Bargain Shares: Beating the market Part II

Trifast on course for record profits

Trifast (TRI:259p), a small-cap manufacturer and distributor of industrial fastenings, with operations across 28 locations in 18 countries across Europe, Asia and North America, has been a cracking investment since I included the shares, at 51.9p, in my 2013 Bargain Shares portfolio. Since then the board has paid out total dividend of 10.6p a share, a sum equivalent to 20 per cent of that entry point, and the share price has risen fivefold to 259p.

I advised top-slicing at 223p about nine months ago ('Hitting target prices', 2 May 2017) and last recommended running profits at 240p on the balance of your holdings ahead of the third-quarter trading update (‘Three small-cap stars’, 27 November 2017). It didn’t disappoint. The directors confirmed the company is on track to deliver a near-5 per cent rise in pre-tax profit to £21.5m on revenue of £200m to produce EPS of 13.3p, as analyst Ben Thefaut at Arden Partners predicts. The “order pipeline is still very encouraging” too. I would also flag up that the board has a habit of overdelivering.

It’s worth noting that this has largely been an organic growth story. Trifast’s profits have benefited from the twin effects of rising sales on the back of stellar growth in its key electronics and automotive markets, and improved margins. The operating margin earned on sales is 77 per cent higher now than in the 2013 financial year. As a result, pre-tax profits and EPS have trebled in the past five years on revenues up two-thirds, a performance driven by increasing higher-margin in-house manufacturing, which now accounts for 35 per cent of sales, targeting overseas growth markets and industries, and creating additional shareholder value through a few well-timed bolt-on acquisitions.

The value created for shareholders also reflects the shrewd recycling of rising cash flow. Operating cash flow before movements in working capital has increased from £8.8m in the 2013 financial year to £22.5m four years later. This cash generation has enabled the directors to hike the dividend sharply, and make value-accretive bolt-on acquisitions without needing to tap shareholders. Indeed, Trifast’s issued share capital has only increased from 108m to 121m shares since February 2013. That clearly appeals to investors, which is why the company’s price-to-book value ratio has trebled from parity in the past five years. The share price has done even better, reflecting the increase in net asset value (NAV) per share from 51p to 83p, a reflection of the profits retained after paying out dividends.

Bearing in mind the low level of balance sheet gearing – net debt of £7.9m equates to 8 per cent of shareholders' funds – Trifast’s directors are “evaluating several interesting acquisition opportunities which would further enhance our vendor sourcing, technical portfolio and engineering skills; and expand our global footprint”. They have a great track record as highlighted by the acquisition of VIC, an Italian maker and distributor of fastening systems predominantly for the white goods industry, and Kuhlmann, a distributor of customised industrial fasteners focused mainly on the German market. I reckon the company could have upwards of £40m on an earnings-accretive acquisition.

I also maintain the view that an earnings beat, or a bolt-on deal will be required for Trifast’s share price to hit Peel Hunt’s upgraded target price of 275p. I would not rule out either possibility. So, rated on 19.5 times likely earnings, I would continue to run profits ahead of next month’s pre-close trading update.

Profiting from cyber security

Crossrider, a provider of cyber security software, has just changed its name to Kape Technologies (KAPE:78p) to reflect the change in the business in the past year.

Employing 350 staff across seven locations globally, the company offers four main products to 887,000 customers: Reimage, a patented Microsoft-based product tool that enables users to clean up their computers; DriverAgent, a PC maintenance software products company offering a leading device driver search and update service, which scans computers for outdated drivers; and Cyberghost, a cyber security provider of secure virtual private networks (VPNs) which securely pass data traffic over public networks.

It’s proving a profitable area to be operating in as the global cyber security market has grown from $3.2bn to $120bn in size in the past 13 years. Kape is reaping the benefits: premium subscribers surged by 81 per cent to 260,000 last year, buoyed by the Cyberghost acquisition, which posted 30 per cent growth in premium customers and now accounts for 187,000 of the total. They are proving loyal as 69 per cent renewed their subscriptions last year, hardly surprising given that 689m people were victims of cybercrime in 2016 and $16bn was lost to ID fraud. More than 40 per cent of working Americans have now installed a VPN on their laptop to encrypt their data and provide a secure internet connection.

Moreover, Cyberghost has been outperforming guidance, posting a net profit of $1.5m in 2017, or 50 per cent more than forecast at the time of the acquisition in March 2017, making the $9.6m maximum consideration paid a bargain. Driver Agent, acquired for $1m, posted annual cash profits of $0.6m. This helped Kape deliver an eye-catching 30 per cent hike in cash profits to $8.3m on revenues 17 per cent higher to $66.4m.

Interestingly, chief executive Ido Erlichman told me during our results call that complementary acquisitions are being “actively considered”. The board can easily afford to as the balance sheet is awash with cash. Net funds of $69.5m dipped by only $2.6m last year, even though Kape made $7.4m of acquisition-related payments. That’s because the business converted an impressive 92 per cent of cash profits into operating cash flow. Shareholders are getting their share as the board has just declared a special dividend of 3.55p a share to return $7m of the excess cash.

The positive momentum across all business segments has continued into the new financial year. Mr Erlichman revealed that the roll-out of the Reimage subscription model is “far better than we expected” and that in a recent cross-selling promotion to Cyberghost customers “nine out of 10 signed up for Reimage.” A new Reimage product for Mac users offers potential to boost the user base too.

Having posted a record cash profit performance in the final quarter of 2017, current monthly revenue is at record levels, supporting forecasts of cash profits rising from $8.3m to $10.1m to deliver a 36 per cent hike in both pre-tax profit and EPS to $9.1m and 5.2¢ (3.7p), respectively, in 2018.

Rated on 11.5 times forward earnings after adjusting for 35p a share cash on the balance sheet, I have a 100p target price, or double the 48p entry point in my 2017 Bargain Shares portfolio. Buy.

Tiso Blackstar delisting from Aim

The laggard in my 2017 Bargain Shares Portfolio, dual-listed South Africa-focused investment company Tiso Blackstar (TBGR:38p), has announced plans to cancel its Aim listing on Tuesday, 17 April and transfer UK shareholdings to the South African Register so that they can be traded on the main board of the Johannesburg Stock Exchange.

Only 12 per cent of the shareholder base is in the UK, thus creating liquidity issues, one reason why the Aim-traded shares are priced on less than half NAV even though cash profits from the group’s media operations increased by a third to £23.8m in the past financial year.

True, the transformation of Tiso Blackstar into a single-sector investor in the media industry is taking longer than expected, but there is value here, with the company’s market cap only £103m. Moreover, the Johannesburg share price is around 46p at current exchange rates, so it makes financial sense to transfer your holdings and that’s my advice.

Finally making the connection

It has taken time, but high-street clothing retailer French Connection (FCCN:42p), the long-time laggard in my 2016 Bargain Shares portfolio, is finally delivering. The key to a rerating is the same as it always has been: cut losses on the retail side, which has proved a drag on the company’s hugely profitable wholesale and licence operations (combined operating profits of £18.8m pre-central overheads in the 12 months to end January 2018), so that the business can move back into profit.

Full-year results this week were more than encouraging. French Connection’s full-year underlying operating loss was slashed from £3.7m to £600,000, the business actually generated net cash of £1.1m from operating activities, and net funds of £9.5m, accounting for a fifth of French Connection’s NAV of £46.7m, was better than I had expected.

The retail division produced modest like-for-like growth and cut losses by £1.5m as non-performing outlets were closed and online sales improved. Wholesale revenues  surged by 7 per cent at constant currencies to £71m, accounting for almost half the £154m total, and at better margins too, so lifting divisional operating profit by a quarter. Encouragingly, both the Spring 18 and Winter 18 collections have been well received.

So, with a move into profit on the cards, and French Connection’s shares trading in line with book value, then the buy advice I gave at the time of the interims last autumn still holds (‘Inflexion points’, 20 Sep 2017). It also makes the company a far more appealing takeover candidate. Buy.

H&T on a roll

Pawnbroker H&T (HAT:353p) has issued four earnings upgrades since I included the shares, at 289p, in my 2017 Bargain Shares portfolio. You can effectively make that five after the company posted pre-tax profits of £14.1m in 2017, up from £9.7m in 2016, and £500,000 higher than analyst Andrew Wade at brokerage Numis Securities had been predicting after upgrading estimates at the time of the pre-close update in early January.

The company’s lower interest rate personal loan product (APR 49.9 per cent) is proving very popular and fuelled an almost doubling of H&T’s personal loan book to £18.3m. The division delivered gross profit of £5.7m, or 10 per cent of the total, so is now a major profit contributor. Mr Wade sees “scope for the personal loan book to grow by 20 to 30 per cent this year”, a sensible prediction in light of demand from customers looking to rebuild their credit score. An improved concession format in H&T’s stores, higher loans made on quality watches, and the benefit of a strong sterling gold price on the £46.1m pledge book were the other key profit drivers.

Shareholders are reaping the rewards after the board hiked the payout per share by 14 per cent to 10.5p, covered three times over by EPS of 31.4p, and Numis predicts a further rise to 11p this year paid from EPS of 33.7p. That’s based on H&T’s pre-tax profit rising to £15.1m on 5 per cent higher revenues of £106m. I have a feeling those estimates will be upgraded as the year progresses as the growth factored into them is based largely on the personal loan book alone.

Priced on a modest 10.5 times earnings estimates, offering a prospective dividend yield of 3.1 per cent and rated on a modest price-to-book value of 1.2 times, my target price of 400p is now looking conservative. So, having rated H&T’s shares a buy at 289.75p in my 2017 Bargain Shares Portfolio, since when the board has paid out dividends per share of 9.6p, excluding the proposed final payout of 6.2p, I continue to rate the shares a buy.

■ Simon Thompson's new book Successful Stock Picking Strategies is published on Thursday, 15 March and can be pre-ordered at www.ypdbooks.com for the discounted price of £14.50, 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. The book will be sold from tomorrow at its full price of £16.95 plus postage.

Simon's previous 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.