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Exploiting undervalued situations

Exploiting undervalued situations
October 31, 2016
Exploiting undervalued situations

According to analyst John Cummins at house broker WH Ireland, the current fleet value of these ATR72 planes is $385m (£315m) post depreciation based on an original acquisition cost of $440m. He notes that "assuming the debt against these aircraft is paid back over a 25-year period, and on average just under 80 per cent of the purchase price is funded through debt, this would imply a conservative net asset value (NAV) for these 22 aircraft of around $85m, or 118p a share." This means that the 16 other planes in Avation's portfolio - five Fokker 100s, nine Airbus A321s and A320s, and the two ATR72s subject to finance leases - have a net asset value of $88.6m, or 124p a share.

That's worth noting because executive chairman Jeff Chatfield says that any sale will have to be priced at a premium to book value, and understandably so. Rival Avolon was acquired at close to 1.6 times book value earlier this year by Bohai Leasing, a Chinese public company listed on the Shenzhen Stock Exchange. Subsequent to that deal completing, Avolon has since purchased a portfolio of aircraft at a 20 per cent premium to book value. The point being that, with Avation's shares trading 30 per cent below book value, there is obvious potential for significant shareholder value to be created through the sale of the company's ATR72 portfolio at a premium to book value, and then recycling this capital into new aircraft purchases.

True, there is no guarantee a deal will be done, but with Avation's shares priced on only six times likely EPS of 27.5p in the 12 months to the end of June 2017, offering a 1.8 per cent prospective dividend yield and rated well below book value, investment upside from any disposal is in the price for free.

So, having recommended buying Avation's shares at 147p at the time of the full-year results ('In the ascent', 12 Sep 2016), I feel that my fair value estimate of 220p is looking conservative and I have raised it to a target range between 225p and 240p. At the upper end the shares would be rated on less than nine times earnings, and 10 per cent below the end of June 2017 NAV estimates of 266p a share, excluding any bid premium on a sale of the ATR portfolio. Strong buy.

 

Undervalued small-cap play

Aim-traded CareTech (CTH:275p), a leading provider of specialist social care services, supporting adults and children with a wide range of complex needs, has issued an upbeat trading update ahead of full-year results in early December.

Analysts expect pre-tax profit to rise from £22m to £25.8m based on a 20 per cent increase in revenue to £149m in the 12 months to the end of September 2016. EPS will edge up slightly to 32.9p, reflecting the initial dilutive impact of an equity raising last year that raised £21m and has enabled the company to embark on a series of earnings-accretive acquisitions to boost net capacity by almost 10 per cent to 2,319 places in the financial year just ended. Occupancy rates have been maintained at 93 per cent in the mature estate so, after factoring in the full benefit of acquisitions and the upside from refurbishments, the extra fee rates earned should lift revenue by £10m in the current financial year.

On this basis, analysts expect pre-tax profit to rise to £28.5m to produce EPS of 35.6p in the 12 months to the end of September 2017 and underpin a dividend per share of 9p, implying CareTech's shares are being rated on less than eight times forward earnings and offer a 3.3 per cent prospective dividend yield. Reassuringly, annual fee negotiations with local authorities have led to another positive outcome and, although the increase in the minimum wage has only had a small impact on the business, the extra costs here have been passed on to local authorities.

The low rating aside, there is hidden value in the balance sheet. By my reckoning, once you mark property to open market value, the valuation surplus is at least £46m, a sum worth 74p a share, so adjusted shareholders' funds are nearer to £187m, or 300p a share. It also means that CareTech's £300m-plus portfolio of freehold property has a comfortable loan-to-value ratio of around 50 per cent, based on year-end borrowings of £157m. I would flag up that deals in the sector are being agreed at valuations much higher than that attributed to CareTech. For example, Acadia Healthcare recently sold 22 behavioural health facilities on an enterprise value to cash profit multiple of 10.5 times, significantly above the nine times multiple CareTech is valued on for the year just ended.

So, having commenced coverage when CareTech's shares were 230p ('Time to take care', 16 Mar 2015), and last advised buying at 237p ('CareTech on major buying spree', 23 Jun 2016), I continue to see decent upside potential at the current price of 275p. In fact, I have upgraded my target price to 320p, implying a more reasonable cash profit to enterprise value of nine times for the new financial year. Buy.

 

Bargain shares insider buying

Non-executive director Peter Dubens of private equity investment company Oakley Capital Investments (OCL:145p) has splashed out £1.6m purchasing shares at an average price of 138.4p.

The buying spree follows completion of Oakley's sale of a controlling stake in a leading German online dating site, Parship Elite, in a transaction that values that business at €300m (£246m). Oakley has retained a minority stake in Parship, allowing it to participate in further potential value upside. The transaction values Oakley's indirect economic interest at €67m, including its cash returns of €43m, so the disposal has resulted in an uplift of £19m over the carrying value of the holding at the half-year stage to lift its NAV per share by 10p to 225p.

Moreover, Oakley's holding in newly listed media group Time Out (TMO:143p), representing 20 per cent of its NAV, has recovered more than half its post-IPO losses since the half-year end, which adds a further 4p a share to NAV. Interestingly, the company's boss has just purchased almost £100,000 of shares. The 6.5 per cent decline in sterling against the euro since the end of June is worth flagging up too because the majority of Oakley's investments are denominated in euros. Adjusting for positive currency movements, it's not inconceivable that Oakley's spot NAV could be 235p a share, of which cash and interest receivables account for 77p.

Trading on a near-39 per cent discount to my estimate of spot NAV, Oakley's shares rate a bargain buy at 146p, the price at which I included them in my 2016 Bargain Shares Portfolio ('Bargain shares updates', 21 Sep 2016). Buy.

 

Gresham House moves towards profitability

Gresham House (GHE:315p), a specialist asset manager and another constituent of my 2016 Bargain Shares Portfolio, has been in the news, too. I analysed the first-half trading performance in an online article ('Bargain Shares: small-cap updates', 3 Oct 2016), since when the company has announced the early receipt of £940,000 of deferred proceeds from the sale of its Newton-le-Willows site after the acquirer, Persimmon, sold properties more quickly than anticipated. The company's Kleinwort Benson banking facility is secured against the deferred proceeds due from the sale of Newton-le-Willows and the cash has been used to reduce borrowings to £6m.

The company has also announced that it issued 909,908 warrants at 28p each and with an exercise price of 323p to investment company LMS Capital (LMS:57p). Subsidiary Gresham House Asset Management (GHAM) was appointed as external investment manager to LMS in the summer and at the time LMS became a strategic investor in Gresham House through the issue of 332,484 initial consideration shares. Since then, LMS has made market purchases of 469,501 shares to give it a holding of 7.8 per cent. If all the warrants are exercised by their expiry in June 2018 then this will take LMS's stake in Gresham House to 15.4 per cent.

As manager of the £86m LMS mandate, GHAM plans to adopt the same strategic public equity (SPE) investment strategies it has been successfully pursuing as investment manager of Gresham House Strategic (GHS:820p). It's a win-win situation as LMS benefits from the investment upside in Gresham House, while the income earned in management fees means that Gresham House now has annualised fee income above £4m. Add to that £750,000 of annual rental income from a legacy property in Speke, Liverpool, known as Southern Gateway, a fully let office and industrial complex that is being marketed for sale at £7.6m, and Gresham House's revenue almost covers its annual administration costs of £4.8m. A move into profit looks likely next year, far sooner than analysts had envisaged.

Furthermore, Gresham House has rock-solid asset backing including property assets worth £9.9m; deferred consideration from Persimmon of £5m on the aforementioned land sale, of which £1.14m is due in March; a holding in GHS shares worth £6m; and the £4.3m initial investment in forestry asset manager Aitchesse. Net debt of £1.9m at the end of June equated to 8 per cent of shareholders' funds.

Or, to put it another way, strip out property and legacy assets from Gresham House's market value of £32m and its fund management business, which now has assets under management of £374m, is being valued on less than three times annual management fee income. That's a harsh valuation for a company that could move into profit next year on the back of lucrative mandate wins. Indeed, its new forestry fund attracted £15m of capital at first close this week, and the aim is to increase the fund size to £50m by final close in the second half of 2017.

The shares are modestly up on my buy-in price in this year's portfolio and fair value around 400p is not unreasonable. Buy.

 

PV Crystalox's potential windfall

Finally, the evidentiary hearing for arbitration between solar wafer maker PV Crystalox Solar (PVCS:20.25p) and one of its customers, a leading photovoltaic company, has been pushed back from November until March next year on the request of the customer. The photovoltaic company failed to purchase wafers in line with its obligations under a long-term sales contract with PV Crystalox, and in an attempt to find an amicable solution both parties have agreed to follow a mediation process led by an external mediator. This will be conducted without prejudice to the pending arbitration at the International Court of Arbitration of the International Chamber of Commerce.

PV Crystalox's board maintains that if a judgment is found in its favour then compensation could be a multiple of its market capitalisation. So, with the shares priced in line with the value of cash and inventories on its balance sheet, and the company in cash-conservation mode having extricated itself from its last remaining long-term polysilicon purchase contract, then any upside from the International Court of Arbitration ruling is in the price for free. The shares are slightly above the entry level in my 2014 Bargain Shares Portfolio, and remain a speculative buy.