In late spring, I felt it was prudent to partly bank gains on a number of the small-caps I follow on valuation grounds. The list included Trifast (TRI:207p), a small-cap manufacturer and distributor of industrial fastenings with operations in 17 countries across Europe, Asia and North America ('Hitting target prices', 2 May 2017). It has proved to be a fantastic investment: having first recommended buying at 53p in my 2013 Bargain Shares portfolio, the holding was showing a 332 per cent gain, including dividends, when I advised top-slicing at 223p.
At the time, I felt that further corporate activity was needed for the price to hit Peel Hunt's top-of-the-range target of 250p (since upgraded to 265p). I haven’t changed that view. The shares are rated on 16 times earnings for the financial year to end-March 2017, a fair valuation given that analysts’ conservatively forecast little in the way of earnings growth this year. That’s not to say the risk to earnings isn’t to the upside; it still is. Last year the company delivered underlying sales growth in excess of 5 per cent, and analyst Ben Thefault at brokerage Arden Partners believes the business is tracking ahead of his assumptions. It’s just that upgrades are needed to get the share price moving again, and an earnings-accretive acquisition is the most obvious catalyst for that.
Importantly, the board has the firepower to make further acquisitions, having in recent years acquired 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. Buoyed by robust cash generation, net borrowings almost halved to £8.2m last financial year, and Trifast could have net debt of £5m by March 2018, according to analyst Henry Carver at Peel Hunt. The balance sheet is clearly underleveraged. Bearing this in mind, Trifast’s directors evaluated two potential bolt-on deals in the past six months, but withdrew from both during due diligence, the lack of progress here being a contributory factor behind the drift in the share price since I top-sliced.
However, I am willing to run profits ahead of the interim results in November. That’s because the directors are out to do deals, and a pre-close trading update revealed that the order pipeline is “very encouraging”, suggesting that analysts are being overly cautious in their forecasts. Run profits.
Avingtrans set to work its magic
Avingtrans (AVG:210p), a maker of critical components and services to energy, medical and industrial sectors, delivered full-year results slightly ahead of analyst Jo Reedman's expectations at broking house N+1 Singer, but last month’s acquisition of specialist engineer Hayward Tyler, a supplier of motors and pumps to customers in the nuclear, power generation and oil and gas sectors, is the real story here.
The company’s shrewd management team has established a track record of buying, building and then disposing of businesses, having achieved an internal rate of return of 21 per cent on the most recent disposal of its aerospace division. The board then returned £19m to shareholders through a tender offer, but retained £28m cash for acquisitions. Hayward Tyler was an obvious target for a number of reasons: it was too highly leveraged – Avingtrans has used its cash pile to pay off £21.5m of expensive debt it assumed on acquisition. And Hayward Tyler has profitable operations in Vermont, in the US, where it is a top-rated supplier to the nuclear industry, thus providing a new geographic location for Avingtrans, which has a strong position at Sellafield where it has a lucrative 10-year contract worth £47m to provide waste storage containers for the Cumbrian nuclear power station. There is a crossover of activities in other key sectors too.
An immediate objective for the management team is to restore Hayward Tyler’s profitability by taking out costs from the business, improving the supply chain management and removing duplicated overheads. Jo Reedman at N+1 Singer believes that £3.2m of costs can be taken out in the financial year to end-May 2018, doubling to £6.6m the year after, and is conservatively assuming that Hayward Tyler will make a nine-month operating profit contribution of £1.6m in 2018, rising to £3m on £61.6m sales in the 2019 financial year. There’s scope for upside as Hayward Tyler’s reported operating profit margins were as high as 9.4 per cent in 2016 prior to getting into difficulty, and finance director Stephen King has only assumed flat sales from Hayward Tyler.
The point being that although analysts expect Avingtrans' pre-tax profits to increase sevenfold to £2.1m on revenues of almost £80m in the 12 months to end-May 2018 – around 85 per cent of which is already supported by contracts in place – rising to profits of £3.4m on revenues of £95m the year after, I can see potential for outperformance given the conservative assumptions on which the estimates are based. Furthermore, with the backing of Avingtrans’ solid balance sheet, there are no financial constraints impeding progress at Hayward Tyler, another reason behind its recent underperformance.
Trading on nine times cash profit estimates to enterprise value for the financial year to May 2019, and offering a dividend yield of 1.5 per cent, I continue to rate Avingtrans shares a buy and maintain my target price of 275p, having included the shares at 200p in my 2017 Bargain Shares portfolio ('Bargain Shares: second chance', 17 Aug 2017). Buy.
|2017 Bargain shares portfolio performance|
|Company name||Market||TIDM||Opening offer price on 03.02.17 (p)||Latest bid price on 28.09.17 (p)||Dividends||Total return (%)|
|Chariot Oil & Gas (see note one)||Aim||CHAR||8.29||12||0||88.9|
|Cenkos Securities (see note four)||Aim||CNKS||88.425||120||5||41.4|
|Manchester & London Investment Trust (see note two)||Main||MNL||291.65||377||3.0||28.4|
|H&T (see note five)||Aim||HAT||289.75||327||5.3||14.7|
|Management Consulting Group||Main||MMC||6.183||6.3||0||1.9|
|Tiso Blackstar Group (see note three)||Aim||TBG||55||50||0.28465||-8.6|
|BATM Advanced Communications||Main||BVC||19.25||17.5||0||-9.1|
|Deutsche Bank FTSE All-share tracker (XASX)||409||413||16.28||5.0|
|1. Simon Thompson advised selling two thirds of the Chariot Oil & Gas holding at 17.5p on 3 April 2017 ('Bargain shares on a tear', 3 April 2017). Return reflects the profit booked on this sale.|
|2. Manchester and London Investment Trust paid total dividends of 3p a share on 2 May 2017. Simon Thompson then advised selling half of the holding at 366.25p on 26 June 2017 ('Top slicing and running profits', 26 June 2017), and selling the remaining half at 377p ('Bargain shares second chance', 17 August 2017).|
|3. Tiso Blackstar paid an interim dividend of 0.28465p on 8 May 2017.|
|4. Cenkos Securities paid a final dividend of 5p on 26 May 2017.|
|5. H&T paid a final dividend of 5.3p on 2 June 2017.|
Strix heating up nicely
Isle of Man-based Strix (KETL:139p), a global leader in the manufacture and design of kettle safety controls, delivered a near-10 per cent increase in first-half pre-tax profits on revenues up almost 7 per cent, in line with the top-line growth rate for the past three years and driven by growth in export markets.
Strix has a 38 per cent share by volume and 50 per cent share by value of the 174m sets of safety kettle controls that were produced globally last year. It manufactures more than 400m components mainly from a facility in Guangzhou, China, where it employs 800 staff. In the regulated markets of western Europe, US, Japan, Turkey and Australia, it’s a dominant player, boasting a market share of over 61 per cent. But it has been seizing the opportunity in less regulated markets (16 per cent market share), where either high safety or intellectual protection standards are not in place, by developing new, lower-cost products designed to increase market penetration.
The company earns a bumper return on its sales: house broker Zeus Capital forecasts an 8 per cent rise in full-year operating profits to £28.8m on revenues of £92.6m, implying a margin of 31 per cent. Moreover, the Isle of Man tax-free base means the company retains virtually all its profits. That’s great news for the dividend. Having floated on Aim last month, Zeus Capital expects a dividend of 2.9p a share this year to be paid out of forecast reported earnings per share (EPS) of 13.7p, increasing to a dividend of 7p a share covered twice over by reported EPS of 14.9p in 2018. A progressive dividend policy is supported by cash generation too – next year’s forecast free cash flow of £23.9m easily covers the £13.7m cash cost of the 7p-a-share dividend, and will also enable net borrowings of £58m to be paid down.
On 10 times current-year earnings estimates and offering a 5 per cent-plus prospective dividend yield for 2018, I maintain the positive stance I made when I suggested buying the shares at the IPO (‘Tap into a hot IPO', 7 August 2017). In fact, I have raised my target price from 150p to 165p. Buy.
Private & Commercial beats expectations
Aim-traded finance house Private & Commercial Finance (PCF:28.5p) has issued a major earnings beat in a pre-close trading update for the financial year to end-September 2017, and one that has prompted analysts at Panmure Gordon to upgrade their EPS estimates by 16 per cent to 2.06p.
The key takes for me were a halving in the impairment charge to 0.5 per cent of the average loan book, suggesting better credit quality; the increase in new business originations, up almost a fifth to £74m, mainly driven by small- to medium-sized enterprises (SMEs) lending and in line with the 17 per cent growth in total receivables to £141m; and news that the company has already received £51m of retail deposits since getting its banking licence in the summer. The savings product has a blended interest rate of 2 per cent, well below the current cost of funding of 5.6 per cent, highlighting potential to recycle low-cost deposits into higher-grade customer lending that was previously deemed uneconomic while maintaining a net interest margin of 8 per cent.
Private & Commercial has more than 8,400 retail customers with an average loan size of £11,500 at inception, of which 86 per cent finances second-hand motor vehicles, while its 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.
When I last suggested buying the shares at 23p ('On the money', 7 June 2017), after they had retreated below the 24.5p level at which I initiated coverage ('A small-cap gem', 18 April 2016), I felt that they had been de-rated unfairly due to investor misconceptions over its exposure to personal contract purchase (PCP) plans. This is a form of finance that has been widely used by consumers to fund new car purchases and where the lender is exposed to used car prices falling below guaranteed residual values. As I pointed out at the time, the company’s consumer motor division finances used vehicles on fully amortising hire purchase contracts, so has absolutely no exposure to PCPs.
It’s also clear that as the retail deposit base ramps up, investors will focus more on the potential for the company to scale up its loan book to £350m by 2020. The plan is to fund the increase in lending with £250m of retail deposits and existing bank loans, targeting a return on equity of 12.5 per cent. Clearly, if this can be achieved then profits will ramp up quickly too: Panmure expects pre-tax profits to rise from £5m for the year just ended to £8.1m in two years time to boost EPS by almost 50 per cent to 3.1p. Add to that a small dividend, and a modest price-to-book value of 1.5 times, and my fair valuation of 35p a share is not unreasonable. Buy.
Cenkos recovery on track
Shares in corporate broker Cenkos Securities (CNKS:125p) surged 20 per cent after the company reported a 156 per cent rise in first-half pre-tax profits to £4.2m driven by a 91 per cent increase in revenues to £29.2m, a performance that lifted EPS five-fold to 6.1p and supported a 350 per cent hike in the interim dividend per share to 4.5p.
Following some major boardroom changes, which saw former chief executive Jim Durkin retire and finance director Mike Chilton hand in his notice, newly appointed chief executive Anthony Hotson reassured investors with news that Cenkos has made a good start to the second half, has been engaged in a number of significant fundraisings and has an encouraging pipeline of transactions. The company has also appointed Philip Anderson as its new finance director, a decent recruit given his wealth of experience in the financial sector.
Prior to the results, analysts were forecasting a strong recovery in full-year pre-tax profits from £4.4m to £7.8m, leading to EPS of 11.2p, underpinning a bumper 11p-a-share dividend. With cash on the balance sheet worth 35p a share, and net trading positions worth a further 30.5p a share, shareholders can expect a hefty final payout too if the current momentum is maintained, a distinct possibility in my view. Indeed, it was the potential for a recovery in trading that prompted me to include Cenkos’ shares in my 2017 Bargain Shares portfolio at 88.4p ('Bargain Shares: second chance', 17 August 2017). The holding is up 41 per cent including last year’s final payout of 5p and, at 125p, the investment risk remains to the upside. Buy.
■ 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 stock picking