A favourable risk reward ratio
Aim-traded insurance sector investment company BP Marsh & Partners (BPM:145p) has announced yet another positive trading update ahead of half year results scheduled for Tuesday, 20 October.
It augurs well for a continuation of what is turning out to be one of the most impressive track records for an investment company over the past few decades. Indeed, in the past 25 years, the company has grown its net assets at a compound annual growth rate of 11.3 per cent. This important measure of shareholder value creation rose by 14p a share to an all-time high of 216p in the last fiscal year to 31 January 2015 to give it a net asset value of £63m. Key to this growth was the performance of the company's equity portfolio, which increased in value from £33.5m to £38.6m in the 12-month period, and in particular BP Marsh's 37.9 per cent holding in Besso Insurance Group, an independent Lloyd's broking group.
The shareholding in Besso is currently in BP Marsh's books for £10.9m, having been sharply revalued from £7.2m at the end of January 2014, so now accounts for 17 per cent of BP Marsh's book value of £62.9m. Another valuation uplift looks firmly on the cards in next month's results as Besso has just reported a strong first half of the year. It's also worth flagging up that at the end of May, after BP Marsh's 31 January financial year-end, Robert Fleming Insurance Brokers, the international Lloyd's insurance and reinsurance broker, agreed terms with Calera Capital, a private investment firm with offices in San Francisco and Boston, for the sale of a majority share in the business valuing it at around £53m, or 10 times cash profits. Attributing the same cash profit multiple to Besso's earnings would give a markedly higher valuation for BP Marsh's stake.
I would also flag up the performance of LEBC, an independent financial advisory firm. Operating from 14 branches across the UK, LEBC continues to perform strongly in the post Retail Distribution Review (RDR) environment. BP Marsh owns a 34.9 per cent stake in LEBC, giving the holding a book value of almost £7m, or 11 per cent of the company's net asset value, so is another significant holding. Bearing this in mind, I understand that LEBC is trading ahead of budget for 2015 and "significantly ahead of 2014." Last fiscal year, LEBC reported a 43 per cent increase in full-year pre-tax profits to £1.1m on revenues ahead by 9 per cent to £12.3m. A valuation uplift could be on the cards here too.
Bumper dividend and cash realisations to come
Moreover, there will be good news on the dividend because the company's board is now recommending to hike the payout per share from 2.75p to at least 3.42p for the next two financial years. With net cash available for investment of £4.7m on the balance sheet, the board also have the flexibility to make further net asset value per share accretive buy backs.
The good news doesn't end there either. That's because BP Marsh still retains a 1.6 per cent equity stake in global insurance broker Hyperion Insurance worth £7.3m and subject to a call option from General Atlantic. That option will undoubtedly be exercised by its July 2016 expiry date especially as the merger of Hyperion with RK Harrison in April will have been value accretive and Hyperion has been reporting robust growth. BP Marsh also has a loan of £6m outstanding to Hyperion due for repayment in 10 months time too. In the meantime it's earning annual interest of £450,000. This means that the carrying value of the loan to Hyperion and the equity stake accounts for £13.3m, or 45.5p a share, of BP Marsh's net asset value of £62.9m. That's a significant windfall for a company which only has a market capitalisation of £42.3m based on a share price of 145p.
Or put it another way, BP Marsh's shares are not only being priced on a deep 33 per cent discount to book value of 216p even though there is a decent chance of valuation uplifts on the equity portfolio next month, but the downside risk is mitigated because over 20 per cent of its book value will be turned into cash in 10 months time. Add to that the near 25 per cent proposed rise in the annual payout, and BP Marsh's shares are being very attractively priced.
Please note that I initiated coverage on the shares at 88p ('Hyper value small-cap buy', 22 January 2012), and last reviewed the investment case when the price was 150p ('Exploiting a valuation anomaly', 3 June 2015). Offering 20 per cent upside to my fair value of 180p a share, the shares rate a strong buy on a bid-offer spread of 141p to 145p.
Running profits on a playful investment
Shares in the fourth largest distributor of toys in the UK, Character Group (CCT:505p), hit my target price of 525p ahead of a pre-close trading update this week which confirmed the company will hit analysts expectations for the fiscal year to end-August 2015. Full-year pre-tax profits are forecast to jump by more than half to £11m, based on a 15 per cent rise in sales of £113m in the 12-month period. In turn, expect adjusted EPS to increase from 25.2p to 41.9p and support a 35 per cent hike in the divided to just shy of 9p a share. The financial results are due to be released in the first week of December so will make for a good read as should the update on current trading.
That's because I understand on the grapevine that there has been a positive reception to The Clangers toy range (launched in the UK in July), and the Clever Keet toy from Character's Little Live Pets range is being tipped by a number of industry commentators to become a Top 10 toy and a best seller over Christmas. Investors are also likely to focus on the re-launch of Teletubbies to our screens in January and the likely positive contribution from these ranges to Character's profits in the current financial year to end August 2016.
So with Character's shares rated on a reasonable 12 times' earnings for the fiscal year just ended, and offering a dividend yield north of 2 per cent, I feel there is scope for the share price rally to continue and take-out my 525p target price. Joint house broker Allenby Capital has a target price of 575p, or 15 per cent above the current share price. If you followed my previous advice to buy the shares ('Playtime', 1 June 2015) I would run your healthy profits.
Tristel hits target
Shares in Aim-traded Tristel (TSTL:95p), a maker of infection prevention, contamination-control and hygiene products, came within a penny of hitting my upgraded target price of 110p in early July, so it's hardly a surprise that price has come off the boil slightly.
I first advised buying the shares at 60p ('Clean up on superbugs', 6 May 2014), subsequently updated the investment case at 80p ('Riding bumper profits', 26 February 2015) and last recommended running profits at 92p in June ('Blue sky potential', 10 June 2015). Since my last article was published the company has paid out a special dividend of 3p a share.
However, with Tristel set to report record results for the fifth consecutive six month period when it releases its full-year results on Monday, 12 October, buoyed by strong profit contributions from direct sales operations in the UK, Germany and Australasia, I feel that there is scope for the share price to return to those summer highs.
Ahead of the figures, analysts Paul Hill and Hannah Crowe at research firm Equity Development are pencilling in full-year revenues of £15.5m, implying 15 per cent like-for-like sales growth in the 12 months to end June 2015, and an operating margin in excess of 16 per cent, a 2.6 percentage point hike on the previous financial year. If achieved, this would result in pre-tax profits (before share-based payments) of at least £2.5m, or 38 per cent more than the £1.8m of profits reported in fiscal 2014.
The business is highly cash generative too. Net funds are forecast to have risen by £1.1m to £3.7m in the 12-months to end June 2015 which covers the vast majority of the £1.25m cost of the special dividend. Expect a 37 per cent hike in the normal dividend to 2.2p too. Post the special payout, net cash on the balance sheet is the equivalent of almost 6p a share.
Strong growth profile
And there is no reason at all to expect the growth to end here either. Indeed, chairman Francisco Soler notes that his company has "a more exciting pipeline of new product developments than I have seen at any time in our corporate history. At the same time we are moving forward with regulatory approvals in new, game-changing markets." Reflecting this positive outlook, analysts at Equity Development predict revenues will rise by a further 15 per cent in the current financial year to £17.8m to drive up pre-tax profits up by a fifth to £3m. On this basis, expect EPS of 5.2p and another hike in the payout to 2.6p a share.
Key to maintaining this double-digit sales growth rate is Tristel's high-margin and patented chlorine dioxide technology healthcare products, accounting for 85 per cent of sales. Prospects are rock solid. For instance, the company's best in class clinically proven consumables product, Tristel Wipes, is the most widely used decontamination method in ear, nose and throat, cardiology and ultrasound departments of UK hospitals. The NHS accounts for a quarter of Tristel's revenues and, with MRSA and Clostridium difficile affecting one in every 16 patients in NHS hospitals, demand is well underpinned. International growth is proving robust too: underlying sales from human health products overseas jumped by a fifth in the first half alone. I expect the company to report a continuation of this positive trend in next month's full-year results.
So with Tristel's operational performance supported by both domestic and international growth, and the company forecast to grow EPS by a further 20 per cent in the current financial year, I feel that a cash adjusted PE ratio of 17 is more than warranted. Trading on a bid-offer spread of 91p to 95p, I would continue to run your very healthy profits.
Greenko exit deal looms
The board of Greenko (GKO:80p), the Indian developer, owner and operator of clean energy projects, have signed non-binding heads of terms with the government of Singapore (GIC) for the sale of all of the company's shares in Greenko Mauritius for a gross cash consideration of approximately £162.8m, a sum worth 104p a share. Both GIC and Global Environment Emerging Markets Fund III LP hold shares in Greenko Mauritius which are capable of being exchanged for ordinary shares in the company with effect from 1 July 2015. If converted this would lead to Greenko's existing ordinary shareholders being significantly diluted. I outlined the implications in detail of a dilutive share issue in early summer when the share price was 55p ('A slick investment', 25 June 2015).
The fact that a compromise deal has been reached is clearly positive given that negative sentiment was damaging, but there is still uncertainty as to the scale of the likely payout for shareholders in Greenko. That's because subject to shareholder approval, Greenko is in effect proposing to sell its ownership interest in the underlying business so will become a vehicle just holding cash. Should the disposal go ahead, the proceeds, net of certain Indian taxation, transaction fees and running costs, as yet to be finalised, will be returned to Greenko's shareholders as a final capital return. However, until Greenko provides greater clarity, at this stage it's impossible to quantify these likely costs. Expect news on this front in the weeks ahead.
The uncertainty to the likely size of the payout to shareholders explains why the company's market capitalisation of £125m is £38m less than the agreed sale price of Greenko's interests in Greenko Mauritius. In the circumstances, I would continue to hold the shares at 80p if you followed my previous advice on the basis that my view is that the total costs incurred in this proposed disposal is likely to be far less than the aforementioned current valuation gap. Hold.
MORE FROM SIMON THOMPSON...
I have published articles on the following companies in the past month:
■ PROACTIS: Buy at 93p, target 117p ('Procuring growth', 10 Aug 2015)
■ Town Centre Securities: Buy at 310p, target 350p ('Equity market watch', 11 Aug 2015)
■ Equity market strategy ('Equity market watch', 11 Aug 2015)
■ KBC Advanced Technologies: Buy at 122p, target 165p; Getech: Buy at 59p, target 80p ('Fuelled for strong growth', 12 Aug 2015)
■ Pure Wafer: Run profits at 162p, target 178p; Inland: Run profits at 71.5p, next target 80p; Macau Property Opportunities: Take profits at 189p ('Bumper cash returns', 13 Aug 2015)
■ Inspired Capital: Accept cash offer of 21.5p; Record: Buy at 40p; Pittards: Buy at 128p; Netplay TV: Buy at 9.5p ('Bargain shares updates', 17 Aug 2015)
■ Equity market strategy ('Stay calm', 25 Aug 2015)
■ Capital & Regional: Run profits at 67p; Redde: Run profits at 152.5p; Cineworld: Run profits at 578p; Cohort: Run profits at 375p; H&T: Buy at 195p; Record: Buy at 33.5p; Bioquell: Buy at 137p, target range 170p to 185p ('Running bumper profits', 27 Aug 2015)
■ Equity market strategy ('A sense of perspective', 1 Sep 2015)
■ LMS Capital: Buy at 73p ahead of tender offer; STM: Buy at 53p, target 60p; Entu: Hold at 65p ('Shareholder activism works', 2 Sep 2015)
■ Henry Boot: Buy at 235p, target 260p; Amino Technologies: Run profits at 162p, target 180p; PV Crystalox Solar: Hold at 9.5p ('Planning for success', 3 Sep 2015)
■ Vertu Motors: Buy at 66p, target range 80p to 85p; Cambria Automobiles: Run profits at 68p ('Poised for a strong rally', 7 September 2015)
■ Avation: Buy at 127p, target 200p; Fairpoint: Run profits at 177p, target 190p, Redde: Run profits at 158p ('Get ready for take-off', 8 September 2015)
■ Stadium: Buy at 132p, target 155p to 160p; Somero Enterprises: Buy at 145p, target 185p; Flowtech Fluidpower: Run profits at 151p ('Switch on for gains', 9 September 2015)
■ Tristel: Run profits at 95p, target return to 110p; B.P. Marsh & Partners: Buy at 145p, target 180p; Character Group: Run profits at 505p; Greenko: Hold at 80p ('Small caps priced for gains', 10 September 2015)
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
