It's a company I have followed for some time, having first advised buying the shares at 35p ('Tapping into a pensions payday', 27 Apr 2015). They subsequently doubled in value before profit-taking set in and I last rated them a buy at 55p when the company reported a bumper set of full-year results ('Lowly rated, cash rich pensions play', 10 Mar 2016).
However, the price has been under pressure since then even though STM has no financial worries - net funds of £8m account for a third of its market value - and analyst Duncan Hall at brokerage FinnCap predicts EPS will rise from 3.8p to 4.9p in 2016 and is pencilling in a dividend of 1.6p, up from 0.9p last year. On the face of it, the shares are seriously undervalued on seven times last year's cash-adjusted earnings, hence my call to the boss.
One potential reason for the derating is the uncertainty caused by next week's EU referendum if there is a Brexit majority. Almost all of STM's earnings are derived from its 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. STM has an office in Malta as a responsible EU jurisdiction to act as a pension hub for the business, and another in Gibraltar.
Malta has a double tax agreement with a number of countries, especially in the Middle East which is a key growth area, and is also being used to tap into the US market. The US and Middle East accounted for 60 per cent of the 2,100 new QROP schemes the company signed up in 2015 to take the total to almost 9,700 clients.
Bearing this in mind, Mr Kentish says that although the QROP market is embedded in the EU Pensions Directive and UK Legislation since 2006, it's not actually an EU product. In fact, 90 per cent of QROPS are not based in the EU at all. Moreover, irrespective of whether the UK remains part of the EU, an individual will retain the ability to move his or her pension to another jurisdiction as long as it complies with the HMRC criteria.
Uncertainty caused by EU referendum
Of more importance to the business right now is the uncertainty created among UK expats about "whether to transfer a pension or not to a QROP. There is a wait-and-see attitude. This has slowed up the decision-making process". That said, Mr Kentish believes that it's "implausible to believe that EU countries like Spain [an estimated 310,000 UK expats live there] would do anything [in the event of a Brexit] to make life more difficult for these individuals". He has a point as it would damage the Spanish economy and undermine employment if these expats were asked to leave. I just can't see that happening.
However, to address the short-term lull in the decision-making process by potential QROP clients, STM introduced a new pricing structure at the back end of April whereby the annual management charge was cut from £900 to £750 (blended rate of £820 on all its QROPS). This has made the company more competitive as its fees were at the top end of the market.
STM will be releasing a trading update shortly, so Mr Kentish was unable to divulge the run rate of new QROP clients in the first five months of this year, but frankly given the derating of the share price, the current valuation implies that it has gone ex-growth, which is clearly not the case.
The miserly rating on the shares also fails to acknowledge that as the underlying book of retained QROPS grows, albeit at a slower rate than was the case last year, each one still earns STM an annual management charge (AMC) in addition to an inception fee of £650. This means that a greater proportion of overall running costs are being covered by recurring income, so reducing the reliance on new business acquisitions to drive profits. It also explains why profits from the business can grow faster than revenues as a greater proportion of recurring AMC flows down to profits as the business scales up. In other words, even if FinnCap's forecasts are now on the high side, this is already factored in to the price in my view.
Potential to deploy cash pile
Interestingly, when we discussed the company's strategic objectives, Mr Kentish notes that "it would be the right time to have a UK self-invested personal pension (Sipp) provider within our armoury. We have a cash-rich balance sheet and are able to talk to the right-sized business." It's worth noting that new capital adequacy requirements that come into force in September could mean this objective is met sooner rather than later and quite possibly at an attractive price for STM shareholders given some existing Sipp providers will be looking to sell their business.
Or put it another way, with net funds of £8m on its balance sheet earning next to nothing in the way of interest, any acquisition would be hugely earnings accretive for the £24m small-cap company, a point not being factored in to the current valuation.
So, ahead of the trading update in a few weeks' time, I consider STM's shares a decent buy on seven times last year's cash-adjusted earnings and offering a 2.2 per cent historic dividend yield as earnings growth this year is in effect in the price for free. Buy.
Trifast on a roll
Trifast (TRI: 137.5p), a small-cap manufacturer and distributor of industrial fastenings, has delivered yet another strong year of growth and one that has prompted analysts to upgrade their forecasts and target prices modestly.
It's a company I have been following for the past three years, having initiated coverage in my 2013 Bargain Shares portfolio at 53p and last recommended running profits at 140p ahead of this week's results ('Top-end performance', 20 April 2016). The figures didn't disappoint and neither did the trading outlook.
Not only did Trifast's operating profit increase by almost 10 per cent to a record £16.8m in the 12 months to end-March 2016, and on margins up 50 basis points to 10.4 per cent, the underlying revenues also rose by just shy of 3 per cent after stripping out the contribution from acquisitions. The key here was growth in multinational OEM (original equipment manufacturer) customers, of which 50 account for 60 per cent of Trifast's sales, which offset a slowdown in sales to smaller national accounts and a lacklustre performance in the UK as anticipated. I would expect further inroads into the global OEM market given that there are rich pickings to be made by increasing market penetration in this key area.
Furthermore, the company has been targeting the right industries and sectors as growth was strongest in automotive and domestic appliance markets, highlighting the ongoing benefits from the acquisition of VIC, an Italian maker and distributor of fastening systems predominantly for the white goods industry. The business was acquired in May 2014 and has trebled Trifast's exposure to domestic appliances to 23 per cent of its sales. Also, last autumn's acquisition of German industrial distributor Kuhlmann has performed slightly ahead of forecasts. Both businesses are enjoying growth in both export and domestic markets, with Kuhlmann now starting to make inroads into the German automotive market, a sector that accounts for 30 per cent of Trifast's revenue, or double the level of seven years ago.
The cash-generation ability of the company is another key factor: almost 90 per cent of cash profits were converted into cash, which underpins ongoing investment. Moreover, with net debt of £16m representing only 19 per cent of shareholders' funds, there is scope for further bolt-on earnings-enhancing acquisitions. The dividend was raised by a third to 2.8p a share, far better than analysts had predicted. I wouldn't rule out a further hike to 3p a share in the current year, as analyst Jo Reedman at N+1 Singer predicts based on Trifast's revenues rising 8 per cent to £175m to deliver a 5 per cent increase in pre-tax profit to £16m and EPS of 10.4p.
On this basis, the shares are rated on 13 times forward earnings, and offer a 2.2 per cent prospective dividend yield, an undemanding rating for a company with a strong order book, solid prospects and one benefiting from a foreign currency headwind. I am not the only one thinking this way as, following EPS upgrades of 4 per cent, analysts have price targets ranging from 150p to 160p. Run profits.
1pm's sharp earnings growth
I feel that investors are being overly cautious in their valuation of Bath-based 1pm (OPM:72p), a specialist provider of finance to small- and medium-sized enterprises (SMEs) and a constituent of my 2014 Bargain Shares portfolio.
The company updated the market at the end of March when the board confirmed it was performing in line with analysts' profit forecasts for the 12 months to end-May 2016. 1pm also announced the £2.75m acquisition of Bradgate Business Finance, a leading independent specialist provider of 'hard' asset finance to clients buying business equipment within the construction, recycling and haulage sectors. The business is complementary to the 'soft' asset focus of both 1pm and Academy Leasing, a provider of equipment finance and an equipment and vehicles broker to the SME market that 1pm acquired for £10m last summer ('Powered up for gains', 29 July 2015).
I outlined details of the acquisition at the time ('1pm's smart bolt-on buy', 24 March 2016), but subsequent to that update analyst Eric Burns at house broker WH Ireland has upgraded his earnings forecasts by more than I had anticipated. Mr Burns now expects 1pm to more than double revenues to £12.2m in the 12 months to end-May 2016, a performance reflecting both acquisitions and ongoing strong organic growth in its loan book, and deliver pre-tax profits of £3.1m, up from £1.6m in 2015. This is based on a year-end loan book of £63.5m. On this basis, expect EPS of 5.1p and a two-thirds hike in the dividend to 0.5p.
Mr Burns has also raised his 2017 earnings estimates by 7 per cent and now expects the company to deliver £17m of revenue, or more than £1m ahead of his prior estimate, pre-tax profits of £4.5m, EPS of 6.7p and a dividend of 0.7p a share. Those forecasts look sensible to me as does the assumption embedded in them that 1pm's receivables will grow to £74m by May 2017. This is after factoring in Bradgate's £3.45m loan book, and the £2m book of 1,000 SME finance leases acquired by 1pm last month.
Importantly, a leverage ratio of 2.5 times receivables to shareholders' funds is not stretched and credit quality is good, with impairments accounting for 0.28 per cent of the loan portfolio in the first half. No single customer represents more than 0.21 per cent of the portfolio value, so credit risk is diversified and average loan size is manageable at around £11,000.
The key point being that 1pm's shares are only rated on 11 times current-year earnings estimates and offer a prospective dividend yield of 1 per cent. For a company likely to have delivered EPS growth of 38 per cent in the year just ended, and forecast to post EPS growth north of 30 per cent again this year, that's a low rating. A PEG ratio below 0.5 is attractive, too, as is a double-digit post-tax return on equity.
I rate 1pm's shares a buy at 72p and have an upgraded target price of 85p. Buy.
