Given the magnitude of these share price gains, I have taken the sensible approach of top slicing several holdings to crystallise a chunk of the paper profit, while at the same time retaining some skin in the game just in case bull market valuations become even richer. That said, I am not adverse to taking profits when I feel valuations are priced to perfection: AB Dynamics (ABDP:570p), a UK designer, manufacturer and supplier of advanced testing systems and measurement products to the global automotive industry ('Taking profits', 18 April 2017) being a case in point. Bearing this in mind, I have been revisiting yet more companies on my watchlist where share prices are trading at or close to multi-year or record highs to decide whether a degree of profit-taking is in order.
Burford Capital bond raise
Investors have reacted positively to a major fundraise from Aim-traded Burford Capital (BUR:912p), a global finance company focused on investing in litigation cases: it has generated an annual internal rate of return of 27 per cent on all its completed investments. It's not short of new investment opportunities either as Burford increased new commitments by 83 per cent to a record US$378m (£295m) last year, buoyed by a 50 per cent hike in investment recoveries to a record US$216m, and by deploying the £100m of loan capital it raised last April.
Interestingly, Burford's chief executive Christopher Bogart points out that "law firms and corporate clients are coming to us with needs which have evolved far beyond the single-case financing model on which this industry is founded - although that remains a core area of our business." So, to exploit this opportunity, the company has just raised £175m through an oversubscribed issue of bonds on the main market of the London Stock Exchange. The bonds pay interest at an annual rate of 5 per cent and mature in December 2026. Burford is also using part of the proceeds to repay early the $43.75m of loan notes which were issued as part of last December's acquisition of Gerchen Keller Capital, the second-largest litigation finance player in the world ('On a roll', 20 December 2016).
The key point to note is that the additional long-term capital raised not only solidifies Burford's position as the industry leader - its legal finance business has more than $2 billion invested and available for investment - but it has the lowest cost of capital too. And given the high returns being generated on its litigation investments, the company can easily service the relatively low cost of its borrowings, redeem the loan capital when it matures, and recycle surplus cash flows into new cases and boost dividends for shareholders. This explains why analysts at broking house Numis Securities raised their EPS estimates by 3 per cent, 8 per cent and 11 per cent for the 2017, 2018 and 2019 financial years to 66.6¢, 92.5¢ and 113¢, respectively. They also raised their target price from 880p to 950p.
In the circumstances, it's hardly surprising that the shares rallied to another all-time high of 920p after the news of the oversubscribed bond issue was announced, justifying my previous call to run profits at 810p ('On the case', 10 April 2017). Longer-term holders who bought in at 146p when I initiated coverage in the summer of 2015 are doing well too as Burford's share price is up 525 per cent ('Legal eagles', 8 June 2015), and the board has declared total dividends of 12.8p a share.
True, the shares are now rated on 17.5 times current year earnings estimates, but if Burford delivers on the bumper growth expected in 2018, then the multiple drops to 12.6 times next year's earnings forecasts. Moreover, I expect investors to react positively to what will undoubtedly be an impressive first-half performance and one that will benefit from substantial investment gains following the post year-end disposal of 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. I am also attracted by the fact that the shares have a beta close to zero, something worth considering if there is an uptick in equity market volatility in the coming months. Run profits.
Telford Homes record profits
Last summer during the market turmoil I made a strong case to buy shares in east London housebuilder Telford Homes (TEF:412p) at around 289p on the basis that investors were being overly cautious on the company's trading prospects even after factoring in a cooling of the housing market in the Capital ('London property trading play', 22 August 2016). The shares subsequently surged, justifying my last call to run profits at 370p ('Taking profits and running gains', 4 April 2017).
Telford has proved a canny residential developer during the boom times, and has made the smart strategic move of de-risking four large developments since the start of 2016 (gross development value of £232m) by entering into build-to-rent funding arrangements with large institutional investors. This strategy not only de-risks the forward sales pipeline, but accelerates profit recognition, drives a higher return on capital as Telford no longer needs to fund these developments, and reduces the company's gearing levels as capital is released from its land bank and from working capital. The benefits of this strategy were evident in last week's full-year results: revenues from build-to-rent activities increased four-fold to account for just over a quarter of the total which in turn helped drive up Telford's pre-tax profit by 6 per cent to a record £34.1m. Net debt levels are very modest, equating to only 7 per cent of shareholders funds.
Furthermore, the company is well on track to exceed £40m of profit before tax in the year to 31 March 2018, rising to £50m in the year to 31 March 2019, as over 80 per cent of anticipated gross profit for the new financial year and over 60 per cent for next year has already been secured. Given the strong demand for private rented sector housing, further block sales are likely as the company continues to de-risk its £1.5bn development pipeline of which more than half is expected to be delivered by March 2019. In fact, analysts at broking house Peel Hunt believe that the segment could account for half of all transactions in the medium-term.
Indeed, only this morning, Telford announced it has signed an agreement with Greystar to deliver 894 build-to-rent homes at the former Royal Mail Depot in Battersea, south London. Greystar is a global real estate developer and management company in the US. Having entered the UK market in 2013, it has built up a UK rental portfolio worth £2.8bn by investing in new housing and student accommodation.
Analyst Gavin Jago at brokerage Peel Hunt points out that “once planning is secured, Telford will develop the scheme for a fixed price and at its target operating margins for build to rent developments (between 12 to 13 per cent); will take no sales or rental risk for the scheme; and will receive regular payments during the build (expected over 4-5 years) with the profit paid upon practical completion.” The point being that there will be limited equity and no debt invested by Telford Homes in the scheme, which significantly mitigates risk. It also has potential to deliver around £40m of profits to the group over the build period which further underpins analysts’ expectations of a sharp ramp up in Telford’s profits in the coming years.
So, with Telford on course to increase EPS from 36.8p to around 47p in the 12 months to end March 2018, as analysts at Peel Hunt and Equity Development predict, and the full-year payout per share forecast to be hiked by a further 8 per cent to 17p, having just been raised by 11 per cent, this means the shares are still only rated on a forward PE ratio of less than 9 and offer a prospective dividend yield of 4.1 per cent. From my lens at least, the valuation gap with larger peers has scope to narrow further and I would recommend running profits.
Time to take profits on Somero
A couple of months ago I recommended top slicing your holdings in Aim-traded shares in Somero Enterprises (SOM:296p), a Florida-headquartered company specialising in the design, assembly and sale of patented, laser-guided concrete levelling equipment for commercial floors. The share price had achieved my upgraded target price of 325p (‘On the case’, 10 April 2017), having first recommended buying at 140p just under two years ago ('On solid foundations', 22 April 2015) and repeated this advice on numerous occasions in the interim.
At the time Somero's shares were rated on 14.5 times current-year EPS estimates of 27.4¢ (22p), based on forecasts from analyst David Buxton at brokerage finnCap, a rating that I felt was right for a company heavily exposed to the buoyant US market, which accounts for three-quarters of its revenue. I also felt that it made sense to take some cash off the table as investors were already factoring in the strong likelihood of a special dividend being paid: Mr Buxton had been forecasting a 17.8¢ (14p) special payout, and a normal dividend of 11.5¢ (9p), reflecting the board’s intention to distribute some of the company's near-30p-a-share cash pile. In the event, the company has just announced this morning that it will be paying out a US$7.5m special dividend in August worth 13.3¢ a share, slightly less than finnCap’s forecast, which may have disappointed some investors.
Also, although the company is on track to deliver a 9 per cent rise in full-year pre-tax profits to US$24m as analysts predict, this morning’s trading update revealed a flat first half performance from the US operations and one that reflected poor weather which delayed numerous project starts, and ongoing political uncertainty. Although that news is disappointing, Somero’s directors still flag up high levels of activity in the region and extended order back logs of its customers. Investors will also have noted that trading in China has also seen a slow start to the year, albeit Somero reports signs of improvement and early traction from sales of a new product in the country.
I can understand why some investors have sold down Somero's shares from 315p, the price at which I advised selling half your holdings in April and running profits on the balance, to around 296p this morning. That's because the softer than expected trading in North America is likely to prove a drag on the share price performance, at least until the next trading update later in the summer. In the circumstances, it makes sense to take profits on the balance of your holdings at the 288p bid price in the market this morning which is still more than double the price I advised buying at two years ago. Take profits.
A chic performance
Shares in formal clothing retailer Moss Bros (MOSB:113p) rallied to a high of 120p after the company reported an acceleration of retail sales since its 31 January year-end, justifying my last buy advice, at 101p ('Five small-cap buys', 29 March 2017).
In the 15 weeks to 13 May 2017, like-for-like sales in the company's 129 retail outlets increased by 5.5 per cent, outpacing the 4.3 per cent growth posted in the first seven weeks of the period, and implying a growth rate of 6.6 per cent in the past eight weeks. This is well ahead of the full-year growth rate of 3.5 per cent embedded in broking house Peel Hunt's full-year revenue expectations of £133m which underpin pre-tax profit and EPS forecasts of £7.2m and 5.6p, respectively. True, a mid-season sale in April helped boost the sales figures, but it's worth noting that year-to-date retail gross margins are only 50-basis points below the same period in 2016, or half the margin contraction Peel Hunt has factored into its full-year numbers.
Admittedly, the value of hire orders declined 1.6 per cent in the 15 weeks period, slightly behind analyst expectations, but the financial impact of this is more than offset by the higher run rate on the retail side. Moreover, it may also reflect customer preferences to buy outright rather than hire, as highlighted by the strong performance of the retailer's relaunched bespoke offer, Tailor Me, although it is impossible to quantify this effect. What is not in doubt is that the business is well placed as it enters the peak trading period encompassing the summer wedding season, Royal Ascot and school proms.
So, underpinned by a 5 per cent prospective dividend yield, and valued on a modest enterprise value to cash profit multiple of seven times which takes into account a cash pile worth 19.5p a share, I am happy to maintain my positive stance and my 130p target price. Please note that I first advised buying Moss Bros' shares at 38p ('Dressed for success', 20 February 2012), since when the board has declared dividends of almost 23p, so the holding has generated a total return of 250 per cent. So, with another 15 per cent potential upside to my target price, it's well worth running your hefty profits.
Sanderson's cautious outlook
Aim-traded shares in Sanderson (SND:79p), a software and IT services business specialising in multichannel retail and manufacturing markets in the UK and Ireland, have succumbed to post results profit taking although not before the price almost achieved the 92p target price I outlined when I rated them a buy at 72p ('Small cap watch', 6 December 2016). It's a company I have followed for some time, having first initiated coverage at 33.5p ('A valuable stock check', 18 July 2011) and banked 10.1p a share of dividends.
A typically cautious trading outlook may have prompted investors to take some money off the table. Chief executive Ian Newcombe notes that "the general economic environment still seems good, but there does seem to be a slightly more considered approach from some customers. Sales cycles often remain protracted, particularly where big projects are being considered especially by larger customers." News that finance director Adrian Frost, who has held the role for 12 years, will be leaving the company later this year "by mutual consent" has probably not helped sentiment either.
That said, the company is trading in-line with analyst expectations which point to adjusted pre-tax profits rising from £3.4m to £3.7m in the 12 months to end September 2017 to deliver EPS of 5.6p. Also, analyst expectations of a full-year dividend of 2.6p seem sensible, especially as net funds have increased by a third to 8.2p year-on-year. This means the shares are rated on 12.5 times earnings net of cash and offer a prospective dividend yield 3.3 per cent. That may represent a deep ratings discount to peers, and there remains upside to analysts' valuations (N+1 Singer has intrinsic value of 106p and WH Ireland has a raised target price of 97p), but the more cautious trading outlook means the valuation gap is unlikely to narrow near-term. I would therefore bank the 134 per cent profit.
Please note that I am still working my way through a bag log of company announcements that were released while I was on holiday last month, as well as updating new announcements, having updated no fewer than 25 companies on my watchlist in the past fortnight. My next column will be published at 12pm on Wednesday this week.
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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