How the 2015 Bargain share portfolio fared

Listen to this week's free IC Companies & Markets podcast in which Simon Thompson discusses his Bargain Shares portfolio with editor John Hughman.

AB DYNAMICS (ABDP)

Aim: Engineer

Share price: 303p

Bid-offer spread: 297p-303p

Market value: £52.5m

Website:abd.uk.com

AB Dynamics (ABDP) is a designer, manufacturer and supplier of advanced testing systems and measurement products to the global automotive industry. It was below the radar of most investors a year ago, but I felt that the business offered solid credentials not to mention an attractive valuation. At the time the shares were trading on 11.5 times cash-adjusted earnings estimates and offered a prospective yield of 1.7 per cent. The earnings risk looked firmly to the upside, underpinned by strong demand from a resurgent car industry, and a robust order book.

And so it proved with AB Dynamics’ absolutely smashing analysts’ estimates. In fact, full-year pre-tax profit soared by over 40 per cent to £3.8m, an outcome that was £1m ahead of market estimates last February. Moreover, the earnings upgrade cycle, and one being driven primarily by the company’s track-testing systems division, which includes driving robots and soft crash vehicles and accounts for almost 70 per cent of revenues, looks to have further to run.

Having raised his EPS forecast by 30 per cent to 15.9p just prior to the company’s full-year results at the end of last year, analyst Sanjay Jha at house broker Panmure Gordon saw his upgraded estimates demolished when AB Dynamics reported a 46 per cent rise in EPS to 19.2p on turnover up 19 per cent to £16.5m. Although the company doesn’t give a breakdown of the revenues from its track-testing systems, sales of soft crash target vehicles designed for testing advanced driver assistance systems are believed to have increased by around 60 per cent based on comments and third-quarter results from the world’s fourth-largest tyre maker, Continental AG. This is higher-margin business than laboratory testing, accounting for 29 per cent of AB Dynamics’ revenue, albeit the 15 per cent year-on-year growth reported in suspension parameter measuring machines was also ahead of forecast.

As a result of this revenue mix, AB Dynamics’ gross margins improved from 29 to 32 per cent, and with the increase in administration expenses lagging revenue growth, this helps explain why operating profit surged. It’s realistic to expect this positive trend to continue given that track-testing systems, soft crash and robots, is expected to deliver revenue growth of around 13 per cent this year and next to account for almost £13m of Panmure’s current year revenue estimate of £18m. This means that AB Dynamics would only have to maintain revenue from laboratory testing and its much smaller measurement and analysis unit to grow operating profit from £3.74m to £4.4m as Panmure forecasts in the 12 months to August 2016.

On that basis, and reflecting an 11 per cent post results upgrade, expect current year EPS of 20.3p. In addition, shareholders can expect a 10 per cent rise on the 2.75p a share dividend just declared given that the company’s cash position remains robust: net funds increased from £4.9m to £8m, a sum worth 48p a share. Priced on 12.5 times cash-adjusted EPS estimates, and offering a prospective dividend yield of 1 per cent, I would recommend running your 73 per cent paper gains.

INSPIRED CAPITAL (INSC)

Aim: Specialty finance

Last share price: 21.5p

Bid-offer spread: taken over

Market value: £47.1m

Website: inspiredcapitalplc.com

Inspired Capital, a company aiming to become a major force in lending to small- and medium-sized enterprises (SMEs), received a cash bid from Bentley Park, a 17.1 per cent shareholder and a company owned by currency billionaire Joe Lewis. The initial cash offer of 20p a share represented a 25 per cent return on my 16p recommended buy-in price.

The bid approach followed a boardroom rift that resulted in the departure of both chief executive Brian Cole and chairman Matt Cooper (‘Three value plays’, 19 May 2015). Although the initial bid represented a healthy premium to Inspired Capital’s share price immediately after news of the boardroom departures became public, it still looked on the low side to me for a fast-growing and profitable company operating in a favourable segment of the finance market.

However, I had to take into consideration the major change in the management structure. That’s because the key reason I was attracted to the investment case was the track record of Mr Cooper, one of the founders of Capital One, the fifth-largest bank in the US, and Mr Cole, former head of Capital One’s UK operations. Their exits nullified a major bull point and clearly other investors were thinking the same way. In the end, Inspired Capital’s institutional shareholders eked out a higher cash offer of 21.5p a share, which went unconditional to give followers of last year’s Bargain Shares Portfolio a 34 per cent return on their holding in a little over four months.

H&T (HAT)

Aim: Pawnbroker and money lender

Share price: 195p

Bid-offer spread: 192-195p

Market value: £71.9m

Website: handtpawnbrokers.co.uk

Aim-traded pawnbroker and money lender H&T (HAT) is a classic Benjamin Graham recovery play on whose investment style I base my portfolio. The company’s equity shareholder funds of £88m were worth 39 per cent more than the company’s market value of £63m a year ago, so even ignoring all the goodwill and intangible assets on H&T’s balance sheet, we were still getting the vast majority of the company’s plant and equipment, worth £11.3m, in the price for free.

It has been the robust nature of the balance sheet that has enabled the business to trade through the tough times following the collapse in the gold price. Importantly, the company’s pledge book has stabilised at around £39m over the past 18 months as the pawnbroking market adjusts to the new trading environment. And having degeared its balance sheet – net debt was slashed to £2.1m by the end of 2015, down from £9.7m a year earlier – the company has ample firepower to expand the business as well as make bolt-on acquisitions of rivals’ pledge books. H&T has a £50m four-year credit facility.

The tight focus on cost control and deleveraging the business has produced improved profitability, too. Having reported a 30 per cent increase in half-year profit to £2.6m, the company should deliver full-year profit of around £7.1m in 2015, up from £5.5m in 2014, to produce EPS of 15p and a payout up by over half to 7.5p a share. Priced on a 21 per cent discount to book value of 246p a share, and underpinned by a prospective dividend yield of around 4 per cent, I continue to rate H&T’s shares a value buy on 11 times EPS estimates of 17.2p for 2016. Buy.

NETPLAY TV (NPT)

Aim: Online gaming

Share price: 8.75p

Bid-offer spread: 8.5-8.75p

Market value: £26m

Website:netplaytv.plc.uk

Aim-traded shares of Netplay TV (NPT) are trading around the 8.35p buy-in price and with the benefit of dividends of 0.55p a share, the holding is up 8.4 per cent. I was expecting far more upside as I felt, and still do for that matter, that the derating in 2014 due to concerns over how the business would be impacted by the new UK point of consumption tax was overdone.

The company is in an enviable position of having a cash-rich balance sheet with net funds around half the current market capitalisation. The board’s strategy is to use this cash to make earnings-accretive acquisitions, and last summer Netplay purchased Otherside, an online marketing, product development and technology business, for £2.7m, with an additional £500,000 payable 12 months after completion. Otherside reported cash profit of £600,000 on revenue of £2.6m in its last financial year, so the bolt-on deal is earnings enhancing. The board subsequently entered into discussions with gaming operator Sportech (SPO) in relation to the potential acquisition of The Football Pools business. However, Netplay sensibly dropped out of the running after Sportech received a number of indicative proposals for that business.

Still, the failure to pursue the Sportech acquisition should not detract from the board’s willingness to deploy a cash pile estimated to be around £11.9m, or 4p a share, at the December 2015 year-end to make earnings-accretive acquisitions, positive news on which is likely to act as a catalyst for a re-rating. So, with Netplay’s shares rated on seven times likely cash-adjusted earnings for last year, I feel that the investment risk remains to the upside. The full-year dividend of 0.55p a share offers a prospective dividend yield of over 6 per cent, too, albeit thinly covered by forecast EPS of 0.7p. Buy.

MOUNTVIEW ESTATES (MTVW)

Main: Residential property

Share price: 11,500p

Bid-offer spread: 11,200-11,500p

Market value: £449m

Website:mountviewplc.co.uk

Mountview Estates' (MTVW) business is focused on renting out residential property in London and the south east, in particular. With these markets in good shape, the company has been reaping handsome gains. In the first half to the end of September 2015, revenue increased 16 per cent to £42.8m to lift pre-tax profit and EPS by a quarter to £25.9m and 531p, respectively.

Interestingly, Mountview sold 94 properties in the period for £33.7m, or three times more than the carrying value in its accounts. The company carries properties on its books at the lower of cost or net realisable value, so given the steep rise in property prices in recent years there is a marked difference between open market value and the much lower stated book value in the accounts.

To address this issue, valuers Allsops carried out a valuation of the portfolio in September 2014. At the time they valued more than 2,400 residential properties under regulated tenancies, 329 life tenancies and 1,127 ground rents and deemed the company’s trading stock had an open market value of £666m, or more than double its £318m carrying value on Mountview’s balance sheet. The company also owns investment properties with a conservative book value of £28m. This mark-to-market value valuation ‘surplus’ of £348m adds 8,923p a share to Mountview’s last reported IFRS net asset value per share of 7,730p and meant that the shares are trading on a 30 per cent discount to adjusted net asset value of 16,653p. But even that valuation is looking conservative.

That’s because the gross proceeds of £33.7m generated by the sale of the aforementioned 94 properties included one investment property that was sold for £1.7m, or £197,000 above its fair value. It also included the disposal of trading stock which had been attributed an open market value of £22.75m by Allsops in September 2014, but raised gross proceeds of £32m.

It’s worth noting, too, that having raised the total dividend by 38 per cent to 275p a share in the financial year to end-March 2015, the board has doubled the half-year payout to 200p a share (ex-dividend date of 18 February 2016) mainly due to less favourable treatment of an individual’s dividend income from the start of the next tax year. However, this still means the shares offer a decent prospective dividend yield 2.6 per cent, assuming a final payout of 100p a share. The dividend could be higher given that Mountview runs a conservative balance sheet with net debt only £50m.

I continue to rate Mountview’s shares a value buy at 11,555p

CRYSTAL AMBER (CRS)

Aim: Investment company

Share price: 143p

Bid-offer spread: 143p-147p

Market value: £145m

Website: crystalamber.com

Crystal Amber (CRS) is an activist fund that invests predominantly in small- and mid-cap UK equities where it identifies opportunities to enhance long-term shareholder value through active engagement with companies. The fund was founded in 2008, and delivered a 68 per cent increase in net asset value between 2011 and 2014, which prompted my interest in the shares. By the end of November, they had delivered a total return of 18 per cent.

However, the reversal in the share price since then reflects a near 6 per cent fall in the fund’s net asset per share in the final two months of last year. The equity markets sell-off this year will mean further modest losses on the portfolio, too. The main reason for the decline is largely down to the share price performance of two holdings: a 14.6 per cent holding in Hurricane Energy (HUR), the UK-based oil and gas company focused on hydrocarbon resources in naturally fractured basement reservoirs, which lost a third of its value in the fourth quarter; and the fund’s investment in student management systems provider Tribal (TRB), which crashed following profit warnings and news of a rescue rights issue. Crystal Amber’s decision to more than double its stake in Tribal from 2.9 per cent to 6.4 per cent at the end of October, paying 67p a share at the time, has proved costly. Gains on other major holdings, mainly budget airline Dart Group (DTG) and media group STV (STVG), failed to offset these losses.

Clearly, this isn’t an ideal situation, but given that I have a positive outlook on more than half the fund’s portfolio, I would hold on to Crystal Amber’s shares, which also offer a useful 3.5 per cent dividend yield if you bought in on my advice. Hold.

ARBUTHNOT BANKING (ARBB)

Aim: Private banking

Share price: 1,455p

Bid-offer spread: 1,401p-1,455p

Market value: £216m

Website:arbuthnotgroup.com

Arbuthnot Banking (ARBB) and Secure Trust Bank (STB), an unsecured lender in which Arbuthnot owns 51.8 per cent of the share capital, both reported storming sets of half-year results, and upbeat third-quarter and pre-close trading updates.

Arbuthnot’s holding in Secure Trust means that the lion share of its reported profits come from that lender. So with Secure Trust increasing its total loan book by over 70 per cent to £1bn last year, reflecting growth in consumer lending led by motor finance and retail, analysts predict Arbuthnot will report adjusted pre-tax profit of £36.6m and EPS of 95.4p, up by over 60 per cent on fiscal 2014. Moreover, following the sale of its Everyday Loans business to Non-Standard Finance (NSF), the regulatory capital base of Secure Trust has risen by 74 per cent. The bank remains well-funded and capitalised.

However, although shares in Secure Trust have re-rated, those in Arbuthnot have flatlined and means that Arbuthnot’s holding of 9.48m shares in Secure Trust is now worth £299m, or 38 per cent more than Arbuthnot’s own market capitalisation of £216m. It’s not as if Secure Trust is outrageously valued, either, as its shares trade on 17 times earnings estimates.

The undervaluation of Arbuthnot’s equity is even more glaring once you consider that Arbuthnot Latham, the company’s private banking arm, more than doubled half-year profit to £3.7m, buoyed by the hiring of new private bankers, a substantial increase in new clients opening accounts, improved outcome from its Dubai office, and a contribution from the Dunfermline Building Society residential mortgage book, acquired from its administrators in December 2014. Analysts believe this unit should report pre-tax profit of £7m in 2015. In effect, it’s in the price for free. Add to that a 1.9 per cent dividend yield, and I feel that the valuation anomaly is still worth exploiting. Buy.

RECORD (REC)

Aim: Currency manager

Share price: 24.75p

Bid-offer spread: 24p-24.75p

Market value: £54.4m

Website: recordcm.com

My rational for including currency manager Record (REC) in last year’s portfolio was simple: with the ultra-easy monetary policy being pursued by the central banks of Japan and Europe – the polar opposite of that being adopted by the US central bank – and economic growth strong in the US, it was only reasonable to expect the US dollar to continue its appreciation against the euro and the yen, a dominant feature of currency markets in the second half of last year.

In turn, this should have created a favourable backdrop for the currency hedging strategies adopted by Record’s clients. The company also has a rock-solid balance sheet, with net cash currently equating to 15p, or 60 per cent of the share price, and it is expected to maintain its dividend at 1.65p a share.

What I didn’t expect was a client to reduce the size of its tactical bespoke currency return mandate by $2.8bn (£1.8bn) at the end of August, which is why the company’s assets under management equivalent declined from $55.4bn to $53.3bn between March and September last year. And last month the company announced that another client instruction, announced in September and worth $500m for a dynamic hedging mandate, has been suspended pending a potential restructure. Analysts now expect the company to report a 10 per cent decline in EPS to 2.4p in the 12 months to the end of March 2016.

Chief executive James Wood-Collins remains upbeat, though, noting that the increase in client numbers over the third quarter of the financial year reflects growing interest in currency hedging and return-seeking opportunities for prospective clients. He is also enthusiastic about the further opportunities presented by his company’s partnership with WisdomTree, an exchange traded fund and exchange traded product sponsor and asset manager. Clearly, Record directors Jane Tuffnell and Cees Schrauwers see value in the shares as they purchased 150,000 shares and 100,000 shares, respectively, in the past few months. They have a point. Adjust for net cash of 15p a share on its balance sheet and Record’s shares are rated on a meagre four times earnings estimates. The shares offer a 6.6 per cent dividend yield, too.

So, although the shares are down in the past year, I feel that with currency volatility likely to be a major theme this year, there is recovery potential off a very low base. Hold for recovery.

PITTARDS (PTD)

Aim: Personal goods

Share price: 82p

Bid-offer spread: 78p-82p

Market value: £11.5m

Website:pittards.com

The specialist producer of luxury leather goods reported a near 50 per cent rise in operating profit to £752,000 on turnover of £15.6m in the six months to the end of June 2015. That’s the good news. The bad news is that the economic chill from Asia and the fallout from the slowdown in China started to dampen demand for leathers last summer, which prompted analyst John Cummins at house broker WH Ireland to rein in his full-year revenue estimate from £37.5m to £31.5m in late September and downgrade his pre-tax profit estimates by a fifth to £1.6m.

This implied a flat profit performance overall rather than the recovery I was anticipating when I included Pittards' (PTD) shares in my Bargain Shares Portfolio. To compound matters, the company warned again just before Christmas that the suppressed demand it was experiencing at the time of the half-year results had continued to impact volumes, and consequently profit for last year will be materially below those downgraded market expectations. Mr Cummins has withdrawn his estimates.

There are glimmers of hope, though. Firstly, the sharp rise in the US dollar, the currency in which over 70 per cent of Pittards’ products are invoiced, together with lower raw material prices, are beginning to be reflected in better margins for the company. A fundraising last year also strengthened Pittards’ balance sheet and enabled the company to acquire the freehold of the factory at Yeovil. Net debt was £6.9m at the half-year stage, representing 29 per cent of shareholders’ funds of £23.8m, and well within facilities of £8.6m. There is substantial asset backing, too, with plant and equipment on Pittards’ balance sheet worth almost the market value of the company alone. It’s worth noting that small-cap fund manager of the year Judith MacKenzie at Downing LLP raised the group’s shareholding in Pittards to 20.6 per cent a fortnight ago.

So, although the holding has been a poor performer, on a 50 per cent discount to net asset value the bad news looks priced in to the valuation and I would hold for recovery.

STANLEY GIBBONS (SGI)

Aim: Rare stamps, coins, antiques & memorabilia

Share price: 73p

Bid-offer spread: 72p-73p

Market value: £34.3m

Website: stanleygibbons.com

The reason why shares in stamp and coin dealer Stanley Gibbons (SGI) are now trading on a 57 per cent discount to book value of 171p and have proved a major drag on the performance of last year’s portfolio is because trading has deteriorated and the company is now sitting on stocks worth £55m. These inventories are made up of rare coins worth £8m, other collectibles including antiques worth £8m and stamps worth £39m.

The inability to turn those stocks into cash meant that borrowings have increased, hitting £17m at the end of September. True, that only represents balance sheet gearing of 21 per cent of shareholders’ funds of £81.9m, but it also assumes the company can realise book value for its assets. It’s clearly struggling. As a result, the board is considering a fundraising to deleverage the balance sheet, having received unsolicited approaches from certain shareholders wishing to discuss its funding arrangements. Bearing this in mind, while an equity fundraising is one potential option, the discount to net asset value at which any such capital raise would likely be priced makes it “a relatively unattractive route to alternatives under their consideration”.

There is value in the shares, but this will only be realised if the distress risk embedded in the current share price dissipates. And the easiest way of doing this is for the company to sell some of its crown jewels. The most obvious is to sell the parts of the business that are performing best and in particular Noble Investments, acquired for £45m just over two years ago, a deal funded by a £40m placing at 295p a share. Noble comprises Baldwin’s (the globally respected brand in coins, established in 1872), Dreweatts (an auctioneer of antiques and collectibles such as watches, fine wine and jewellery, established in 1759), Bloomsbury (a leading auctioneer of books, manuscripts and art) and Apex Philatelics.

Noble’s rare coin division reported half-year trading profit of £1.7m for Stanley Gibbons in the six months to the end of September 2015, and Dreweatt contributed a further £400,000, so there is value to be realised in these profitable businesses if the right buyer can be found. The board may not go down this route, but it should be up for serious discussion given it has a duty to put the company’s finances on a better footing with the least dilution to existing shareholders. Expect news from the company before the end of March. My view is that if a dilutive equity fundraise can be avoided, and clearly the board are considering all possible options, I would expect a sharp relief rally. Hold.

Bargain Shares Portfolio performance 2015

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