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Four small-cap value plays

Four small-cap value plays
January 11, 2016
Four small-cap value plays

As I noted in my central bank feature ('The great divergence', 18 Dec 2015), the elephant in the room is China, and the lack of credibility the authorities have in dealing with the economic slowdown. I am far from complacent, and I'm keeping a close eye on events overseas to ascertain whether the spike in risk aversion we witnessed last week is likely to become even more heightened, but for now I remain on the look out for undervalued special situations to exploit in my small-cap hunting ground.

 

On firm foundations

Aim-traded Somero Enterprises (SOM:139p), a Florida-headquartered company that specialises in the design, assembly, and sale of patented, laser-guided concrete levelling equipment for commercial floors, has beaten market expectations handsomely for the 2015 financial year following a strong operational performance in the final quarter. In fact, sales hit at an all-time high in December, which is not traditionally the strongest month of the year, and with the benefit of an improved gross margin performance, the company now expects to report cash profit materially ahead of current market expectations for the 12-month period.

Demand in the second half of 2015 proved to be robust across the company's core product range, with North America and Europe contributing significantly to sales growth while performance in China was both healthy and stable. It's worth flagging up that year-end demand for its products in North America was predominantly driven by technology upgrades and fleet additions, highlighting lengthy project backlogs for the company's customers that extend well into 2016. Following the announcemnt, analyst Matthew Walker at Canaccord Genuity now expects 2015 adjusted pre-tax profit will rise from $14m to $18.6m (£12.7m), representing a 11 per cent upgrade, based on a 16 per cent increase in revenues to $69m, to produce adjusted fully diluted EPS of 14.9p. Mr Walker has also raised his dividend per share forecast by 11 per cent to 4.5p, up from 3.4p in 2014. And with management guidance pointing towards "another year of growth", and the company in a robust net cash position estimated to be around 14p a share, I feel that Somero's shares should be trading far higher than on a cash-adjusted PE ratio of 8. A forward dividend yield of 3.2 per cent is supportive too.

So, although the shares are trading in line with the level when I initiated coverage ('On solid foundations', 22 Apr 2015), and are just shy of the level at the time of my last update ('Switch on for gains', 9 Sep 2015), I still believe my 185p target price is both warranted and achievable. Trading on a bid-offer spread of 138p to 139p, I continue to rate Somero's shares a buy.

 

Funded for significant growth

Somero is not the only company on my watchlist that has posted an earnings beat, so too has Bath-based 1pm (OPM:70p), a specialist provider of finance to small- and medium-sized enterprises (SMEs) and a constituent of my 2014 Bargain Shares Portfolio. I last updated my view in the summer after the company made the smart looking acquisition of Academy Leasing, a provider of equipment finance and an equipment and vehicles broker to the SME market, for consideration of up to £12m ('Powered up for gains', 29 Jul 2015).

The company is scheduled to release its results for the half year to the end of November 2015 on Monday 25 January and they should make for a good read. That's because in the six-month period the business originated £9.7m of new lease and hire purchase contracts and £6.1m of business loans, representing a 147 per cent year-on-year increase. As a result, the loan portfolio has risen by 30 per cent to £57m since May 2015, financed mainly by reinvesting cash flow and tapping additional debt funding. Importantly, for a fast-growing business, head of research Eric Burns at house broker WH Ireland believes that current funding in place is sufficient to support anticipated growth over the next two financial years. Ahead of the half-year results release, Mr Burns predicts that 1pm is on course to increase revenue from £5.5m to £12.1m in the financial year to the end of May 2016 to almost double pre-tax profit to £3m. After factoring in a placing and open offer to part finance the Academy Leasing acquisition, EPS should rise by a third to 4.9p.

Furthermore, with the full benefit of that acquisition set to come through in the next financial year, WH Ireland is expecting revenue to grow again to £16m in the 12 months to the end of May 2017 to deliver a 40 per cent boost in pre-tax profit to £4.2m and EPS of 6.3p. The respective dividend estimates point to a two-thirds rise in the payout to 0.5p a share in the 2016 financial year, trebling to 1.5p a share the year after. On that basis, 1pm's shares are rated on little over 11 times earnings estimates and offer a 2.1 per cent prospective dividend yield, a rating significantly below that of larger challenger operations who have joined the market recently. That valuation seems anomalous to me given that 1pm has built up a strong track record of delivering, or even exceeding expectations in its niche SME market place. Offered in the market at 70p, I continue to rate the shares a buy and have a fair value target price of 82p.

 

Maintaining a pole position

Shares in eastern European property fund manager First Property (FPO:53p), have smashed through my target price of 49p and have now risen by a third since I recommended buying ahead of November's half-year results ('In pole position for a re-rating', 7 Oct 2015). They have performed well over the longer term, too: after factoring in cumulative dividends of 5.75p a share in the past four and a half years, the holding is showing a total return of 218 per cent since I initiated coverage in my 2011 Bargain Shares Portfolio.

There was further positive news last week to underpin the investment case after the company acquired a portfolio of nine regional Lidl supermarkets in Romania for €10.5m (£7.8m) in conjunction with a group of investors. The investment is being part funded by €4m of equity, of which First Property is providing €1m, and a €6.5m bridging loan from the company which will be refinanced using an agreed bank loan that has already been documented. So, after factoring the annual interest cost on the 4.95 per cent loan, the group's share of the pre-tax profit is about €180,000. First Property will also earn annual management fees of €125,000.

The acquisition has prompted analyst Chris Thomas at broker Arden Partners to upgrade his current year pre-tax profit estimate to £7.4m based on the company delivering revenue of £20.8m to produce EPS of 5p and a 10 per cent hike in the dividend per share to 1.48p. On that basis, the shares are still only rated on a little over 10 times earnings estimates and offer a prospective dividend yield of 2.8 per cent. That's still attractive in my view and I can see potential for more earnings-accretive acquisitions given that First Property will have £13m of cash available to invest once the Lidl properties are refinanced. Run profits.

 

Get ready for take-off

I feel investors are missing a trick at aircraft leasing company Avation (AVAP:145p) whose shares are still adrift of my original buy-in price of 159p ('Get on board for blue sky gains', 11 Sep 2014). The investment advisers at New Jersey-based fund Ocean Capital Management clearly see value in the company as they have just increased their stake from 23.5 per cent to 28 per cent of the share capital, having snapped up another 2.3m shares. They are not alone as Avation bought back 785,544 shares into treasury at the end of last month; executive chairman Jeff Chatfield acquired 139,635 shares to bring his interest to 10.37m shares, or 20.2 per cent of the share capital; and executive director Rodney Mahoney purchased a further 20,000 shares to take his stake to 300,000 shares. I strongly feel it's worth following their lead.

That's because having raised $100m (£68m) in a bond issue at a coupon rate of 7.5 per cent last May with the intention of accelerating the expansion of its fleet, Avation has been busy signing agreements with airlines to lease out its scheduled deliveries of new aircraft. This will see its fleet increase to 40 aircraft by the June financial year-end, up a third year on year; diversified the lessor base; and reduced the reliance on the company's major earner, Virgin Australia. That airline accounted for three-quarters of revenue in the 2014 financial year, but this is set to dip below 40 per cent in the 2017 financial year (June year-end).

Pre-leased aircraft scheduled for delivery include an agreement with Vianet, Vietnam's new-age carrier which has mandated to lease four new Airbus A321 planes in 2016; Chinese carrier Shenzhen Airlines, a subsidiary of the Air China Group and one of the largest airlines in China, which has just completed a lease on a Boeing 737-800; Air Berlin, the second-largest airline in Germany, which is moving to an all Airbus fleet and has contracted an A320 plane; two Flybe ATR72 aircraft scheduled to be delivered in January and February; and two new Airbus A321 aircraft leased out to Thomas Cook for delivery in February and March.

As a result, Avation now leases planes to 12 airlines and has diversified its aircraft book so that by April around half the fleet by value will be jet aircraft. Mr Chatfield believes that larger high-capacity, narrow-body modern commercial aircraft represent an attractive long-term investment class. I agree and feel that with aircraft leasing set to account for half the global fleet by 2020, up from 40 per cent only two years ago and 25 per cent in 2000, then focusing on the most popular planes (ATR 72, Boeing 737-800NG and Airbus A320/321) offers a degree of protection given that asset values and leasing rates will be supported by ongoing high demand. Interestingly, all bar one of the 13 planes the company has subsequently sold have been above book value.

 

The bottom line

The bottom line is that with Avation's average monthly lease revenue set to increase from less than $5m in 2015 to $7.5m by March, reflecting a 70 per cent expansion of the fleet value to $750m, and the currency and length of loans secured on aircraft fixed to match the terms of the lease with the lessor, then the business offers both revenue and profit visibility which enhances the predictability of earnings. It's this predictability that makes me comfortable with the fact that Avation's net debt is set to almost double to $609m in the 12 months to June 2016.

The new lease agreements in place also make me comfortable with analysts' prediction that Avation's revenue will soar from $77m to $101m in the financial year to the end of June 2017. In turn, expect pre-tax profit and EPS to rise by more than half to $25.8m and 43.5¢, respectively. On that basis, the shares are being rated on five times earnings estimates, a valuation that represents a 50 per cent discount to international peers, and 15 per cent below net asset value. On both counts that's very harsh and I rate the shares a buy on a bid-offer spread of 143p to 145p, little changed on my last update ('Flying higher', 14 Oct 2015). My initial target price is 200p.

Please note that I published seven columns on 18 companies since the start of last week all of which are listed below and also on my IC homepage....

 

MORE FROM SIMON THOMPSON...

I have written articles on the following companies this week:

Grainger: Buy at 243.5p, target 280p; Dart: Take profits at 580p; Crystal Amber: Hold at 159p; Redde: Take profits at 203p; Burford Capital: Run profits at 196.5p; Renew: Run profits at 404p; Plethora Solutions: Speculative buy at 4.5p ('Stock check', 5 Jan 2016)

Elegant Hotels: Buy at 118p, target price 130p to 135p ('Check in for a profitable stay', 6 Jan 2016)

Safestyle: Run profits at 272p ahead of pre-close statement on 25 Jan 2016 ('Clear cut gains', 6 Jan 2016)

Epwin: Run profits at 143p, new target 170p ('Epwin on the acquisition trail', 6 Jan 2016)

GLI Finance: Recovery buy at 37.5p ('GLI shelves fundraise and its chief executive', 6 Jan 2016)

LXB Retail Properties: Buy at 97.5p, new six-month target 120p; Urban&Civic: Buy at 286.5p, target 325p; Conygar: Buy at 172p, target 200p ('Hot property, 7 Jan 2015)

Somero Enterprises: Buy at 139p, target 185p; 1pm: Buy at 70p, target 82p; First Property: Run profits at 53p; Avation: Buy at 145p, target 200p ('Small-cap value plays', 11 Jan 2016)

■ 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