A market opportunity
Investors have completely misinterpreted the news from STM (STM:47p), the Aim-traded financial services company specialising in the administration of assets for international clients in relation to retirement, estate and succession planning and wealth structuring.
In a trading update released during the recent equity market rout, the board announced that chief executive Colin Porter will be leaving the company in order to take up a position in a non-competing industry in the United States. Mr Porter will serve his 12-month notice period and Alan Kentish, director of product business development and formerly finance director when the company floated in 2007, will assume the role of interim chief executive in April. What they didn't say is that Mr Porter's decision to leave the company is purely for personal reasons and is unrelated to the business.
Also, last week's news that Mr Kentish has been subject to an administrative measure by the Malta Financial Services Authority (MFSA) in relation to his role as a non-executive director of a Gibraltar based insurance company (that was a client of STM's insurance management division) is of no concern to me. The administrative measure relates to the late notification to the MFSA of an investigation by the Gibraltar Financial Services Commission (GFSC) relating to the statistical methodology used to set the insurance technical reserves during the period from 2007 to 2009. The GFSC concluded that Mr Kentish remained a fit and proper person, and in any case he is no longer a director of that company.
These twin announcements have overshadowed news that STM is trading bang in line with the guidance Mr Porter offered me when we last spoke and I understand that STM's pre-tax profits will increase sharply from £1.7m in 2014 to around £2.7m last year to drive up EPS from 2p to 3.8p when STM releases its 2015 financial results on Tuesday, 1 March 2016. This is based on revenues rising from £15.9m to £17.7m and reflects the robust performance of STM's Qualifying Recognised Overseas Pension Schemes (QROPS) business, an offshore pension scheme approved by HMRC and used by expatriates and internationally mobile employees whose tax domicile can change as a consequence of employment. The operation has been growing quickly and now has over 8,800 clients globally, having added 1,400 in the first six months of last year. Prospects are well underpinned by strong pipeline of applications from new clients.
The sell-off in STM's shares which has seen the price decline from 65p to 47p since news of Mr Porrter's departure was issued on Monday, 18 January means that they are now rated on a modest multiple of 10 times 2015 earnings after adjusting for a cash pile worth 11.5p a share. This is a low valuation for a business that has hit an inflexion point whereby we can expect an increasing amount of incremental revenues to fall straight down to the bottom line given the operational leverage. Indeed, analyst Duncan Hall at brokerage finnCap predicts that pre-tax profits will rise by a further 37 per cent to £3.7m in 2016 based on a 5 per cent rise in revenues. On this basis, EPS is expected to jump to 5p, so in effect the shares are being priced on a miserly cash adjusted forward PE ratio of 7. There is the possibility of some positive news on the future dividend policy in those forthcoming results too.
I would also highlight that peer group analysis suggests that STM's shares are grossly undervalued. Indeed, rival Curtis Banks (CBP) has just acquired Suffolk Life from Legal & General for £45m, a take-out price equivalent to 11 times Suffolk Life's cash profits of £4m and representing a multiple of 2.5 times revenue of £18m. STM is expected to post cash profits of £4.1m on revenues of £18.6m in 2016, but only has a market value of £28m. Also, its net assets of £24.5m include net cash of £7.1m which makes the current valuation even more anomalous. In my view, the company's equity has to be worth £47m, or £40m net of cash on the balance sheet.
So, having first advised buying STM's shares at 35p ('Tapping into a pensions payday', 27 Apr 2015), and maintained that advice after they had doubled in value ('Riding small cap winners', 7 October 2015), I rate them a decent buy on a bid-offer spread of 45p to 47p given there is potentially 60 per cent upside to my maintained target price of 80p. Buy.
Making a fair point
Another company whose shares have derated in the past three months is Aim-traded Fairpoint (FRP:150p), a leading provider of consumer professional services including debt solutions and legal services. The share price has fallen almost 25 per cent from a seven-year high of 195p, a derating that appears completely out of sync with the company's trading update and outlook statement a fortnight ago.
Ahead of full-year results on Wednesday, 16 March 2016, Fairpoint's board revealed that both adjusted pre-tax profit and revenues posted double digit gains in 2015, a performance expected to drive up adjusted EPS from 16.9p to 18.4p as house broker Panmure Gordon forecasts. This means that the shares are rated on 8 times last year's likely earnings and with the payout per share predicted to be hiked from 6.4p to 6.8p in next month's results, they offer a decent 4.6 per cent dividend yield.
The company also flagged up that only 8 per cent of last year's revenues were derived from whiplash claims. That's important because investors were spooked when the chancellor announced in the Autumn Statement plans to restrict the ability of sufferers of minor whiplash injuries to claim compensation for minor motor accidents, specifically removing the right to seek general damages for minor soft tissue whiplash. The aim is to end the cycle in which responsible motorists pay higher premiums to cover false claims made by others. The government's proposals should cut claims by over £1bn each year and reduce the average cost of motor insurance by £40 to £50 per policy. Those genuinely injured will still be entitled to claim for 'special damages' including loss of earnings and medical treatments. More injuries are now likely to be settled in the small claims court as the upper limit of these claims will be increased from £1,000 to £5,000. Bearing this in mind, I feel there are some important points to note here.
Setting the record straight
Firstly, Fairpoint's legal services division now accounts for two thirds of group revenues, so 88 per cent of the income from this division is completely unaffected by the proposed new legislation.
Secondly, the changes to be implemented in April 2017 are likely to follow prior precedent, so are highly unlikely to be retrospective. This means that based on current case volumes Fairpoint's revenues earned from whiplash claims, and road traffic accidents in particular, look well underpinned for at least another 30 months to the summer of 2018, a point that bearish investors have failed to grasp.
Thirdly, and reflecting the acquisitions made to enhance its legal services offering, Fairpoint now has a competitive advantage over rivals looking to process volume legal work on low-cost claims.
Fourthly, the company's net debt of £13.6m at the end of 2015 is comfortably within its committed bank facilities of £25m, so offering the company ample scope to use its robust cash generation and debt facilities to make further bolt-on acquisitions to boost the legal services offering and reduce the company's exposure to debt management books and IVA services. Indeed, there are around 10,000 providers in the fragmented legal services market employing less than 10 people, so offering the potential for Fairpoint to act as a consolidator.
The bottom line is that the company is highly likely to continue to grow as analysts predict over the next financial year, and is far less exposed to the changes in legislation on whiplash claims as the share price derating would imply. This explains why analysts still believe that the company will grow revenues by around a fifth to £65m in 2016 after factoring in the full contribution from last year's bolt-on acquisition. On this basis, expect adjusted pre-tax profits to rise by 10 per cent to £11.4m, EPS to increase to about 20p, and the payout to be hiked to between 7p and 7.2p, as analysts at Panmure and research firm Equity Development forecast. On this basis, the shares are trading on 7.5 times current year earnings estimates and offer a prospective dividend yield of 4.8 per cent.
So having included Fairpoint's shares in my 2013 Bargain Shares Portfolio at 98.25p ('Bargain shares for 2013, 7 February 2013), and last advised running profits at 175p ('Capitalising on investor overreactions', 1 December 2015), I can see scope for the price to recover back towards my previous target price range of 200p to 220p as investors reassess the investment case and realise that the company's profits are far more protected to the changes in legislation than the knee-jerk reaction to the news would suggest. Run profits.
Stadium profits surge under-rated
Shares in Aim-traded Stadium Group (SDM:104p), a specialist provider of niche electronic technologies, have losta fifth of their value since the company issued its half-year results in September ('Switch on for gains', 9 September 2015), albeit the price is still 33 per cent up on the level at which I initiated coverage ('Switch onto the Stadium of light', 30 July 2014).
Analyst Jon Lienard at broking house N+1 Singer believes that the share price decline in the second half of last year is most likely down to a misguided perception amongst investors that the company is reliant on China to drive the success of its integrated high-tech product offering. In fact, the company has little domestic China revenue and a pre-close trading update confirmed that the profit surge I had anticipated at the time of those interim results has been delivered. Mr Lienard believes that Stadium's full-year revenues shot up by over a third to £56m to lift pre-tax profits by almost a half to £4m and deliver EPS of 8.9p, up from 7p in 2014. On this basis, he anticipates a sharply higher dividend of 2.7p to be declared in next month's results on Tuesday 15 March 2016, up from 2.1p in 2014, implying the shares offer a healthy prospective dividend yield of 2.6 per cent.
The company, led by chief executive Charles Peppiatt, also announced that last summer's bolt-on acquisition of Stontronics, a UK based maker and supplier of power units, is working out as planned. And with an important relocation to a new facility in China successfully completed last summer, the strategic inventory build in the first half to support customers during the move, which led to a £1m rise in both stocks and net debt in the first half, should have unwound. Analysts expect net debt to have fallen to around £4.5m by the end of last year, down from £5.9m at the half year stage, implying gearing of 27 per cent of shareholder funds after factoring the £6m placing and open offer which funded the purchase of Stontronics.
So, with the benefits of the Stontronics acquisition yet to come, analysts believe Stadium should be able to lift pre-tax profits by half again to £6m on revenues of £65.6m in 2016 to deliver EPS of 12.3p and a dividend of 3p. On this basis, the shares are rated on just over 8 times earnings estimates and offer a prospective yield of almost 3 per cent for the current year, a rating completely at odds with a company that has just announced a strong start to the new financial year.
In the circumstances I feel that the share price derating from last summer's high is overdone and rate Stadium's shares a decent trading buy ahead of the forthcoming results. They are unlikely to disappoint. Buy.
Please note that my 2016 Bargain shares portfolio will be published on Friday, 5 February 2016 before trading commences on the stock market and will be available on both my home page and on the home page of the website. I will be updating my view on the 10 companies I included in last year's portfolio, as well as providing detailed investment cases on another 10 companies in this year's portfolio.
Finally, I have published articles on 36 small-cap companies from my watchlist so far this year, all of which are available on my IC home page. I will endeavour to publish online articles in the near future on a further 20 or so companies on my watchlist that have issued trading statements in the past few weeks.
MORE FROM SIMON THOMPSON...
I have written articles on the following companies since the start of last 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)
■ 32Red: Run profits at 147p; Netplay TV: Buy at 7p ('Chipping in', 12 Jan 2016)
■ Cambria Automobiles: Buy at 87p, new target 95p; Vertu Motors: Buy at 76p, target range 85p to 90p ('Motoring ahead', 12 Jan 2016)
■ Global Energy Development: Hold at 24p ('Cash rich, but unloved', 12 Jan 2016)
■ KBC Advanced Technologies: Bank profits and sell in the market at 183p ('Tech watch, 13 January 2015)
■ Sanderson: Buy at 75p, target range 85p to 90p ('Tech watch, 13 January 2015)
■ Trakm8: Buy at 300p, new target 400p ('Tech watch, 13 January 2015)
■ Amino Technologies: Buy at 120p, new target range 155p to 160p ('Amino has the ammunition', 14 January 2015)
■ easyHotels: Buy at 89p, initial target 100p ('easyHotels ramps up expansion', 14 January 2015)
■ Stanley Gibbons: Hold at 58p ('Stanley Gibbons fundraise', 14 January 2015)
■ Miton Group: Buy at 28p, target 35p; Moss Bros: Buy at 97p, target 120p to 130p; Bioquell: Buy at 140p, minimum target 170p; UTV Media: Trading buy at 184p ('An awesome foursome', 18 January 2015)
■ Equity market strategy ('Bear Market signals', 25 January 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
