Supreme value stocks

I am not concerned at all if other market participants have yet to recognise the apparent value on offer. In fact, I welcome this as it enables me to buy in at a price point that maximises the medium-term upside potential even if I have to be patient to realise it. The investment in Bollywood film producer Eros, a company I discussed in last week's column, is a case in point as I am now making significant gains on that holding as other investors finally cotton onto the value on offer. It is not an isolated example and this week I am revisiting several of my recommendations which I firmly believe will deliver the gains I outlined in my original analysis.

Unlocking value in Sanderson

Shares in Aim-traded software and IT services business Sanderson, a specialist in multi-channel retail and manufacturing markets in the UK, delivered the re-rating I anticipated when I advised buying at 33.5p last summer ('A valuable stock check', 18 Jul 2011) and subsequently hit a high of 45p in February. However, they failed to reach my upgraded price target of 50p, which I gave when I reiterated the buy advice at the end of January ('Three undervalued small caps', 30 Jan 2012) and, following a bout of profit-taking, they can now be bought at a bargain basement 37.5p. True, we have banked a 0.45p dividend along the way and the shares have handsomely outperformed the FTSE Aim index, which is down 11 per cent since my original recommendation. But there is no getting away from the fact that patient buy-and-hold investors in for the medium term have yet to reap the gains even though nimble stock traders have been well rewarded.

In my view, this could all change on Tuesday 15 May when the company (www.sanderson.com) reports its results for the six months to the end of March 2012. That's because those figures will incorporate the sale of the company's electronic point-of-sale solutions business to Torex Retail at the end of January in a deal valuing the struggling division at £11.75m. It is also a disposal that has improved the company's finances and business mix no end and, in my view, is not being factored into the current valuation.

In fact, after repaying borrowings, Sanderson was left with a healthy net cash pile of £4m and a significant one, too, considering the company only has a market value of £15.9m. The plan is to invest the cash into higher-growth segments of the business: online sales and e-commerce product offerings. This looks a sensible move since order intake in Sanderson's manufacturing and multi-channel businesses will be 10 per cent ahead when the company reports those first-half results, and is up by over 30 per cent since last September. Moreover, the order intake in Sanderson ecommerce software business, which addresses the fast growing market for online, catalogue and internet sales, has soared over 25 per cent year-on-year, buoyed by a number of new customer wins in internet sales.

These ongoing businesses are highly profitable, too, and half year profits here will be up 6 per cent to £0.8m which adds weight to full-year estimates from analysts. Currently Peter McNally of Charles Stanley Securities expects the company to report underlying operating profit of £1.9m in the 12 months to 30 September 2012, rising to £2.1m the year after. On this basis, underlying EPS is forecast at 3.8p this year and 4.2p in 2012-13. So if you strip out the 9p a share of net cash on the balance sheet from the current share price of 37.5p, the shares are being rated on a modest 7.5 times earnings estimates, falling to only 6.8 times next year.

If that isn't attractive enough, investors are in for a substantial hike in the dividend as the board has said it will increase the current year payout by 60 per cent to 1.2p a share, implying a prospective yield of 3.2 per cent. This includes an interim payout of 0.5p, up from 0.3p last year. And, given the cash generative nature of the business, there is scope for further hefty dividend rises in the future.

So, if you continue to see value in the shares as I clearly do, then buying ahead of the forthcoming first-half results is a sound strategy given the positive news flow to be announced and which I believe will be the catalysts for a re-rating. I maintain a fair value price target of 50p to offer us with 33 per cent potential upside on an offer-to-bid basis, with the shares (TIDM: SND) currently priced on a spread of 35p to 37.5p.

Time to capitalise on LMS

LMS Capital (www.lmscapital.com), an investment company with over 30 years' experience in private equity and development capital, remains a compelling investment and one that I am utterly convinced will reward patient investors. We are not doing that badly as the shares have risen 10 per cent to 60p (TIDM: LMS) since I advised buying at 54.5p ('Capital returns', 14 Feb 2011), during which time the FTSE All-Share index has fallen 5 per cent. There are very good reasons to expect the share price outperformance to continue.

For starters, LMS is in the process of winding itself up. so it's worth noting that the shares still trade on a 33 per cent discount to end-December 2011 net asset value (NAV) of 90p, despite the fact that the company's investment management business was sitting on net cash of £30.6m, or the equivalent of 9p a share. An investment portfolio worth £218m compares favourably with a market value of £164m and includes fund holdings of £63.5m, which are mainly exposed to UK property and US buyouts and venture capital. Reassuringly, uncalled fund commitments have been reduced to £18.9m and are more than covered by the above cash pile, which paves the way for capital to be returned to shareholders as the divestment process unfolds.

With this in mind, it's also worth pointing out that LMS also has a portfolio of unquoted direct investments totalling £131m, which have been performing rather well, having risen in value by 17 per cent in 2011. In addition, quoted investments were last valued at £24.2m, but will have fallen as shares in Weatherly International - accounting for £19.4m of the listed portfolio at the end of December - have performed poorly this year.

Still, with the board stating that shareholders can expect an initial return of cash by the end of 2012, and with a further distribution by the end of 2013, there is ample scope for the large share price discount to NAV to narrow significantly over the course of the following year.

Still a boot’ful investment

Sheffield-based construction and property company Henry Boot has yet to enjoy the re-rating towards my sum-of-the-parts valuation of 210p and justify the strong investment case I made last summer to buy the shares at 140p ('A Boot'ful investment', 13 Jun 2011). That is roughly where they are now and I can only reiterate the point that this is a quality company with a fantastic track record of growing shareholder value and rewarding loyal investors. In fact, the board raised the dividend by 21 per cent from 3.5p to 4.25p a share at the time of full-year results a month ago and has "set a target of building the dividend back to the pre-recession level of 5.0p per share, as market conditions allow". The final dividend of 2.6p, payable on 1 June, goes ex-dividend on 2 May.

Henry Boot's impressive financial performance: 1994 to 2011

The decent yield aside, there is also hidden value in the shares. That's because, although they trade in line with reported NAV of 142p a share, Henry Boot (www.henryboot.co.uk) has a very conservative and virtually ungeared balance sheet that fails to recognise the true value in the strategic land holdings of subsidiary Hallam Land. This business has interests in over 8,051 acres across 120 sites, of which 1,432 acres are owned; 3,986 acres are under option and 2,633 acres under planning promotion agreement. The inventory value of these assets is only £58.8m because optioned land is in Henry Boot's balance sheet at its agricultural value of around £2,000 an acre. Development land is worth substantially more, especially as the business has a geographical bias towards the more prosperous regions of the south and west of England and Scotland. In fact, brokers estimate that marking these land holdings to their open market value adds upwards of 40p a share to Henry Boot's NAV alone.

Moreover, demand for Hallam's land holdings look well supported as homebuilders replenish their land banks in what is now clearly an improving market for new-build housing. In turn this should help the business realise the value hidden in its own strategic land holdings. Add to this a solid property investment division with almost £160m of assets, a resilient construction business underpinned by a healthy forward book, and the shares, which now yield 3 per cent, have ample scope to narrow the 33 per cent gap to Henry Boot's sum-of-the-parts valuation. Trading on a bid offer spread of 136p to 138p (TIDM: BHY), I am very comfortable in reiterating my buy advice.

Zetar set for sweet profit recovery after warnings

Disappointing trading over the all-important Easter period has forced Aim-traded confectionary and snack food producer Zetar (www.zetarplc.com) to issue its second profit warning of the year. Adjusted pre-tax profits for the 12 months to end-April 2012 will now come in at £5.5m, which is significantly less than the £7.1m analysts at Liberum Capital forecast at the start of 2012 and well below the £6.6m they forecast after the first warning in January. It also means that profits will be well down on the £6.7m reported in the year to April 2011. The bottom line is that, when the company reports its full-year numbers in mid-July, we can expect adjusted EPS to fall from 38.5p to 32.1p.

That's the bad news. The good news is that Zetar has been winning contracts with a number of customers for both branded and private-label products; the company's confectionary business will get a boost from sales of Olympic biscuits, which were deferred into the current financial year and accounted for part of the above profit shortfall; and a cost reduction plan will reduce overheads by £600,000. Moreover, and reassuringly, the management team is maintaining tight control of its finances and borrowings are bang in line with market estimates despite the profit alert. In fact, analyst Patrick Coffey of Liberum expects net debt to have been cut by almost £5m over the course of the 12-month trading period to £10m, which implies gearing of only 21 per cent of shareholders' funds of £47m.

Clearly, there is value in the shares, which now trade around 50 per cent below NAV and on a modest 5.6 times downgraded earnings estimates for the 12 months to 30 April 2012. However, it is also true that the same value was on offer last July ('Appetising returns', 18 Jul 2011) when I first advised buying at 223p, but now you can buy them for 185p (TIDM: ZTR) following the profit warnings. Nonetheless, I continue to rate the shares a medium-term buy because there is ample scope for a decent profit recovery driven by new contracts; interest savings on the lower borrowings; and the cost savings mentioned above. In fact, Liberum is still maintaining its pre-tax profit estimate of £7.2m in the 12 months to April 2013, which would produce EPS of 42.3p.

Even if these forecasts prove too bullish, with the benefit of very weak comparatives, Zetar is well- placed to produce the good news story and the catalyst for a share price re-rating. So, although I have cut my fair value estimate to 270p, this still offers a potential 45 per cent upside on a 12-month view.

■ Next week's column will appear online on Tuesday 8 May and will include comprehensive trading updates on my 2011 and 2012 bargain share portfolios.