I have been in the very fortunate position over the past year or so to report a constant slew of good news from companies on my watchlist. Ultimately, what counts most is not whether I have spotted a company doing well, and likely to continue to do so, but whether there is an attractive investment opportunity for you to exploit having fully considered the risk and rewards on offer. But even when this is the case, sometimes these opportunities prove to be slow burners, the case of small-cap stockbroker and asset and wealth manager Walker Crips (WCW:42p) being a prime example.
I included the shares in my 2016 Bargain share portfolio at 44.9p, and banked dividends of 1.85p excluding the recently declared final payout of 1.29p which goes ex-dividend on Thursday, 31 August, but the shares still languish at 42p. True, the company had a disappointing first half of the financial year as did many in the sector as uncertainty over the EU Referendum negatively impacted markets and made investors more cautious. However, yesterday’s full-year results revealed that business was buoyant in the second half in far more benign market conditions, so much so that revenues in that six month period ramped ahead by 25 per cent to £16m and delivered an underlying operating profit of £840,000. As a result full-year underlying operating profits surged by three quarters to £1.14m on revenues up 12 per cent to £29.2m.
Importantly, Walker Crips continues to build a valuable asset management operation. This side of the business increased discretionary and advisory funds under management by 27 per cent from £4.1bn to a record £5.2bn in the 12 month trading period to end March 2017, buoyed by a 39 per cent rise to £3.2bn in higher-margin discretionary and advisory assets under management (AUM). This reflects both favourable market movements, but also the expansion of the client base, predominantly through the recruitment of new investment managers. For instance, clients now hold £764m of investments in Isas, up by more than a quarter on the previous year, and buoyed by a near 10 per cent rise in new subscriptions. The structured products division has performed well too, benefiting from many ‘kick out’ style products maturing early due to the strong equity market performance, and a high level of reinvestment rates amongst investors, reflecting the benefits of Walker Crips’ client-focused strategy.
The contribution from a well-timed acquisition, London-based Barker Poland Asset Management (BPAM), a private client wealth management business, is benefiting the bottom line too. The initial consideration at the time of the acquisition in March 2015 was £2m in cash and £200,000 in Walker Crips shares with a £2m maximum earn-out, subject to BPAM's annual revenues averaging £1.6m or more over the following three years. Not only has BPAM met the earn-out conditions, but it has been trading above the board’s expectations.
The point is that Walker Crips has actually delivered the £1m plus worth of profits I thought the business was capable of producing when I included the shares in my 2016 Bargain share portfolio. However, with the share price hardly moved at 42p, giving the company a market value of £17.6m, this means that net of £7.7m cash on its balance sheet, this fast growing business is effectively being valued at just £10m, hardly a punchy valuation for one that has just turned in an adjusted operating profit of £1.14m and hit its £5bn AUM target 12 months ahead of schedule. Moreover, it’s not stopping there as the board now believe that the fund management business can double in size again.
Needless to say, priced on a cash-adjusted PE ratio of 10 for the year just ended based on a normalised tax charge and adjusting for one-offs, offering a 4.4 per cent dividend yield, rated on a near 20 per cent discount to book value, and with market conditions favourable, I feel Walker Crips shares are being harshly valued. So, having last rated them a hold at 40p when I updated my 2016 Bargain share portfolio in February, and given the dramatic improvement in trading, I now rate them a buy at 42p. Buy.
Value in fast growing Arbuthnot
Shares in Arbuthnot Banking Group (ARBB:1,252p) rallied almost 10 per cent to hit an all-time high of 1,600p after I advised running profits in late March when I suggested they should be trading closer to book value of 1,533p a share ('Eight small-cap plays', 27 Mar 2017). For good measure, investors also banked an 18p final dividend in April to take the total to 383p since I included the shares in my 2015 Bargain Shares portfolio at 1,459p.
However, the company’s share price has pulled back sharply since then and is now priced 18 per cent below book value even though Arbuthnot has a rock solid balance sheet and is clearly making progress in investing the £148m cash raised last summer by selling down its stake in challenger bank Secure Trust Bank (STB:2,149p). Arbuthnot still retains an 18.6 per cent shareholding in Secure Trust worth £69m, a sum equating to a 35 per cent of its own market capitalisation, and is using the cash realised to bulk up its banking operations.
Progress here was evident in yesterday’s interim results which showed that its private banking arm, Arbuthnot Latham, increased its underlying pre-tax profit by 75 per cent to £4.9m. The bank is growing at quite a lick with loans rising by a third in the past 12 months to £880m, but it remains very well funded with customer deposits rising by a quarter to £1.2bn, thus covering the loan book almost 1.4 times over and providing ample funding for further lending. Acquisitions are boosting loan growth too including that of Renaissance Asset Finance (RAF), a provider of finance for a range of specialist assets including vintage and high value cars. The deal completed in late April and since then Renaissance’s loan book has grown by 5 per cent to £60m. Prior to that Arbuthnot Latham purchased a private banking loan portfolio worth £44.9m from banking group Duncan Lawrie. The loans are secured on property worth £104m, so have a low loan-to-value ratio, and offer an attractive yield of 5.2 per cent. The bank also managed to negotiate a £2.2m discount on the deal.
Of course, like any lender Arbuthnot is exposed to any deterioration of economic conditions, so it’s worth noting that the bank refuses to chase volume at the expense of relaxing its lending criteria, a point that is highlighted by a low level of impairments and a comfortable loan-to-value ratio on its lending. Furthermore, with the benefit of a well funded balance sheet, and assuming Arbuthnot Latham continues to recycle customer deposits into lending at an economic net interest margin, it will continue be value accretive to shareholders.
This explains why analysts at Hardman & Co expect Arbuthnot's pre-tax profits to double this year to £8m based on a 30 per cent rise in operating income to £54.1m, increasing to £14.1m and £68.5m, respectively, in 2018. On this basis, expect adjusted EPS to almost treble to 50p this year, rising sharply again to 84.7p in 2018. In terms of the contribution factored into those forecasts from Secure Trust Bank, which is treated as an associate undertaking, Hardman expects it to contribute a pre-tax profit around £4.2m this year, rising to £4.8m in 2018. By contrast Arbuthnot Latham is expected to contribute £11m at the pre-tax level, rising to £17.5m in 2018, an outcome that would more than cover central costs of £8.2m twice over. In other words, if Arbuthnot continues to ramp up its lending as it has been doing, then the profit from Secure Trust will become a diminishing amount of the mix.
I would also flag up that the £69m shareholding in Secure Trust aside, Arbuthnot used £53m of its cash windfall to acquire a prime property in the West End of London, comprising 22,500 sq ft of office space and 7,000 sq ft of retail space. The property generates an annual rental income of around £1.8m and will be used by Arbuthnot Latham to develop a presence in the West End in the future. This means that these two assets are worth almost two thirds of Arbuthnot’s own market capitalisation, leaving its fast growing private banking arm very modestly priced on a sum-of-the-parts basis.
Trading on around 14.5 times next year’s earnings estimates, offering a 2.8 per cent prospective dividend yield, and rated on a deep 18 per cent discount to book value, I feel Arbuthnot’s shares are being treated harshly and rate them a buy.
Inland hits forecasts
An upbeat pre-close trading update this week from Inland Homes (INL:59p), a specialist housebuilder and brownfield land developer, has confirmed that the company is trading in-line with market estimates which point towards it delivering a pre-tax profit of around £17m for the 12 months to end-June 2017, up from £14.9m the previous year, as analysts John Cahill and Miranda Cockburn at broking house Stifel predict.
When I rated the shares a buy at 57p three weeks ago (‘A trio of small-cap buys’, 27 Jun 2017), I made the point that the share price underperformance relative to peers was mainly down to investor caution over the company hitting analyst profit estimates. True, by its nature, land sales can be lumpy which makes it incredibly difficult in forecasting. Nonetheless, the company has increased revenues from land sales from £52.5m to £59.5m in the 12 month period including £27m from selling 400 plots in Aylesbury, Buckinghamshire and a further 173 plots at Alperton, Greater London which were sold through a joint venture and the sale of a subsidiary, respectively. Moreover, even though Inland sold 780 plots in total, up from 425 plots the previous financial year, it has still increased its total land bank by almost 100 plots to a record 6,776 plots including a short-term development pipeline of 4,606 plots with a gross development value of £1.34bn. Success at the planning stage is playing its part as the company secured consent on 1,856 plots in the financial year, maintaining a 100 per cent record of success in its planning applications.
This bodes well for the planning applications it will shortly submit for 350 residential plots at its flagship Wilton Park site in affluent Beaconsfield, Buckinghamshire, and for 214 plots across 19 acres on two sites in Buckinghamshire and Essex. Inland’s 405-acre strategic land bank currently accounts for a third of the total land bank, highlighting the opportunity to create value by securing planning permission on this land and then selling it onto developers.
I would also flag up that revenue from Inland’s housebuilding arm rose from £49.5m to £57.5m in the period, reflecting 188 unit sales at an average price of £306,000. Importantly, the positive momentum in this side of the business has continued since the period end with the forward order book up 11 per cent year-on-year to £26.1m. Inland has 249 open market units under construction and plans to commence work on a further 177 units next month.
The bottom line is that the shares continue to be harshly valued on a 40 per cent discount to Stifel’s end June 2017 EPRA net asset value (NAV) forecast of 98p a share, on less than 9 times EPS estimates of 6.8p even though the company is expected to deliver 25 per cent earnings growth, and offer a decent 2.6 per cent prospective dividend yield assuming the board raise the payout from 1.3p to 1.6p as analysts predict. In my book that represents value.
So, having included the shares in my 2013 Bargain Shares portfolio at 23p ('How the 2013 Bargain Shares fared, 7 Feb 2014), and maintained my positive stance ever since, I feel that the risk here is skewed to the upside with the shares trading at 60p. In fact, I completely agree with Mr Cahill and Mrs Cockburn at Stifel that a much fairer valuation for the equity is around the 80p mark, representing a 25 per cent discount to end June 2018 EPRA NAV estimates of 107p a share. Buy.
Poised for take off
Aim-traded Gama Aviation (GMAA:250p), an operator of privately owned jet aircraft, has issued the robust trading statement I was expecting ahead of interim results due out on Thursday, 7 September 2017.
I outlined the investment case just over a fortnight ago (‘Four small-cap plays’, 3 Jul 2017) when I noted the unwarranted undervaluation relative to peers even though the company is now producing growth across all segments. Yesterday’s trading updates did nothing to dispel my enthusiasm as it revealed that Gama’s fast-growing US aircraft management business continues to benefit from strong organic growth as well as the Landmark fleet joint venture with BBA Aviation (BBA:307p); its European air operation has extricated itself from some underperforming legacy contracts and is benefiting from cost savings and margin improvements; and its European ground services operation is seeing higher maintenance activity on the back of contract wins announced earlier this year, and a ‘modest pick-up’ in discretionary aircraft improvements and modifications spend. This suggests that analyst expectations of a 10 per cent rise in EPS to 33 cents this year look well founded and that the shares are likely to maintain their ascent to narrow the 40 per cent ratings discount with peers as highlighted by analyst John Cummins at broking house WH Ireland.
Trading on just under 10 times EPS estimates of 26p using an average blended exchange rate of £1=US$1.28 for 2017, with net debt set to fall sharply this year, so offering scope for further earnings enhancing bolt-on acquisitions, and offering 20 per cent upside to my new target price range of 275p to 300p, I continue see decent upside here.
It’s of interest too that Gama’s share price is pressurising the 250p level that acted as a major support level until May last year when it gave way. A break-out above this key resistance level is worth noting as it narrows the odds significantly of a run up to my aforementioned target price range. I would also flag up that my fair valuation is well below the 370p target price of house broker WH Ireland and could have scope for upgrades if the current momentum in the business continues. Buy.
Light at the end of the tunnel for PV shareholders
The board of solar wafer maker PV Crystalox Solar (PVCS:22.5p) has announced that in light of adverse trading conditions it will cease all ingot production operations in the UK during the current quarter and will continue its focus on the niche low carbon footprint wafer market where it has some competitive advantage. The move is in-line with management guidance at the time of the full-year results in March.
The redundant plants have not been fully utilised for several years and their carrying value had already been written down in the accounts. The move reflects the adverse photovoltaic market environment where wafer prices remain below production costs. So, in order to better align production costs with market prices and reduce overheads, the company will now source ingot blocks from an external supplier and cease its own ingot production altogether.
However, of far more importance to the future direction of the share price is the forthcoming judgement at the International Court of Arbitration of the International Chamber of Commerce which is ruling over a dispute between the solar wafer maker and one of its customers, a leading photovoltaic company. The unnamed photovoltaic company failed to purchase wafers in line with its obligations under a long-term sales contract with PV Crystalox, hence the decision of the board to take the matter to arbitration in March 2015. Bearing this in mind, PV Crystalox’s board subsequently stated that if the judgement is found in its favour then compensation could be a "multiple of its market capitalisation". The share price has more or less doubled since then, but it still implies that a favourable judgement could be worth at least the company’s current market capitalisation of £35m, and perhaps substantially more. The ICC is expected to announce its judgement before the end of the third quarter this year, albeit this has been a protracted process.
True, this is a binary bet, and even if the company wins the ruling then there is no guarantee that the unnamed defendant will be able to pay up in full. However, the company does have some solid asset backing: net cash was €27.9m at 30 June 2017, a sum worth 13.5p a share; and inventories of €11.2m (£10m) at the last balance sheet date are worth a further 6.2p a share. This implies that stocks and cash are worth almost 20p a share before accounting for this year’s operating losses. This asset backing not only limits the downside in the event of a negative ruling, but with the potential share price upside from a ruling in the company’s favour substantial, then I feel that it’s worth holding onto the shares at the current price, having last rated them a hold at 21.75p back in March ('Eight small-cap plays', 27 Mar 2017) and first included them at 19p in my 2014 Bargain Shares Portfolio. Hold.
Order book building at Stadium Group
I am also comfortable advising holding on to shares in Stadium (SDM:133p), a niche electronics company specialising in wireless, power and human machine interface products, ahead of the interim results due out on Tuesday, 7 September. I first advised buying the shares at 75p ('Switch on to the Stadium of light', 30 Jul 2014), since when the board has paid out total dividends of 7.7p a share, and last advised running profits at 134p ('Five growth opportunities', 30 May 2017).
A brief pre-close trading update confirmed that the company is trading in-line with analysts’ full-year forecasts which point towards pre-tax profits rising by a quarter to £5.3m on revenues up from £53m to £62m. This outcome should produce a 23 per cent hike in EPS to 10.7p and enable the board to lift the payout from 2.9p to 3.1p as analysts predict. On this basis, the shares are rated on a modest 12.5 times forward earnings and offer a prospective dividend yield of around 2.3 per cent. Importantly, the trading outlook remains robust with the order book rising from £25.8m to in excess of £28m since the start of the year, driven by growth in higher-margin technology products, including high-growth wireless devices such as insurance telematics, and the fast-growing market for the internet of things, which encompasses security, smart home devices and energy management.
Furthermore, if the current momentum is maintained, then this improves the odds of Stadium delivering double-digit EPS growth next year too. Analyst Jon Lienard at broking house N+Singer is pencilling in EPS of 12.9p and a dividend of 3.3p for 2018, implying the shares are rated on just over 10 times earnings estimates and offer a near 2.5 per cent forward dividend yield. That’s not a punchy rating, and certainly one to support further share price upside, so ahead of the interim results I would continue to run your profits.
