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The 8 bargain shares for 2010

FEATURE: Simon Thompson selects the best bargains on the market using a system devised by legendary inveestor Benjamin Graham.
February 12, 2010

Simon Thompson has run the bargain portfolio rule over 2,800 listed businesses to come up with a portfolio of companies where the asset backing should be strong enough to overcome any short-term trading difficulties. Here are 2010's bargain shares:

TELFORD HOMES (TEF)

Share price: 94.5p, Market capitalisation: £38.2m

Website: www.telfordhomes-ir.co.uk

Housebuilder

At first sight it seems remarkable that East London homebuilder Telford Homes managed to turn in pre-tax profits of £6.5m and EPS of 10.6p in the six months to 30 September 2009 against £7.3m for the whole of the prior financial year. Completions almost doubled to 224 homes (average selling price of £228,000) on the same trading period in 2008 despite the restricted availability of mortgage finance that has made it difficult for off-plan investment buyers to fund their purchases.

However, the London market has clearly recovered strongly from the dark days following the Lehman Brothers crisis 15 months ago, so much so that Telford is confident enough to develop the third and final phase of its Queen Mary's Gate development in Woodford. It also reports a total of 52 off-plan sales, mainly at Greenwich Creekside, due for completion from this year onwards, which indicates that the investor market is showing some signs of life. And of the 57 pre-sold units that have failed to complete since last April, Telford has so far sold 44 of these homes. Including the retained 10 per cent deposits on the rescinded contracts, it has generated the same amount of revenues as the original sales. In fact, it has weathered the credit crisis far better than other builders as no fewer than 470 of the 613 pre-sold homes due for completion between October 2008 and March 2010 have either been completed or re-sold.

Including Telford's affordable housing business, the company has a total of 2,368 homes in its pipeline (99 per cent of which have planning permission). Of these, 1,234 units are currently under construction and 821 have been pre-sold either on the open market or for affordable housing. That is important as Telford is carrying £71.3m of debt on its balance sheet and therefore needs to convert its £146m of inventories into cash to pay down those borrowings. If it manages to do so, and the forward sales are encouraging, then the shares are clearly in bargain portfolio territory as the company's £38m market value is a hefty 30 per cent below the last reported net asset value (NAV) of £54.7m. The board seems confident enough as it reinstated the dividend at the time of the half-year results in early December.

And as an added kicker, the 2012 Olympics are now rapidly approaching, which could create wider investor interest on the merits on the regeneration of East London. Trading on an attractive bargain rating of 1.42 the shares look built on solid foundations.

MJ GLEESON (GLE)

Share price: 138p, Market capitalisation: £72.5m

Website: www.mjgleeson.com

Urban regeneration & strategic land specialist

The trading statement from MJ Gleeson in late November made for very interesting reading especially since it came only two months after the company had posted a loss of £8.3m in the financial year to end June 2009, and that was before it took a hefty £46m exceptional hit mainly from asset write-downs. As a result, the company's NAV had plunged from £159m to £103m by the year-end.

However, the management team notes that in the past few months sales from its regeneration and home division have exceeded expectations and selling prices have not only stabilised, but have actually risen in some segments of the market. This division mainly focuses on brownfield sites in the north of England, and of the 317 sales last financial year, around half were to the private sector at an affordable average selling price of £107,000.

Gleeson notes that demand from housebuilders for land has increased in recent months, too, which is good news for the company's strategic land division which owns a portfolio of 3l,755 acres in the south of England, including 1,700 plots of residential land with approved planning consent. As a result it now expects to bring a number of sites onto the market this year.

The company also has other businesses in social housing maintenance (annual profits of around £1m); a private finance initiative (PFI) division that holds investments in four PFI projects; and a commercial property arm that is in run-off. The latter now has two sites remaining for disposal (net book value of £5.9m) which when sold will give a useful boost to the company's current net cash position of £19.7m (up from £10.9m at the end of June).

Ultimately, Gleeson's long-term prospects rest on a sustained recovery in the housing market to return the business to profitability. However, there is also a short-term investment opportunity here as, even after those hefty asset write-downs, the company's market value of £72.5m is still significantly below the last reported NAV of £103m. In fact, even if we attribute no value at all to the £22m of fixed assets on Gleeson's balance sheet, the company's current assets of £119m exceed its liabilities by £81.4m which is more than its market capitalisation. In other words we are getting the fixed assets thrown in for free. And remember that more than half of those liabilities are backed by the company's burgeoning cash pile.

So, with no finance issues to worry about, the business cash generative and the housing market showing embryonic signs of recovery, the shares are worth buying on a bargain rating of 1.12.

JACQUES VERT (JQV)

Share price: 14.5p, Market capitalisation: £27.9m

Website: www.jacques-vert-plc.co.uk

General retailers

The clothing retailer behind high-street brands Precis Petit, Windsmoor and Planet put on a very chic financial performance in its latest six-month trading period. Reported pre-tax profits of £2.9m were £800,000 above broker estimates and reflected a much improved margin performance (gross margin was up almost 3 percentage points) on the back of improved input prices, mainly from Far East suppliers and lower promotional spending.

At the same time Jacques Vert has ramped up its internet offering, albeit from a low base, using its own website and leveraging off the online portals of Debenhams and John Lewis. So although group sales overall edged up 2 per cent to £55.8m in the half-year period to end-October, the combination of better costs management and a good response to its autumn/winter ranges meant that profits shot up from £1.1m to £2.9m. And brokers expect this momentum to be maintained with Numis Securities expecting pre-tax profits to more than double from £2.1m to £4.8m in the 12 months to the end of April. Those estimates certainly look achievable as underlying sales, both online and through the 1,030 outlets selling the company's brands, have risen by over 2 per cent in the 10 weeks since 24 October.

It's worth noting that Jacques Vert's bumper profits will not be going to the taxman, either, as the company has enough tax losses to offset its UK tax liabilities for the next couple of years. On an earnings basis, the shares look dirt cheap trading on around six times full-year earnings estimates of 2.5p, but even on a 30 per cent tax charge they would still be cheap. And it gets better when you consider that Jacques Vert's burgeoning cash pile of £10.2m accounts for almost half its shareholders' funds of £21.3m and means that around 5.3p of the current 14.5p share price is fully backed by cash.

Trading on a bargain rating of 0.52, and with the retailer's lines proving a hit with the ladies, the shares are dressed for a major rerating.

BLOOMSBURY PUBLISHING (BMY)

Share price: 129p, Market capitalisation: £95m

Website: www.bloomsbury.com

General retailers

Life after Harry has been anything but magic for the publisher of JK Rowling's famous Harry Potter books. It was always going to be a hard act to follow as the series sold more than 400m copies worldwide and the last four novels consecutively set records as the fastest-selling books in history. This led to wizard profits for the company that boarded the Hogwarts Express in 1997 when it published the first book, Harry Potter and the Philosopher's Stone.

By the time JK Rowling had released her seventh and final book, Harry Potter and the Deathly Hallows, a decade later, Bloomsbury Publishing's revenues and pre-tax profits had soared to £150m and £17.9m, respectively. But without Harry's financial wizardry brokers' estimate that revenues fell to around £85m last year and profits more than halved to £8.2m. The shares have been under a spell, too, falling from an all-time high of 396p in 2005 to a 10-year low of 114p last summer.

However, there are reasons to believe the sell-off has gone too far. For starters, at the current share price Bloomsbury has a lowly market value of £95m, which is not only below its last reported NAV of £109m, but means that almost half its £30m of fixed assets are in the price for free. And it's not as if the company has any financial issues as current assets of £102m - representing inventories, trade and receivables and a hefty £35m cash pile - exceed total liabilities of £23.5m by a hefty margin.

Moreover, the earnings decline may have hit a low point last year as analysts expect revenues to recover to £90m in 2010, which will help pre-tax profits rise from £8.2m to around £9m. Strip out that hefty cash pile and a business generating cash profits of £9.2m is in effect being valued at a bargain basement £60m. A forecast free cash-flow yield of 13 per cent is pretty impressive, too, using estimates from analysts at KBC Peel Hunt.

It's worth pointing out that Bloomsbury has diversified its revenue base, helped in part by acquisitions. For example, following four acquisitions in 2008 the company spent £10.4m six months ago on a specialist publisher in tax and law and some of Hodder Higher Education textbook lists which brings in combined annual operating profits of almost £1m. The management team, led by founder and chief executive Nigel Newton, is also building up a number of database and management contracts to improve cash flow and profit visibility, and in December signed a deal to set up a new scientific journal publishing house in Qatar.

So with profits set for recovery this year, and Bloomsbury sitting on a sizeable war chest for selective earnings enhancing acquisitions, the shares are an attractive proposition on a bargain rating of 0.83.

DELTA (DLTA)

Share price: 147p, Market capitalisation: £226m

Website: www.deltaplc.com

General industrials

Industrial manufacturer Delta has three main divisions, the largest of which is Engineered Steel Products which produces road-safety barrier systems, power transmission, lighting and telecoms poles, industrial access systems and forged steel grinding media.

It's very pretty profitable, too, reporting operating profits of £15.6m on £111m of sales in the first half last year and accounting for two-thirds of group sales and profits. Moreover, despite the economic downturn, the business is proving resilient with margins improving, helped in part by tighter cost management and operational efficiencies. It's worth pointing out that Delta's Donhad subsidiary manufactures forged steel grinding media for the mining industry and operates from three plants in Australia, and is therefore heavily weighted towards the gold and copper segments, both of which have been buoyant in the last 12 months. Admittedly, the strength of the Australian dollar is starting to encourage some miners to source grinding media offshore, but prospects for this major profit earner still look sound.

Delta also has an interest in a South African galvanising services business, Delta EMD, which is a leading global supplier of electrolytic manganese dioxide (EMD) used in the manufacture of disposable batteries worldwide. Delta EMD is listed on the Johannesburg Stock Exchange and Delta plc holds 56.4 per cent of the outstanding shares. Delta EMD is forecast to report post-tax profits of around £10m in 2009 and the group announced in January that it is in the process of disposing of the operation. At current market prices Delta plc's stake in Delta EMD is worth around £28m.

In addition, Delta owns a 49 per cent shareholding in Manganese Metal Company (MMC), a global supplier of electrolytic manganese metal used in the production of steel, aluminium and electronic components. MMC produces only selenium-free electrolytic manganese - the purest form of manganese - to meet the needs of its customers around the world. BHP Billiton owns the other 51 per cent stake in MMC, and although Delta is negotiating the sale of this shareholding, a deal has yet to be finalised. In the first half of 2009, Delta's share of MMC's after-tax profit was £2.7m.

The investment case becomes even more attractive when you consider that Delta's current market value of £226m is not only well below the group's NAV of £244m, but a hefty £131m of those net assets are already in cash. If we add on conservative proceeds from the sale of the stakes in MMC and Delta EMD, it's not unrealistic to arrive at a pro-forma net cash position of around £180m. In other words, if the above disposals take place then around 74 per cent of Delta's market value could be fully backed by cash, which means we are in effect getting its engineered steel products business and a galvanised services operation - combined operating profits of £19.3m in the first six months of last year - for a bargain basement £64m.

On a bargain rating of 0.65, and trading on a modest nine times earnings estimates, Delta's shares are due a rerating and one that could be helped by news of not one, but two major asset sales.

KBC ADVANCED TECHNOLOGIES (KBC)

Share price: 40p, Market capitalisation: £22.9m

Website: www.kbcat.com

Consultant to energy industry

For over 30 years KBC's consultants have provided strategic and engineering expertise to enable energy clients to manage risk, improve strategic decisions, increase operating performance and comply with environmental regulations.

It's a profitable niche to be in as KBC won contracts worth more than £55m last year, up 7 per cent on 2008, and ended 2009 with a closing workload backlog of over £40m. Contracts won in the final quarter included its largest deal ever with Petrobas, the state national oil company of Brazil, for the licensing of the company's refinery simulation software, Petro-SIM™. Other awards include contracts with Sinospec in China, TNK-BP in Russia and Qatar Petroleum. There were also license renewals with Repsol in Europe and South America.

Forecasting the timing of new business is difficult, though, as the refining industry is currently characterised by continued investment and expansion in the developing world and overcapacity and margin pressure in the developed world. In turn, this has led to greater competition as the larger engineering contractors are less busy and perhaps this is one reason why the shares trade on only eight times earnings estimates.

That said, KBC started 2010 with a higher backlog and a lower cost base than in 2009 and with an improved suite of services and products to offer clients. And the company's board was confident enough in this year's prospects to raise the dividend from 0.35p to 0.45p at the half-year stage. So even if the final dividend is maintained at 1p a share, the running yield is still a very decent 3.6 per cent. There is no reason why the payout shouldn't be increased as net cash more than doubled to £4m in the second half last year.

The shares also look undervalued using a balance-sheet approach. In fact, at the current share price of 40p, KBC commands a modest market value of £22.9m which is 16 per cent below its last reported NAV of £27.3m at the end of June. There is little reason to warrant a discount at all as the company has no funding issues - current assets of £23.2m (mainly trade and receivables) comfortably exceed total liabilities of £8.5m. So in effect we are getting a third of the company's £12.6m of fixed assets thrown in for free. True, that may not be all of the fixed assets as Ben Graham wanted, but it is generous enough considering that KBC is hardly struggling for business as its current order backlog represents around 75 per cent of the company's annual revenues.

Trading on a bargain rating of 0.64, the shares may be unloved, but they offer value nonetheless.

ACAL (ACL)

Share price: 132p, Market capitalisation: £37.5m

Website: www.acalplc.co.uk

Electrical & electronic equipment

Acal has been distributing electronic components across Europe since 1986, operating in 12 countries and boasting a base of over 5,000 active customers. This has been a tough market to be in recently with the International Distribution of Electronics Association noting that this market collapsed by 25 per cent between March and September last year. As a result, Acal's main revenue generator was hit hard and the business posted a £1.5m loss in this six-month period on revenues of £39.4m, down from £51.4m a year earlier.

However, swift action to reduce headcount and overheads has reduced operating expenses by over £700,000 a month and management has sensibly kept a tight rein on working capital by reducing inventories. Combined with a stabilisation in sales since the half year-end, and improved order rate flows in the second half, this division was operating at break even by the end of last year.

Acal's IT supply chain division has also been finding the going tough, but still managed to stay in the black and reported profits of £0.6m on £29.2m of sales in the first half to end-September 2009. The division's activities includes supplying ATM parts and services to banks, OEMs, maintainers and repairers and distributing parts for products such as laptops, servers and printers.

In addition, Acal has a small medical scientific business, specialising in supplying high-quality radiology and bone densitometry equipment. This has exposure mainly to the NHS, and as a result has been suffering from deferral of budget spend. Still, the business managed to post first-half profits of £200,000 on sales of £2.9m.

Despite the undoubted tough backdrop facing all three of Acal's divisions, the company managed to operate at break-even during both October and November. And the €10m (£8.7m) acquisition of BFi OPTiLAS in December should help a return to overall profitability as it not only enhances Acal's position in the electronic and photonics distribution market, but will enable the company to cut around £4.3m from its annual operating expenses.

The board seem confident enough in Acal's recovery prospects, having approved the payment of a half-year dividend of 2.33p last month. Even if the final dividend is held at this level, the shares offer a decent 3.5 per cent yield, especially for a recovery play. And that can only be helped with the appointment of Ian Fraser, the well-respected chief executive of Brammer, as a non-executive director.

However, this recovery story seems to have been overlooked by investors with the shares not only trading at a 30 per cent discount to NAV, but backed by cash on the balance sheet equating to around half the current share price even after accounting for the recent acquisition. In fact, even if we write off all of Acal's £22.3m-worth of fixed assets, the company still has adjusted net assets (after deducting all liabilities) of £31.6m. That compares favourably with a market value of £37.5m to give an attractive bargain rating of 0.84.

BOWLEVEN (BLVN)

Share price: 103p, Market capitalisation: £205m

Website: www.bowleven.com

Oil exploration and production

When Kevin Hart, chief executive of BowLeven, reported his group's preliminary results in November, he noted that "2010 is shaping up to be the most active period in the West African oil and gas exploration group's history….with a scheduled work programme that will shape its history." Whether his optimism proves founded will be determined by a drilling campaign in the shallow waters of the Etinde Permit off the coast of Cameroon. The omens are good, though, as the company has drilled four wells on the permit in the past three years and all have been successful.

Swiss oil investment company Vitol was certainly bullish enough six months ago to have agreed to fund a $100m (£61.5m) gross work programme in return for a 25 per cent interest in Etinde. It also has an option to acquire a further 25 per cent interest in the project in return for funding an additional $100m gross work programme as well as paying Bowleven $25m in cash.

The plan now is to drill four further wells on Etinde with the aim of proving up reserves and commercialising the discoveries towards production. The first work is scheduled for April/May with the spudding of an appraisal well on the important Isongo E field, which brokers think could hold 32m barrels of recoverable gas condensate and 27m barrels of oil equivalent of gas. The company will then drill an appraisal well on the Isongo F field, which could feasibly hold between 53 and 80m barrels of oil, before focusing on high-impact exploration activity. Drilling in Cameroon aside, Bowleven also plans drilling an exploration well this year on the Epaemeno Permit, offshore Gabon, in which the company has a 50 per cent non-operated equity interest alongside partner Addax Petroleum.

The story gets even better when you consider that BowLeven has net assets of $426m which at current exchange rates equates to £263m, or 136p a share. That's a hefty 30 per cent more than its current market value so we are getting some of its assets for free to start with, and that's before we factor in a potential fillip from a successful drilling campaign. So with Vitol on board to fund a large part of the works, and BowLeven sitting on $110m of net cash at the end of December, the company continues to be in a very strong financial position.

Trading on a bargain rating of 0.4, the shares admittedly have a higher risk profile due to the nature of the business. But with analysts at Evolution Securities estimating the company has a core and risked NAV of 159p a share, there is clearly scope for the share price discount to NAV to narrow markedly in the year ahead.

Bargain Portfolio 2010

CompanyTIDMMarketActivityShare price (p)Market value (£m)Bargain Rating
Telford HomesTEFAimHouse builder94.538.21.42
Gleeson (MJ)GLEMain Urban regeneration and strategic land13872.51.12
AcalACLMain Electronics distributor13237.50.84
Bloomsbury PublishingBMYMain Publisher12995.10.83
DeltaDLTAMain General industrials1472260.65
KBC Advanced TechnologiesKBCAimOil equipment services4022.90.64
Jacques VertJQVAimGeneral retailer14.527.90.52
BowLevenBLVNAimOil & gas exploration1032050.40