Bargain shares 2012

It is the very essence of stock-picking, and whatever fans of passive investment might say, it works: our portfolios have beaten the FTSE All-Share index in 11 out of the 13 years in which we have run them. During that time, they’ve generated a compound annual return of 13.8 per cent, which means that £10,000 invested in our first bargain portfolio, and reinvested every subsequent year in the following portfolio, would now be worth more than £53,000. To put this smart performance into perspective, the FTSE All-Share has struggled to even post an annual average return of 1 per cent over the same period.

Admittedly last year's motley crew of bargain stocks failed to maintain this impressive track record which is mainly down to the fact that the portfolio is entirely small-cap based - a segment of the market that has been badly impacted by a rise in risk aversion in the past year; investors have shunned small caps in favour of mega caps. However, over the long run, our record has stood the test of time and this has been in no small part down to the stellar performance of the unloved and undervalued small-cap shares we have uncovered. And it is no surprise either that after the underperformance last year this is the segment of the market where we found most value.

So, once again, I have run the rule over 2,000 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 and, eventually, reward our loyal following of long-term investors.

Trading Emissions (TRE)

Aim: closed-end investment company

Share price: 26p

Bid-offer spread: 24.5-26p

Market capitalisation: £65m

Website: www.tradingemissionsplc.com

When Trading Emissions started life seven years ago its main investment objective was to make capital profits from purchasing emissions assets in the European economic area. To say that it hasn’t been a success for shareholders would not be an understatement as investors backing the float in April 2005, when the company raised £135m, and those that participated in a £175m secondary placing 12 months later have seen the value of their investments plunge by more than 70 per cent in value.

At a bombed-out 26p, the company is now worth just £67m, having steadily fallen from well above the 100p-a-share float price since last June. Plans to sell off both the private equity investment portfolio and carbon portfolio have bombed, too, having failed to generate bids high enough last summer.

The reason for this became apparent at the end of last year when the board revealed that the company's net asset value (NAV) had fallen from £302m, or 121p a share, to just £191m, or 76.7p a share, in the second half of last year. The carbon portfolio was worthless – it had a negative worth of £16m, or a liability of 6.4p a share based on carbon prices on 6 December. In addition, the company's investment adviser, EEA Fund Management, calculates that Trading Emissions' unhedged exposure to carbon obligations for pre-December 2012 delivery had a maximum liability of £77.3m, albeit in the unlikely event that the carbon price fell to zero. So, taking the worst-case scenario, you can wipe another 31p a share off that NAV figure.

Fortunately, Trading Emissions has the money to honour these carbon obligations as the company held cash of £50.2m in December and received a further £14.8m of cash last month from a loan repayment. The company also holds cash of £15.2m under existing carbon hedging arrangements to offset the £16m carbon liability mentioned above. It is important to note that the business is not contractually obliged to purchase carbon obligations after December 2012 so - irrespective of what happens to the carbon price - this should be the low point for this side of the business.

Trading Emissions still owns a private equity portfolio, valued at £150m, which equates to 60p a share. True, these are illiquid investments and a discount should be applied to value the portfolio on a fire sale basis. But even factoring in a hefty 50 per cent write-off on these private equity investments, a further £10m wind-up costs for the company and a carbon price of nil value, then Trading Emissions still has a break-up value around 28p a share, above the current share price.

So although any investment in Trading Emissions needs to carry a wealth warning, the risk looks to the upside. Simon Shaw of investment manager EEA Fund Management certainly thinks so as he has purchased 250,000 shares at 26.5p each and, if you can stomach the risk, his lead is worth following.

Telford Homes (TEF)

Aim: Housebuilder

Share price: 92.5p

Bid-offer spread: 90-93p

Market capitalisation: £44.8m

Website: www.telfordhomes-ir.co.uk

If you are looking to benefit from the London Olympics this summer then look no further than undervalued East London housebuilder Telford Homes, which reported an impressive 30 per cent increase in contracted sales (to 288 units) and a 70 per cent reduction in the number of unsold properties between March and September 2011.

With gross margins up almost 3 percentage points to 18.2 per cent, driven by higher selling prices, build cost savings and a lower number of affordable homes in the 125 completions in the six-month trading period, analysts at Shore Capital believe operating profits will rise 9 per cent to £3.7m in the 12 months to March 2012. And profits are set to soar as those contracted sales come through in the next financial year. In fact, Shore Capital predicts that pre-tax profit will treble from £2.5m to £7.5m in the year to March 2013, reflecting a 9 per cent increase in revenue to £138m and improved margins. In turn, this will drive earnings per share (EPS) up from 3.6p to 11.5p which places the shares on a modest eight times prospective earnings.

Turning its land bank into cash should also support a sharp rise in Telford's dividend. The interim payout was increased by 20 per cent to 1.5p and Shore Capital expects a similar rise at the full-year stage, which would take the annual dividend to 3p, and the broker is pencilling in a 3.5p payment in the year to March 2013. On this basis, the shares offer an attractive forward yield of 3.8 per cent.

The company looks undervalued when you consider that its market value is a hefty 32 per cent below net asset value despite the fact that it has no financing issues and has gearing of a comfortable 70 per cent. Having secured a £70m bank facility last March, the company had ample headroom of £39m at the end of September. Telford has also agreed a £43.1m loan facility to develop its Avante-Garde, E1 site, a joint venture with the Williams Pears Group which has secured 186 sales, two-thirds from overseas and the balance from London buyers.

It is worth noting that Telford is reinvesting cash in new developments and has purchased or agreed to acquire eight sites for a combined £30m since March last year. This pipeline alone will provide 600 homes in its east London heartland and takes the total pipeline to just under 1,900 homes.

Trading on a bargain ratio of 1.45 and a chunky 32 per cent below book value, shares in Telford Homes look set for a gold-winning performance this year.

Rugby Estates (RES)

Aim: real estate

Share price: 428p

Bid-offer spread: 420-435p

Market capitalisation: £11m

Website: www.rugbyestates.plc.uk

Investors in Rugby Estates have been reaping bumper cash returns after management of the real estate company changed its investment strategy three years ago to focus on asset management and wind down its directly held property portfolio. In fact, for every £1,000-worth of shares held in January 2009, the company has returned cash of £1,267 to shareholders who still own shares worth £263.

However, the ongoing disposal programme is yet to be fully reflected in the company's current valuation. Adjusting for the last cash return of £4.6m and a subsequent share consolidation, the company's pro-forma triple net asset value, or break-up value, was £17m at the end of July. This not only compares very favourably with a market value of £11m, but the valuation is even more attractive if you consider that £4.2m of those assets are in cash so, in effect, 165p of the current share price is completely cash backed.

Or, to put it another way, strip out net cash from the company's market capitalisation of £11m and we are getting hold of the remaining property assets (worth £14.1m, or 553p per share) for a bargain basement £6.8m. And it’s not as if these are non-yielding poor-quality assets as the portfolio had an annual contracted rental value of £1.3m at the end of July.

Since then, Rugby has exchanged contracts to sell a property in Portsmouth for £950,000 (due to complete this month), is selling a convenience store let to a major supermarket chain in Surbiton and has received planning permission to redevelop an industrial site in Bridgewater, Somerset, to provide 67 homes and 14 small business units. As a result, there should be more good news to report when the company announces full-year results on 4 May. It is also fair to assume that a much higher percentage of the share price will be cash backed by then as the board "expects the property realisations to be substantially completed this year". They are certainly incentivised to do so as senior management receives 5 per cent of the distributions made to shareholders from these sales under a Property Realisation Incentive Plan, so there is a potential £1m further windfall for them to reap. I have already factored this payment into the triple net asset value figure above.

In turn, this opens the door for further significant cash returns to shareholders and makes a 35 per cent share price discount to triple net asset value of 667p anomalous.

Bargain portfolio 2012

MJ Gleeson (GLE)

Urban regeneration & strategic land specialist

Share price: 111.5p

Bid-offer spread: 110-113p

Market capitalisation: £59.5m

Website: www.mjgleeson.com

The investment case for buying shares in MJ Gleeson remains as strong as ever. The urban regeneration and strategic land specialist has a market value of £59.5m with the shares priced at 111p, but has shareholders' funds of £96.5m - equating to 184p a share - after factoring in the payment of a 5p-a-share special dividend in December. That means the shares trade 40 per cent below book value despite the fact that £15.2m of those assets were in cash at the end of September, which will have been boosted by the £7.5m proceeds from the sale of three social housing private finance initiative (PFI) investments in the final quarter of 2011. The last remaining PFI investment will be sold by the March year-end to complete the exit from this business.

So strip out pro-forma net cash of £22.7m from Gleeson's market value and we are able to get hold of £74m of net assets for a bargain basement £35m despite the fact that all of those assets are in land and housing stock. These include 1,220 plots across 14 sites in the north of England, where cash-rich Gleeson is taking advantage of low land prices to bolster its housebuilding operation. Currently, it is in discussions to acquire a further 1,380 plots to take its land bank to 2,600 plots, or nine years' worth of build based on the 286 completions made last year.

In addition, the company has a 3,766 acre strategic land bank in the south of England, of which 185 acres is owned, 2,608 acres under option and 973 acres under a planning promotion agreement. The geographic bias is mainly in the wealthy shires and includes land holdings in Buckinghamshire, Hampshire, Oxfordshire and Wiltshire. Around 17.5 per cent of the portfolio has planning consent or an application to obtain planning consent lodged.

It's worth noting that Gleeson owns in excess of 1,000 plots with residential planning consent. These are valuable assets and ones that are keenly sought after as "demand from the major housebuilders for 'oven ready' land in the south of England remains robust". There should be news on this front shortly as a 600-unit site in Littlehampton, West Sussex, and a 58 unit site in Swaythling, Hampshire, are both expected to be sold by March, which will bring in a further cash windfall.

Moreover, the UK new-build residential housing market is a segment of the property market that is in far better shape than a few years ago since all the major builders now have lowly geared balance sheets or are in net cash positions which means they have funds available to compete to buy for the Gleeson's land. So with the company continuing to turn its property assets into cash, and with the board returning surplus capital to shareholders, the shares are an asset backed bargain buy priced 40 per cent below book value.

Mallett (MAE)

Aim: art dealer

Share price: 72.5p

Bid-offer spread: 70-75p

Market capitalisation: £9.8m

Website: www.mallett.co.uk

Mallett, one of the UK's oldest dealers in high-quality antique furniture and works of art, is on the move and in more ways than one. In two weeks' time the company moves from its current London showroom in New Bond Street to Ely House, an 18th century Grade I listed townhouse in Mayfair's Dover Street. Not only does the building - spanning 14,500 sq ft across six floors - provide more accommodation for the company's works of art, primarily 18th century and Regency period furniture, clocks and pictures, but importantly it cuts the company's rent bill in half, to £1.2m. For a business generating £13.2m of revenue a year, that's a significant saving.

Better still, luxury goods retailer Fendi is paying Mallett around £1.7m for its New Bond Street lease, which will be used to cover refurbishment costs on the new premises and general working capital needs. Not that Mallett needs the cash to fund the business as at the end of June the company's net borrowings were just £335,000, equating to a miniscule 2 per cent of equity shareholder funds of £14.5m. As one would expect the majority of the company's assets are invested in inventories and property which were in the books for £11.8m and £3.8m, respectively, at the June half year-end. This means that the company's share price is more than covered by the value of stocks alone so, in effect, we are getting the property assets thrown in for free.

That miserly valuation is hard to justify when you consider that the company's pre-tax loss more than halved to £329,000 in the first half of 2011 and a pre-close update in November revealed that trading results were ahead of the prior year. Since then, Mallett has exhibited at the Fine Art Asia fair in Hong Kong for the first time in the autumn and plans to boost sales and marketing efforts in China and Asia over the coming months. The company also booked a number of sales at the International Fine Art and Antique Dealers Show in New York.

This improvement in fortunes has not been lost on one investor, activist Peter Gyllenhammar, who has been quietly increasing his shareholding in the past year and, having raised his stake yet again at the end of January, now controls 25.5 per cent of Mallett's share capital. His stakebuilding has been made through two companies he controls, Bronsstädet AB and Union Discount Company of London Ltd.

It looks a sound investment as trading 33 per cent below net asset value and on a bargain rating of 1.09, the shares have yet to factor in the much-reduced cost base and clear potential for a return into profit in 2012. If that happens then a rerating is firmly on the cards and one that could be quite sharp since the shares are tightly held, with five shareholders controlling over 70 per cent of the company.

Stanley Gibbons (SGI)

Aim: stamps, rare coins and memorabilia

Share price: 180p

Bid-offer spread: 176-183p

Market capitalisation: £45.4m

Website: www.stanleygibbons.com

Stamp collecting may not be to everyone's taste but, in these uncertain times, it is proving a highly profitable business for Stanley Gibbons, the most famous name in stamps.

A pre-close trading statement from the 155-year-old company has confirmed that 2011 earnings are bang in line with market estimates with analyst Charles Hall at broker Peel Hunt forecasting a 12.5 per cent increase in revenues to £29.7m, a rise in pre-tax profits from £4.3m to £5m and EPS up 15 per cent to 17.4p. On this basis, the shares only trade on a modest 10.5 times last year's earnings and there is a useful dividend yield, too. In fact, having seen the board raise the interim payout by 11 per cent, Mr Hall predicts a full-year dividend of 6p a share when Stanley Gibbons releases results at the end of March.

There is also every reason to believe that the business will hit Peel Hunt's EPS estimate of 18.9p in 2012, which would support a further rise in the dividend to 6.5p as the broker predicts. The company can certainly afford this as net cash had surged from £709,000 at the end of June to over £5m at the turn of this year, buoyed by the strong trading performance. But this has not been at the expense of stock levels as inventories rose by almost 10 per cent to £17m in the second half of 2011 so the company has enough stock to meet a current order pipeline "materially better than at this stage last year".

This has been partly driven by the successful launch of the company's new website at the end of May, which has helped increase second-half internet sales by 67 per cent year on year, and the opening of a new and profitable office in Hong Kong to tap into the growing international interest in collectibles especially in the Far East. Stanley Gibbons has also boosted the size of its investment sales office in the Channel Islands and reports that sales have surpassed management's internal projections.

And the good news story doesn't end there as Peel Hunt calculates that if you mark-to-market value the company's holdings of stamps, coins and memorabilia, Stanley Gibbons' net asset value comes out at £45.2m rather than the £21.8m reported in the June 2011 balance sheet. To put that into perspective, with the shares trading at 180p, the company only has a market value of £45.4m.

So, in effect, we are able to buy the shares safe in the knowledge that they are completely asset backed, rated on a modest 9.5 times 2012 earnings estimates and offer a decent prospective yield of 3.6 per cent. Those expectations could prove conservative given that the company has ample cash to fund new growth opportunities, a point non-executive chairman Martin Bralsford made in his update to investors last month. Trading on an adjusted bargain rating of 0.93 after stripping out £3m of non-current assets and marking inventories to market value, the shares are a value buy.

Eurovestech (EVT)

Aim: pan-European development capital fund

Share price: 9.25p

Bid-offer spread: 9-9.5p

Market capitalisation: £30.5m

Website: www.eurovestech.co.uk

Long-term shareholders in pan-European development capital fund Eurovestech have been well rewarded for their loyalty. Since floating at 5p a share in March 2000, the company has returned 6p a share of cash to investors and they are still holding shares worth 9.25p each.

There should be more upside to come because other investors have clearly failed to grasp the significance of a complicated deal Eurovestech completed last year. It is only a matter of time before they do. That's because when ToLuna, a leading independent provider of online panels, communities and technology services to the market research industry, was bought by ITWP in a £161m takeover last April, Eurovestech's 29.5 per cent stake in Toluna was valued at £48m, an eye-watering 24 times its £2m investment back in 2000. As part of the acquisition, Eurovestech received a 9.8 per cent stake in ITWP worth £11.6m, discounted 'B' and 'C' loan notes worth £12.2m and a further £25m of bank guaranteed loan notes. ITWP is backed by Verlinvest, a Belgian family-owned investment holding company, which has a 44.9 per cent stake in ITWP and retains loan notes worth £10m. The other major shareholder in ITWP is Invesco with a 37.1 per cent stake and £8.5m of discounted 'C' loan notes.

Those loan notes are of great interest to me because having redeemed the £25m of bank guaranteed notes last year, the discounted notes are due to mature in June. In my view, ITWP controlling shareholders have every reason to use Toluna's strong cash generation - the company reported positive operational cash flow of £15.8m and had year-end net cash of £13.2m in 2010 - to redeem the loan notes otherwise they will automatically convert into equity. If that were to happen it would raise Eurovestech's stake in ITWP to 16.4 per cent, dilute Verlinvest's interest to 42.1 per cent and Invesco's interest to 34.8 per cent. It would also dilute the stake of Frédéric-Charles Petit, Toluna's founder and CEO, to 6.6 per cent.

The significance of this has clearly been lost on investors who have failed to grasp that £22.1m of Eurovestech's pro-forma net asset value of £46.6m could be in cash by end June this year. To put this into perspective, the company only has a market value of £29.7m. Moreover, it's not as if Eurovestech's other investments are not performing well as the directors have raised the carrying value of wholly owned subsidiary KSS Fuels, a global leader of fuels pricing and retail network planning solutions, from £9.5m to £13m on the back of bumper trading in November.

Trading 34 per cent below a conservative calculation of Eurovestech's pro-forma net asset value and on a bargain rating of 0.67, the shares offer great value at 9.25p especially since the company could be sitting on net cash of 6.7p a share by the end of June if the loan notes are redeemed.

Bloomsbury Publishing (BMY)

Main market: publishing

Share price: 112.5p

Bid-offer spread: 110-115p

Market capitalisation: £83m

Website: www.bloomsbury-ir.co.uk

Bloomsbury entranced investors with a magical operational performance for the best part of a decade after boarding the Hogwarts Express in 1997. By the time Harry Potter mania hit its peak in 2005, Bloomsbury was making wizard annual profits of over £20m largely from JK Rowling's bestselling books. However, life after Harry has been anything but magic for the company and profits had slumped to £7.1m three years ago.

The share price has done a vanishing trick, too, down 75 per cent from its all-time high. But, with profits in recovery mode, some overdue respite is in store for long-suffering shareholders. In fact, a trading statement a few weeks ago confirmed that adjusted pre-tax profits for the 12 months to 28 February 2012 are well on course to hit brokers' estimates of £9m. This represents a 17 per cent rise on the previous year and boosts underlying EPS by 15 per cent to 8.8p. These resurgent earnings underpins the 5p-a-share annual dividend and a progressive one, too.

Bloomsbury's growth is in part being driven by e-book sales, which have grown 38 per cent year on year since August and that's set to remain a high-growth area. Market research firm YouGov reports that 1.3m e-book readers were sold in the UK alone over Christmas.

Bloomsbury has been serving up tasty culinary offerings, too, with bestsellers River Cottage Veg Everyday! by Hugh Fearnley-Whittingstall and Heston at Home by Heston Blumenthal.

The company has also been exploiting its valuable intellectual property rights and has signed a long-term licensing deal for cricketing bible Wisden in India, which will bring in contracted revenues of around £2.1m over five years plus a royalty share. A new online version, Wisden Extra, has been launched, too. In addition, Bloomsbury has signed a smart looking deal with a private independent research institute in Germany for the development and provision of a reference and information resource in labour economics. This will bring in around £4.3m of revenues over the next five years.

So with online and e-books growing strongly, and the company doing some savvy deals to exploit its intellectual property, analyst Malcolm Morgan at brokerage Peel Hunt expects pre-tax profits to continue their upward trajectory to £10.7m in the 12 months to February 2013 based on 8 per cent higher revenues of £109m. On this basis the shares trade on a modest 10 times forward EPS of 10.4p and yield 5 per cent.

There is value on offer by adopting a balance sheet approach as net assets of £107m currently dwarf the company's market value of £80m even though Bloomsbury has a debt-free balance sheet. In fact, at the end of December the publisher was sitting on £7m of net cash and Peel Hunt predicts that this will have risen to around £15.4m at the end of this month as Christmas receipts come in. So strip out cash from the market value and a business forecast to make operating profit of £10.45m this year is being valued at just £67m. A rerating is long overdue.

Indigovision (IND)

Aim: security

Share price: 310p

Bid-offer spread: 300-320p

Market capitalisation: £23.4m

Website: www.indigovision.com

Edinburgh-based Indigovision, a pioneer in internet protocol network-based security surveillance systems, popped up on my radar at the end of last year when Scottish Equity Partners (SEP) and former chief executive Oliver Vellacott, who controls 22.9 per cent of the share capital and stepped down from his role in early December, made no fewer than three indicative proposals to acquire the company. An offer at 265p a share was rightly rejected by the board and, with the parties unable to reach agreement, the bid talks terminated last month. SEP acquired 500,000 shares in mid-December so holds 6.63 per cent of the share capital.

It's not hard to see why the directors considered this a low ball offer. In late November, Indigovision reported that gross margins had recovered sharply in the first four months of the current financial year - after falling to unacceptably low levels in the second half of the previous financial year - and with overheads down, first-half profits to end-January 2012 will now exceed £1.5m when the company reports on 14 March. That record first-half performance prompted Brewin Dolphin to upgrade its full-year pre-tax profit estimate by 25 per cent to £2.5m, but the broker sees "forecast risk on the upside" so further earnings upgrades look likely given that the new product pipeline is "looking better than it had for some time".

Even without upgrades the shares are too lowly rated since the company's market value of £23.4m fails to factor in the £5m cash pile on the balance sheet. Strip this out and the business is, in effect, being valued on less than 11 times conservative earnings estimates net of cash. The company is also modestly rated on a price-to-book value basis. This has not been lost on the directors who have been buying heavily. Non-executive chairman Hamish Grossart spent almost £550,000 acquiring 217,750 ordinary shares at prices ranging from 250.5p to 257.5p in December to take his stake to 5.4 per cent and new boss Marcus Keen splashed out £20,000 to take his holding to 180,000 shares, or 2.5 per cent of the share capital.

So irrespective of whether SEP and Mr Vellacott come back to make another bid approach at a later date, I see value in the shares which look well supported by a recovery in earnings. In the meantime, there is a 7.5p-a-share annual dividend to provide us with income. Trading on a bargain rating of 0.56, and with directors buying and the rejected bid approach having created a share price floor, the rerating has significantly further to go.

Molins (MLIN)

Main market: General industrials

Share price: 105p

Bid-offer spread: 104-106p

Market capitalisation: £21.2m

Website: www.molins.com

Molins is a specialist engineering business and one well below the radar of most investors. As a result, the share price has yet to factor in news that the company's profits are on an upward trajectory and with margins on a number of projects expected to show improvement, the underlying performance for the full year has strengthened further.

Currently, two-thirds of sales come from the tobacco industry. Molins specialises in improving the effectiveness of existing customer plant, monitoring and testing product quality and conducting the analysis of cigarette smoke. This is the high-end part of the business and accounted for a quarter of revenues and £0.9m of profit in the first six months of 2011.

The core business remains manufacturing and servicing tobacco processing machinery – an operation that made £1.8m of profit in the same period, although the second half is unlikely to have been as impressive. The remaining third of sales come from supplying packaging machinery to the pharmaceutical and FMCG markets with the aim of improving operational efficiency of plant.

By its nature the business carries a variety of risks, no more so than macro risk as it is highly exposed to a changing economic climate which impacts order visibility and can lead to cancellations. Molins also carries currency risk since only 13 per cent of sales are in the UK and manufacturing facilities are in a number of countries overseas. There is competition in the aftermarket from third-party suppliers, too.

Still, risk warnings aside, there is a lot to like about the company at the current price. First, the shares trade a hefty 58 per cent below book value of 248p a share even though the company was sitting on net cash of £6.3m at the end of June 2011 - the equivalent of 31p a share, or 30 per cent of the current share price. And with last year's underlying operating profits forecast to have risen from £3.7m to £4.1m that cash pile should have swollen further and adds support to a 5p-a-share annual dividend, which is almost three times covered by forecast adjusted EPS of 14.4p.

True, analysts don't expect much in the way of growth in 2012, but yielding 4.8 per cent and rated on a modest 7 times earnings the share price isn’t expecting much either. On a bargain rating of 0.50 and priced on less than half book value, the risk is firmly to the upside.

Bargain Share Portfolio: 13-year track record