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OPINION

On the money

On the money
June 7, 2017
On the money

Not that I am averse to running profits if there is potential for bull market valuations to become richer still. In the same article I gave sound reasons why you should run profits on litigation finance company Burford Capital (BUR:912p) even though its share price is up 525 per cent since I commenced coverage two years ago ('Legal eagles', 8 June 2015); clothing retailer Moss Bros (MOSB:115p), which has produced a 250 per cent total return since I spotted its recovery potential, but still looks undervalued ('Dressed for success', 20 Feb 2012); and east London residential developer Telford Homes (TEF: 411p) whose shares are still only rated on nine times forward earnings even after a 40 per cent re-rating since I initiated coverage last summer ('London property trading play', 22 Aug 2016). For good measure, I have also identified some buying opportunities for you to recycle some of your gains into.

 

Bango on the money

Aim-traded Bango (BGO:143p), a provider of a state-of-the-art mobile payment platform that enables smartphone users to charge purchases made in app stores straight to their mobile phone account, has announced a groundbreaking direct carrier billing (DCB) payment route for online giant Amazon in Japan, and one that is hugely important for the company.

Under the terms of the agreement, customers with a KDDI or NTT DOCOMO mobile phone account can now pay for goods purchased from Amazon.co.jp by charging the cost of them to their mobile phone account. Charging online payments to a phone bill is a widely-adopted payment method in Japan, where mobile usage is deeply embedded into business and culture, in part reflecting relatively low levels of credit card penetration. Indeed, industry analysts point out that over half of all e-commerce transactions in Japan were completed by a mobile platform in 2015.

Given that the two mobile operators account for three-quarters of the entire Japanese mobile subscriber market with a combined 123m customers, and that Amazon's e-commerce revenue increased to close to $10bn (£7.76bn) in 2016, according to analyst Ian McInally at house broker Cenkos Securities, there is obvious scope to give a significant boost to Bango's end-user spend. Even before factoring in any upside from the DCB agreement, Mr McInally expects the company to hit a run-rate cash break even by the fourth quarter this year, moving into profitability and cash generation in 2018.

So, having first advised buying Bango's shares at 93p ('Bang on the money', 26 Sep 2016), and reiterated that advice at 105p ('Going for growth', 20 Mar 2017), I feel that my 200p target price is more than achievable, a valuation equating to 13 times its potential net profit in 2020 based on my financial models. Strong buy.

 

Financed for growth

Aim-traded finance house Private & Commercial Finance (PCF:23p) remains on track to meet the regulatory requirements for its new banking licence so that it can start taking retail deposits in the summer. A few months ago, the company raised £10m net proceeds in a placing and open offer to maintain pre-determined liquidity ratios and operate comfortably within the regulatory capital regime.

Importantly, there will be no need to tap shareholders again. Chief executive Scott Maybury pointed out during our results call that the company's regulatory capital base will support the board's target of almost trebling the portfolio of loans and receivables to £350m by the summer of 2020. The plan is to fund the ramp-up in lending with £250m of retail deposits and existing bank loans, targeting a return on equity of 12.5 per cent and a net interest margin of 8 per cent. The company currently has loans of £69m outstanding to more than 8,400 retail customers with an average size of £11,500 at inception, of which 86 per cent finances second-hand motor vehicles, while its £59m business loan book has around 2,900 customers that have raised finance for commercial vehicles and plant with an average loan size of £30,700.

Mr Maybury rightly points out that accessing a retail deposit base will enable the company to fund higher-ticket items for businesses as well as targeting prime borrowers. That's important as Private & Commercial's highest credit quality retail customers are currently charged annual interest rates of 8 per cent, so with access to cheaper retail funding, it can tap into the huge prime market by offering rates as low as 6 per cent through its broker network.

Clearly, maintaining credit quality is key, so it was reassuring to see the impairment charge fall to a record low of 0.5 per cent of the loan book. It's worth flagging up that the business has no exposure to the personal contract purchase (PCP) market that has been used to fund the majority of car purchases in recent years, and where there are concerns over the underlying collateral given the impact on second-hand values of increased supply. Instead, it offers a hire purchase product and tailors the offering as a "risk for rate lender".

True, the £553,000 of costs incurred launching the bank proved a drag on first-half pre-tax profits, which otherwise would have risen by 16 per cent to £2.3m, in line with the full-year estimate of £4.5m from analyst Robert Sanders at Stockdale Securities. Expect costs of running the bank to be between £1.5m and £1.6m next year. However, the opportunity to recycle low interest retail deposits into higher-yield lending will more than offset these costs as loan growth ramps up, which is why Mr Sanders predicts that pre-tax profits (post banking costs) could surge to £5.2m next year, rising to £8.5m in the 2019 financial year. This implies the shares are rated on 11.5 times fully diluted EPS estimates for this year and next after factoring in the dilutive impact of the placing, falling to seven times 2019 EPS forecasts, a modest valuation in my view.

So, having recommended buying the shares at 24.5p ('A small-cap gem', 18 Apr 2016) and again at 27p ('Four small-cap plays', 21 Mar 2017), I feel the shares should be trading on at least two times book value, implying a target price of 35p. Buy.

 

A smart operator

I had an informative results call this week with Brian Marsh, chairman of cash-rich insurance sector investment company BP Marsh & Partners (BPM:215p). It's a business I know well, having initiated coverage on the shares at 88p ('Hyper value small-cap buy', 22 Jan 2012), and last advised buying them at 200p after the board raised £22m selling its stake in Besso Insurance, a top 20 independent Lloyd's broking group ('Four undervalued growth plays', 24 Apr 2017). The investment in Besso produced an eye-catching internal rate of return (IRR) of 21.9 per cent since 1995, and it's not the only one that's done incredibly well. The recently announced disposal of a stake in Trieme Insurance was pitched at a 15 per cent premium to the last carrying value in the accounts and generated an IRR north of 15 per cent since 2010.

Gains from disposals and valuation uplifts in its equity portfolio led to a 12.5 per cent increase in BP Marsh's full-year net asset value to a record £79.7m, a sum worth 273p a share. As a result of the disposals, the company now has a cash pile of £29.2m, or 100p a share, to deploy on new investments and Mr Marsh expects to announce "two substantial events over the coming fortnight". Shareholders are being rewarded, too: the board also raised the payout by 10 per cent to 3.76p a share and has committed to buybacks if the discount to book value widens to 25 per cent or more.

There are very real prospects for further valuation gains on two of its largest investments: Nexus Underwriting, an independent speciality managing general agency; and LEBC, an independent financial advisory firm that has been making hay in the post retail distribution review (RDR) environment. Having raised its stake in Nexus to 18.9 per cent last December, the holding is now worth £13.9m, valuing Nexus's equity at £74m, or 28 per cent higher than at the time of BP Marsh's half-year results. But this percentage increase still lags behind the near-doubling of Nexus's cash profits last year and only values Nexus on 15 times cash profits. To put this valuation into perspective, Hyperion Insurance has just sold its majority stake in CFC Underwriting to a consortium of private investors and the management team on a multiple of 22 times cash profit.

BP Marsh's 43 per cent stake in LEBC looks undervalued at £13m too, even after being revalued upwards by 11 per cent since July. The latest valuation implies a value for LEBC's equity of £30.2m, or 15 times trading profit. However, Mr Marsh informs me that "every now and again we are passed an enquiry to buy LEBC" and the current valuation "is a long way below these approaches". It's understandable as a good benchmark is Mattioli Woods (MTW:811p) whose equity is rated on 20 times cash profits for the year just ended. A narrowing of the valuation gap looks in order, implying further gains on BP Marsh's stake in LEBC.

So, with the cash pile equating to almost half the share price, its largest investments conservatively valued, and news on acquisitions imminent, BP Marsh's shares look well underpinned, so much so that I have raised my target price from 230p to 250p. Buy.

 

Watkin Jones building momentum

Half-year results from Watkin Jones (WJG:176p), a construction company specialising in purpose-built student accommodation, delivered exactly half the full-year pre-tax profit forecast of £42.7m expected by broking house Peel Hunt. A repeat performance in the second half points to full-year EPS rising by 8 per cent to 13.4p and the dividend soaring by two-thirds to 6.6p a share based on cover of two times. Equity Development has almost identical estimates and justifiably so as all 10 of Watkin Jones' student developments (averaging 330 beds each) slated for completion in the 12 months to the end of September 2017 have been sold to institutional investors ahead of the start of the academic year.

Moreover, half of the 10 developments slated for the 2017-18 financial year have been pre-sold and the other five are in legal negotiations for sale, suggesting that analyst expectations for a 10 per cent-plus rise in pre-tax profits, EPS and dividends next year are well founded. On this basis, the shares are rated on 12 times EPS estimates for the 2018 financial year, and offer a prospective dividend yield of 4.1 per cent. The payout looks rock solid as net funds of £11.7m at the end of March are expected to surge to £60m, a sum worth 23.5p a share, by September as developments complete. There is an encouraging pipeline of developments for 2019 and beyond, too.

I would also flag up a growing pipeline of six build-to-rent residential developments scheduled for delivery between 2019 and 2021, negligible profits from which are embedded in forecasts even though analyst Gavin Jago at Peel Hunt believes this side of the business offers potential to generate a similar level of profits as student accommodation in the medium term.

So, having first advised buying the Aim-traded shares around the 103p mark when it joined London's junior market ('A profitable education', 3 Apr 2016), and last recommended running gains ahead of last week's half-year results ('Hitting target prices', 2 May 2017), I feel there is scope for more upside. Run profits.

 

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 stockpicking'