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Bargain shares portfolio half-year report

Bargain shares portfolio half-year report
August 15, 2016
Bargain shares portfolio half-year report

Based on the investment ideas of Benjamin Graham, the grandfather of value investing, our portfolios have beaten the FTSE All-Share index in 14 out of the 17 years in which we have run them. And the motley crew of 10 small cap shares I selected in early February are already producing some eye-catching gains, rising on average by 17.1 per cent in the past six months after taking into consideration tender offers and special payouts which have been reinvested, but excluding normal dividends.

The portfolio has outperformed the FTSE SmallCap, FTSE Aim indices and the FTSE All-Share which is heavily weighted to the FTSE 100, the best performing UK index this year and outside my small-cap share hunting ground.

JURIDICA (JIL)

Aim: Capital provider for corporate legal claims

Share price: 70p

Bid-offer spread: 69-70p

Market value: £77.5m

Website: juridicainvestments.com

Aim-traded Juridica (JIL:70p) specialises in backing corporate legal cases in North America with its own capital in return for taking a share of the financial awards in the event of a positive outcome. It has been successful over the years, but a series of write-downs in 2015 spooked investors, so much so that the shares were trading on a huge discount to book value when I included them in the portfolio at 41.2p in February. Since then the board have paid out an 8p a special payout which I advised recycling into buying more shares at 61p to lower your average buy in price to 36p ('Brexit winners', 1 Aug 2016).

I had good reason too. That's because following settlement of two major litigation cases in Juridica's favour, the company will receive cash proceeds of $65.8m (£50m) by the end of September, a sum equating to 44.5p a share, which will increase net funds to 58.5p a share by my calculations. This means Juridica's other 13 legal cases, which have a combined book value of $35.4m, or 24.5p a share, are being rated on a deep discount to their carrying value. So given potential for the remaining legal cases to deliver cash returns above book value, the strong likelihood of the board declaring a bumper payout in next month's half year results, and ongoing dollar strength which is boosting net asset value in sterling terms, I continue to rate Juridica's shares a buy.

 

 

MINDS + MACHINES (MMX)

Aim: Share price: 11.5p

Bid-offer spread: 11.25-11.5p

Market value: £88m

Website:mindsandmachines.com

Shares in Mind + Machines (MMX:10.25p), a company that provides services in all areas of the domain name industry and primarily focused on the new top-level domain (gTLD) space, have risen by 28 per cent in the past six months, but still look very undervalued. True, the business has been benefiting from earning income in US dollars, its functional currency, so sterling's weakness has lifted the value of its overseas earnings.

However, this is more than a currency play as a recent pre-close trading update revealed a quadrupling in first half billings to $8.05m; a 45 per cent surge in domains under management to more than 728,000; and significant reduction in operating expenses. Insiders are clearly confident of a move into profitability and have been buying shares in their company all year. Given that spot net asset value per share of 8p includes cash deposits of 3.4p and a conservatively valued portfolio of domain names worth 4.2p, then it only seems reasonable for the shares to trade on a significant premium to book value once the company moves into profit. And the chances of that look high in my view. Buy.

 

BIOQUELL (BQE)

Main: Share price: 153p

Bid-offer spread: 150-153p

Market value: £35.0m

Website: bioquellplc.com

Andover-based Bioquell (BQE:153p), a provider of specialist microbiological control technologies to the international healthcare, life science and defence markets, is firmly in play. Having returned £40.8m of its cash pile through a tender offer to buy back half its share capital at 200p a share, bid talks are ongoing with several parties regarding the sale of its retained biocontamination control technology products division.

Strip out current net cash of £6.8m and ongoing operations are effectively being valued at £27m, or 8 times last year's cash profits. A price-to-book value ratio of 1.4 times is hardly punchy either. And that's before considering that a purchaser could take out £1.5m of annual central costs, a saving worth 40p a share if capitalised using a normalised tax charge. In the circumstances, I expect any bid to be at a 20 per cent plus premium to the current share price which is why I recommended ('On the acquisition trail', 5 Jul 2016) using the cash proceeds from the 200p a share tender offer to buy more shares in the market and average down your holding to 125p a share. Buy.

 

VOLVERE (VLE)

Aim: Share price: 520p

Bid-offer spread: 500-520p

Market value: £21.0m

Website: volvere.co.uk

Shares in Volvere (VLE:520p) hit an all-time high after the Aim-traded investment company posted a 32 per cent surge in net asset value to a record £23.2m, or 569p per share, in its full-year results.

The company is led by Jonathan and Nick Lander, who have the respective roles of chief executive and finance director, having founded the company 13 years ago to invest in distressed and undervalued businesses with a view to turning them around and exiting at a hefty profit. They have been very successful as over the past 13 years book value per share has increased at a compound annual growth rate of 14.3 per cent, a performance that any fund manager would be mightily proud of.

There are decent prospects of further gains because I feel that the company's three investment holdings are being conservatively valued in its latest accounts. For example, profits have risen sharply at frozen pie and pasty maker Shire Foods, a food producer in which Volvere owns an 80 per cent shareholding. The holding is in the books at only £5.8m, or a miserly 3.6 times Shire's underlying pre-tax profit last year. In anyone's book it has to be worth £10m.

Volvere's purchase of Impetus Automotive, a provider of consulting services to the automotive sector, including vehicle manufacturers, dealerships and national sales companies, looks a well-timed acquisition. In the first nine months under Volvere's control, Impetus generated underlying operating profit of £583,000 on revenue of £12.1m, not a bad return on the £1.3m Volvere paid. The company also owns a security business generating £118,000 of annual profits. So, in effect, the combined valuation of £2.5m for these two holdings equates to just 3.5 times their aggregate pre-tax profits.

The company also has a cash rich balance sheet and ended last year with net funds of £13.3m, a sum worth 326p a share, which offers substantial asset backing. So, with the investment risk firmly to the upside, and the company cashed up to make further value enhancing acquisitions, I continue to rate the shares a buy.

 

Bargain Shares Portfolio 2016 performance

Company

TIDM

Market

Opening offer price 5 Feb 2016 (p)

Latest bid price 16 Aug 2016 (p)

Percentage change (%)

Juridica (see note two)JILAim36.16991.1
Mind + MachinesMMXAim811.2540.6
Bioquel (see note one)BQEMain12515020.0
VolvereVLEAim41950019.3
BowlevenBLVNAim18.93522.2517.5
Gresham House StrategicGHSAim7968253.6
Gresham HouseGHEAim312.53202.4
Walker CripsWCWMain44.944-2.0
Oakley CapitalOCLMain146.5132-9.9
French ConnectionFCCNMain45.740.25-11.9
Average gain17.1
FTSE Small Caps4320490813.6
FTSE Aim69378313.0
FTSE All-share3240376216.1

Notes:

1. Simon Thompson advised buying Bioquell's shares at 149p in February 2016. Bioquell bought back 50 per cent of shares in issue at 200p each in June 2016 through a tender offer and Simon recommended buying back the shares in the market at 145p to give an average buy-in price of 125p ('Bargain shares updates', 22 Jun 2016).

2. Simon Thompson advised buying Juridica's shares at 41.2p in February 2016. Juridica subsequently paid out a special dividend of 8p a share in June 2016 and Simon recommended buying shares in the market at 61p using the cash proceeds to take the average buy-in price to 36.1p ('Brexit winners', 1 Aug 2016).

 

BOWLEVEN (BLVN)

Aim: Share price: 22.5p

Bid-offer spread: 22.25-22.5p

Market value: £73m

Website: bowleven.com

I feel investors are harshly valuing the shares of Bowleven (BLVN:22.5p), the African-focused oil and gas exploration group. At current exchange rates, the company's net cash pile of $100m (£77m) at the end of March 2016 equates to 23.5p a share and Bowleven's net asset value of $367m (£282m) is almost four times its market capitalisation. This means that $267m worth of exploration assets are in the price for free.

Clearly some investors believe there is value in the company's exploration assets, and specifically those that invested in the Etinde Permit off the coast of Cameroon, in which Bowleven has a 20 per cent non-operated interest. The company completed a farm-out deal to energy giants Lukoil and New Age 18 months ago when they acquired their 40 per cent interests in that project for $250m.

Moreover, Bowleven is carried up to $40m by its partners Lukoil and New Age for two appraisal drilling wells at Etinde, and is due to receive $15m of deferred consideration next month irrespective of when the drilling takes place. The fact that drilling of two wells has been pushed back to next year due to the capital requirements of its partners has no bearing whatsoever on this deferred consideration, nor does it impact a further $25m payable to Bowleven at the time of the final investment decision being made on the development.

Of course, some investors will be wary after the company booked a non-cash impairment charge of $133m in the six months to end December 2015 following a revaluation of its exploration assets. Half of the write-down was attributed to a downward revaluation of the interest in Etinde from $229m to $168m (£129m). This reflects a long-term oil price of $65 a barrel being used in the valuation of a project which has gross 2C contingent reserves of 290m barrels of oil equivalent rather than $80 a barrel previously. But the simple fact remains that the investment in Etinde, and one worth 39p a share, is in the price for free. And so too is the 100 per cent equity interest in the Bomono project, offshore Cameroon, which has a book value of $36.6m, a valuation that reflects a gas price of $7 per million cubic standard feet of gas.

It's worth flagging up having cut monthly overheads by a fifth to $800,000, analysts at Edison Investment Research believe the company ended its financial year to 30 June 2016 with net funds of $102.5m, or 24p a share. That's before accounting for the aforementioned $15m of deferred consideration due next month.

The bottom line is that with the oil price rebounding off its multi-year lows, and the shares trading below cash, Bowleven's exploration assets are being attributed a negative value. Clearly, Lukoil and New Age think otherwise and so do I. Buy.

 

 

GRESHAM HOUSE STRATEGIC (GHS)

Aim: Share price: 840p

Bid-offer spread: 825-840p

Market value: £30.9m

Website: ghsplc.com

It's not often that you can buy shares in a cash-rich investment company trading 22 per cent below book value, and with the company's largest holding riding a high, but that's the case with Aim-traded investment company Gresham House Strategic (GHS:840p).

I estimate the company's net asset value per share is 1,076p of which net funds account for 312p a share, and equity holdings a further 764p a share. The 10.5m shares held in Aim-traded technology company IMImobile (IMO:195p), a business that helps companies engage with their customers across all mobile devices by offering smart software products based on proprietary technology, is by far the largest holding, and one worth £20m, or 542p a share.

IMImobile has been delivering operationally, hence the sharp rise in its share price this year. In its latest 12-month trading period, a 10 per cent hike in organic revenues propelled adjusted cash profit up 17 per cent to £10.7m and forced analysts at brokerage Investec to upgrade their forecasts. They now expect adjusted pre-tax profit of £9.4m and EPS of 11.3p in the 12 months to end March 2017, up from £8.5m and 10.4p, respectively, in the previous year.

The point is that net funds and the holding in IMImobile are worth more than GHS’s share price, so leaving five other investments in the price for free. That’s anomalous, especially as GHS has just agreed to invest £7.5m by transferring 3.88m of its 10.5m IMImobile shares into a new sister fund that will adopt the same Strategic Public Equity (SPE) investment strategies that GHS has been successfully deploying: GHS’s net asset value per share has outperformed the FTSE SmallCap index by 7.5 per cent in the past 12 months. GHS shareholders can also expect a dividend of 15p a share by the end of the year.

Moreover, it's not as if GHS’s other investments don't offer decent upside potential either. In fact, having run through the investment case of Quarto (QRT:261p), a global illustrated book publisher and distribution group in which GHS holds a 4.6 per cent stake worth 63p per GHS share, I rated shares in that company a buy ('Small cap value buys', 9 Aug 2016).

The board's strategy is to acquire smaller niche operators at attractive multiples (between four to five times cash profit) and deliver growth by leveraging the distribution and purchasing base of a larger business. The first such deal was pulled off last week, the earnings accretive acquisition of the publishing assets of US-based becker&mayer. It looks a sound strategic fit and strengthens Quarto's offering in North America. That's worth noting because Quarto's US revenue now accounts for 45 per cent of total revenues so will provide a significant currency tailwind to profits. Moreover, on a miserly 6.5 times earnings estimates, and offering a prospective dividend yield of 4.5 per cent, there is obvious upside to Quarto's shares.

The same is true of GHS's holding in fund manager Miton Group (MGR:26p), a company whose shares I recently rated a buy ('Miton primed for recovery', 4 Aug 2016). Net of cash the fund management business is in effect being valued at £28m, or 1.1 per cent of assets under management of £2.54bn, a low rating for an asset manager. Offering a prospective dividend yield north of 3 per cent, and rated on a cash adjusted PE ratio of 8 times' likely earnings for 2016, Gresham House Strategic should do well here too.

The upshot is that GHS shares are anomalously priced and are still well worth buying at 840p.

 

GRESHAM HOUSE (GHE)

Aim: Share price: 330p

Bid-offer spread: 320-330p

Market value: £32m

Website: greshamhouse.com

Gresham House (GHE:330p), a specialist asset manager, won the £91m mandate to be investment adviser to investment company LMS Capital (LMS:60p) at the end of last month, a deal I covered in quite some detail at the time and one pending approval from LMS shareholders on Tuesday, 16 August ('Investment company watch', 28 Jul 2016).

The company will adopt the same Strategic Public Equity (SPE) investment strategies it has been pursuing as investment manager of GHS since winning that £38m mandate last summer. It's been successful too. Despite volatile markets, GHS's net asset value per share is up 10 per cent since mid-August 2015, representing a 7.5 per cent outperformance of the FTSE SmallCap index. The LMS mandate win is a storming deal for Gresham House shareholders as the company will receive an annual management fee of 1.5 per cent of assets under management below £100m, plus a performance fee of 15 per cent of the value created for LMS shareholders on new investments made subject to hitting a hurdle rate of net asset value growth of 8 per cent a year.

I feel this is a game changer and could prompt a move into profitability for Gresham House next year. House broker Liberum Capital has yet to update forecasts but was previously forecasting a trading loss of £1.1m on revenues of £3.8m in 2017 after factoring in a rise in asset management fees from £2.65m in 2016 to £3.76m, so the LMS mandate win is clearly material. There have been interesting developments elsewhere in the business too.

Having had an indepth call with Tony Dalwood, the boss of Gresham House, I can reveal that he expects the first tranche of Gresham House's new forestry fund to close in the second half with subscriptions north of £12m. Gresham House will earn a 1.5 per cent annual management fee on the new funds managed and a 2 per cent transaction fee.

This means that the initial forestry portfolio should earn year one fees in excess of £400,000, and possibly significantly more because although the target size for the fund is £25m, the cap is actually £40m if investor demand is high enough. It's well worth noting then that sterling's recent sharp decline is highly supportive of demand for UK forestry as it makes overseas imports of wood far more expensive, so further underpinning prospects for the company's new forestry fund.

Gresham House has also just launched a SPE Limited Partnership vehicle that will adopt the same SPE investment strategies which Gresham House has being pursuing as investment adviser to GHS. Gresham House has invested £1.5m of the initial £24m raised for the SPE fund which has an ultimate target size of between £50m to £75m.

So, with the shares trading on a modest 23 per cent premium to net asset value, the current valuation is seriously undervaluing Gresham House's asset management operation which now has mandates in excess of £350m. That's because the company also has rock solid asset backing through property assets worth nearly £11m including the cash due from the disposal of a Royal Mail sorting office in Edinburgh; deferred consideration from Persimmon of £6.3m which is being released through a £7m bank facility with Kleinwort Facility; a holding in GHS shares worth over £6m; investments in cemeteries worth £620,000; and the £4.3m initial investment in forestry asset manager Aitchesse. Buy.

 

WALKER CRIPS (WCW)

Aim: Share price: 45p

Bid-offer spread: 44-45p

Market value: £17.2m

Website: wcgplc.co.uk

Shares in Walker Crips (WCW:45p), the financial services company whose activities encompass stockbroking, investment and wealth management, have yet to make headway this year, but that doesn't negate the fact that there is significant value on offer here.

Underlying operating profit rose by a fifth to £650,000 in the 12 months to end March 2016 once you strip out one-off gains that flattered the performance. Higher-margin discretionary and advisory funds rose by 15 per cent to £2.3bn which helped total assets under management (AUM) hit a record high of £4.1bn and drive up investment management fees by 30 per cent to £13.6m. The target of achieving £5bn of AUM by 2018 looks achievable. Furthermore, the contribution from London-based Barker Poland Asset Management (BPAM), a private client wealth management business acquired in March 2015, was above expectations, a performance that is supportive of the board's strategy to materially increase the proportion of revenues earned as fees, rather than transaction-driven commissions.

But, despite reducing reliance on more volatile transaction fees, and increasing recurring revenue from the asset and wealth management sides of the business, Walker Crips' market value of £17.2m is still well below net asset value of £20.6m even though net funds of £7.2m provide firepower to make further measured value-added acquisitions. There is a decent dividend yield of 4 per cent after the board raised the full-year payout by almost 9 per cent to 1.85p a share. Buy.

 

FRENCH CONNECTION (FCCN)

Main: Clothing retailer

Share price: 41p

Bid-offer spread: 40.25-41p

Market value: £39.5m

Website: frenchconnection.com

There has been a fair amount of activity on the share register of fashion retailer French Connection (FCCN:41p). In the past few weeks newly appointed non-executive director Christos Angelides has splashed out £47,000 buying 120,000 shares at prices as high as 40p. He brings significant expertise in fashion retailing, having spent the majority of his career at Next (NXT) in a number of senior management roles, with the last 14 years on the main board as group product director. Latterly he was President of Abercrombie & Fitch and Abercrombie Kids in the US, experience that could prove invaluable if French Connection's retail operations are to be successfully turned round.

I also note that WA Capital, the investment vehicle of 44-year-old Will Adderley, former chief executive and current deputy chairman of homewares retailer Dunelm (DNLM:895p), has raised its stake to over 8 per cent, having only started buying at the start of this year. Marion Sears, a 54-year old non-executive director of Dunelm and a former JP Morgan investment banker with M&A experience, joined WA Capital's board a few months ago, a move that may shed some light on Mr Adderley's stakebuilding. WA Capital has no other listed interests apart from a 25 per cent stake in Dunelm, worth £453m, and the 8.16 per cent stake in French Connection.

It's not the only activity from shareholders as a few weeks ago US hedge fund Gatemore Capital Management, which owns 8 per cent of the share capital, urged 70-year old founder and 41.7 per cent shareholder Stephen Marks to relinquish his dual role as chairman and chief executive, called for the company to get rid of its dated FCUK logo, cut back on its product ranges and speed up the closure of certain stores. Admittedly, French Connection has been exiting poorly performing retail stores and earlier this year received a £2.4m cash payment for surrendering the lease on its flagship, but loss-making Regent Street shop.

The key here is whether losses on the retail side can be reduced enough so that the company moves back into profit given that its wholesale and licence operations are hugely profitable, generating combined operating profit of £20m before central overheads. I was willing to bet on that possibility six months ago, and I still am. That's because comparatives for the first half of this year are pretty easy; the appointment of new finance director Lee Williams is a positive move especially as his online experience at internet fashion retailer ASOS (ASC) should help French Connection's grow its digital sales which currently account for 15 per cent of turnover; and the board is acting on shareholders demands to exit loss-making stores which have previously been draining resources.

Moreover, once you strip out a cash pile worth £14m equating to more than a third of French Connection's market value of £39.5m, then the company's operations are being rated on just 0.15 times annual sales of £164m, a valuation that will prove bargain basement if the board can execute a return to profitability. Ahead of next month's half-year results, and with insider buying, stakebuilding, and an activist shareholder putting pressure on the board, I remain a buyer.

 

OAKLEY CAPITAL (OCL)

Main: Private equity investment company

Share price: 135p

Bid-offer spread: 132-135p

Market value: £256m

Website: oakleycapital.com

I updated my view on Aim-traded private equity investment company Oakley Capital Investments (OCL:135p) after the company issued a trading update which highlighted a 12p to 15p rise in net asset value per share to between 212p and 215p in the first half this year ('Taking profits and running gains', 8 Aug 2016). Sterling's weakness has been a contributing factor given the company's overseas investments, but so too has the performance of the funds Oakley invests in which added 9p a share to the uplift.

This means that Oakley's shares are rated on a 37 per cent discount to net asset value, and with cash and interest receivables accounting for 58p a share, then in effect the private equity portfolio and the company's interest in newly listed media group Time Out Group (TMO:140p) are being attributed a value of only 77p in Oakley's share price, or less than half their combined book value. That's an incredibly harsh rating for a company that generated a 33 per cent positive return on its investment portfolio in 2015 driven by the cash profitability of its investee companies. It's an anomalous one too and though the holding in Oakley is the laggard in this year's portfolio I have no reason to change my positive stance. Buy.

* This article was first published on Monday, 15 August and was republished on Tuesday, 16 August to incorporate the subsequent announcements from Gresham House and Gresham House Strategic to co-invest in a SPE Limited Partnership vehicle to be managed by the asset management arm of Gresham House.