Adjusted pre-tax profit of $110m (£88m) for the 12 months to end-December 2016 was not only 62 per cent higher than in 2015, but a thumping 28 per cent ahead of consensus estimates. Cash generation was mightily impressive, too, buoyed by a 50 per cent hike in investment recoveries to a record $216m. In turn, this has enabled Burford to recycle some of the proceeds into new litigation cases, along with deploying the loan capital raised last year, to such an extent that the company increased new commitments by 83 per cent to a record $378m. Given that Burford generates an eye-catching annual internal rate of return of 27 per cent on completed investments, and a return on capital employed of 60 per cent, the new investments made should be highly supportive of future profits.
Admittedly, forecasting Burford's profits is fraught with difficulty given the nature of the business. Indeed, of the $140m of litigation income reported in 2016, a third related to net realised gains and the balance was fair value adjustments on litigation investments. Analysts at Numis Securities have upgraded their 2017 adjusted EPS estimate by 25 per cent to 64.8¢ and raised their 2018 estimate by 15 per cent to 86¢, implying the shares are rated on 15.5 times current-year earnings estimates, falling to 12 times 2018 forecasts.
Investors are happy to pay that price because the forecasts factor in a chunky uplift in unrealised gains after Burford sold off further participation interests in its investment relating to the 2012 expropriation by Argentina of a majority interest in YPF, the New York Stock Exchange-listed energy company formerly owned by Repsol, the Spanish energy major. At the time of the expropriation Repsol owned more than 50 per cent of YPF, and the Petersen Group, another Spanish company, owned 25 per cent of YPF. After suing, Repsol settled its claims and received a payment of $5bn (£4bn) from Argentina and YPF. Burford is providing financing to the liquidators of the Petersen Group, which went bankrupt after the expropriation, who are proceeding with claims worth $3bn against both YPF and Argentina. Burford is entitled to 70 per cent (less expenses to take its recovery levels below 60 per cent) in the YPF-related claim, and has so far invested $17.5m (£14m) of capital.
Clearly, other investors believe it is on to a good thing as they have paid $40m to take a 10 per cent stake in the claim, implying Burford's residual interest in this case alone is worth $360m, or more than three times the company's profits in 2016. Burford's board takes a far more conservative view when valuing its investment in the YPF-related case, but what is clear to me is that as the chances of success increase, as seems likely, then even more investors are likely to be enticed to buy participation interests, thus offering Burford additional opportunities to bank profits, and at a higher price. Furthermore, if it actually wins in the courts, then Burford's cut of the financial settlement could be worth well in excess of £1bn even after allowing for costs and the aforementioned sale of its participation interests.
In the circumstances, it's hardly surprising that Burford's shares are on a tear, having surged by 30 per cent since I reiterated my positive stance at the start of the year ('Investment company watch', 5 January 2017). Longer-term holders who paid 146p when I initiated coverage in the summer of 2015 are in seventh heaven as the share price is up 455 per cent ('Legal eagles', 8 June 2015), and the board has also declared total dividends of 12.8p a share.
Furthermore, with analysts raising their target prices as well as their earnings forecasts - Numis Securities upgraded its price target from 760p to 880p, Macquarie has a target of 843p and Liberum Capital raised its target by 11 per cent to 816p - it's fair to say that institutional investors who ultimately drive Burford's share price are likely to continue to view the investment merits of this alternative asset class favourably. Indeed, not only does litigation finance offer potential for high returns, but it is uncorrelated with the general stock market.
In the circumstances, it makes sense to run profits, especially as we are guaranteed an impressive first-half performance in light of the substantial investment gains set to be booked on the post year-end disposal of participation interests in the YPF-related claim. Run profits.
Top-slicing
A week ago I decided to top-slice the holding in Aim-traded oil exploration company Chariot Oil & Gas (CHAR:17.5p) to crystallise some of the 111 per cent gain achieved on the holding after I advised buying the shares in my 2017 Bargain Shares portfolio ('Bargain shares on a tear', 3 April 2017).
I feel it's sensible to do the same with Aim-traded shares in Somero Enterprises (SOM:320p), a Florida-headquartered company specialising in the design, assembly and sale of patented, laser-guided concrete levelling equipment for commercial floors. I raised my target price from 275p to 325p only three weeks ago ('Going for growth', 20 March 2017), having first recommended buying at 140p just under two years ago ('On solid foundations', 22 April 2015). My new target of 325p was duly hit last week, and for good measure the shares have also gone ex-dividend for the 6.8p-a-share final payout.
This means that Somero's shares are now rated on 14.5 times the recently upgraded current-year EPS estimate of 27.4¢ (22p) from analyst David Buxton at brokerage FinnCap, a rating that appears about right for a company operating in a sweet spot right now, and one heavily exposed to the buoyant US market, which accounts for three-quarters of its revenue. Trading activity is being boosted by a combination of new product launches and a healthy non-residential construction market, both of which are supporting demand for replacement equipment, technology upgrades and fleet additions.
The positive trading outlook and prospects for a special dividend later this year should keep investors interested as the board looks to distribute some of the company's near-30p-a-share cash pile. Mr Buxton is forecasting a 17.8¢ (14p) special payout, and a normal dividend of 11.5¢ (9p). However, I feel Somero needs to beat current guidance to support another upleg in the share price. That's a possibility, and I am happy keeping some skin in the game, but I feel it's also prudent to top-slice the holding by selling half at around 315p and running the balance for free.
A fluid performance
Skelmersdale-based Flowtech Fluidpower (FLO:143p), the UK's leading specialist supplier of technical fluid power products, has delivered a near-10 per cent rise in full-year operating profits, driven by a 20 per cent rise in revenues, a performance that at first sight appears to defy the tough trading conditions across the industry. The British Fluid Power Distributors Association reported a 4 per cent year-on-year revenue decline last year.
However, the company has managed to keep both its top and bottom line moving by making no fewer than seven well-timed earnings accretive bolt-on acquisitions since listing on London's junior market three years ago. Having a broader spread of businesses has helped as Flowtech now offers original equipment manufacturer (OEM) and own-brand products to more than 3,400 distributors and resellers. Its catalogue contains 100,000 individual product lines and is distributed to more than 80,000 industrial maintenance, repair and overhaul end users from facilities in the UK and Benelux. Recognised as the definitive source for fluid power products, over 80 per cent of products are stocked and can be delivered next day by national courier service, providing a 'best in industry' service offering.
The company has also insulated margins to some extent by making significant inventory purchases in China ahead of last summer's EU referendum, thus gaining better pricing from suppliers before sterling started to weaken last year. Admittedly, the one-off benefits of currency hedging only lasts so long, so it's worth noting that the company's Flowtechnology distribution business, accounting for over three-quarters of the company's operating profit, has been passing through general price rises this year to offset input cost pressures - typically between 30 per cent and 40 per cent of Flowtech's UK purchasing is denominated in foreign currency. It's been successful, as chief executive Sean Fennon says that not only are gross margins in the first quarter of 2017 at a similar level to the same period in 2016, but that the Flowtechnology division is generating organic growth too.
Furthermore, there are prospects of further profit growth this year as the full benefits of the four acquisitions made in the past 13 months feed through and the company deploys the £9.6m cash raised in last month's placing. The board has already identified 25 acquisition targets, some of which the directors are in active discussions with. They have ample firepower as net debt was only £5m at the end of March 2017, so balance sheet gearing is a modest 7 per cent of pro-forma shareholders' funds. Also, analyst Andy Hanson at broking house Zeus Capital is predicting that the company's free cash flow will rise by around 50 per cent to just shy of £5m this year, thus offering scope to recycle some of this cash back into the business. Importantly, shareholders are benefiting as the full-year dividend per share has been hiked from 5.25p to 5.51p, a payout covered more than two times by adjusted EPS of 12.9p.
Potential for upgrades
Of course, the fact that the recent equity-raising represents 16 per cent of the enlarged share capital means that even if Flowtech raises current-year pre-tax profits by 14 per cent to £8m on revenues up a quarter to £65.5m, as Mr Hanson at Zeus Capital predicts, the dilutive impact of the placing means that EPS will be flat this year. But those forecasts only factor in the likely profits from Flowtech's existing business, thus offering scope for a series of upgrades as and when acquisitions are made. I would highlight a slight first-half weighting to the forecast numbers which, given the positive first-quarter trading update, de-risks the investment case.
Moreover, even without factoring in earnings upgrades from likely acquisitions, the case to invest is pretty compelling as Flowtech's shares are by far the lowest rated in its peer group. For instance, distributor Diploma (DPLM:1,065p) is rated on 22.6 times this year's earnings estimates, and an old favourite of mine, Trifast (TRI:213p), a company whose share price has quadrupled since I included the shares in my 2013 Bargain Shares portfolio, is rated on 18 times likely earnings. Priced on a modest 11 times earnings, and generating margins above the sector average, I feel Flowtech's shares are anomalously priced as a listed entity and could easily prove attractive to a trade buyer. That's a real possibility given the uptick in merger and acquisition activity in the sector; larger rivals Premier Farnell and Brammer have both been acquired by predators in the past six months, and at premium valuations too.
So, having last rated the shares a buy at 135p ('Clear-cut investments', 19 September 2016), after initiating coverage at 118p at the time of the Aim listing ('A fluid performance', 2 June 2014), since when the board has declared dividends of 15.76p a share, I feel the 2015 all-time high of 157p is likely to be taken out. Offering 19 per cent upside to my new target price of 170p, I rate the shares a buy.
MORE FROM SIMON THOMPSON...
A comprehensive list of all the investment columns I have written in 2017 is available here.
The archive of all the share recommendations I made in 2016 is available here
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com for £14.99, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source. Simon has published an article outlining the content: 'Secrets to successful stock picking'
