Bargain Shares Portfolio 2017

Our portfolios are based on the investment ideas of Benjamin Graham (see ‘Rules of Engagement’, below) and they have certainly withstood the test of time, beating the FTSE All-Share index in 14 out of the 18 years in which we have run them. During that time, they’ve generated an average return of 20.7 per cent in the first 12-month holding period, compared with an average increase of 4.2 per cent for the FTSE All-Share.

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That’s not to say this investment strategy is a one-way bet. Investing rarely is. Indeed, the 11.1 per cent return on last year’s Bargain Shares Portfolio was well below that of the FTSE All-Share, the index against which we benchmark our annual performance, although this was more a reflection of our lack of exposure to the resources sector – and the mining sector in particular – which buoyed the return on the index. As usual, the hidden gems we uncovered in the stock market were found among the under-researched small- and micro-cap segment. Targeting smaller-cap companies has reaped handsome rewards over the years, so justifying our long-term bias here, but it works both ways as any companies that disappoint can be punished severely given the less liquid nature of these shares. The flipside is that when we get it right you can expect substantial long-term outperformance, as our track record shows.

It’s worth pointing out that no portfolio can be immune to a market crash: the collapse in share prices in the global financial crisis in 2008 wreaked havoc, but readers who kept faith subsequently recovered all their paper losses, which again highlights the solid asset backing of the companies. In fact, two of those companies from the 2008 portfolio – Indian Film Company and Raven Mount – both succumbed to takeovers. It was a similar story in 2011, with that portfolio recouping all its losses, and going on to reward investors with some mightily handsome gains in later years.

Merger and acquisitions (M&A) activity has been a recurring feature of all our portfolios, as predators, attracted by the asset backing on offer, run their slide rule over the numbers. There is a fair chance that corporate activity will play a part in this year’s portfolio, too. That’s because virtually all bar two of the 10 companies I selected this year have cash-rich balance sheets, and are trading well below the book value of their assets. In some cases, valuations are so depressed that we are getting all the fixed assets in the price for free, thus offering the substantial “margin of safety” Benjamin Graham was aiming for.

So, once again, I have run the rule over 1,700 listed companies on Aim and the main market of the London Stock Exchange to come up with a portfolio of companies where the asset backing should be strong enough to overcome any short-term trading difficulties and, in time, reward our loyal following of long-term value investors.

Rules of engagement

The Bargain Shares Portfolio is based on the writings of Benjamin Graham, who favoured looking for companies that were “out of favour because of unsatisfactory developments of a temporary nature”.

How do we know whether the “unsatisfactory developments” are indeed “temporary”? Mr Graham’s approach was to focus on the balance sheet, and specifically the net current assets – stocks, debtors and cash less any creditors. He believed that a bargain share is one where net current assets less all prior obligations exceed the market value of the company by at least 50 per cent.

Mr Graham’s theory was that a strong balance sheet will usually see a company through any short-term difficulties; he called it his “margin for safety”.Finding companies that match these strict criteria has become more and more difficult over the years as the link between market capitalisation and asset value has become more tenuous.

In practice, when we ran our search we found only a handful of the 1,700 listed UK companies hold a bargain ratio of one or above and this included a high number of relatively illiquid microcap companies with market values below £10m that are very difficult to trade. So, to widen the net, the cut-off point has been lowered to 0.5, but we only considered companies on a price-to-book value of one or less to make sure there is still substantial asset backing on the balance sheet.

We have also only considered companies with a market value above £10m to avoid liquidity issues. Finally, market makers could easily raise their offer quotes for smaller companies by 10 to 15 per cent on publication day. However, prices and spreads have demonstrated a habit of drifting back over subsequent weeks, so please be disciplined in your share buying.

Bargain Shares Portfolio 2017

BOWLEVEN (BLVN)

Aim: Share price: 27.75p

Bid-offer spread: 27.5-27.75p

Market value: £88.8m

Website: bowleven.com

Bowleven (BLVN:27.75p), the Africa-focused oil and gas exploration group, made it into my Bargain Shares Portfolio last year and continues to offer substantial share price upside even after rising 45 per cent in the past 12 months. If anything the investment case has strengthened given the oil price has bottomed out and doubled to $56 a barrel since hitting multiyear lows in January 2016. There are even prospects of shareholder activism to release value in the balance sheet.

The level of the oil price is important because Bowleven’s last reported net asset value (NAV) of $361m, or £289m at current exchange rates, consists of net funds of $95m, a sum worth 23.75p a share, and two major investments: the Etinde permit off the coast of Cameroon, in which it has a 20 per cent non-operated interest, having completed a farm-out deal with Lukoil and New Age at the start of 2015; and a 100 per cent equity interest in the smaller Bomono project, also off the coast of Cameroon. These developments, worth in excess of $200m on the company’s balance sheet, are effectively in the price for free given the shares are almost fully backed by cash.

Bearing this in mind, Etinde has been valued using a long-term oil price of $65 a barrel for a project that has gross 2C contingent reserves of 290m barrels of oil equivalent; and Bomono’s valuation reflects a gas price of $7 per million cubic standard feet of gas. Etinde accounts for almost half of the company’s NAV of 90p a share, so it is a key investment. Furthermore, as the oil price rises towards levels at which these two developments become commercially viable, this increases the potential for them to create substantial value for Bowleven’s shareholders in due course.

The fact that Lukoil and New Age acquired their 40 per cent interests in Etinde for $250m two years ago shows that at least they believe there is significant value to be realised here. Importantly, under the terms of the farm-out agreement, Bowleven is carried for $40m of net drilling on two appraisal wells at Etinde, and is due to receive a further $25m once the final investment decision is made. The timing of these wells is dependent on ongoing discussions between New Age and the Cameroon government, but it’s reasonable to assume drilling will take place later this year, albeit this is later than previously expected, to provide an important catalyst for the project and Bowleven’s share price, too.

It’s worth pointing out that the directors are looking to deploy some of Bowleven’s huge cash pile on purchasing a business or asset that provides enough free cash flow to cover its general and administration expenses, albeit progress on this front has been painfully slow and it parted company with its exploration director, Ed Willett, last month. In the meantime, the board repurchased 7.8m shares at a cost of around £2m pursuant of a $10m (£8m) accretive share buyback programme.

Intriguingly, Crown Ocean Capital, a Monaco-based offshore private investment vehicle with a 13.3 per cent stake in the company, voted against the motion at December’s annual meeting to continue with market purchases, forcing the board to suspend the buyback programme. It has just sent the company a requisition for a general meeting. The activist shareholder is calling for the board to be replaced and the company to pursue a new strategy to transform Bowleven into a holding company with the aim of returning excess cash to shareholders; identify the best way to value maximisation from Etinde; and curtail further spending on the Bomono project. Crown Ocean Capital expects Bowleven’s share price to significantly appreciate upon the adoption of this new strategy as “the implied uncertainty over cash spending and monetisation of assets is removed, with further material upside from Etinde expected over time”.

Whether Crown Ocean Capital can garner support from enough of Bowleven’s other major shareholders remains to be seen, but given that the shares are trading almost 70 per cent below book value, and are almost fully backed by cash, then any move to return cash to shareholders will undoubtedly lead to a sharp re-rating.

The bottom line is that with Bowleven’s current assets less all liabilities exceeding its market capitalisation by a third, the valuation still fails to attribute any value to its investment in Etinde and Bomono; the potential for a successful drilling programme; and scope for corporate activity to release substantial value in the balance sheet. Buy.

BATM ADVANCED COMMUNICATIONS (BVC)

Main: Share price: 18.25p

Bid-offer spread: 18-18.25p

Market value: £73.6m

Website: batm.com

The main activities of BATM Advanced Communications (BVC) are focused on network solutions and biomedical laboratory systems, both of which have been winning a raft of new contracts. For example, in the third quarter last year BATM’s networking and cyber business started work on a $4m (£3.2m) three-year contract for a national defence agency to provide monitoring for detecting, investigating and analysing network threats and advanced persistent threats. Under the terms of the agreement, BATM will deliver an array of new cyber-secured networked applications, and enhance the security and monitoring of the customer’s existing solution whereby the usage will be more accurately monitored and analysed.

At the same time, its telecoms subsidiary was awarded a three-year contract worth between $1.5m and $2.5m by a major provider of high-speed network and ICT services to education and research facilities in Australia. The client’s network connects education and research institutions throughout Australia as well as with their global peers – facilitating collaboration nationwide and internationally. BATM is providing its aggregation and demarcation products and services to upgrade the client’s existing network, and replace the two incumbent global technology providers. There is also an option for the contract to be extended to five years, with the potential for additional orders of at least the same magnitude.

And at the end of last year, the company’s pathogenic waste treatment and sterilisation unit, which forms part of its biomedical division, was awarded a second order worth $1.4m for its biological waste solution. Developed for the biopharmaceutical industry by one of the world’s largest manufacturers of vaccines for animal health, the solution automates the entire process of disposing of biohazardous waste safely and enables the treatment of the waste on-site, thereby mitigating the risk of cross-contamination. Importantly, it does not involve any environmentally-damaging materials and the treated waste is safe for humans and the environment.

A few weeks later, the company won a contract worth €1.75m (£1.5m) for the supply and installation of an agri-waste treatment solution unit at the bovine slaughterhouse facilities of a leading food group in Israel. The solution treats the remaining byproducts of bovine processing, and produces protein and fat products suitable for use in producing other commercial products, such as high-grade domestic animal food. During the treatment process, no hazardous materials, chemicals or methods are used and it is completely eco-friendly, with no environmental hazards or damage.

These contract wins, and BATM’s bullish trading update at the time of the half-year results, suggest that both divisions should be able to contribute operating profit of $2m in the second half of 2016, as analyst Lorne Daniel at broker FinnCap predicts, thus underpinning a move into profit for the 12-month period. Clearly, chief executive Dr Zvi Marom is upbeat as he purchased 300,000 shares in September at 16.625p each to take his holding to 96.6m shares, or almost 24 per cent of the issued share capital. So too is chairman Dr Gideon Chitayat, who acquired 1m shares at 15.5p in mid-November to treble his stake in the company.

It’s easy to see why the insiders see value in the shares, as the board announced just before Christmas that its wholly-owned subsidiary, Adaltis, an Italian manufacturer of medical diagnostics equipment, received a $2.85m investment in return for a 4.93 per cent equity stake from Egens Biotechnology, a leading biotechnology company combining biological material development and diagnostic reagent manufacturing. This investment values Adaltis at $58m. Egens also has an option to purchase a further 10 per cent of Adaltis’s shares based on a valuation of 5.5 times its revenue within 90 days of the publication of its 2016 and 2017 accounts.

In 2015, Adaltis was granted a licence by the China Food and Drug Administration of the People’s Republic of China for the importation, marketing and sale in the country of its diagnostic kit for hepatitis C. The hepatitis C disease currently has no vaccine and it is estimated to kill approximately 350,000 to 500,000 every year. China is by far the world’s largest nation affected by hepatitis C, with more than 60m people estimated to be affected. Most of the diagnosis is undertaken by locally-developed instruments and reagents, with very few foreign companies providing solutions.

Bearing this in mind, BATM also announced last year that a joint venture between Adaltis and Egens had won a major distribution agreement with Sino Pharm – a prominent Chinese medical and healthcare group – to distribute Adaltis HCV (Hepatitis C) diagnostic kits nationwide. BATM’s diagnostics business is focused on developing compact, cost-effective products for small- to midsize laboratories, including advanced genomic solutions that are being introduced to the market. In particular, it is targeting areas where many laboratories are midsized and dispersed in different localities - and hence require the solutions provided by its diagnostics business. Clearly, Egens believes there is significant potential here, as the price it paid equates to almost five times Adaltis’s gross assets.

And the ‘hidden value’ in Adaltis is simply not being factored in to the valuation. That’s because BATM had net funds of $14m at the end of June, since when it has sold a property in Israel for $8.9m – or almost 50 per cent above book value – and received the Egens investment of $2.85m. Pro-forma net funds of $26m are worth 5.2p a share and mean that the company’s enterprise valuation of $65.6m is almost fully backed by the valuation placed on Adaltis alone. That leaves BATM’s profitable network solutions and biomedical divisions effectively in the price for free.

Or, to put it another way, if you mark Adaltis to market value then I reckon BATM’s current assets less all its liabilities equate to almost all of its market value of £73.6m. This means we are getting over $40m of fixed assets in the price for free, including $17.2m of valuable property assets. The insiders’ lead is well worth following. Buy.

AVINGTRANS (AVG)

Aim: Share price: 190p

Bid-offer spread: 188-190p

Market value: £34.8m

Website: avingtrans.plc.uk

Avingtrans (AVG), a maker of critical components and services to energy, medical and industrial sectors, is a classic Benjamin Graham value play, and one where the investment risk looks weighted firmly to the upside.

The board’s investment strategy is to acquire assets, restructure them to improve efficiency, and then sell them on to release the hidden value in the balance sheet. Importantly, the directors have been rather successful, having sold off the company’s industrial division, Jenatec, to Kuroda of Japan for £13.75m in 2012, and reinvested the proceeds in developing its aerospace, energy and medical divisions.

Under the leadership of chief executive Steve McQuillan, finance director Stephen King and chairman Roger McDowell, who between them own almost 10 per cent of the share capital, the company then scaled up its aerospace unit before selling it for £65m last March to funds controlled by European private equity firm Silverfleet Capital Partners LLP. The exit multiple equated to two times NAV and 14 times operating profit to enterprise value, a decent price and one on which Avingtrans booked a hefty pre-tax profit of £27.5m. The board then carried out a £28m tender offer at 200p a share in order to redeem half the share capital, but it was telling that it only received acceptances from holders of £19.4m-worth of shares, a clear indication that the majority believe there is more share price upside to come.

It’s not difficult to see why, given that the company’s share price is trading 30 per cent below pro-forma book value of 270p a share, even though I estimate that Avingtrans retains net cash of £26.1m, a sum worth 143p a share, after accounting for transactions costs on the disposal and working capital movements. This means that we are effectively getting £10.1m, or 55p a share, of fixed assets in the price for free, in addition to £4.6m of current assets. That’s anomalous given that the board plans to deploy the hefty cash pile on making earnings-accretive acquisitions to complement the decent growth prospects of its retained operations.

For example, Avingtrans’ energy and medical division diversified into the materials technology market last year, winning a three-year contract worth £3.5m to provide composite components for airport scanners with Rapiscan, a leading security screening provider based in California. Avingtrans is providing key components for Rapiscan’s new and groundbreaking airport scanner, the RTT110 (real time tomography), the first scanner to successfully pass the European Civil Aviation Conference’s (ECAC) Standard 3 threat detection test for baggage-borne explosive risks – a standard that will become compulsory for airports around the world by 2020.

In addition, Avingtrans’ Stainless Metalcraft subsidiary signed a framework agreement worth £1m a year with Bruker BioSpin AG, a Switzerland-based market leader in analytical magnetic resonance instruments, to produce high integrity cryostat components for Bruker’s nuclear magnetic resonance systems (NMR). NMR spectroscopy complements other structural and analytical techniques, such as X-ray, crystallography and mass spectrometry, and can be used alongside MRI-related technology to provide multidimensional images and spatially resolved information. The division also signed a 10-year agreement worth £9m to produce high integrity cryostat components for NMR with Wuhan Zhongke Niujin Magnetic Resonance Technology Co in Wuhan, China. Component production will initially take place in the UK before moving to the company’s own established facility in Chengdu, China.

I would also flag up that Metalcraft has a lucrative 10-year contract with Sellafield, worth £47m, to provide waste storage containers for the Cumbrian nuclear power station. Phase one of the project is worth between £5m and £8m over a two- to three-year period and covers the set-up and development of a production facility for nuclear waste storage containers. During the second phase, the facility will produce 1,100 of these three-meter-cubed storage waste containers over a period of seven years.

It was a landmark contract for Metalcraft and Avingtrans’ directors rightly describe the potential in nuclear decommissioning as “a cracking opportunity”. I wholeheartedly agree because the first tranche of the contract represents just 10 per cent of the potential business at Sellafield and the nuclear power station will need more than 40,000 of these waste containers over the next 20 to 30 years, according to chairman Roger McDowell. Furthermore, analysts at broker FinnCap estimate that Sellafield represents only half of the potential UK nuclear decommissioning opportunity.

True, with the company’s highly profitable aerospace division sold, Avingtrans’ profits will be modest in the current financial year to the end of May 2017 before the full benefits of the aforementioned contract wins kick in. This explains why analyst David Buxton at FinnCap believes that pre-tax profit can rise more than sixfold to £1.3m on revenue of £31m in the 12 months to the end of May 2018. But the real opportunity here is to scale up the retained businesses through earnings-accretive acquisitions and repeat the success enjoyed in scaling up the aerospace division. And that’s simply not being priced in.

Strip out net funds of 143p a share and the shares are effectively being valued on six times forward earnings per share (EPS) of 7.6p for the forthcoming financial year, a bargain basement valuation that fails to factor in the fine track record of Avingtrans’ management team, or the fact that the earnings risk is heavily skewed to the upside as the aforementioned forecasts only factor in contracts that are already in place. Buy.

CHARIOT OIL & GAS (CHAR)

Aim: Share price: 8.37p

Bid-offer spread: 8.1-8.37p

Market value: £22.5m

Website: chariotoilandgas.com

It’s not often that you are able to buy shares in an oil exploration company marginally above cash on the balance sheet and where there are real prospects of upside on exploration activities, but that’s what’s on offer at Chariot Oil & Gas (CHAR), a minnow with activities in Morocco, Namibia and Brazil.

That’s because the company confirmed a few weeks ago that the Moroccan authorities had approved a farm-out deal for Chariot’s Rabat Deep Offshore permits to a subsidiary of oil giant Eni, which has taken a 40 per cent operated interest in the licence. This reduces Chariot’s equity interest to 10 per cent, but in exchange the company is being fully reimbursed for its back costs, which analyst Werner Riding at broker Peel Hunt estimates at between $3m and $5m, and Eni will also provide a capped carry for Chariot’s share of an exploration well. The JP-1 Jurassic carbonate prospect has gross mean prospective resources of 768m barrels located across a large 200 sq km area and is slated for drilling early in 2018 at a cost of more than $50m, so effectively the first estimate for this deal is around $10m for Chariot’s shareholders. The fact that Chariot has been able to attract a high-quality industry partner is significant, as is the presence of Woodside and the Moroccan government, which both have 25 per cent equity interests. Analysts believe that if operator Eni’s drilling programme hits pay dirt, then JP-1 could be worth 17p a share on a risked basis to Chariot’s shareholders, and 87p a share on an unrisked basis.

Furthermore, Chariot owns a 75 per cent equity interest in the Mohammedia Offshore Exploration Permits adjacent to the Rabat Deep licence area, and is also the operator. This prospect has the potential to be substantially de-risked by the drilling on the JP-1 prospect. The team has identified material prospectivity in the JP-2 prospect and other prospects in the shallower Lower Cretaceous play, which have a combined gross mean prospective resource in the region of 1bn barrels. Chariot will be acquiring 3D seismic data in the early part of this year to investigate the extension of the Lower Cretaceous play into a region with no current seismic coverage.

Of interest too is the company’s activities in offshore Namibia, where it has an 85 per cent operated interest in the Southern Blocks (2714A and 2714B). The partnering process is ongoing, with the data room currently open and showcasing the newly identified AO-1 and AO-2 prospects. In the latest Competent Person’s Report, Netherland Sewell Associates Inc has assigned 8.1 trillion cubic feet and 2.2 trillion cubic feet of gross mean prospective gas resource, respectively, to these two prospects. A partnering programme will be initiated on Chariot’s licences in the Central Blocks in offshore Namibia later this year.

The point is that the potential for either the Eni drilling campaign to hit pay dirt early next year, or for Chariot to farm out its Namibian interests, is not priced in. That’s because the company ended last year with net funds of $25m, a sum worth 7.75p a share. Factor in the back costs to be reimbursed by Eni and in effect the company started 2017 with net funds in line with its market capitalisation. This means that all the company’s exploration assets, which are in the books for $117m, are in the price for free.

Or, to put it another way, with the shares trading on a 80 per cent-plus discount to NAV, this is a low-risk way of gaining exposure to what could be a transformational event for the company and one offering substantial capital upside for shareholders. Buy.

CROSSRIDER (CROS)

Aim: Share price: 50p

Bid-offer spread: 48-50p

Market value: £70.5m

Website: crossrider.com

The business model of online distribution and digital products specialist Crossrider (CROS) has evolved since the company floated on Aim in the autumn of 2014, when it raised £46m at 100p a share. The business is no longer solely focused on monetising web and mobile media through the use of big data, but now has an app distribution platform that its customers can use for marketing their own products. The board is also using the company’s cash-rich balance sheet to add to its product portfolio.

A good example is Crossrider’s bolt-on acquisition a few months ago of DriverAgent, a PC maintenance software products company offering a leading device driver search and update service, which scans computers for outdated drivers. The product is designed for use with desktop computers, tablets and mobile devices and is compatible with all Windows operating systems. It’s popular too, having been downloaded more than 50m times in the past decade. Before the acquisition, Crossrider had successfully promoted DriverAgent on its own proprietary app distribution platform, achieving a 125 per cent increase in revenue from the product and doubling the monthly average gross profit achieved before launch on the platform. In a trading update a few weeks ago, Crossrider’s directors revealed that DriverAgent has been fully integrated into its own proprietary app distribution platform and the $1m (£800,000) acquisition is expected to be earnings accretive in the first year under the company’s ownership.

Crossrider’s web app distribution business also offers Reimage, a patented Microsoft-based product tool that enables customers to clean up their computers. Users are offered a free scan that identifies infected files and then offered the product for $99 before incentives if a repair to their computer is required. I understand that the conversion rate is around 5 per cent, thus providing a decent income stream for Crossrider.

The transition from an advertising technology company to one that provides a distribution platform and product hub for companies focused on digital products as well as its own consumer base makes commercial sense. App distribution accounted for almost two-thirds of Crossrider’s first-half revenue of $28.7m, and at sharply higher margins, reflecting more than 250,000 individual product sales. Rising profitability from this segment is being supported by a move to reduce reliance on outsourcing activities and increase direct control over distribution, thus improving customer service and retention rates with the aim of shifting towards a more recurring revenue base.

The company’s other main activity has two business lines: Ajillion, a white label mobile ad server for ad networks, and agencies; and DefinitiMedia, a mobile ad network. Ajillion enables ad networks to buy and sell mobile advertising capacity from publishers and advertisers and takes a cut of the value of traffic generated across its platform. DefinitiMedia is an advertising network that uses the Ajillion hub to offer managed services through the Ajillion platform. The profit contribution from Crossrider’s media division rose by around 13 per cent in the first half of 2016.

Under the leadership of chief executive Ido Erlichman and finance officer Moran Laufer, who were both brought in last year, the company has successfully restructured its operations, cut $2m of annualised overheads, and hit analysts’ cash profit estimates of $6.4m on revenue of $56.5m in 2016. True, full-year pre-tax profit of around $5.9m will be a quarter below the prior year’s result, a reflection of the decline in its web apps business, which was focused on providing software code to large numbers of independent code developers and small publishers. These developers then incorporated Crossrider’s extensions into their own products, pages and apps, allowing adverts to be served to users, thus generating revenue for the content owner. The problem being that the monetisation methods were intrusive for end users, prompting Crossrider to withdraw from this previously profitable business line.

Clearly, investors have been concerned that Crossrider’s business is in structural decline, hence a share price trading at half the flotation price. However, with the company’s year-end cash pile equating to £58m at current exchange rates, representing 83 per cent of the market capitalisation of £70m, its profitable and growing media and app distribution platform businesses are effectively being valued at only £12m. That’s anomalous considering Crossrider is cashed up for further bolt-on acquisitions, and analysts expect a return to growth in 2017. In fact, Gareth Evans at Progressive Equity Research believes that Crossrider can grow pre-tax profit to $6.7m and generate EPS of 3.4¢ (2.7p) this year, estimates that don’t look out of place to me.

So, with forthcoming full-year results on Tuesday 14 March set to highlight the successful business transition and upbeat trading prospects, a substantial share price re-rating is in order. Buy.

MANAGEMENT CONSULTING (MMC)

Main: Share price: 6.5p

Bid-offer spread: 6-6.5p

Market value: £32.9m

Website: mcgplc.com

As its name implies, Management Consulting's (MMC) business is focused on implementing tangible performance improvements for its corporate clients so that they can achieve their objectives with greater speed, predictability and control.

It’s a slimmed-down version of its former self, having raised around £200m of cash by selling off a raft of profitable operations in the past 12 months, and at eye-catching prices, too, the result of which has been to de-gear the company’s balance sheet and leave it with just one operating unit, Alexander Proudfoot. This business has been around for 65 years, during which time it has completed more than 16,000 projects across the globe, in virtually all business sectors.

However, in recent years its main focus has been on the natural resources sector, a segment that accounted for almost half of ongoing revenue of £25.7m in the first half of 2016. That outcome was

23 per cent higher than in the second half of 2015, but fell well short of the level needed to turn a profit as Management Consulting posted a first underlying loss of £1.9m. The performance reflects challenging conditions in the natural resources industry, although the group did manage to secure increased levels of work from larger global mining groups rather than the mid-market players who have been most affected by the sector weakness. Entering the third quarter with a weaker order book than at the start of 2016 suggests a hefty full-year loss, too, even if the recovery in commodity prices and the Chinese government’s reflationary policies offer some hope that trading prospects could improve this year.

The key point is that this uncertain trading outlook is already fully priced in to the current valuation. In fact, having spent a considerable time unravelling the complex web of corporate transactions – and I hasten to add this was no mean feat – there is obvious value on offer. That’s because the company completed the $165m disposal of its retail and consumer business, Kurt Salmon, in early November and subsequently returned £75m of the proceeds to shareholders. When the circular was sent out in early October outlining the financial implications of the disposal, the sterling-US dollar exchange rate was £1:$1:33. However, by the time the deal actually completed the rate had plunged to £1:$1:23.

This means that effectively Management Consulting received an extra £9.6m of cash proceeds after accounting for transaction fees, non-recurring costs and tax expenses. So, after factoring in all of the disposals made since the end of June last year, I calculate that the company’s pro-forma NAV is around £76.4m, of which net funds account for £62.3m. That cash pile is worth 12.3p a share, or double the current share price.

Of course, the fact that the company is being valued on a massive discount to book value, and on half net cash, is a reflection of the losses Alexander Proudfoot has been making as its commodity sector clients tightened their budgets. However, this balance sheet strength offers the ‘margin of safety’ Benjamin Graham is looking for, and the cash buffer is certainly large enough for Management Consulting to trade through these testing times.

Moreover, I have a feeling that its days as a listed entity are limited. The board has been dramatically slimmed down and now only consists of three non-executive directors and chairman and chief executive Nick Stagg. These directors own less than 0.33 per cent of the share capital, so they have little skin in the game, whereas the company’s two major shareholders – BlueGem Capital Partners LLP and Henderson Global Investors – own more than half the shares in issue. Clearly, they supported the major asset disposals last year, so undoubtedly would not rule out further corporate activity if the price is right.

Bearing this in mind, with the company capitalised at just £33m, over 80 per cent of the fixed assets worth £53.5m are in the price for free, albeit these include £47m of intangible assets. It wouldn’t surprise me at all if predators started sniffing around given the value on offer here. Buy.

TISO BLACKSTAR (TBGR)

Aim: Share price: 55p

Bid-offer spread: 52.5-55p

Market value: £146m

Website: tisoblackstar.com

Aim-traded South Africa-focused investment company Tiso Blackstar (TBGR) may be off the radar of most investors, but it’s worth acquainting yourself with the business as there is an investment opportunity to exploit here.

That’s because the company is turning itself into a single-sector investor in the media industry to build on its wholly owned investment in The Times Media Group (TMG), the premier news group in South Africa, accounting for the highest market share in advertising and circulation in the English language newspaper market as well as a significant portion of the digital news landscape. Titles owned include Business Day, Financial Mail and The Sunday Times. Apart from newsprint, TMG’s activities also encompass television, films and radio stations. In fact, three-quarters of TMG’s cash profit of £23.5m earned in the last financial year came from non-newspaper and magazine activities.

In order to develop this media-only focus, Tiso Blackstar’s board is in the process of selling off noncore assets and just before Christmas announced the R1.5bn (9p) proposed disposal of its 22.9 per cent stake in KTH, another South African investment company. It’s a significant asset sale, as at current exchange rates it will raise £90m of cash for Tiso Blackstar – enough to pay off borrowings that stood at R413m (£25m) at the end of September and leave the company with around £65m of net cash, a sum equating to 44 per cent of its market value, for reinvestment in media-focused businesses. The disposal is expected to complete no later than the end of April. Other assets up for sale include a 51 per cent stake in Robor, a specialist steel manufacturer, and Consolidated Steel Industries, which have a combined price tag of R487m, or £29.2m at current exchange rates, a price tag that equates to just under four times their combined annual cash profit.

So, assuming disposals are achieved in line with the asking price, Tiso Blackstar will have a near £95m war chest available for new investments, as well as owning TMG outright. And there is clear value on offer here because TMG is valued in Tiso Blackstar’s latest accounts at £117m based on current exchange rates. However, with Tiso Blackstar’s market capitalisation of £146m a third below its spot NAV of £210m, then the implied value of the TMG investment is only £51m after factoring in a likely cash pile of £95m after all the asset sales go through. Given that TMG earned cash profit of £23.5m in its last financial year, then it’s effectively being attributed a valuation of just two times cash profit in Tiso Blackstar’s market capitalisation. And that low rating will become obvious for all to see when the company reports its next set of results for the half year to the end of December 2016. Also, there is a stark valuation anomaly with other listed African peers including Nairobi-listed Nation Media (NAI:NMG) and Johannesburg-listed Caxton and CTP Publishers (SJ:CAT), which are both rated on between 10 and 11 times post-tax earnings.

For good measure, Tiso Blackstar’s board is actively using excess cash to buy back shares in the market to try to narrow the share price discount to book value, having purchased 1.4m of the 268m shares in issue since Christmas. There is also a dividend of around 0.5p a share and the board “places emphasis on making some dividend payments on an interim and final basis, with a view to growing the dividend over time”.

I would also flag up that following the completion of the planned migration of the company’s registered office from Malta to the UK in the first half this year, Tiso Blackstar’s board will “investigate the possibility of transferring its current trading on Aim to the London Stock Exchange main market for listed securities to enhance the company’s visibility and share liquidity”. This can only increase investor interest. Buy.

H&T (HAT)

Aim: Share price: 284.5p

Bid-offer spread: 282-284.5p

Market value: £105.3m

Website: handt.co.uk

Shares in pawnbroker H&T (HAT) made it in to my 2015 Bargain Shares Portfolio and have produced a total return of 68 per cent since then, but they are still significantly undervalued.

The re-rating has been underpinned by a sharp operational improvement as highlighted by last month’s pre-close trading update. This revealed strong growth in the company’s personal loans book, which more than doubled from £4.2m to £9.4m, fuelled by customer demand generated through its 181-store estate and a new online offering; and a near-6 per cent rise in the pledge book to £41.9m. A new format for pawnbroking services focused on higher-value loans at lower interest rates and the ongoing slide in sterling, which has enhanced the value of dollar-denominated gold assets, were the key drivers of demand there. Indeed, although the gold price has risen by 13 per cent since the start of 2016, in sterling terms it has shot up by a third to £955 an ounce in the same 13-month period. A rising gold price boosts a pawnbroker’s profits on pledges as it can offer higher-value loans to customers, and also increases profits on pawnbroking scrap and gold buying activities.

In fact, when H&T reports full-year results on Monday 13 March analysts believe that last year’s pre-tax profit will have increased by at least 36 per cent to £9.3m on a modest 5 per cent rise in revenue to £92.7m, a performance that should lift EPS a third higher to 20.5p and support a 12.5 per cent hike in the payout per share to 9p. Moreover, after factoring in an 11 per cent upgrade to 2017 earnings estimates to almost 25p a share, H&T’s shares still only trade on a price/earnings (PE) ratio of 11.5 and offer a prospective dividend yield of 3.8 per cent based on a 2017 payout of 11p a share. For a company that’s generating a return on equity north of 11 per cent, and one that has a lowly geared balance sheet – net debt of £6.5m equates to only 7 per cent of shareholders’ funds of £95.2m – that’s an attractive rating. And so too is a modest price-to-book value ratio of 1.1 times.

True, we are no longer getting all the fixed assets, worth £26.2m, in the price for free, which was the case when I recommended buying the shares two years ago, but equally the company is now in an earnings upgrade cycle, which wasn’t the case back then. This is important as it reduces the investment risk as investors are now more likely to attribute a higher multiple to H&T’s rising earnings. Indeed, in a recent note to clients, analyst Jeremy Grime at broker FinnCap points out that “the company is transitioning from a period of consolidation to a growth company positioned in the developing alternative lending space”, adding that “investors can look forward to a period of successive upgrades as the underleveraged balance sheet, combined with new products growth in a growing market with significant potential, ensure this stock will outperform most other lenders”.

I wholeheartedly agree with those comments, and with H&T’s costs being reduced at the same time as the loan book is growing, so solidly underpinning profit expectations, I see strong potential for the shares to continue their re-rating. A valuation closer to 15 times upgraded earnings estimates and 1.4 times forecast book value, implying fair value around 375p a share, is not unreasonable. Buy.

MANCHESTER & LONDON INVESTMENT TRUST (MNL)

Main: Share price: 290p

Bid-offer spread: 286-290p

Market value: £62.5m

Website: manchesterandlondon.co.uk

It’s not often you get the opportunity to buy shares in US technology giants at a 21 per cent discount to their market value, but that’s what’s on offer at small closed-end investment trust Manchester & London (MNL).

That’s because over half the investment portfolio is invested in US-listed shares with a distinct bias to the technology sector: holdings in Amazon (US:AMZN), Microsoft (US:MSFT), Facebook (US:FB), Alphabet (US:GOOG), Apple (US:AAPL) and Yahoo (US:YHOO) account for around 38 per cent of the portfolio and the investments in tech stocks account for over half the company’s last reported NAV of £79m, or 367p a share.

This hefty sector bias is based on the belief of Manchester & London’s investment managers, led by Mark Shepherd who controls 62.9 per cent of the share capital, that “over the next decade we will see dramatic growth in the following themes: internet of things, electric vehicles, robotics, cloud computing, internet retailing, wearables and the shared economy”. So, to capitalise on this view, they have focused on investing in mega capitalisation stocks or specialist funds, noting that “no other sector can provide the same return on invested capital, margins and growth at similar valuations”. In fact, they have actually increased the tech weightings in the portfolio since the US election.

Manchester & London also has a strong bias towards global healthcare and pharmaceutical investments based on the “exciting prospects for healthcare over the next decade due to Genomics, Immunology and Biologics. We anticipate strong public service pricing pressures, but anticipate the result will be further consolidation to remove duplicated cost structures. Hence, yet again, our strategy is to hold growth-based, multi-product companies that are potential consolidation targets”. Holdings in AstraZeneca (AZK), Beiersdorf (Ger:BEIX), GlaxoSmithKline (GSK), Roche (ROG:VTX), Shire (SHP), Smith & Nephew (SN.), Unilever (ULVR) and Worldwide Healthcare Trust (WWH) account for 22 per cent of the company’s net assets.

True, exposure to multinational consumer goods investments has been shaved since the US election, but the investment managers still believe it’s worth holding “the larger, more global players that are targets for consolidation with top-class brands such as Nivea, Heineken, Dove and Campari, and to cover most positions with short call option strategies”.

Of course, it’s not unusual for shares in an investment trust to trade at a discount to NAV and investors have been rightly cautious on Manchester & London after its NAV per share declined by a third to 293p in the three-year period ending July 2014, and was flat the year after. However, a much-needed change in investment focus, and a hefty overseas exposure, has worked wonders, with the company reporting a total return of 62.5p a share in the 12 months to the end of July 2016, a performance that enabled the board to pay out total dividends of 13.3p a share. In fact, only once in the past decade has the dividend been less than 10p a share, highlighting an important income stream for investors. The fact that Mr Shepperd owns 13.5m of the 21.5m shares in issue means that he has an added incentive to maintain this dividend policy.

Importantly, the company’s NAV per share has continued its upward trajectory, rising from 350p to 367p in the past six months and that’s after paying out total dividends of 10.4p a share. So, although investors started to cotton on to the improved investment performance last summer, the trust’s share price has lagged behind the sharp market rally seen since the EU referendum, so much so that the discount to NAV has actually widened to 21 per cent.

This either implies that investors are sceptical that the company can maintain its much improved investment returns, which have in part been driven by the fall in sterling, or a far more likely explanation is that the small-cap nature of the company and a restricted free float means that it’s below the radar. I side with the latter view and with a hefty ‘margin of safety’ built into the valuation, the risk:reward looks skewed to the upside to me. There is even the chance of netting a couple of centre court tickets at Wimbledon. That’s because the company owns two debentures at the All England Club and holders of at least 2,500 shares are entered into a draw before the annual meeting to win a pair of tickets for each of the 13 days’ play during The Championship. If Manchester & London’s portfolio bias proves on the money, it could be game, set and match for this investment this time next year. Buy.

CENKOS SECURITIES (CNKS)

Aim: Share price: 93p

Bid-offer spread: 90-93p

Market value: £50.6m

Website: cenkos.com

It’s fair to say that 2016 was an annus horribilis for shareholders in corporate broker Cenkos Securities (CNKS) as fundraising activity declined sharply on the junior market. As a financial adviser and nominated broker to 119 companies, Cenkos is at the coal face, and although it managed to raise £529m for clients in the first six months of last year, this was only a quarter of that raised in the first half of 2015, albeit that period included the £1bn fundraising for FTSE 250 constituent BCA Marketplace (BCA). Profit was absolutely smashed, although the company still reported a first-half pre-tax profit of £1.7m on a precipitous 71 per cent decline in revenue to £15.3m.

To compound matters the broker was fined £530,500 by the Financial Conduct Authority (FCA) for regulatory breaches following an investigation into its role as sponsor to insurance services outsourcer Quindell with regards to its proposed move from Aim to the main market in June 2014. The FCA’s investigation concluded last summer, with the regulator acknowledging the remediation programme undertaken by Cenkos to improve its systems and controls in relation to its sponsor services.

In the circumstances it’s hardly surprising that investors jumped ship, myself included as I advised selling the shares at 135p (‘Cenkos profits slide’, 31 March 2016), reversing a previous buy recommendation at 159p (‘Broking for success’, 20 May 2014), although the 30p a share of dividends paid out in the interim compensated.

However, with equity markets on a tear and hitting record highs, Cenkos’s fortunes may be in for a turn for the better. Indeed, in the second half of 2016 it raised £612m across 16 transactions for clients, significantly higher than the £529m raised in the first half. This included some notable fundraisings, including the £350m IPO of Civitas Social Housing, and a £70m placing for oil explorer Hurricane Energy (HUR), a company I have a keen interest in as it’s a core holding of activist investment company Crystal Amber (CRS), a constituent of my 2015 Bargain Shares Portfolio.

The investment case is certainly well supported by the resilient nature of Cenkos’s business model, a key reason why the company has been profitable every year since it was founded a decade ago. Activities include providing corporate broking and securities services to small- and mid-cap growth companies across a wide range of industry sectors, and making markets in the securities of clients where it has a broking relationship. Importantly, the business model has been designed to minimise the impact of lower revenue by ensuring that performance-related pay for Cenkos’s staff falls too as was the case last year.

The flipside is that a relatively low fixed cost base, and a remuneration structure highly geared to performance, results in profit increasing significantly in a positive operating cash cycle. The fact that Cenkos retains a strong and debt-free balance sheet with net funds of £20m at the half-year stage, a sum worth 37p a share, highlights the cash-generative nature of its business model.

Of course, full-year results will not be a pretty sight given the company posted a record pre-tax profit of almost £20m in 2015, but markets are forward looking, which is why bargain hunters have started to pick up the shares. They have good reason to because Cenkos’s business is effectively only being valued at £31m after adjusting for cash on the balance sheet, hardly an exacting valuation for a company that has rewarded shareholders handsomely over the years, having paid out total dividends of 115.5p a share since flotation a decade ago, and repurchased £25.4m of shares for cancellation.

On a bargain ratio of 0.5, with the board having significant skin in the game (combined shareholdings of 26 per cent of the issued share capital), and financial markets more benign, the risk:reward once again looks tilted to the upside. Buy.

Bargain Shares Portfolio: 18-year track record

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Find out how the 2016 Bargain Shares Portfolio fared.