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Six small-cap plays

Simon Thompson highlights six investment opportunities
January 22, 2018

Burford Capital (BUR:1,205p), a global finance provider focused on investing in litigation cases, is now one of the largest companies listed on Aim, with a market capitalisation of £2.5bn, a reflection of the 725 per cent rise in its share price since the summer of 2015 when I initiated coverage ('Legal eagles', 8 Jun 2015). I last advised top-slicing your holdings when the shares hit a record high of 895p ('Top-slicing and running profits', 26 Jun 2017). It paid to maintain a financial interest as the share price is up another third since then, and within touching distance of last autumn’s all-time high of 1,258p. Ahead of full-year results on Wednesday 14 March, this looks an opportune time to reassess the investment case.

In a pre-close trading update, the directors revealed that new commitments made to litigation funding cases more than trebled to $1.34bn (£970m) last year. This implies Burford made $855m (£620m) of new commitments in the second half of 2017, up from $488m in the first half, and $488m for the whole of 2016. As analysts at investment bank Berenberg Capital rightly point out, this suggests the company, which is the leading litigation funding player in a litigation market worth $800bn in annual revenue, has had no problem finding sufficient opportunities to deploy its capital. It also augurs well for future profits. That’s because new cases typically take two years to complete, so, given the high returns on capital Burford makes, its high success rates and portfolio diversification, which mitigate risk, it can realistically expect a hefty financial return on these new commitments.

It also makes sense for the company to consider tapping the debt market again to recycle low-cost capital into funding potentially high return litigation cases. Having raised a total of $519m through three London Stock Exchange retail bond issues since 2014, all of which are trading above par, Burford has just launched an offer of 6.125 per cent Eurodollar bonds maturing in August 2025 and which will be listed on the London Stock Exchange. The offer closes on 6 February.

Importantly, results for the 2017 financial year are going to be eye-wateringly good. Analysts at Numis Securities predict a near-doubling of pre-tax profit to $218m on revenue of $313m, up from $163m in 2016, to produce EPS of 96.6¢, or 75p based on the average sterling dollar exchange rate last year. Part of the profit booked reflects the gain Burford realised by selling off 25 per cent of its economic interest in the multibillion-dollar Petersen legal case relating to the 2012 expropriation by Argentina of a majority interest in YPF, the New York Stock Exchange-listed energy company formerly owned by Repsol, the Spanish energy major. The $106m realised equates to six times its original investment, and analysts believe its retained economic entitlement could be worth $1.25bn (£905m) in the event of a successful outcome in the courts.

In addition, Burford had a favourable decision in an arbitration relating to the claim by Teinver S.A. and others against Argentina in connection with the country’s expropriation of two airlines. The arbitration tribunal ruled against Argentina, requiring it to pay $324m in damages, of which Burford’s entitlement is estimated to be $140m, or 10 times higher than its original investment of $13m in the case. Burford’s entitlement represents over 4.5 times the $30m carrying value of its investment in the company’s half-year accounts to the end of June 2017. Rated on 16 times likely earnings, I would run your bumper profits.

 

Watkin Jones built on solid foundations

Shares in Watkin Jones (WJG:207.5p), a construction company specialising in purpose-built student and private rented sector (PRS) accommodation, have been on a tear since I first recommended buying at 103p when the company floated on Aim ('A profitable education', 3 Apr 2016). I last advised running profits at 223p ahead of this month’s full-year results (Trading plays’, 9 Oct 2017), and the price subsequently hit the 250p target I highlighted. The results certainly didn’t disappoint, but the share price has since pulled back on news that chief executive Mark Watkin Jones, who has so successfully led the company, is stepping down for personal reasons. The caution is overdone.

In the 12 months to the end of September 2017, Watkin Jones’ underlying pre-tax profits and EPS both rose by 13 per cent to a record £43.3m and 14p, respectively, on revenues up from £267m to £302m, reflecting the completion of 10 student accommodation developments. Cash generation was mightily impressive, driving net funds up by more than a quarter to £41m. The pipeline is impressive, too, as all 10 student accommodation developments scheduled for delivery this year have been forward sold, as have 85 per cent of the targeted beds for the 2019 financial year. Furthermore, the company’s activity in the build-to-rent market is gathering pace. Watkin Jones now has five development sites targeting 1,500 units, having completed its first scheme of 322 units in Leeds.

Reassuringly, the forward pipeline de-risks forecasts which point to EPS of 15.2p this year, and 16p in 2019, so underpinning expectations of a further 10 per cent hike in the payout per share to 7.3p and 8p, respectively. Also, as more developments complete, net funds are forecast to swell to £74m by September 2018, a sum worth 25p a share. This implies the shares are attractively rated on 12 times forward cash-adjusted earnings and offer a prospective dividend yield of 3.5 per cent. Buy.

 

Bilby hits target, and pulls back

Aim-traded shares in Bilby (BILB:108p), a provider of gas heating appliance installation and maintenance services to residential and commercial properties, surged by a third to 126p after I suggested buying, at 89p, after its bumper half-year results and hit my 120p target price (‘Exploiting buying opportunities, 22 Nov 2017). However, they then gave up all those gains on fears that the company could be hit by the collapse of construction group Carillion. Those concerns are completely misplaced as Carillion’s collapse will have no financial impact on Bilby.

That’s because Bilby has two contracts with CarillionAmey, a separate legal entity that operates independently of Carillion, and partner Amey (with which Bilby has a strong relationship) has said that it will continue to provide the services provided by the joint venture and service all its obligations. So, with Bilby’s shares rated on 10 times EPS estimates of 10.5p for the 12 months to the end of March 2018, and offering a 2.5 per cent prospective dividend yield, this is a repeat buying opportunity.

 

Cambridge Cognition’s bumper pipeline

Bilby is not the only company on my watchlist that has seen its share price pull back this year. The same is true of Aim-traded shares in Cambridge Cognition (COG:120p), a company that has developed a suite of computer-based cognitive assessments to improve the understanding, diagnosis and treatment of neurological and psychological diseases. I highlighted its investment potential last April ('Positive thinking', 19 Apr 2017), and the shares had surged by 57 per cent by the time I advised running profits at 137p last autumn (‘Plain sailing’, 27 Sep 2017). It was the right call as the price hit an all-time high of 169p the following month, almost double my entry point.

The reversal since then reflects news that two contracts, worth £2.3m and due to be signed in the fourth quarter, are now expected to commence in the first half of this year. Consequently, last year’s revenues will be slightly down on the £6.9m reported in 2016 and the company will break even on a cash profit basis. The important point is that these contracts have not been lost. Moreover, the company’s forward sales pipeline is up 56 per cent year on year, and the number of pharmaceutical clinical trials and academic research contracts secured increased by 18 per cent in 2017. House broker FinnCap is maintaining its 2018 pre-tax profit and EPS forecasts of £1m and 4.6p, respectively. So, with cash in the bank, and a significant move into profit still expected this year, I would run profits.

 

Bango buying opportunity

Aim-traded Bango (BGO:217p), a provider of a state-of-the-art mobile payment platform enabling smartphone users to charge purchases made in app stores straight to their mobile phone account, has issued two major announcements since I last rated the shares a buy at 240p (‘Three small-cap stars’, 27 Nov 2017), having first advised buying at 93p ('Bang on the money', 26 Sep 2016).

Firstly, it has partnered with Netflix, the world's leading internet entertainment service, to launch direct carrier billing (DCB) to more than 12m subscribers in Mexico, thus enabling them to charge their monthly subscription cost to their pre- or post-paid mobile phone bill.

Secondly, and following last summer’s groundbreaking DCB agreement with Amazon Japan, Bango has expanded the use of its platform to provide resale and bundling technology to Amazon, enabling customers to sign-up to Amazon Prime in India through resellers that offer product bundles. India's largest mobile network operator, Bharti Airtel, is the first to make Amazon Prime available as part of a bundled package offered to its customers.

Both agreements are a further validation of Bango’s payment platform and one that’s proving increasingly popular: the annualised end-user spend (EUS) run rate of transactions processed exceeded £400m at the end of 2017, or more than double the level a year earlier. Also, the acquisition this week of Audiens, a developer of a cloud based platform that collects and analyses valuable consumer data, accelerates Bango’s own data strategy and will enable its customers and advertisers to market more efficiently. This can only be good for business. The acquisition was funded by a £5m placing of new shares.

Furthermore, having hit monthly cash profit break-even in November, analyst Ian McInally of Cenkos Securities forecasts a cash profit of £3m in 2018 based on total EUS activity of £592m. If Bango can maintain its EUS growth rate, my models suggest it could be making net profits of £10m by 2020, supporting my 300p target price to value the equity at £200m. I remain a buyer ahead of full-year results on Tuesday 13 March. Buy.

 

1pm undervalued

The share price of 1pm (OPM:52p), a specialist Aim-traded provider of finance to small- and medium-sized enterprises (SMEs) and a constituent of my 2014 Bargain Shares Portfolio, is little changed since I last rated the shares a buy (‘Profiting from cyber crime’, 13 Sep 2017).

However, the modest rating – the forward PE ratio is eight, price-to-book value below one, and there is small but growing dividend, too – is certainly not an accurate reflection of the operational progress being made, nor the company’s increased scale. A number of bolt-on acquisitions – which added invoice discounting and factoring to 1pm’s existing asset finance and business loan products – and ongoing organic growth have boosted the company’s loan portfolio to £130m, and also diversified revenues.

Last week’s trading outlook was certainly upbeat. 1pm continues to see strong loan demand from UK SMEs, credit quality is sound, and its average cost of debt is being reduced – factors suggesting that the 13 per cent implied post-tax return on equity in the 12 months to the end of May 2018 (based on a doubling of reported net profits to £6.4m) is attractive. Buy.

Finally, I will be publishing my 2018 Bargain Shares Portfolio on Friday 2 February and will also be reviewing all 10 companies in the 2017 portfolio. It proved a vintage year as my motley crew of small-caps have produced a total return of around 30 per cent, building on the performance of my 2016 portfolio, which is now up 43 per cent. Having spent a considerable amount of time uncovering some potentially lucrative investment opportunities for you to exploit, I will now endeavour to update as many of the companies on my watchlist that reported announcements while I was working on this year’s portfolio, and while I was away on sabbatical at the end of last year.

This article was first published at 12pm on Monday, 22 January and updated at 10.30am on Wednesday, 24 January.

■ 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