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How the 2013 Bargain shares portfolio fared

How the 2013 Bargain shares portfolio fared
February 7, 2014
How the 2013 Bargain shares portfolio fared
IC TIP: Buy

TERRACE HILL (THG)

Aim: Property investment and development

Share price: 23.75p

Bid-offer spread: 23p-23.75p

Market capitalisation: £50.9m

Website: www.terracehill.co.uk

Shares in Terrace Hill (THG) had doubled in value to 31.5p when I advised banking profits in mid-December ('Property play fully valued', 13 December 2013).

The surge in the company's share price reflects a de-risking of its balance sheet as assets were sold off and borrowings repaid. Net borrowings of only £17.8m is a significant reduction on 12 months earlier when the company was saddled with net debt of £85.7m. Consequently, balance sheet gearing is now very comfortable at 29 per cent, compared with 142 per cent a year ago, as is a loan-to-value ratio of 28 per cent (2012: 49 per cent).

The obvious implication of this debt reduction programme is to significantly improve the financial risk profile on Terrace Hill's remaining short-dated borrowings. The average maturity of the debt is only 19 months and it was the combination of high gearing and impending debt maturities that led to the hefty share price discount to net asset value previously. However, with a much lower debt to equity ratio, the risk of running short-dated debt liabilities is much reduced as is the refinancing risk. Terrace Hill has always operated this way and a relatively low weighted average interest rate of 3.5 per cent on its borrowings helps explains why it will continue doing so.

So with the finances under control, investors have been focusing on valuation and profit gains from the company's operational activities to drive the share price higher. These are mainly the development of foodstores and property in the retail and leisure sectors. And it was a lower than expected end of year net asset value of 28.8p a share, albeit up from 28.3p a year earlier, which prompted me to advise banking profits a couple of months ago.

However, after the 25 per cent share price sell-off the shares are starting to look good value again once you consider that analyst Miranda Cockburn at broking house Oriel Securities expects Terrace Hill's adjusted net asset value to rise 14 per cent to 32.9p a share by September this year, and is pencilling in a further increase to 34.9p a share by September 2015. This reflects £19m of future profits from a number of developments, of which food store developments account for 60 per cent of the total. And chairman and 62 per cent shareholder Robert Adair has stated that his company intends to recommence the payment of dividends, reflecting the much improved financial position.

Trading on a 25 per cent discount to book value, the oversold shares rate a medium-term buy at 23.75p.

INLAND HOMES (INL)

Aim: Housebuilder

Share price: 45.5p

Bid-offer spread: 45p-45.5p

Market capitalisation: £91.7m

Website: www.inlandplc.com

Brownfield regeneration specialist and housebuilder Inland (INL) was the second top performer in last year's portfolio, but I am not tempted to bank profits. That's because the company is ideally placed to take advantage of the favourable housing market conditions and positive sentiment that habitually leads to the sector rising in the first quarter each year.

The board's decision to ramp up its housebuilding operation means that the company is set to see profits rise sharply over the next few years at a time when the government's Help to Buy mortgage guarantee scheme is helping to drive demand in the housing market. These positive trends will become obvious to a wider audience once the company starts issuing trading updates in the first half of this year.

At this stage, analyst Duncan Hall at broking house finnCap expects Inland's pre-tax profits to surge almost 40 per cent from £5.1m to £7m in the year to end-June 2014, reflecting an 18 per cent rise in revenues to £38.8m. The respective figures for the following financial year are turnover of almost £60m and pre-tax profits of £9m. On this basis, expect EPS to increase 40 per cent to 2.8p in the current financial year, rising to 3.6p in the 12 months to June 2015. This means that Inland's shares are priced on 12.5 times next year's earnings estimates, a valuation that doesn't seem punchy considering the scope for earnings upgrades if house prices rise further as seems a reasonable assumption to make. If this happens the extra profit on house sales will largely drop straight through to the bottom line and boost margins and profits significantly.

Higher house prices will have a major impact on the open market value of the company's 2,500 plot land bank, too, the vast majority of which is situated in the prosperous south of England including sites in Beaconsfield, Poole, Chelmsford and Drayton Gardens Village (DGV) in west London. To put this into some perspective, every 10 per cent move in land prices should add about 14p a share to Inland's current net asset value of 34p (this figure includes the 5p a share of profits embedded in DGV).

So, with the sector enjoying a favourable tailwind, and Inland shares trading on a modest 1.33 times book value - a significant discount to larger rivals - I have no hesitation repeating my earlier buy advice. My fair value price is 60p, or a third above the current share price.

RANDALL & QUILTER INVESTMENT HOLDINGS (RQIH)

Aim: Insurance

Share price: 178p

Bid-offer spread: 176p-178p

Market value: £127m

Website: www.rqih.com

Shares in specialist non-life insurance investor Randall & Quilter (RQIH) are riding a 12-month high and have produced a total return of more than 60 per cent in the past year.

Founded in 1992 by executive chairman and chief executive Ken Randall and finance director Alan Quilter, Randall & Quilter is a specialist in managing the run-off of insurance companies and Lloyd's of London syndicates that have stopped underwriting new contracts, but have already settled liabilities arising from policies written.

It's a hugely profitable business, which explains why Randall & Quilter's board has been able to pay out over 23p a share of dividends in the past three years. R&Q currently has a portfolio of 12 companies in run-off with net assets of £96.4m, owns a Lloyd's authorised managing agency and manages Lloyd's syndicates 102 and 3330, which are both in run-off. It has been growing through acquisitions, too, having raised £25m at 120p a share in March through an institutional placing. The money is being spent wisely as the company seeks out legacy portfolios which meet its strict capital return and pay-back criteria.

However, although the 4.7 per cent dividend yield is still attractive, the shares now look fully valued on a 28 per cent premium to book value of 138p. It’s time to bank profits.

TRIFAST (TRI)

Main: Engineering

Share price: 85p

Bid-offer spread: 82.25p-85p

Market value: £92.4m

Website: www.trifast.com

Shares in Trifast (TRI), a leading global manufacturer and distributor of industrial fastenings, employing more than 1,000 staff around the world, have surged by more than half in the past year, but a valuation nearer 100p a share is not unrealistic given the operational progress being made.

Having streamlined its operations, Trifast's management is far more discerning about the level of profit margins on the business it takes on; older contracts are renegotiated upwards or withdrawn. Better sourcing from suppliers has led to improved pricing, quality and lead times, while product innovation has enhanced the offering and helped the company win new contracts. Progress on this front was evident in Trifast's half-year figures as operating margins surged almost one percentage point to 7.45 per cent and with revenues up almost 7 per cent to £65.3m, this meant operating profits rose by over a fifth to £4.86m.

It is only reasonable to expect this positive trend to continue. Interestingly, the UK division was the strongest performer, lifting sales by 11 per cent to £32.1m and growing operating margins from 5.4 per cent to 8.2 per cent. The business accounts for almost half of the company's revenues and the growth here, as well as in the European businesses was underpinned by demand from the automotive sector. This is a key earner, accounting for a third of revenues. It's also notable that the recovery in the US market has been marked and the plan is to exploit this trend by targeting a number of new business opportunities in the region.

The company certainly has funding to support further orders, having slashed net debt by a third to £3.55m, or a miniscule 6 per cent of shareholders funds. It also paved the way for the reintroduction of an interim dividend of 0.4p a share and analysts at brokerage Arden Partners expect the full-year payout to be lifted by 50 per cent to 1.2p a share, implying a prospective yield of 1.5 per cent. Furthermore, following 11 per cent earnings upgrades for the full year, and 7 per cent upgrades for fiscal 2015, analysts at broking house finnCap now expect Trifast to increase pre-tax profits from £7.3m to £8.6m in the current financial year, rising to £9.2m in the 12 months to March 2015. On this basis, expect full-year EPS of 5.5p and 5.9p, respectively, up from 4.7p in the 12 months to end-March 2013.

In my view, Trifast's earnings guidance is conservative especially since the Asian business is now showing a strong recovery, buoyed by a number of contract wins. The next trading update in mid-February should make a good read. But even without further upgrades, and factoring in the low gearing, the company is still only being valued on eight times 2015 cash profit estimates of £11.4m. That is too modest and the shares are still worth buying.

NOBLE INVESTMENTS (NBL)

Aim: Alternative investments

Share price: 270.5p (see text)

Market value: see text

Website: www.nobleinvestmentsplc.com

A feature of my bargain shares portfolios over the years has been corporate activity as bidders run their slide rule over the value opportunities on offer.

A year ago, shares in international rare coin, banknote, medal and stamp dealer and auction house Noble Investments (NBL) had yet to enjoy the rating they fully deserved when I uncovered their potential, mainly because the company was off the radar of most investors. However, larger rival Stanley Gibbons (SGI), the most famous name in stamps and a company that has been around for 156 years, certainly saw the rationale in acquiring Noble's well regarded businesses: Baldwins, which was established in 1872 and is a leader in the field of numismatics; and Apex Philatelics, which focuses on the auctioning of world stamps.

A recommended bid of 192.5p in cash and 0.2118 Stanley Gibbons shares per each Noble share completed in early December. This meant that if you followed my advice to buy Noble shares at 199p last February you now have a free carry on Stanley Gibbons shares. Those shares are a good investment too as I noted a few weeks back ('Target prices smashed', 20 January 2014).

The benefits of the acquisition are already being realised through cross-selling opportunities between Stanley Gibbons and Baldwin's and I anticipate that a wider range of cross-selling opportunities across the enlarged business will drive sales in the year ahead. There are cost benefits from the tie-up, too, and work has started on delivering integration annual cost savings of about £1.8m, around half of which should be delivered in 2014. Another benefit is to even out revenue streams across the financial year.

But even after a rerating there is value in Stanley Gibbons shares which are trading on a prospective PE ratio of 14 net of cash, hardly an exacting valuation for a company that is expected to grow EPS by over 20 per cent over the next couple of years. At 368p, I continue to rate Stanley Gibbons shares a buy and have a fair value target price of 400p.

FAIRPOINT (FRP)

Aim: Debt management

Share price: 129p

Bid-offer spread: 127-129p

Market value: £53.3m

Website: www.fairpoint.co.uk

The earnings recovery at Aim-traded debt management specialist Fairpoint (FRP) has been impressive and analysts expect the company to report full-year adjusted EPS of 14.5p last year, up from 13.4p in 2012, penciling in a further rise to 15.4p next year.

Cash generation remains robust and net cash ended last year at £2.8m, up by £1.2m in the 12-month period, which augurs well for the dividend after the board "committed to a long-term progressive dividend policy, which takes into account the underlying growth in earnings and strong cash generation". Analysts are forecasting a full-year dividend of 6p a share, up from 5.5p in 2012, implying a prospective yield of 4.7 per cent. The shares are also attractively rated on an earnings basis, priced on a forward PE ratio of 8. It's worth pointing out that the payout is more than twice covered by earnings.

And those earnings estimates look well underpinned by Fairpoint's strategy of diversifying its revenue streams by using its cash to boost its debt management plan (DMP) business. Last year, the company purchased 3,500 plans and since the financial year-end a further £4m has been spent acquiring 9,000 plans to take the total to 24,000. Claims management services are contributing strongly to revenues and profits, too, which means that ongoing weakness in the core IVA services is being more than offset by growth elsewhere.

So ahead of full-year results on Thursday 13 March, I continue to rate Fairpoint's lowly rated shares a value buy at 129p.

OAKLEY CAPITAL INVESTMENTS (OCL)

Aim: Investments

Share price: 184p

Bid-offer spread: 182p-184p

Market value: £226m

Website: www.oakleycapitalinvestments.com

I was intrigued to see that Neil Woodford, the star fund manager at Invesco Perpetual, will be running a fund for Oakley Capital Management when he leaves his employer in April after 25 years of service. This is a real coup for Peter Dubens, the founder of Oakley.

It should also be good news for Oakley Capital Investments (OCL), the closed-end Aim-traded investment company that 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 in the first half of last year. 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.

Furthermore, with ample cash resources, and access to the Limited Partnership, shareholders in Aim-traded Oakley Capital should be ideally placed to take advantage of the investment opportunities arising from the funds and strategies Mr Woodford will be implementing for the new funds he will be running.

So, although shares in Oakley have been significantly rerated since I spotted their investment potential 11 months ago, and now trade on a small discount to book value, I would continue to run your profits if you followed my earlier advice.

HERITAGE OIL (HOIL)

Main: Oil & gas

Share price: 186.75p

Bid-offer spread: 186.5p-186.75p

Market value: £520m

Website: www.heritageoilplc.com

Fourth-quarter results from oil and gas independent upstream exploration and production company Heritage Oil confirmed that the company is delivering on its Nigerian interests, while making progress in both Tanzania and Papua New Guinea on exploration activities.

Following a complex series of transactions to fund the $850m (£531m) acquisition of OML 30, one of the largest of Shell's onshore Nigerian assets sold in the past couple of years, Heritage Oil ended up with a 30.7 per cent working interest. The balance is held by its Nigerian energy partner, Shoreline Energy. After a blip in the second quarter, when production missed targets due to a manifold in a gas lift compression system failing and a strike by local workers, output recovered strongly and ended the year at over 50,000 bopd. The net daily production attributable to Heritage averaged 13,300 bopd in the fourth quarter, up from around 8,150 bopd in the first nine months of last year, which meant the resource delivered total revenues of $465m net to Heritage, including $170m from four liftings in the final quarter.

The increase in production has been achieved by the installation of new equipment, working over existing wells and commencing production from the Uzere West field, which has been shut-in for nearly two years. The plan now is to ramp up output to between 60,000 and 65,000 bopd in 2014, of which the net production to Heritage will be in the range 16,000 to 21,000 bopd. If achieved analysts expect OML 30 to produce around $500m of revenues this year, pre-tax profits of about $300m and EPS of 67c. On that basis, the shares are trading on a miserly 4.5 times earnings forecasts.

In turn, this sharp increase in production should generate the bumper cash flow needed to pay down the $500m of net borrowings Heritage took on to fund the purchase of its interest in OML. And this is exactly what is happening as unrestricted cash on Heritage's balance sheet increased from $113m to $190m in the final quarter of last year. It is likely to increase even further this year as output is ramped up.

True, Heritage Oil has proved one of the laggards in my 2013 Bargain shares portfolio, but no matter which way I look at it the shares are undervalued and I am maintaining my buy stance ahead of full-year results in April.

CAIRN ENERGY (CNE)

Main: Oil & gas

Share price: 217.5p

Bid-offer spread: 217p-217.5p

Market value: £1.3bn

Website: www.cairnenergy.com

Despite boasting an enviable 20-year track record of delivering significant financial rewards to shareholders, Edinburgh-based Cairn Energy (CNE) had fallen out of favour with investors last year when I selected the company as one of my bargain shares. That is still the case and news that the Indian tax authorities are looking into the company’s tax assessments dating back to the March 2007 tax year has not helped sentiment either. However, there is no suggestion by the company’s board that it has acted improperly and following a steep sell-off in January, there is undoubtedly value on offer if you are prepared to ride out the current negative sentiment.

To put the scale of the undervaluation into perspective, the market value of Cairn's 10 per cent interest in Cairn India - which has the potential to account for more than 30 per cent of India's oil production - is currently worth £590m and the group also has net cash of £757m. Combined these assets are worth more than Cairn’s own market value. True, Cairn is not allowed to sell down the Cairn India stake until the tax investigation is completed, but even so the current valuation ascribes little value for the acquisitions of Agora Oil & Gas and Nautical Petroleum in 2012 which cost a combined £565m.

Agora is a Norwegian company with non-operated exploration, appraisal and development assets in the UK and Norwegian North Sea. The company's portfolio is made up of interests in 11 licences in the North Sea basin where it is pursuing an active drilling programme. This provides Cairn with additional growth potential through an active near-term exploration and appraisal programme in the UK North Sea.

The acquisition of Nautical Petroleum made sense too as it increased Cairn's working interest in the Catcher area of the North Sea to 30 per cent including the Catcher, Burgman, Carnaby and Varadero oil discoveries; and gave Cairn a 25 per cent interest in Kraken, another large, North Sea oil development project.

The plan is to use the cash pile and the stake in Cairn India to first bring on Kraken and Catcher, and to fund an ongoing exploration and appraisal programme costing around $400m this year. In terms of the drilling campaign outside the North Sea margin, expects news of the first well, Prospect A, offshore Morocco, in the coming months. Cairn also plans two proposed wells offshore Senegal, the Spanish Point appraisal well offshore Ireland, and further exploration in Greenland. In total, Cairn plans to drill nine wells this year. If any one of these pays dirt, then expect the near 40 per cent share price discount to book value of 355p a share to narrow sharply. So, if you followed my advice a year ago, I would hold on.

POLO RESOURCES (POL)

Aim: Resources investment company

Share price: 19.25p

Bid-offer spread: 18.5p-19.25p

Market value: £50.4m

Website: www.poloresources.com

Shares in Aim-traded resource investment company Polo Resources (POL) have wiped two and a half percentage points off the total return from my 2013 Bargain shares portfolio. But I am not bailing out of the holding because I have reasons to expect a share price recovery in the coming months to narrow the unwarranted 40 per cent discount to mid-December net asset value of 32.3p a share. Chairman Michael Tang, who acquired 11.77 per cent of Polo's share capital at 40p a share in May through his investment vehicle, Mettiz Capital, has told me that he expects Polo to make some important announcements by the end of March.

They are also likely to highlight the chronic undervaluation of the company's two main assets: a 44.9 per cent equity investment in Signet Petroleum, the independent African oil exploration company with interests in four prospective assets in Benin, Burundi, Namibia and Tanzania; and Polo's largest investment, the Nimini Komahun Gold Project in Sierra Leone, in which the company holds a 90 per cent stake. These two holdings account for around two thirds of Polo's net assets.

To put the extent of the undervaluation into perspective, Polo is sitting on short-term investments, cash and receivables of 4.2p a share, or 22 per cent of its current share price of 19.25p. Strip out liquid resources from the company's book value of 32.3p a share, and assets worth 28p a share are being valued at only half their carrying value in Polo's accounts. That undervaluation will look even more anomalous if Polo releases the long awaited farm-out/asset disposal of its investment in Signet Petroleum by the end of March. Polo's holding in Signet is in the books for 10p a share, or half the current share price, so is a significant holding.

It's therefore worth noting that First Energy Capital Corporation, which has been appointed by Signet to assess strategic alternatives for Mnazi Bay, including potential farm-out opportunities, is in final discussions with potential partners and is exploring all options. Signet's main investment is an 80 per cent interest in Hydrotanz, a company that has a production-sharing agreement with the United Republic of Tanzania and the Tanzania Petroleum Development Corporation on the offshore North Mnazi Bay Block. This prospect is adjacent to BG and Ophir Energy's offshore Chaza 1 gas discovery well, which is targeting an eye-catching 12 trillion cubic feet of gas.

Another third of Polo's net asset value is tied up in the Nimini Komahun Gold Project in Sierra Leone. The last resource estimate showed an indicated gold resource at the site of 550,000 ounces and another 340,000 inferred ounces of gold, bringing the total potential resource to 890,000 ounces. Polo's investment in the project is valued at a modest $60 an ounce in its accounts. The next update from Nimini will be made by the end of March and will be the long awaited release of the Preliminary Economic Assessment (PEA).

So, despite the lack of progress in Polo's share price, the company remains substantially undervalued. True, a rerating will only happen when Signet closes a farm-out deal, or when there is concrete news regards the PEA on Nimini. I am prepared to await for these catalysts to spark a well overdue re-rating and continue to rate Polo shares a buy. Please note that I am unconcerned about the recent retirement of Ian Burns, finance director. Gary Good, the company's chief financial officer since 2008 and a Fellow of the Institute of Chartered Accountants, is an able replacement.

How the 2013 Bargain shares portfolio fared

CompanyTIDMOpening offer price on 8 February 2013 Bid price on 30 January 2014Dividends paid (p)Total return (%)Latest advice
Terrace Hill (see note five)THG15.431.50104.5%Buy
Inland HomesINL23.545091.5%Buy
Randall & Quilter (see note one)RQIH113.31768.4062.8%Take profits
Trifast (see note four)TRI51.982.250.8060.0%Buy
Noble Investments (see note three)NBL199.4270.52.5036.9%Takenover
Fairpoint (see note two)FRP98.251275.7035.1%Buy
Oakley Capital InvestmentsOCL139.7182030.3%Run profits
Heritage OilHOIL202.3186.50-7.8%Buy
Cairn EnergyCNE287.22170-24.4%Hold
Polo ResourcesPOL24.5318.50-24.6%Buy
Average    36.4% 
FTSE All-Share 32753565 10.4% 
FTSE SmallCap 36594451 23.9% 
FTSE Aim index 742858 16.2% 

1. Randall & Quilter returned 5p a share on 3 May 2013 to shareholders through the issue of L and M shares and proposes a return of 3.4p a share through the issue of N and O shares on 28 October.

2. Fairpoint paid a final dividend of 3.55p a share on 20 June and an interim dividend of 2.15p on 25 October.

3. Noble Investments paid a dividend of 2.5p a share on 19 July. Company was takenover by Stanley Gibbons and shareholders received 192.5p a share in cash and 0.2118 Stanley Gibbons shares as consideration. Latest price reflects this capital change with Stanley Gibbons shares trading on a bid offer spread of 368p to 372p.

4. Trifast paid a final dividend of 0.8p a share on 18 October

5. Terrace Hill - Simon Thompson advised taking profits at 31.5p ('Property play fully valued', 13 December 2013)

Note: Latest prices on Thursday, 30 January 2014

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Find out the shares in my 2014 Bargain Shares portfolio