net asset value (NAV) of £73.8m. It's not the only one doing well either.
In the first half, BP Marsh increased its NAV per share from 243p to 253p after paying out a 3.42p dividend, maintaining a track record that has seen NAV per share rise at a compound annual rate of 11.3 per cent since 1990. Guidance is for a 10 per cent hike in the payout per share to 3.76p in the financial year to January 2017, an expectation well underpinned by the company's ongoing strong investment performance.
A key reason for the £4m investment gain booked on BP Marsh's £53m equity portfolio in the first half was the performance of its 37.94 per cent holding in Besso Insurance, a top 20 independent Lloyd's broking group that has appointed investment bank Canaccord Genuity to carry out a strategic review. Discussions are ongoing with potential investors, with a view to a sale or investment in Besso. The value of BP Marsh's stake increased from £18.1m to £20.1m in the half-year, implying a valuation of £53m for Besso's equity, or 8.8 times its forecast cash profits of £6m in 2016. Bearing this in mind, there is potential for further valuation upside given that investment firm Calera Capital acquired a majority interest in Robert Fleming Insurance Brokers, the international Lloyd's insurance and reinsurance broker, on a multiple of 10 times cash profits.
The rock solid asset backing doesn't end there either because BP Marsh's loan portfolio of £15.2m, worth 52p a share, includes a £6m loan to privately owned global insurance broker Hyperion Insurance on which it earns annual interest of £450,000 and is due for repayment in October 2017. This means that cash, loans, receivables and the stake in Besso alone account for 150p a share of BP Marsh's NAV.
So, with BP Marsh recycling its cash pile successfully, and potential for Besso to deliver the company's second bumper windfall in as many years following the successful exit from Hyperion, then I believe the shares should not be trading on a 20 per cent-plus discount to book value. Having booked 11.17p a share of dividends since initiating coverage at 88p ('Hyper value small-cap buy', 22 Jan 2012), and last advised buying at 198p ('Riding small-cap bumper gains', 24 Oct 2016), I feel that my 230p target price could prove conservative in the event of an exit from Besso being achieved. Buy.
Faroe breaks out
It has taken some time, but the investment in Aim-traded Faroe Petroleum (FPM:96p), an independent oil and gas company primarily focused on exploration, appraisal and production opportunities in Norway and the UK, has finally delivered. When I initiated coverage ('A slick operator', 5 Feb 2015), the shares were priced at 75p and I had a target price of 94p. I have maintained my positive stance ever since, although it has been a rollercoaster ride.
I last advised buying at 68.75p in late summer ('A quartet of small-cap buys', 30 Aug 2016), after the company raised £66m in a placing at 70p primarily to fund the acquisition of the production assets of DONG Energy. The five Norwegian North Sea producing oil and gasfields acquired in that transaction have added almost 10,000 barrels of oil equivalent (boe) per day to Faroe's production, higher than previously expected, and has resulted in Faroe recently upgrading its 2016 average daily production to between 17,000 and 18,000 boe, up from 15,000 and 17,000 boe previously. Estimated unit operating expenditure is around $19 per boe, so with Brent crude recovering to $55 a barrel, then the acquisition will bring in substantial cash flow to support Faroe's promising development programme.
It's worth noting that Faroe retains a very healthy balance sheet. Analyst Werner Riding at brokerage Peel Hunt forecasts year-end net cash of £109m, or 30p a share, thus offering scope for further exploration acquisitions. And that's still not being fully priced into the valuation, as Faroe's share price is well below both Peel Hunt's target price of 115p, and its risked net asset value estimate of 135p which factors in appraisal and development upside. Interestingly, the technical set-up is highly supportive as the share price has just broken out above the 2015 summer highs.
So, with the macro risk suggesting further oil price upside, Faroe's exploration campaign offering potential for positive newsflow, and the major oil producers recently agreeing on production cuts to bring the oil market back into equilibrium, I maintain my buy recommendation.
