Bargain shares for 2011

Founded in 1992 by executive chairman and chief executive Ken Randall and finance director Alan Quilter, Randall & Quilter is a specialist in managing the run-off of insurance companies and Lloyd's of London syndicates that have stopped underwriting new contracts, but have already settled liabilities arising from policies written.

This is a huge market estimated to be worth nearly £30bn in the UK alone – accounting for 15 per cent of the non-life insurance market – and in excess of $500bn (£316bn) globally, according to research house Equity Development.

To date R&Q has managed the purchase of 17 companies, either for itself or for private equity firm Dukes Place, and currently has a portfolio of nine companies in run-off with net assets of £74m. This insurance investment business posted profits of £4.7m in the first half of last year, but the company also has an insurance services business, which generated £3.9m of profit in the first half. Its principal activities are claims management, accounting, regulatory returns and reinsurance management.

If you deduct central overheads and contributions from a couple of smaller divisions, R&Q reported pre-tax profits of £5.8m in the six-month period. On the same basis, analysts at Numis Securities are looking for pre-tax profits of around £7.3m for the year as a whole, rising to £7.8m in 2011. This should produce EPS of 9.2p and 9.8p, respectively, and fund a full-year dividend of 7.35p as well as offering scope to raise the payout to around 7.75p this year, as brokers predict. In other words, at 91p, the shares are currently offering a chunky forward 8.5 per cent yield – with the dividend covered 1.3 times by earnings – and are rated on a modest PE ratio of nine.

The investment case is even more compelling when you consider that £30m of the company's £80m net assets are in the price for nothing. On a bargain rating of 1.1, and with the high-yielding shares trading 37 per cent below book value of 146p, R&Q is significantly undervalued.

Polo Resources (POL)

Aim: Mining investment company

Share price: 5.2p

Bid-offer spread: 5.17-5.2p

Market capitalisation: £122m

Website: www.poloresources.com

Directors in Polo Resources have been big buyers of its shares lately. Three weeks ago non-executive director Bryan Smith topped up his holding to over 10.3m shares by snapping up a total of 794,000 shares at prices of 5.13p and 5.26p. This follows a similar heavy purchase of 500,000 shares in December.

He is not alone. Regent Mercantile Holdings, a company in which executive chairman Stephen Dattels has a beneficial interest, acquired 15m shares at 4.976p three months ago. At the same time executive co-chairman Neil Herbert purchased 4m shares at 4.99p.

The investment case is pretty simple. The shares trade at a hefty discount to the company's 7.03p net asset value (NAV) as of 31 December, and that discount could get wider still if a proposed cash bid for Caledon Resources goes ahead.

Caledon is a coking coal producer in the Bowen Basin of Queensland. Following a complex series of transactions, Polo has now emerged holding 83.3m shares in Caledon, which is the subject of a 112p a share bid from Chinese group Guangdong Rising. The deal is awaiting approval from the Chinese regulatory authorities, and could net Polo £93.3m if it proceeds.

Polo also holds a 24 per cent shareholding in Bangladesh coal mining company GCM Resources, worth £33m at current market prices. In other words, the stakes in Caledon and GCM alone equate to Polo's market value of £122m.

That's not all. In addition, the company holds net cash and receivables of £28.5m, other investments with a book value of £8.4m and a 3 per cent holding in Ironstone Resources, a private Canadian company which owns the Clear Hills iron ore and vanadium project in Alberta, Canada. Clear Hills currently has a resource of 203m tonnes of iron ore at a grade of 33 per cent, but that could easily be upgraded – work in the 1950s estimated a resource of over 1bn tonnes of iron ore. Any positive news would increase the value of Polo's stake in Ironstone, which it acquired for C$8m (£5m) in December.

If the Caledon takeover completes, Polo's share price will be fully backed by cash and receivables of around £122m, or 5.2p a share. That's worth noting because the board has a history of returning cash to shareholders – it paid a special dividend of 3p a share last summer – and it is likely that some of this cash will be returned to shareholders. Trading on a 29 per cent discount to an indicative NAV of 7.43p a share – assuming the Caledon sale completes – there is scope for the share price discount to significantly narrow in the months ahead. On a bargain rating of 1.0, I would advise following the directors' lead.

Ambrian Capital (AMBR)

Aim: Investment bank

Share price: 29p

Bid-offer spread: 28.5-29.5p

Market capitalisation: £31.1m

Website: www.ambrian.com

Natural resources investment bank Ambrian Capital looks to be in full recovery mode. In a pre-close statement in December, the board revealed that total income for the second half of 2010 will be materially ahead of that reported in the first half, when the company posted underlying pre-tax profits of £70,000 on £7.9m of income. The recovery has been so strong that Ambrian upgraded its earnings guidance again last week and William Howlett, an analyst at broker Macquarie, now expects the company to report adjusted pre-tax profits of £2m in the second half of last year.

The corporate finance and equity division, Ambrian Partners, has completely reversed a first-half loss of £1.8m as second-half revenues more than doubled to over £5.4m and the business is now expected to have made a small profit for the year as a whole. This has been achieved by refocusing on the core sectors – mining, oil & gas and cleantech – and by cutting non-core sector coverage and headcount. Second-half work booked includes a £46.6m placing for Nautical Petroleum, a £28m fund-raising for Archipelago Resources, the IPO of Ferrum Crescent and a £42m fund-raising for Kalahari Minerals. The company has over 30 corporate clients, including Chariot Oil & Gas and Mwana Africa.

Ambrian is also investing more capital in its physical metals and energy products trading division by redeploying the £5m of equity capital invested in its London Metal Exchange futures and options brokerage operation. This looks a sensible move given the LME unit only accounted for £250,000 of annual profits and its physical metals and energy business generates greater returns on capital. In addition, last summer Ambrian established a new division to supply European clients with biodiesel and other renewable fuels and aims to scale up this business in time.

However, this recovery has yet to be reflected in the share price, with the company trading 10 per cent below its NAV of 32.4p a share and a sizeable 17p a share of that is net cash. That should mean the annual 1.5p a share dividend – equating to a 5.2 per cent yield – is safe. In addition, Ambrian has an investment portfolio of around 20 quoted holdings valued at £3.76m at the June half year-end – and unlisted investments worth a further £350,000 – which has been performing strongly.

Trading on a bargain rating of 0.9, and with profits on the up – the second-half profit run rate of £2m is well ahead of Macquarie's £3.7m pre-tax profit forecast for 2011 – Ambrian Capital's shares rate a bargain buy.

Terrace Hill (THG)

Aim: Property development & investment

Share price: 20.25p

Bid-offer spread: 20-20.5p

Market capitalisation: £42m

Website: www.terracehill.co.uk

Aim-traded property developer and investment group Terrace Hill has been recovering well in the past year, reporting pre-tax profits of £8.4m in the 12 months to the end of September and increasing NAV by 7 per cent to 48.3p a share. However, this has been completely overlooked by investors, with the shares trading well under half book value.

And it's not as if borrowings are weighing down the share price, either, as year-end net debt was £90.7m, down from £98.1m a year earlier and representing less than 90 per cent of shareholders' funds of £104m. The latter figure is higher than the reported net assets of £84.1m in the company's accounts and reflects a hefty £18.2m uplift on the £104.9m of development properties held as current assets. But, even if you ignore this chunky unrealised gain, the company's market value of £42m is still half reported NAV.

The loan-to-value ratio on the company's properties is hardly worth worrying about, either, at 55.6 per cent for its commercial property and 72.5 per cent for its residential portfolio. It is also comforting to note that almost half of Terrace Hill's residential property is located in the strong London and the south east market, where values rose by more than 10 per cent in the last financial year which helped its portfolio's value to rise by over 5 per cent. Occupancy rates of 94 per cent and a strong rentals market should help underpin the value of these assets.

The company has been following a low-risk investment strategy on the commercial side, too, focusing on pre-let developments, particularly food stores.

Terrace Hill's joint-venture office and industrial projects have also proved successful, with the remaining office space in its Wilton Road development in Victoria, London, sold in December. The company has now commenced work on another joint-venture scheme encompassing 135,000 sq ft of office and 23,500 sq ft of residential space in Howick Place, Victoria, which completes late next year. The development finance on the scheme is non-recourse so Terrace Hill will benefit from the upside potential without risking shareholders' funds.

True, most of Terrace Hill's debt is short term, with an average maturity of 14 months, and £33.7m is due for repayment in September. But chairman Robert Adair, who owns 130m shares or 61.3 per cent of the share capital, expects this loan to be partially repaid through sales with the balance refinanced. In addition, Terrace Hill share of joint-venture debt is around £135m with an average maturity of 21 months, but the company has mitigated risk by making borrowings non-recourse on most of its joint ventures to protect shareholders.

On a bargain rating of 0.81, and with a number of projects set to complete in the year ahead, the shares have potential for a substantial rerating.

First Property Group (FPO)

Aim: Property fund manager

Share price: 18p

Bid-offer spread: 17.75-18.25p

Market capitalisation: £19.7m

Website: www.fprop.com

European property fund manager First Property Group has been making something of a name for itself and is currently ranked as the best-performing fund manager for central and eastern Europe (versus the benchmark IPD index) and the top-performing manager in Poland since 2005.

At the end of September, around £244m (77 per cent) of assets under management (AUM) were invested in Poland; £59m in the UK and the balance of £12m in Romania. And AUM are likely to increase strongly as First Property won a mandate to manage a £106m UK fund over a seven-year term, of which £45m had been invested at the end of September. Since then a further £32m of properties have been acquired or are under offer, taking the fund up to £77m, at an average initial net yield of 7.47 per cent.

First Property has also launched and invested £7m of its own cash in a pan-European opportunity commercial property fund, Fprop Opportunities. To date, Fprop has acquired one property, a Carrefour hypermarket in Lodz, Poland, for E20m (£17m) which equates to an impressive annual pre-tax return on equity of 30 per cent. All funds invested by First Property in Fprop will be ring-fenced and will be non-recourse to the group.

Not that there is much downside risk to this strategy. The case for exposure to property in Poland is pretty compelling, with the country's GDP forecast to have grown 3.4 per cent last year – the highest in the EU – and expected to top 4 per cent in 2011. Occupancy levels on commercial property are high, rentals are stable and the currency, the zloty, has rallied strongly against the euro and sterling in the past couple of years.

It is also good news for the two properties the company owns directly in Warsaw. The largest investment, Blue Tower in the city's central business district, has been a shrewd investment, rising 40 per cent in value from $12.9m (£8.1m) in December 2008 to $18.1m by last October. Net rental income has increased from $1.08m to $1.47m, which means that the property is still yielding 8.1 per cent, a return high enough to offer scope for further capital appreciation. First Property holds both these properties at cost in its accounts which is significant as this unrealised $5.2m (£3.3m) gain adds over 20 per cent to its reported NAV of £15.7m and means the company is being valued only in line with book value. Moreover, almost £10.2m of its assets were in cash before the company made its £7m cash investment in Fprop.

So, with First Property using its cash to make shrewd investments in a country enjoying a currency tailwind and a strong economy, and its property funds performing well as its ranking testifies, then we can expect profits to rise strongly.

This is exactly what Arden Partners anticipates, pencilling in revenues of £12.2m, pre-tax profits of £3m and EPS of 2.2p in the 12 months to March 2011, increasing to £14.7m, £3.5m and 2.4p, respectively, the year after. Shareholders can also look forward to rising dividends with the full-year payout of 1.08p forecast for the year to March 2011, increasing to 1.13p in the year to March 2012. That means the shares are being rated on only eight times earnings estimates and offer a decent 6 per cent yield. On a bargain rating of 0.73, a re-rating is well overdue.

Shore Capital (SGR)

Aim: Investment bank & asset management

Share price: 27p

Bid-offer spread: 26.5-27.5p

Market capitalisation: £65.9m

Website: www.shorecap.co.uk

For a company that has delivered an average return of 40 per cent a year to its shareholders, measured by the growth in NAV per share and the accumulated dividends paid between 1 January 2000 and 31 December 2009, it seems incredible that you can still buy shares in Shore Capital below book value.

Moreover, net assets of £68.7m look rock solid and include £27.5m of net cash, £1.9m in bonds, £3.4m of quoted equities and £13.8m invested in the asset manager's highly successful Puma Funds. It's not as if those funds under management have been poor performers as the track record of Shore Capital's alternative asset class and structured finance funds is mightily impressive. Total assets under management now exceed £1.28bn and the company reported a pre-tax profit of £1.3m from this operation in the first half of last year.

Shore also has a successful equity capital markets division which posted a first-half profit of £3.4m. In fact, the company is the second-largest market maker on Aim and the third-largest on the main London market, so it should have benefited from the surge in small-cap stocks last year.

Overall, the company reported pre-tax profits of £4.8m on revenues of £18.1m in the first half of 2010 and generated an annualised return on total capital employed of 12.8 per cent. And with chairman Howard Shore controlling 41 per cent of the share capital and managing director Graham Shore holding a further 8.9 per cent, then outside shareholders can expect dividends to remain firmly on the agenda. The company paid out 0.875p a share in 2010.

However, despite these positives, the shares trade slightly below book value even though a high percentage of net assets are in cash and readily realisable assets. That looks anomalous and fails to attribute any value at all to the asset management business the company has built up since it was formed in 1985. Trading on a bargain rating of 0.65, and with Shore Capital clearly able to redeploy its sizeable cash resources on value-enhancing acquisitions, the shares are undervalued.

Victoria (VCP)

Aim: Home furnishings

Share price: 225p

Bid-offer spread: 220-230p

Market capitalisation: £15.6m

Website: www.victoria.plc.co.uk

Manufacturing and supplying carpets can sometimes be a threadbare business, but it would be a mistake to overlook the potential for Victoria to roll out a significant profit recovery this year and next.

That's because 63 per cent of the company's annual revenues come from Australia, one of the few OECD countries to have escaped recession and one that is doing so well that the monetary authorities have already started tightening interest rates to take some of the heat out of the domestic economy.

As a result, the Australian dollar has been rampant, which not only means higher profits for Victoria when they are translated back into sterling, but this positive currency effect also helps to reduce raw material costs (for example, imports of dyed nylons), which is helping to boost margins. Improved capacity utilisation at the company's two Australian woollen mills was also behind the 53 per cent hike in operating profits from the Australian business on modestly higher revenue in the six months to 2 October 2010. And, given the currency tailwind, when these profits were translated back into sterling they surged 80 per cent to £1.7m.

But the average exchange rate used to convert overseas profits was A$1.699; since then, sterling has fallen even further, hitting a low of A$1.522 and is now around A$1.60. So it's increasingly likely that the operating profits from the Australian business could surpass Arden Partners' estimate of £3.25m for the 12 months to 3 April 2011.

Closer to home, things aren't going so well. Victoria's UK and Ireland businesses both posted first-half losses of around £240,000, although the UK operation is expected to return to profitability in the second half as it has now managed to pass on higher wool prices to customers. These are at the mid to high end of the market and include retailers such as John Lewis. As a result, Arden is looking for full-year operating profit of £400,000 from the UK side, which implies a sharp profit recovery.

By contrast, the Irish business is only expected to break even by the financial year-end and is forecast to rack up second-half losses of £150,000. Assuming these scenarios pan out, then Arden Partners' full-year pre-tax profit forecast of £1.6m is looking pretty conservative, as is the estimate of £2.2m for the year to April 2012 – which would produce EPS of 18.5p and puts the shares on a modest forward PE ratio of 12. The board is certainly confident enough to have raised the half-year dividend by 15 per cent to 3p and analysts expect the full-year payout to be raised from 8p to 9p, increasing again to 10p in the year to April 2012. So, with the shares trading at 225p, the forward yield is a decent looking 4 per cent, increasing to 4.5 per cent the year after.

But the best part of all is that we can buy into this recovery story at a massive discount to book value. In fact, net assets of £37.6m – mostly property, plant and equipment and inventories – dwarf the company's market value of £15.6m. And it's not as if finances are stretched as net debt of £8.6m is a modest 23 per cent of shareholders' funds. So, we are getting £22m of property in the price for nothing. On a bargain rating of 0.55, Victoria's shares are well worth a spin in this year's portfolio.

PV Crystalox Solar (PVCS)

Solar-wafer manufacturer

Share price: 57p

Bid-offer spread: 56.75-57.25p

Market capitalisation: £236m

Website: www.pvcrystalox.com

When PV Crystalox Solar (PVCS) floated in June 2007, raising £49.5m at 130p a share, investors had every right to believe the solar-wafer manufacturer was going to be a good play on global growth in solar-power installations. The company came to the market boasting a 25-year track record as a producer of quality, low-cost solar wafers and had a business supported by long-term supply contracts. It was very profitable, too, generating pre-tax profits of Ä49m (£41.8m) on revenues of Ä242m in 2006.

However, the industry was hit hard by the global credit crunch, which not only subdued demand for solar installations, but led to customers renegotiating and postponing contracts. Profits slumped from a peak of Ä147m in 2008 to Ä43m in 2009, and analysts at JP Morgan Cazenove expect them to drop to Ä30m in 2010, producing adjusted EPS of around 5.1¢, or 4.3p a share. It's hardly surprising that the shares, which fell to an all-time low of 43p last May, have been under severe pressure.

However, 2010 is likely to mark the low point for PV Crystal Solar and analysts expect 2011 profits and EPS to bounce back to Ä42m and 7.2¢, respectively. This makes the shares an interesting proposition, since they trade well below book value, are rated on a forward PE ratio of nine and are supported by a dividend of 3¢ (2.55p). The company also has Ä50m of net cash, although this has been earmarked for investment in new production facilities as the company ramps up capacity from 400MWp to 500MWp by the end of March, 630MWp by the year-end and 800MWp by the end of 2012. Each stage of the expansion will cost around Ä25m-Ä35m to fund, but it looks money well spent given that 75 per cent of output is sold into growing Asian markets – Taiwan now accounts for 20 per cent of sales, China is the second-largest geographic location (over 30 per cent of revenues) and Japan remains the largest market (39 per cent in the first half of 2010).

On the back of sales into these Asian end-markets, analysts expect wafer shipments to rise from 350MW in 2010 to 475MW this year. So, although average selling prices (per Wp) are set to decline from 72¢ to 64¢, production costs are also expected to fall by 12 per cent to 55¢, which supports the earnings estimates outlined above. On a bargain rating of 0.46, the shares look priced to shine this year.

Noble Investments (NBL)

Aim: General financials

Share price: 149.5p

Bid-offer spread: 148-151p

Market capitalisation: £22m

Website: www.nobleinvestmentsplc.co.uk

Aim-traded rare coin trading company Noble Investments may have only been formed eight years ago, but its business is one of the oldest around. In 2005, it acquired AH Baldwin, a numismatic dealer and auctioneer established in 1872 and which now offers customers the ability to buy and sell coins over the counter, online or through around 20 auctions held each year in London, New York and Hong Kong. It looks a bargain buy at £4.5m, but more of that later. Noble is also making its mark in the stamp world, having acquired Lingfield-based Apex Philatelics, a trader and auctioneer of postage stamps, for £1.25m in 2008.

The company's combined client base is now around 45,000 and includes high-net-worth individuals looking to invest into what has been a high-growth market. In fact, according to Noble, a notional portfolio of coins comprising a basket of gold, silver, copper, bronze and tin examples has increased by 187 per cent since 2000 or a compound annual growth rate of 11 per cent.

And these impressive returns are hardly unusual as a rare collection of US gold coins acquired by New York City lawyer Harold Bareford was auctioned by his heirs for $1.2m in 1978 – 87 times the amount he paid for them. Mr Bareford started his collection in the late 1940s and stopped buying in 1955. These include a 1933 eagle ($10 gold piece) which fetched $92,500 in 1978 compared with a purchase price of $310 in 1947.

Business has been booming as investors seek out alternative investments. Noble has almost doubled revenues to £14.1m in the last four financial years and more than doubled operating profits to £2.2m. As a result, adjusted EPS have risen from 6.2p to 10.1p and with the benefit of an ungeared balance sheet – net funds stood at £3.5m at the August 2010 year-end – dividends have risen sharply from 1p to 3.5p. Admittedly, this is partly reflected in a share price rating of 13 times earnings for the current financial year, and a market value (£22m) that's over 50 per cent higher than net assets (£13.5m).

However, there is hidden value in some of those assets. Firstly, the rare coin collection acquired as part of the AH Baldwin purchase is recorded in the balance sheet at cost, so fails to recognise the sharp rise in the coin market in the past five years. Analyst Eric Burns of WH Ireland believes that the true value of inventories held could be £1.85m higher than the reported figure of £7.23m, based on a 10 per cent annual appreciation in these rare coins.

In addition, Noble owns a 4,700 sq ft freehold property off The Strand, London, which is in the books for £1.15m. Mr Burns conservatively estimates this property could be worth £3m, a further £1.85m uplift. Noble also owns 13m shares in Aim-traded Avarae Coins, which have a market value of £1.2m or £75,000 above book value. In other words, the true NAV of Noble is nearer £17.3m, and even that could be a very conservative estimate.

Sensibly, Noble has been using its cash pile to buy back shares, having repurchased 1m at an average of 103p in the last financial year. This not only boosts EPS given the low returns on cash deposits right now, but in effect puts a floor under the share price. It's a sensible use of capital because if you strip out the £3.5m cash pile and the £1.2m quoted investment in Avarae, then Noble's market value is only modestly above the value of the company's property and stocks. So the current share price attributes hardly any value to the business itself – which WH Ireland expects to turn in operating profits of £2.3m this year. Trading on a bargain rating of 0.44, investors in Noble can expect to coin it in for some time yet.

Pilat Media Global (PGB)

Aim: Business management software

Share price: 45.5p

Bid-offer spread: 45-46p

Market capitalisation: £27.4m

Website: www.pilatmedia.com

Pilat Media Global is fairly unusual in being dual listed on London's Alternative Investment Market and the Tel Aviv stock market. It is also a small-cap company in recovery mode.

The business develops, markets and supports business management software for content and service providers in the media industry. Designed with the direct involvement of top-tier broadcasters, Pilat Media's main product, IBMS – a business-management system for large broadcasters – manages workflows, channel scheduling, airtime pricing and billings. These help streamline the running of TV businesses and can be used throughout the entire broadcast cycle right through to post-production processing, transmission, reconciliation and finance.

Pilat's client list is pretty impressive, too, including FOX, AT&T, Virgin Media, BBC, Sky Italia, ESPN Star Sports and Foxtel. The business has also been winning some significant contracts, including a seven-year deal with a new media client in Australia worth £3.6m which was announced last month. This follows a similar contract, worth £7.1m in fees over the next two to three years, with a major US telecoms company for the licensing, implementation and maintenance of IBMS.

This success is not being lost on SintecMedia, a private company that is also engaged in the development and marketing of business management software for broadcasters. In December, SintecMedia snapped up almost 1m shares in Pilat on top of a previous purchase of 813,000 shares last year, and bought a further 100,000 shares this week to take its stake to 20.91 per cent. This is the seventh major purchase of shares by SintecMedia since it failed in an attempt to acquire Pilat in May 2009.

It's easy to understand SintecMedia's interest given analysts expect Pilat's pre-tax profits to surge to around £3.4m in 2011. If this forecast is met, then the shares are trading on a modest forward 11 times adjusted EPS of 4p. Moreover, the company also has a strong and cash-rich balance sheet, boasting net funds of £4.2m – or 7p a share – and net assets of £18.2m, or over 30p a share. And the business is clearly cash-generative, having increased net cash by £1.8m in the first nine months of 2010. Trading on a bargain rating of 0.46, with profits recovering strongly and stake-building in evidence too, the investment case is pretty compelling.