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Four undervalued growth plays

Four undervalued growth plays
April 24, 2017
Four undervalued growth plays

A good example is Aim-traded and cash-rich insurance sector investment company BP Marsh & Partners (BPM:200p). It's a company I know well, having initiated coverage at 88p ('Hyper value small-cap buy', 22 Jan 2012), and last advised buying at 216p after the board announced the sale of its 37.94 per cent holding in Besso Insurance, a top 20 independent Lloyd's broking group ('Investment company watch', 5 Jan 2017). Subsequent to that announcement, BP Marsh revealed that it received cash proceeds of £22m for the stake in Besso after adjustments, a sum £1.4m higher than expected, and one that generated a thumping internal rate of return (IRR) of 22 per cent on the investment over a 21-year holding period.

I can also reveal that the company has recently sold its entire 29.94 per cent shareholding in Trieme Insurance for almost £3m, or 15 per cent higher than the carrying value in its accounts. The investment produced an IRR of 15.6 per cent over a seven-year holding period. In addition, Trieme has repaid a £2.1m loan outstanding under a facility provided by BP Marsh, which means the total cash realisation here is almost £5.2m. The hefty cash inflow doesn't end there, either. That's because just before BP Marsh's 31 January 2017 financial year-end, the company exited its £7.3m equity investment in global insurance broker Hyperion Insurance, and received full repayment of a £6m loan outstanding.

So, by my reckoning, since the half-year results BP Marsh has realised £32.2m of its £53.1m equity portfolio at a premium to book value, and has cashed in £8.2m of its loans and receivables of £15.1m. The company has made new investments including acquiring a further 6.87 per cent in Nexus Underwriting, an independent speciality Managing General Agency, from two of the founding shareholders for £4m to raise its stake in the fast-growing company to 18.8 per cent. It has also acquired an additional 0.42 per cent in LEBC, an independent financial advisory firm that has been making hay in the post Retail Distribution Review (RDR) environment, to take its holding to 43 per cent. This means that the investments in LEBC and Nexus account for around a third of BP Marsh's last reported book value of £73.9m, or 253p a share, and are by far the largest of the company's 13 investments. It also means that after adjusting for the aforementioned disposals the board should have a current cash pile in excess of £25m available for new investments.

So, with a further decent uplift in net asset value expected when BP Marsh reports its results on Tuesday 6 June 2017, the board committed to maintaining a dividend of at least 3.76p a share for the next two financial years, and continuing to make low volume net asset value accretive share buybacks, too, then I feel the heavily cash backed shares continue to represent a sound investment. Priced on a 21 per cent discount to book value, I continue to rate the shares a buy and have a 230p target price.

 

Smashing forecasts

Lombard Risk Management (LRM:13.25p), a leading provider of collateral management and regulatory reporting software products to 30 of the top 50 global banks, as well as hedge funds, asset managers and other institutions, has absolutely smashed analysts' forecasts for the full year to the end of March 2017.

It's clearly a good time to be servicing their needs given they have been slammed with over $200bn (£155bn) of fines for their previous misdemeanours during the light touch years in the run up to the 2008 global financial crisis, and are now facing an unprecedented wave of new regulations to keep their operations in check. At the same time, the top brass of these global banks prefer to source vendor software solutions rather than self build to comply with banking regulations, having slimmed down their IT departments in cost-cutting measures since the financial crisis. Lombard has clearly been exploiting the business opportunity.

Building on an excellent set of half-year results that revealed an eye-catching 43 per cent hike in revenue to £15.2m, the company has just announced that full-year revenue is expected to be in the region of £34m to £34.4m, easily beating analysts' expectations of £31.8m (Equity Development) and £32m (finnCap). This implies that second-half revenue increased by 49 per cent to £19m, so outpacing the heady first-half growth rate. Moreover, upgraded management guidance is for adjusted cash profit to be in the range £2.4m to £2.8m, rather than the small loss that analysts had anticipated. It gets better because a strong focus on debt collection and working capital management, combined with strong licence sales which account for about a third of total revenue, has led to a much better cash-flow performance. In fact, the company ended the financial year with net cash of £7m, or five times higher than analysts had forecast.

The trading update is significant for a number of reasons. Analysts Paul Hill and Hannah Crowe at research firm Equity Development rightly point out that Lombard's burgeoning cash pile removes "any lingering investor concerns that the business might need to raise fresh capital to fund its future growth plans", and add that the ramp up in second-half sales indicates "beyond doubt that the first-half performance was not a flash in the pan". I wholeheartedly agree and would flag up that the impressive cash performance was after capitalising £7.5m of research and development spend, and investing in a new state of the art centre in Birmingham.

 

Impact of operational gearing

The other obvious take from the trading update is that if the sales momentum can be maintained at these heady growth rates, then analysts' predictions of revenue rising to £40m in the current financial year are now looking far too conservative. That's worth noting because the step change in revenue from £34m to £40m would see an underlying operating loss of £1.5m turn into a profit of £1.6m, thus highlighting the operational leverage in the business. Indeed, based on Equity Development's revenue target of £46.6m for the 12 months to the end of March 2019, operating profit is forecast to rocket to £5.6m.

So, with the company continuing to win a raft of contracts for its software that automates the tedious and expensive tasks of regulatory reporting for clients, and also optimises collateral management to reduce the costs, complexity and constraints of trading in financial markets, I feel that the 18p target price I highlighted when I initiated coverage at 9p is now looking too conservative ('Banking on regulation', 13 Mar 2017). Indeed, net of cash on the balance sheet I feel the equity should be worth around 12 times what could prove to be conservative operating profit forecasts for the 2018-19 financial year, suggesting a target price of 20p is in order. Analysts at Equity Development are even more bullish, having just raised their target price from 20p to 26p, although Lorne Daniel at finnCap is keeping to his 16.5p target ahead of the full-year results on Wednesday 24 May.

For good measure, the technical set-up is highly supportive of a continuation of the current rally and the April 2016 high of 13.3p is now being tested. Beyond that the all-time high of 15.75p dating back to March 2015 comes into play, and one I expect to be exceeded by some margin if the company maintains its impressive sales momentum. True, the shares have risen sharply since last month's buy recommendation at 9p, but they still offer 50 per cent upside to my upgraded 20p target price. On a bid-offer spread of 12.75p to 13.25p, I rate Lombard's shares a strong buy.

 

Broking for hefty dividends

I updated my 2017 Bargain Shares Portfolio only three weeks ago ('Bargain shares on a tear', 3 Apr 2017), but since then an interesting analyst note has been issued on Aim-traded corporate broker Cenkos Securities (CNKS:107p) by Edison Investment Research, the main points of which are well worth highlighting given the paucity of coverage.

Analysts Martin King and Andrew Mitchell at the equity research firm have been running through the numbers and predict that Cenkos should be able to grow revenue by around 19 per cent to £52m this year, reflecting a recovery in corporate broking activity and one underpinned by a strong pipeline including M&A, IPOs and follow-on issuance. Moreover, with the benefit of operating leverage in the business, the anticipated top-line growth is forecast to drive up pre-tax profit by 77 per cent to £7.8m. However, EPS is predicted to rise even faster, up from 4.7p to 11.2p, reflecting the absence of an abnormally high tax charge in 2016. And because the company has a cash-rich balance sheet - net funds of £23.8m equates to 42p a share - then Edison is expecting all of Cenkos's earnings this year to be paid out to shareholders, implying the annual dividend per share will rise from 6p to 11p. As an aside the 2016 final payout of 5p a share goes ex-dividend on Thursday 27 April and is paid on 26 May.

The point being that unless institutional demand to fund high-quality companies falls off a cliff - corporate broking accounts for three-quarters of Cenkos's annual revenue - then shareholders could be in line for a bumper payday as the 2016 final payout and the likely 2017 dividend equates to 15 per cent of the current share price. The board has form here as the directors have declared total dividends of 121.5p a share since Cenkos's flotation a decade ago, and repurchased £25.4m-worth of shares for cancellation. The reason they have been able to do so is because the business has been profitable every year since listing on Aim. In fact, the company still managed to post a double-digit return on equity in 2016 even though market conditions in the first half held back the full-year outcome.

The bottom line is that the dividend alone is reason enough to buy the shares, let alone the potential for a profit recovery to drive a share price recovery. Admittedly, investors are cottoning onto the income and capital growth potential here as Cenkos's share price is up 15 per cent on an offer-to-bid basis since I included the shares in this year's Bargain Shares Portfolio. However, they are still only rated on a price-to-book value of two times, or 25 per cent less than the 10-year average, and a single-digit prospective earnings multiple. Needless to say, I rate Cenkos's shares a buy and have a target price of 150p.

 

Bargain Shares Performance Portfolio 2017

Company nameTIDMOpening offer price on 03.02.17 (p)Bid price on 24.04.17 (p)DividendsTotal return (%)
Chariot Oil & Gas (see note one)CHAR8.2915.50103.0
Crossrider CROS47.960025.3
Management Consulting GroupMMC6.1837.75025.3
AvingtransAVG200249024.5
Manchester & London Investment Trust (see note two)MNL291.65353322.1
BowlevenBLVN28.934.25018.5
Cenkos Securities (see note four)CNKS88.425102015.4
Tiso Blackstar Group (see note three)TBGR55580.284656.0
H&T (see note five)HAT289.75301.2504.0
BATM Advanced CommunicationsBVC19.2519.00-1.3
Average    24.3
Deutsche Bank FTSE All-share tracker (XASX) 40940116.282.0

Notes:

1. Simon Thompson advised selling two-thirds of the holding at 17.5p on 3 Apr 2017 ('Bargain shares on a tear', 3 Apr 2017). Return reflects the profit booked on this sale.

2. Manchester and London Investment Trust pays total dividends of 3p a share on 2 May 2017 (ex-dividend date 13 Apr 2017).

3. Tibo Blackstar pays a half-year dividend of 0.28465p on 8 May 2017 (ex-dividend date 6 April 2017).

4. Cenkos Securities pays a final dividend of 5p on 26 May 2017 (ex-dividend date 27 Apr 2017).

5. H&T pays a final dividend of 5.3p on 2 June 2017 (ex-dividend date 4 May 2017).

 

A boot'ful investment

Shares in Henry Boot (BOOT:248.5p) have risen 17 per cent since I last advised buying after the company issued a bullish pre-close trading update ('Exploiting undervalued special situations', 6 Feb 2017), and with good reason: full-year pre-tax profit and EPS surged by over 20 per cent to £39.5m and 21.5p, respectively; cash inflow from operations rose fivefold to £28.5m, which reduced gearing to only 14 per cent; and the dividend was hiked by 15 per cent to 7p a share.

I would flag up that the construction forward order book covers almost 90 per cent of 2017 planned activity, and the company continues to realise value in its residential land bank, having already exchanged contracts on more than half the 2,000 plots analysts expect to be sold this year. This not only highlights the ongoing strong demand for the company's well located residential sites, but with the directors confident on trading prospects, Henry Boot should be able to deliver EPS of 23p and a payout of 7.5p as analysts predict.

Rated on a hefty discount to analysts' 300p plus sum-of-the-parts valuations which marks a conservatively valued land bank of almost 27,000 plots to market value, and factors in the profit embedded in some lucrative construction contracts including The Aberdeen Exhibition and Conference Centre, a £333m property development, I feel Henry Boot's share price has potential to rerate to the 300p level. 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

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