Corporate activity has been a recurring theme among the small-cap companies I follow. In fact, 15 of the small-cap companies I cover have exited the London stock market in the past three years, the vast majority of which have rewarded shareholders handsomely.
We can now make that 16 as Lombard Risk Management (LRM:13p) – a provider of collateral management and regulatory reporting software products to clients including 30 of the top 50 global banks, hedge funds and asset managers – has received a recommended bid from Amsterdam-based Vermeg, an insurance management solutions and financial software provider. The 13p a share cash offer values Lombard’s equity at £52m and represents a hefty premium to my original 9p entry point ('Banking on regulation', 13 March 2017). It is also 86 per cent higher than the 7p price at which I last rated the shares a trading buy 11 weeks ago (‘Trading opportunities’, 30 October 2017).
With shareholders controlling 38.76 per cent of the shares indicating they will support the takeover, it looks likely to succeed. The exit multiple of 11 times forecast cash profits is also fair in light of the higher execution risk resulting from a greater seasonal bias to Lombard’s numbers, and the lumpy nature of contracts, as I outlined in my last article. Accept.
On the earnings beat
This is an opportune time to reassess the merits of my 2016 Bargain Shares Portfolio constituent Bioquell (BQE:332p), a provider of specialist microbiological control technologies to the international healthcare, life science and defence markets. The share price has surged by 35 per cent since I last rated the shares a buy at 245p (‘A trio of small-cap buys’, 31 October 2017). I included them in my 2016 Bargain Shares Portfolio at an average buy-in price of 125p, so the holding has returned 165 per cent in the past two years.
Last week’s trading update explains why. Bioquell reported pre-tax profit of £1.4m for the first six months of last year, up from just £400,000 in the same period of 2016, on revenue up by almost a fifth to £14.3m. Management guidance previously pointed towards a similar sales performance in the second half, suggesting full-year revenue will rise by 9 per cent to £29.3m to lift pre-tax profit by half to £2.4m. However, buoyant trading means that pre-tax profit will now be significantly ahead of those upgraded estimates. Analyst Chris Glasper at broking house N+1 Singer upgraded his pre-tax profit forecast to £2.9m, implying EPS of 10.4p, up from 5.6p in 2016. Cash is building strongly, too, rising from £8.8m to £14.5m in the 12-month period, a sum worth 64p a share.
Importantly, I don’t think the earnings upgrade cycle has peaked. The industry backdrop remains favourable as a number of drivers are positively impacting Bioquell’s business, including the need for customers to achieve regulatory compliance, the threat posed by antibiotic resistance, and growth in research and small-scale production associated with cell-based healthcare products. New products are driving up revenues, too – and at eye-catching gross margins of 50 per cent – so an increasing amount of revenue is dropping straight to the bottom line. Also, more than three-quarters of Bioquell's sales are generated overseas, so sterling's weakness is benefiting margins, as have cost reductions from a restructuring programme.
Trading on 23 times upgraded 2018 cash-adjusted EPS estimates after stripping out net cash on the balance sheet, I would run your bumper profits ahead of the full-year results on Wednesday 7 March 2018. The next trading update is unlikely to disappoint. Run profits.
Beating expectations again
Bioquell is not the only constituent of my annual Bargain Shares Portfolios to have posted an earnings beat. The same is true of pawnbroker H&T (HAT:360p), which has issued two earnings upgrades in the past couple of months, making it four in the past year. I last rated the shares a buy at 290p, in line with the entry point in the 2017 portfolio ('Bargain Shares: second chance', 17 August 2017), so the holding is up 27 per cent after factoring in dividends of 9.6p a share.
The key drivers behind the earnings beat include the expansion of the company’s lower interest rate personal loan product, which has almost doubled the personal loan book to £18.3m year on year; and an 11 per cent rise in the pawnbroking pledge book to £46.1m, reflecting the higher gold price, an improved concession format and increased loans made on quality watches. By offering customers access to cheaper loans, H&T gives them an opportunity to rebuild their credit score, and has diversified its client base, too. It also makes a decent profit for the company.
Analyst Andrew Watson at broker N+1 Singer had been anticipating a rise in pre-tax profit from £9.7m to £12.5m in 2017, but now expects a 5 to 10 per cent increase in consensus profit estimates and that follows on from a 10 per cent upgrade in early November. Trading on 11.6 times N+1 Singer’s 2018 EPS estimate of 31p, and offering a 3.2 per cent prospective dividend yield based on a 2018 payout of 11.5p a share, I have upgraded my target price to 400p. Buy.
Tax legislation offers upgrade potential
The newly announced corporation tax cuts by the US Republican administration have the potential to benefit Avingtrans (AVG:220p), a maker of critical components and services to energy, medical and industrial sectors. Last autumn the company acquired Hayward Tyler, a supplier of motors and pumps to customers in the nuclear, power generation and oil and gas sectors. That company has profitable operations in Vermont, US, and is a top-rated supplier to the nuclear industry, providing a new geographic location for Avingtrans, which has a strong position at Sellafield, the Cumbrian nuclear power station.
Importantly, the acquisition is bedding down well and Avingtrans continues to win new contracts across its enlarged business, announcing another £7m of awards in a pre-close trading update ahead of half-year results on Wednesday 28 February.
After factoring in cost savings, and a restructuring of Hayward Tyler, analyst Jo Reedman at N+1 Singer anticipates Avingtrans’ cash profit rising eightfold to £5.6m on revenue of £79.9m in the 12 months to the end of May 2018, increasing to cash profits of £7.6m on revenue of £95m the year after. On that basis, the company is rated on an enterprise value to cash profit multiple of 9.7 times, a deep discount to the sector average. So, having last advised buying the shares at 210p (‘Engineering gains’, 2 October 2017), I maintain my 275p target price. Buy.
Miton upgrades again
While I was on sabbatical at the end of last year, fund manager Miton (MGR:38p) issued a trading update that revealed an 8 per cent rise in its assets under management (AUM) to £3.63bn in the four months to the end of October 2017, tracking well ahead of the £3.5bn year-end forecast of analyst Stuart Duncan at broking house Peel Hunt. This prompted Mr Duncan to raise his year-end AUM estimate to £3.7bn, up from £2.9bn at the start of 2017. Mr Duncan also upgraded his full-year pre-tax profit and EPS forecast by 9 per cent to £6.3m and 2.8p, respectively, implying 16 per cent EPS growth year on year. Since then, the board has spent £3.4m of the company’s hefty cash pile, purchasing 8.5m shares in an earnings-enhancing share buyback at 39.75p a share.
By my reckoning, the company is currently being valued on an enterprise value to post tax profit multiple of less than 10 times – a significant discount to the sector average. A 3.7 per cent prospective dividend yield for the 2018 financial year is also attractive. So, having initiated coverage at 23p ('Poised for a profitable recovery', 4 April 2015), and last advised buying the shares at 41p (‘Plain sailing’, 27 September 2017), I continue to see upside to my 50p target price. Buy.
Asset-backed play
I had an informative results call with Sunil Chatrani, chief executive of Elegant Hotels (EHG:91p), the largest operator of luxury hotels on the Caribbean island of Barbados. As I highlighted when I rated the shares a buy at 87p in the autumn ('Hitting target prices', 18 October 2017), trading was affected in the financial year to the end of September 2017 by a number of factors, the most significant of which was the sharp fall in sterling. This impacted the spending power of UK visitors, accounting for 80 per cent of Elegant Hotel’s customers, and meant that the hotelier needed to discount its rates in a sensible and controlled manner to maintain bookings from this important segment of the market.
Cash profit declined from $19.6m (£14.5m) to $18.1m in the 12-month period and, with net borrowings up from $61.8m to $73.1m, largely due to the $10.6m spent on the purchase and refurbishment of the 35-suite Treasure Beach Hotel, the interest bill increased, as did the depreciation charge. The net result was that the pre-tax profit declined from $14.2m to $11.1m, and EPS fell from 13.1¢ to 10.1¢.
The board’s decision to cut the final dividend to 1.75p a share, giving a full-year payout of 5.25p a share, down from 7p a share in the previous financial year, was taken so that cash flow could be freed up to take advantage of acquisition opportunities, one of which is in the advanced stages of discussions. House broker Zeus Capital is pencilling a rebased payout of 4p a share in the 2017-18 financial year as the new norm, based on pre-tax profit and EPS recovering to $12.4m and 10.7¢, respectively – albeit this is well shy of previous estimates. On this basis, the shares are currently rated on 11 times earnings estimates, and offer a 4.4 per cent forward dividend yield.
Importantly, I feel there is still a good chance of a profit recovery this year as the company will have the benefit of income from Treasure Beach, which opened in December, and management contracts won in Antigua. In addition, the company is targeting more affluent visitors to the island from North America to compensate for the subdued demand from the UK.
Interestingly, Spanish hotel operator Meliá Hotels International (BMAD:MEL) made an unsolicited approach for the company, undoubtedly attracted by the 44 per cent share price discount to net asset value of 163p. Discussions have since been terminated, but I would not rule out other operators circling. So, although the holding has flatlined since I recommended buying the shares at 105p when the company floated on Aim ('Checking into an elegant investment', 15 June 2015), and that’s after taking into account 14p a share of dividends banked to date, I can see upside potential, especially if corporate activity ensues. Buy.
Moss Bros warns
Clothing retailer Moss Bros (MOSB:75p) has issued a profit warning after like-for-like sales at its stores declined 8 per cent in December, a lack of footfall contributing to the weak sales performance and leading the directors to guide down profit expectations.
Analyst John Stevenson trimmed his full-year pre-tax profit estimate by £900,000 to £6.5m for the 12 months to the end of January 2018, in line with the lower end of the board’s new guidance, implying a £400,000 decline year on year. He has also cut his 2018-19 pre-tax profit forecast by £1m to £6.2m, suggesting the tough trading conditions are unlikely to lift any time soon. Investors reacted badly, selling the shares down 16 per cent to 75p, way below the 98p level at which I advised running profits (‘On an earnings beat’, 3 October 2017).
Long-term holders are still well in the money as I first spotted the company’s recovery potential when the shares were 38p ('Dressed for success', 20 February 2012), since when the board has declared total dividends of almost 25p. The uncovered dividend of 5.9p a share should offer support at these levels, especially with net cash of 17p a share on the balance sheet. However, with profits going into reverse, and the shares rated on 16 times downgraded forward EPS of 4.8p for 2018-19, I am banking profits.
■ 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
