Re-rating beckons

Each year, I use the investment criteria set down by Mr Graham in his book, The Intelligent Investor, to select a portfolio of shares that I firmly believe have potential to both outperform the market and generate decent long-term returns for shareholders. The key point is that the asset backing of my portfolio of small-cap companies has to be strong enough to overcome any short-term trading difficulties so that our loyal following of investors can reap the rewards in the medium term.

It's the very essence of stock-picking and it is a stock-picking system that has proved itself over the years: my portfolios have beaten the FTSE All-Share index in 11 out of the past 13 years, generating a compound annual return of 13.8 per cent. To put this into perspective, the FTSE All-Share has posted a meagre annual average return of 1 per cent over the same period. And this year's 10 undervalued small caps have maintained the record, generating a total return of over 19 per cent since mid February (calculated on an offer-to-bid basis). That not only compares favourably with the flat performance of the FTSE All-Share and the 5.6 per cent gain from the FTSE Small Caps, but it also means my portfolio has beaten virtually every single one of the 55 small-cap funds in the UK covered by Trustnet, including this year's top-performing small-cap fund: Fidelity UK Smaller companies. 

How Simon Thompson's 2012 Bargain Shares Portfolio has performed

That's not to say that all the 10 shares have produced the goods. They haven't, as three are currently losing money. But that highlights the benefits of having a diverse portfolio to spread risk. Still, there is every reason to believe that my second worst performer, Trading Emissions (TRE), is being unfairly undervalued by the market, a situation that could easily change once other investors realise the importance of an announcement the company made in its final results statement last week.

Value in Trading Emissions

The business is not difficult to understand. When Trading Emissions started life seven years ago, the company's 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 would be the understatement of the year as the company's net asset value of £156m at the end of June equates to only half the £310m raised at 100p a share, which was subsequently invested. To compound matters, Trading Emissions' shares are being priced on a vast discount to the underlying value of the company's assets.

In fact, with the shares being offered in the market at 23.25p, Trading Emissions' is only being valued at £57m, a 63 per cent discount to book value of £156m, or 63p a share, despite the fact that the company is sitting on a cash pile of £61m. If this sounds anomalous, that's because it is and largely reflects the fact that, until now, investors have been unable to quantify with any degree of certainty the carbon emission reduction (CER) liabilities of the company. However, that is set to change. In the results release, management went into great detail about how it is containing these liabilities. In turn, this enables investors to get a grip on what the underlying value in the business really is and, importantly, how much of the 68p a share of net assets is likely to be returned to shareholders as Trading Emissions winds itself up. Let me explain.

Currently, Trading Emissions' book value consists of a carbon credit portfolio with a negative liability of £17m, or 6.8p a share; a private equity portfolio worth £114m, or 45.7p a share; and net cash of £61m, or 24.4p a share. But the company's investment adviser, EEA Fund Management, calculates that the net liability payable by Trading Emissions to acquire contracted CERs is £33.6m, assuming the worst-case scenario where spot prices fall to zero and after taking into account portfolio hedges already in place. In other words, having renegotiated a number of these CER contracts after the carbon price collapsed, the maximum possible liability to Trading Emissions equates to 14p a share, which would reduce its net asset value by a further 7p to 56p a share. Importantly, the cash pile of 24p a share covers all of this 14p-a-share liability, so there is no further recourse to shareholders. In fact, as these contracts are wound down, Trading Emissions will be able to return lumps of cash to investors.

There is also value in the private equity portfolio, worth 45p a share. For instance, even if we write off an eye-watering 50 per cent of its value in a fire-sale scenario, and charge £10m, or 4p a share, to wind up the company, net asset value would still be 28p a share. And remember this is the worst-case scenario. So, with Trading Emissions' shares currently priced at 23.5p, and the company looking to sell down assets and return cash to shareholders, there is clearly value in the shares. A re-rating beckons.

Indigovision's buying opportunity

Shareholders in Edinburgh-based Indigovision (IND), a pioneer in internet protocol network-based security surveillance systems and a company I selected as one of my 10 Bargain shares in February this year, have endured a roller coaster share price ride in recent months.

Having reiterated my buy advice in the summer (Tech stocks rack up gains, 6 August 2012) ahead of full-year results on 27 September, when the shares were trading at 350p, the price subsequently exploded skywards. In fact, when I last updated my advice the shares were trading at 440p at the start of last month (Small cap wonders, 1 October 2012). At the time I noted that "the share price looks poised to make further headway towards what I consider conservative analyst targets around 500p. With at least a further 15 per cent upside on the table I remain a buyer." That proved the right call with the shares rallying a further 28 per cent in the following 12 trading days, hitting a high of 565p on 16 October.

Since then the company has paid out dividends of 75p a share, so my fair value estimate remains around 425p. However, Indigovision's share price has been sharply marked down from around 400p post a trading update at the company’s annual meeting and is now priced on a spread of 322p to 324p. True, last week management did not upgrade guidance for the current financial year to July 2013, as clearly some investors had hoped given the number of earnings upgrades we have seen in the past year, but it seems lost on them that the company is still firmly on course to deliver 30 per cent earnings growth in the current 12 month trading period. Indeed, first quarter revenues to end October 2012 grew by 6 per cent and order intake increased by over 10 per cent, continuing the improvement seen in the second half of the prior financial year. Moreover, analysts remain comfortable with their forecasts. Jon Lienard at broking house N+1 Singer Capital Markets still expects revenues to rise from £30.3m to £32.4m in the financial year to end July 2013 which in turn would drive pre-tax profits up from £3m to £3.7m and produce EPS of 32.7p, up from 25p in the prior year. In other words, at the current price, the company is being valued on only 10 times earnings estimates. Also, the prospective dividend is 12p a share so the forward yield is a healthy 3.65 per cent.

It's worth noting, too, that even after paying out 80p a share this year in dividends, Mr Lienard expects the company to have net cash of £2.8m, or 37p a share, by next July. Strip out that year-end cash pile and the shares can be bought on only 9 times full-year EPS estimates. It also seems lost on some trigger happy investors that the company has not actually warned on profits, but has simply said that profits will be more heavily weighted to the second half of the current year. That's a big difference. From my lens, the current share price weakness is a great buying opportunity.

Henry still a boot'ful investment

I have to admit that the lack of share price progress from Sheffield based construction and property firm, Henry Boot (BHY), is proving incredibly frustrating. To recap, I first highlighted the hidden value on offer in the company's shares 15 months ago (A boot’ful investment, 13 June 2011), and reiterated the advice in the spring of this year when they were also trading around 140p (Supreme value stocks, 30 April 2012). However, the shares have failed to break-out of their trading range, successfully bouncing off support from the 200-day exponential moving average on no fewer than four occasions, while the 140p to 145p level has capped progress to the upside. The bottom line is that with Henry Boot's share price around 124p, the holding is showing a 7 per cent net loss after factoring in total dividends of 6.2p a share, one of the reasons I advised buying the shares.

Henry Boot's impressive financial performance: 1994 to 2011

It is equally frustrating that Henry Boot has missed out on the massive rally this year in housebuilders and land bank developers, a trend I have benefited from hugely through holdings in urban regeneration and strategic land specialist MJ Gleeson (GLE) and East London housebuilder Telford Homes (TEF).

One reason for the share price underperformance is the lack of progress made in the first half this year when Henry Boot's profits declined over a third because land trading arm, Hallam Land Management, didn't make any significant sales. However, it's worth pointing out that a significant number of strategic land sites are working through the planning process and a number of sales are in progress. In fact, in a trading statement on 12 November, the company confirmed that it now has a "record number of consented sites available for disposal at 13 locations including Banbury, Mansfield, Bishopbriggs, Kilmarnock, Torrance, Edinburgh and Stratford-upon-Avon. All of these sites are being, or are about to be marketed, and a number of them are already the subject of agreed terms."

Hallam, which buys land, obtains planning consent and sells it on to housebuilders, now over 9,000 acres of land owned or under option, around 1000 acres more than at the start of the year. Of this, 1,833 acres are owned, 3,513 acres are held under option and 3,723 acres are held under agency agreements.

These land holdings were in the books at just £68m at the end of June, because optioned land is on the balance sheet at its agricultural value of around £2,000 per acre. Development land is worth substantially more. Hallam also has a geographical bias towards the more prosperous regions of the south and west of England and Scotland, so it's not as if the land is in less affluent parts of the country. This is why analysts believe that if you mark Hallam's land to market value, the open market value is nearer 90p a share rather than book value of 52p. So even though the value in the land bank will take time to realise, it is the reason why I continue to see value in Henry Boot's shares which are now trading almost 10 per cent below a very conservative net asset value of 135p and over 20 per cent below Investec's sum-of-the-parts valuation. It's worth noting, too, that Henry Boot has a rock solid and lowly geared balance sheet: net debt of £22m equated to only 12 per cent of shareholders funds of £177m at the June half-year end.

Interestingly, the share price has drifted once gain towards to its exponential 200-day moving average, currently around 120p, a long-term trend line from which it has rallied strongly every time since March last year. I may be frustrated, but I still think Henry Boot could be a boot'ful investment, in time.  

MORE FROM SIMON THOMPSON ...

In the past few weeks I have written a number of online articles, all of which are available on my homepage. These include articles on the following companies or investment strategies:

Elementary: Simon Thompson's guide to stock picking (9 November 2012)

Spark Ventures (Time to spark a re-rating, 8 November 2012)

LMS Capital (Capitalise on LMS, 7 November 2012)

Stanley Gibbons (A stamp of authority, 5 November 2012)

Molins (A share ready to smoke, 29 October 2012)

BP Marsh & Partners (A hyper value buy, 26 October 2012)

FTSE 100 Trading strategy (A smarter option, 25 October 2012)

Sanderson (Online growth drives Sanderson, 23 October 2012)

IQE (Take that and rally, 19 October 2012)

Communisis (Trading buy: Communisis ready to fly, 19 October 2012)

Noble Investment (Noble's missing commission, 16 October 2012)

Sanderson (An app investment, 15 October 2012)