The main point to note is that if the investment case is sound, and a company's shares are anomalously valued, then more often than not the value will be recognised in time. It just takes patience. So with this thought in mind, I have been revisiting the investment case of two of the constituents of my 2013 Bargain share portfolio, both of which have rewarded us with decent gains to date.
Oakley a medium-term buy
As I predicted, closed-end Aim-traded investment company Oakley Capital Investments (OCL: 156p) delivered a bumper investment performance in the first half of the year.
The company makes its money by taking stakes in private equity ventures established by its associated limited partnership, Oakley Capital Private Equity, and provides mezzanine debt finance. It has been clearly doing well, as the company's book value per share rose 9 per cent to 195p, up from 181p at the start of the year and 174p at the same stage in 2012. Net asset value (NAV) is made up of cash of 49p a share, the investment in Limited Partnership and loans provided to Limited Partnership and a number of portfolio companies.
So with Oakley's shares trading on a bid offer spread of 153p to 156p, the share price discount to NAV is 20 per cent. However, adjust for the fact that net cash equates to 25 per cent of Oakley's book value and underlying investments, worth £172m or 140p a share, are in effect being value at only 107p. Accrued interest and receivables of £7.4m account for the balance of Oakley's net assets of £240m.
Now a share price discount of that magnitude would be in order if Oakley's investments were underperforming. But that is clearly not the case. In fact, to date, Limited Partnership has exited four of its portfolio investments, achieving an internal rate of return of 43 per cent on invested capital and an eye-catching 14 per cent uplift in realisation proceeds above the previous book value of those investments.
In other words, Oakley shares are not only trading on an unwarranted share price discount to NAV, but the book value of its investments is conservative while the cash pile mitigates risk. It's also worth noting that 28 per cent of the investment portfolio is held in the form of mezzanine loans with fixed interest rates of up to 15 per cent and secured senior debt financing to portfolio companies, usually at interest rates of 8.5 per cent. As a result, these investments should produce decent medium-term upside.
In the meantime, Oakley has been taking advantage of the share price discount to NAV to buy back shares, including the purchase of 2.9m shares in May at an average price of 150p. This not only means that five million of the company's 128m shares are now held in Treasury, but every repurchase made in this way is supportive of the share price as it takes stock out of the market. It is also accreditive to Oakley's NAV.
Trading on a 24 per cent discount to the underlying value of its assets, the shares rate a medium-term value buy.
Upside potential in high-yielding Fairpoint
Aim-traded debt management specialist Fairpoint (FRP: 126p) also issued its half-year results last week and the figures were bang in line with my estimates.
Fairpoint's cash generation remains robust and net cash increased to £2.8m in the six months to end-June, reflecting £3.8m of net cash generated from operating activities. That augured well for the dividend, which was raised by 10 per cent to 2.15p a share, and analysts at research house Equity Development are pencilling in a full-year dividend of 6p, up from 5.5p in 2012, implying a prospective yield of 4.8 per cent.
Importantly, Fairpoint's net earnings easily cover the raised payout. Underlying EPS rose by 12 per cent to 5.87p in the six-month period and analysts at broker Shore Capital expect full-year adjusted EPS of 14.5p (13.4p in 2012), rising to 15.4p next year. Equity Development has identical forecasts.
Assuming these estimates are hit, the shares are trading on a modest forward PE ratio of 8.6 for this year, a massive discount to the sector average PE ratio of 18. It's worth noting, too, that the prospective dividend is covered 2.4 times, so there is scope for even greater payouts in the future. But based on the current dividend guidance, the 4.8 per cent forward yield this year, rising to 5.1 per cent in 2014, is attractive.
The earnings growth driving the progressive dividend policy also looks well underpinned once you consider that Fairpoint has been growing its debt management plan business, acquiring two back books earlier in the year, and a further 850 plans in August. The company has successfully developed claims management activities, too. Revenues from both these operations have helped to offset the anticipated decline in profits from Fairpoint's core individual voluntary agreements (IVAs) business. In fact, non-IVA revenue now accounts for 44 per cent of revenue, up from 38 per cent at the same stage last year.
That said, the IVA business is still a decent money spinner from which Fairpoint made £1.1m of profit in the first half on the 20,200 policies it manages. And there is little doubt that the company is likely to see a surge in business as soon as the Bank of England starts to normalise interest rates. That's because as interest rates rise, this will drive many so-called zombie borrowers over the precipice and force them to seek five-year IVAs - rather than a much longer debt management plan - as they are unable to service the higher interest charges on their debts. True, that may still be 15 months or so away as the consensus is that a first rate rise is unlikely before 2015. However, it could be sooner if the UK economy continues its recovery and unemployment drop to levels where the Bank of England would start raising rates.
Factoring in this medium-term growth potential to the current low earnings multiple and high yield, and I continue to rate Fairpoint's shares a decent value buy on a bid-offer spread of 124p to 126p.
Please note that KBC Advanced Technologies (KBC: 83p) results will be released on Monday, 23 September and not tomorrow as I stated in a previous article. I will update my advice on the company following those results.
In response to requests from dozens of readers, I have published an article outlining the content of my new book, Stock Picking for Profit: 'Secrets to successful stock picking'
