It’s pretty rare for a company to increase its net asset value (NAV) at a compound annual growth rate of almost 12 per cent for the best part of three decades, and reward shareholders with a progressive dividend policy too, but that’s what cash-rich insurance sector investment company BP Marsh & Partners (BPM:260p) has delivered.
It’s a company I know very well, having first recommended buying the shares at 88p ('Hyper value small-cap buy', 22 January 2012), and last reiterated that advice at 260p in the autumn ('Hitting target prices', 18 October 2017). It was the right call as BP Marsh’s upbeat pre-close trading update for the financial year to end-January 2018 suggests the company will report yet another record set of results on Tuesday 12 June 2018.
Indeed, I feel that BP Marsh’s year-end NAV could easily be 330p a share or more, up from 304p in July 2017, 273p in January 2017 and 253p in July 2016. I have good reason to think this way as I have been running my slide rule across the company’s largest shareholdings: LEBC, an independent financial advisory firm that has been generating explosive earnings growth from developing its traditional advice model and growing corporate project work; and Nexus Underwriting, an independent speciality managing general agency that has been making some shrewd acquisitions to scale up the operation. These account for half of NAV.
At the interim stage last year, BP Marsh’s valuation committee believed LEBC’s equity was worth £42.85m, implying a valuation of £25.9m on BP Marsh’s 60.88 per cent stake. However, LEBC has subsequently reported a 42 per cent rise in trading profit to £3m on revenues up 17 per cent to £18.1m in the financial year to end-September 2017. Moreover, LEBC reports “current trading significantly ahead of last year and budget”. LEBC has also made the £5m acquisition of a Bristol-based advisory firm with £500m of assets under management, a deal that “is expected to be earnings accretive in the current year”. So, with LEBC effectively being valued on just 14 times trading profit, a 30-per cent plus discount to listed larger rival Mattioli Woods (MTW:765p), then we can realistically expect another decent valuation uplift on BP Marsh’s shareholding.
The same is true of BP Marsh’s 18.1 per cent stake in Nexus Underwriting, which was last valued at £19.4m, implying a value of £107m for Nexus. Following a number of acquisitions, and organic growth too, Nexus lifted its gross written premium from £56m in 2014 to £132m last year, an outcome that should deliver cash profits of £10m from commission income of £23.5m. After taking into account loans that funded the acquisitions, this implies Nexus is only being valued on 12.5 times cash profits to its enterprise value. To put this valuation into perspective, Hyperion Insurance sold its majority stake in CFC Underwriting to a consortium of private investors and the management team on a multiple of 22 times cash profits.
The news gets even better because BP Marsh’s board plans to declare a 26 per cent hike in the payout to 4.76p a share for the financial year just ended, and is no longer required to make a £4.9m deferred tax provision in respect of unrealised gains on investments as it qualifies for a 'substantial shareholder exemption' on its current investments. The one-off credit of £4.9m to the income statement will boost NAV per share by about 16.7p.
The bottom line is that I feel a share price target of 300p is now in order, and possibly even higher as three of BP Marsh’s other investee companies have reported very bullish trading updates recently. Buy.
Gresham House turns profitable
I also feel that it’s worth buying shares in specialist asset manager Gresham House (GHE:400p) ahead of full-year results on Thursday, 1 March. I included the shares in my 2016 Bargain Shares Portfolio, and last rated them a buy at 335p at the time of the interim results last autumn (‘Inflexion points’, 20 September 2017).
Since my last update, Gresham House has completed the £2.6m acquisition of the asset management business of Hazel Capital, a leading UK manager of new energy infrastructure, and has become investment adviser to two renewable energy VCTs managed by that company. Hazel Capital also manages several battery storage projects and has successfully commissioned one of the UK's largest battery storage facilities near Bristol. Gresham House has invested £2m to take stakes in three of these projects too. The acquisition of Hazel Capital adds a portfolio of operating assets which, alongside the VCTs, forms a new division with £100m of assets under management (AUM). It also means that Gresham House has AUM of at least £630m, up from £242m only two years ago.
Part of the increase reflects last summer’s first close of the British Strategic Investment Fund (BSIF), a closed-ended Guernsey Limited Partnership with a 12-year life, which raised £150m of capital from pension funds, endowments and family offices. The fund is focused on generating an annualised net total return of between 8 and 10 per cent from relatively illiquid investments in UK housing and infrastructure-related assets that have low correlation to traditional asset classes and a positive link to inflation. A final close is planned for the second half of this year and is supportive of further growth in Gresham House’s fee income.
So too are Gresham House’s forestry funds, which increased AUM by 5 per cent to £258m in the first half of 2017, and will benefit from the final close of the Gresham House Forestry Fund. This fund is targeting net returns of 10 per cent a year, and an annual distribution of between 2 per cent and 4 per cent from timber sales.
As a result of the boost to fee income, analyst Justin Bates at brokerage Liberum Capital believes that Gresham House will hit run rate profitability in the second half of 2017, earlier than anticipated. Mr Bates predicts the company will report a small underlying pre-tax loss of £784,000 based on fee income of £5.6m in 2017, and is pencilling in pre-tax profits of £793,000 on fee income of £8.55m this year. Given the operational gearing of the business, expect profits to ratchet up quickly thereafter, which is why Liberum predicts pre-tax profits will more than double to £1.65m on fee income of £10m in 2019.
Importantly, Gresham House has ample cash to support further investment in scaling up its funds, having recently announced the £2.1m disposal of its remaining legacy asset, a five-acre site to Countryside Properties. This should lift net funds to around £14.6m, representing half the company’s net asset value of £30m. Gresham House also owns a shareholding worth £6.5m in investment company Gresham House Strategic (GHS:840p), another constituent of my 2016 Bargain Shares Portfolio and one in which Gresham House’s asset management arm has the investment mandate. There is upside to that holding given that Gresham House Strategic’s shares are priced on a harsh 27 per cent discount to NAV of 1,145p a share, and it holds a number of investments in companies I am positive on including: Aim-traded technology company IMImobile (IMO:250p), a business that helps companies engage with their customers across all mobile devices by offering smart software products based on proprietary technology; asset manager Miton (MGR:41.5p); and challenger bank PCF (PCF:27p), a constituent of my 2018 Bargain Shares Portfolio.
Needless to say I continue to rate shares in Gresham House and Gresham House Strategic in a positive light, and have respective target prices of 460p (based on a sum-of-the-parts valuation) and 1,000p (based on a 13 per cent share price discount to spot NAV). Buy.
A binary bet
In April 2016, I recommended buying shares in Aim-traded clean energy investment company Leaf Clean Energy (LEAF: 27p) ('Pointing towards a profitable income', 19 April 2016). My interest was sparked by Aim-traded activist investor Crystal Amber (CRS: 207p), which holds a 29.9 per cent shareholding in the company, and the fact that it has been undertaking an orderly realisation of its unlisted assets in order to return capital to shareholders in a tax-efficient manner.
Key to the realisation process will be the outcome of a protracted litigation claim in the Delaware Court of Chancery filed by Leaf Clean Energy in the summer of 2016. The action relates to its investment in Invenergy Wind LLC, North America's largest independently owned wind power generation company, and centres around whether or not Invenergy’s disposal of 930 mega watts of wind power capacity for $2bn (£1.4bn) to New York Stock Exchange-listed TerraForm Power (US:TERM) at the end of 2015 breached the terms of an operating agreement Invenergy entered with Leaf Clean Energy when it acquired $40m-worth of Invenergy convertible loan notes in 2008 and 2009. Leaf Clean Energy subsequently converted the loan notes into equity in 2015, and the investment is carried in its 2017 accounts at $99.1m.
Leaf Clean Energy's board believe that Invenergy was required to either obtain its consent to the TerraForm Sale prior to its consummation or, absent such consent, make a payment to Leaf Clean Energy upon the closing of the sale. The directors believe that the amount of such payment is determined by a formula in the operating agreement and which they have calculated to be $122.2m plus interest charged at 6 per cent per annum from the date of the breach. The total claim for damages therefore equates to three times Leaf Clean Energy's own market capitalisation of £32m. Invenergy is not surprisingly contesting the legal action, and has brought a counterclaim itself.
To complicate matters, Leaf Clean Energy’s 2.3 per cent shareholding in Invenergy has been valued independently at an average of $50m pursuant of a call/put arrangement between the two parties. That’s half the carrying value in Leaf Clean Energy’s accounts, but still represents 10 per cent more than its £32m market capitalisation.
Ultimately, this is a binary bet. In the worst-case scenario, Leaf Clean Energy will have to write down the value of its stake in Invenergy significantly, a possibility that is now reflected in the company’s market value. Alternatively, the claim for damages succeeds, albeit Invenergy could then appeal to the Delaware Supreme Court, delaying payment of any award. So, in light of the protracted nature of the legal proceedings, Leaf Clean Energy has entered into a $5m unsecured loan facility with certain shareholders including Crystal Amber to ensure it has sufficient resources to pursue the litigation against Invenergy.
Some investors have clearly lost patience, which explains why Leaf Clean Energy’s share price, which stayed above my 38p recommended buy-in level until October last year, has dropped in recent months. The fact that the top three shareholders own 88 per cent of the shares also accentuates price moves. However, with the upside potentially a multiple of the company’s current market value, and the downside limited by the aforementioned put/call valuation, I feel it makes sense to await the outcome of the legal proceedings. Hold.
Lightening up for PV Crystalox
I would also await further news from solar wafer maker PV Crystalox Solar (PVCS:20.5p) which was awarded €34m, a sum worth 18.75p a share, by The International Court of Arbitration of the International Chamber of Commerce in a long-running dispute between the company and one of its customers, a leading photovoltaic company that failed to purchase wafers in line with its obligations under a sales contract. PV Crystalox had net funds of 15.5p a share on its balance sheet at the end of June 2017, and stock worth 4p a share, although operating losses in the second half of last year will have dented that cash pile. Even so, the shares are trading at a hefty discount to the underlying value of the company’s assets, assuming the award can be recovered in full. So, having included the shares at 19p in my 2014 Bargain Shares Portfolio, I can finally see light at the end of the tunnel. Hold.
■ 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
