Of course, what I may ascertain to be fair value is not necessarily what other investors may conclude. That’s what makes a market. Moreover, sometimes I can be too conservative in my initial analysis, so it’s only sensible to review the valuation assumptions I made in the first place to ascertain whether I am being overly cautious and an even higher rating is warranted.
And this is the very reason why I have been maintaining run profit recommendations on a raft of companies I have previously advised buying shares in even though they have hit my target prices. In fact, since the start of this year I have written 100 investment columns and given 159 share recommendations, all of which are available on the following page.
Of these share recommendations I have advised running profits on 28 occasions, taking profits or cutting losses on 16 recommendations, rated the shares a hold on 12 occasions, seen three companies taken over, and given outright buy advice on around 100 of those 159 recommendations.
Looking back at the first 16 weeks of this year, it’s clear to me that the right stance to take was to back my judgement on the majority of the profitable past winners and maintain exposure even though the general economic and stock market backdrop was at times worrying, and at best frightening. Indeed, if I had bailed out and you followed that advice then you would have missed out on some significant gains. It's also paid to initiate coverage on a host of special situations irrespective of the market backdrop including the best perfomer in my 2016 Bargain share portfolio, Juridica (JIL: 58.5p), a financial services company that's in the process of winding itself up and returning cash to shareholders.
Bumper retail bond issue boosts Burford Capital
For instance, at the start of the year I recommended running profits on Aim-traded Burford Capital (BUR:285p), the world's largest provider of investment capital and professional services for litigation cases to lawyers and clients engaged in major litigation and arbitration. The price at the time was 196p ('Stock check', 5 Jan 2016), a hefty gain on my recommended buy in price of 146p last summer ('Legal eagles', 8 Jun 2015). By the time I updated my view a month ago the price had risen to 256p (‘Legal eagle flying high’, 24 March 2016) and since then has risen another 20 per cent to a record high of 310p on Friday, 15 April.
It looks justified too because Burford posted full-year EPS of 31.5¢ (22p) in 2015, beating consensus EPS estimates of 23.7¢ by a thumping 35 per cent, and hiked the dividend by 14 per cent to 8¢ (5.6p), which means that the payout has been raised by 153 per cent in the past five financial years. RBC Capital Markets' top of the range predictions point to the payout being raised by 25 per cent to 10¢ (7p) this year based on EPS rising from 31.5¢ to 37¢ (26p), having upgraded EPS estimates by 23 per cent post the full-year results. On this basis, the shares still only trade on 11 times full-year earnings estimates and offer a prospective dividend yield of almost 2.5 per cent.
Moreover, Burford has just raised £100m through an oversubscribed retail bond issue which will be listed on London Stock Exchange's Order Book for Retail Bonds (ORB) platform. The bonds will pay interest at an annual rate of 6.125 per cent and mature in October 2024. The company previously raised £90m on an eight-year retail bond priced at a coupon rate of 6.5 per cent in 2014, so the latest issue is more keenly priced, highlighting the strong fixed-income investor demand for Burford’s credit. Bond investors are clearly happy with the bond’s pricing, and so should shareholders be given that the company will recycle the cash into a large and diversified portfolio of legal cases selected by advisers who have never produced a return on invested capital below 50 per cent on any concluded case in the past five years; and generated an internal rate of return on these concluded cases of 28 per cent, or more than four times higher than the cost of the retail bond being issued.
So, with the company’s legal eagles continuing to back the right cases, making thumping returns for shareholders, and the company well funded, I have no hesitation advising running your near 100 per cent paper profits.
Into orbit
It hasn’t taken long for investors to cotton onto the investment merits of Satellite Solutions Worldwide (SAT: 8.5p), a satellite internet service provider that provides an alternative high-speed broadband service. The company listed on Aim last May and I recommended buying the shares at 5.5p only a month ago, targeting a 12-month fair value range between 9p to 10p ('Blue sky tech play', 21 Mar 2016).
At the time I noted that the company offered the compelling mix of a rapidly expanding customer base, rising margins, a move to profitability, and a likely stream of positive newsflow on earnings-accretive acquisitions. There is a lot to like, and I wasn’t the only one impressed as the bottom end of my target range was reached early this week when the shares hit a high of 9.2p. So some of you should be sitting on 50 per cent plus return on your investments.
To put the current rating into some perspective, analysts at house broker Arden Partners predict that, excluding further customer acquisitions, Satellite Solutions’ current client base should be able to produce revenues of £15.6m in the 12 months to end November 2017 to generate pre-tax profits of £1.4m and EPS of 0.47p. In other words, the shares are now trading on 17 times forward earnings, but forecasts look firmly skewed to the upside given the ambition of the board to grow the business both organically and by acquiring more European satellite service resellers.
Moreover, Satellite Solutions has the infrastructure to act as a consolidator in a fragmented market, having invested about £1m in a scalable customer servicing platform with the capacity to handle 100,000 customers, four times the current number. I am willing to back them to do so, and would recommend you run your hefty profits ahead of news on further earnings accretive bolt-on acquisitions. On a bid-offer spread of 8.25p to 8.5p, I would run profits.
K3 re-rating set to continue
Shares in Aim-traded retail software company K3 Business Technology (KBT: 341p), the Salford-based supplier of software to the retail, manufacturing and logistics sectors and provider of managed IT and web hosting services, have drifted off slightly off their autumn highs (‘In the money’, 9 November 2015), but I still feel it’s worth running profits if you followed my earlier advice to buy at 220p ('Tapping into retail growth', 16 Sep 2014).
I have taken a close look at the recent interim results and feel that the company is well on course to deliver the sharp uplift in underlying full-year pre-tax profits from £7.2m to £9.2m as predicted by analyst Katherine Thompson at Edison Investment Research. In the six months to end December 2016, pre-tax profits increased by a third to £4.78m, so more than half that 12 month estimate has been booked already. Moreover, with the benefit of a strong order book, improved margins on the back of a higher proportion of sales of the company’s own-IP products, and the company winning major contracts for its "ax|is fashion" solution with major German online retailers, then there are sound reasons to remain positive.
Cash generation is strong, so much so that net debt is expected to fall from £12.1m to £10m in the 12 months to end June 2016, implying balance sheet gearing of only 17 per cent. Part of this cashflow is expected to fund a 10 per cent hike in the dividend per share to 1.65p, following a 20 per cent increase in the previous financial year. It’s well covered too by EPS of 23.3p, up from 19.1p a year earlier, and is likely to remain so if K3 grows EPS to somewhere between 25.6p and 26.8p in the financial year to June 2017 as analysts at Edison and finnCap respectively forecast. Given the momentum in the business, I feel comfortable with those estimates.
I also believe that a forward earnings multiple of 12.5 times is an unwarranted 20 per cent discount to the average rating for small cap IT and software companies in K3’s space. A valuation closer to 400p is justified to bring the rating into line with peers – Edison has fair value of at least 384p and finnCap has a target price of 435p.
So, ahead of a pre-close trading update in early July I would continue to run your 55 per cent gains. Run profits.
