Hitting record highs

The company has just smashed analyst earnings estimates out of the water by reporting a 140 per cent rise in full-year adjusted pre-tax profits to $264m (£189m) on total income which more than doubled to $341m. When I suggested running profits at 1,208p ahead of the results release ('Six small-cap plays', 22 January 2018), analysts at corporate broker Numis Securities were predicting pre-tax profit of $218m in 2017. EPS of 127c was a third higher than analysts at Liberum Capital were expecting.

Cash receipts from completed litigation cases surged by almost two-thirds to $336m in 2017, an outcome that means Burford has so far realised $773m from investments since being formed in 2009, representing a 75 per cent return on the capital committed to them. Return on equity has trebled to 37 per cent in the past four years alone, highlighting the hefty returns the company has been generating for shareholders and explains why the share price has now increased by 900 per cent to a record high of 1,458p since I first recommended buying, at 146p, in the summer of 2015 ('Legal eagles', 8 June 2015).

Furthermore, with an investment portfolio worth $1.54bn spread across 82 different investments and 877 individual litigation claims, the book is not only well diversified, but offers sound prospects of producing further hefty gains on realisation. It’s very conservatively valued too as Burford only booked $191m of unrealised gains on its portfolio.

To put the scale of the undervaluation into perspective, part of the bumper profit reported in 2017 reflects the gain Burford realised by selling off 25 per cent of its economic interest in the multibillion-dollar Petersen legal case (in late 2016 and early 2017) 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 sum realised equates to six times Burford’s original investment. However, trading activity in the secondary market since then implies a value of around $660m for the company’s total original investment, and analysts at Liberum believe the retained 75 per cent economic entitlement could be worth $1.12bn in the event of a successful outcome in the courts.

Also, a day before the results release, Burford announced that it had sold off its entire investment in an arbitration matter arising out of the expropriation of two Argentine airlines by Argentina's government. The company realised $107m, or more than eight times the $12.8m invested in the case. The unrealised portion of this gain will show up in the interim results for the first half of 2018.

Bearing this in mind, it’s hardly surprising that analysts have been upgrading earnings estimates. Trevor Griffiths at N+1 Singer predicts pre-tax profits of $272m based on income of $371m in 2018, implying EPS of about 90p to support a raised dividend per share of 13c, up from 11c in 2017. Run profits.

Paragon shares hit 10-year high

I noted with interest the latest mortgage lending data from the Bank of England which showed that, at 12.7 per cent of total lending, the share of buy-to-let loans has fallen to its lowest level since the third quarter of 2013. It’s hardly surprising as novice landlords are faced with the UK government’s ill-construed attempt to rein back their activities by tapering the tax relief on mortgage interest, and by imposing a 3 per cent stamp duty surcharge on new property purchases, in line with the policy on second homes.

In the circumstances, it may seem odd that the share price of Paragon (PAG: 493p), the UK’s largest buy-to-let lender, is riding a 10-year high. I first recommended buying the shares at 347p (‘Riding the buy-to-let boom’, 27 October 2014) as a way of playing the buoyant UK housing market at the time and the changes in pension legislation that came into effect in April 2015 and has enabled millions of over 55s to access their pension pots.

My belief was that some of their pension funds would make their way into the buy-to-let market as deposits on debt-funded property purchases. By the first quarter of 2016, buy-to-let mortgages accounted for more than a fifth of total lending volumes. However, former Chancellor George Osborne may have had the same thought when he subsequently targeted buy-to-let landlords, and now they also have to contend with stricter lending criteria after the Prudential Regulatory Authority (PRA) introduced tighter underwriting rules in this market. 

However, Paragon has not suffered at all. In fact, the lender’s first-quarter trading update revealed buy-to-let mortgage lending was up 85 per cent to £343m in the first three months of the financial year to end September 2018. The reason for this boom is because a number of mortgage lenders have either exited this complex segment of the market, or reduced their offering following the PRA’s underwriting rule change. Paragon has been the beneficiary. Also, larger landlords have been putting the ownership of their properties into limited companies to circumvent the tax changes, offering another source of business for Paragon. It’s well funded to capitalise as highlighted by a common equity tier one capital ratio of 15.6 per cent, and a retail deposit base that has doubled to £4bn since December 2016.

Reassuringly, Paragon’s buy-to-let mortgage pipeline was £618m at the end of last year, slightly higher than three months previously despite the introduction of the PRA’s underwriting reforms. Admittedly, redemptions of buy-to-let mortgages are still high, equating to 12 per cent of the portfolio as some smaller landlords exit the market due to the tax changes. However, they are down from last summer’s peak levels – a good sign – and arrears are low, highlighting sound credit quality.

The question is whether or not the shares, which have paid out total dividends of 46.2p since my buy recommendation in October 2014, still represent value on 1.3 times book value? Based on the latest forecasts from analyst Stuart Duncan at broking house Peel Hunt, Paragon’s forward PE ratio is 11, and the prospective dividend yield is 3.2 per cent, both of which are supportive. So too is an ongoing £50m share buy-back programme – the company has repurchased 4.7m shares since the end of November at a cost of about £23m. Therefore, I am inclined to run rather than bank the 55 per cent gain on this holding. Run profits.

In the picture

I have been taking a close look at Europe's leading cinema chain, Cineworld (CINE:240p). It’s a company I know well, having first recommended buying the shares, at 336p, in the autumn of 2014 ('Lights, camera, action', 28 October 2014), and banked dividends of 32.4p a share by the time I advised top-slicing half the holding, at 670p, after it had doubled in value ('Taking profits', 18 April 2017).

Cineworld subsequently paid out dividends of 19.8p a share before announcing a 4:1 rights issue pitched at 157p a share in February this year to raise £1.7bn of capital to part-fund the $5.8bn (£4.1bn) acquisition of US chain Regal Entertainment. The acquisition has made the company the second-largest cinema operator in the world and one with more than 9,500 screens across almost 800 locations in 10 countries. The rump of the rights issue shares not taken up by shareholders have been placed with investors at 238p.

This means that if you bought 1,000 shares at a cost of £3,360 on my initial advice in October 2014, you will have banked £3,350 of cash in April 2017 by selling 500 shares, and received total cash dividends of £423. If you didn’t participate in the rights issue then a cheque for £1,620 from underwriters is on its way to you, representing the difference between the rights issue price of 157p and the placing price of 238p on your allocation of 2,000 shares. That represents a total cash return of £5,393, or £2,000 more than your original capital outplay, and you still hold 5,000 shares worth £1,200. Alternatively, if you used £3,140 of the £3,350 cash raised from top-slicing your holding last April to take up the 2,000 share allocation you will now have a holding of 2,500 shares worth £6,000 and hold cash of £633.

Clearly, the acquisition of Regal has changed the picture somewhat, and the company’s leverage ratio too as Cineworld secured an additional $4.1bn of debt facilities to fund the acquisition. However, if management can exceed its $100m annual cost savings target, and achieve a two-year payback period on the upgrades of Regal’s underperforming cinemas, then the turnaround potential of the newly acquired US operations could deliver significant earnings growth.

To put this into perspective, analyst Douglas Jack at brokerage Peel Hunt predicts Cineworld’s EPS can grow from 17.3p to 18.8p this year, but rocket to 23.5p in 2019 as the full upside from the acquisition is seen, implying the shares trade on a forward PE ratio of less than 11 for 2019. Taking into account the higher debt levels, the 2019 enterprise value to cash profit multiple is eight times, a reasonable valuation and a better gauge of the rating given the fact that debt holders' interests now equate to a greater proportion of the enterprise than before. Importantly, equity shareholders can expect to continue getting their share of the profits as the prospective dividend yields are 4.5 per cent for 2018, and 5.7 per cent for 2019.

The bottom line is that if Cineworld’s management can deliver on analysts’ earnings forecasts, then the investment risk is skewed to the upside, which is why I now rate the shares, at 240p and effectively down from 296p (adjusted for the rights issue) when I top-sliced last April, a buy once again and have introduced a 12-month target price of 280p. Buy.

Bango on hunt for Google Play

I had a very informative results call with Ray Anderson, chief executive of Aim-traded Bango (BGO:171p), 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. It’s a company I know well, having first advised buying the shares 18 months ago at 93p ('Bang on the money', 26 September 2016), and last reiterated that advice after the company made the small acquisition of Audiens, a developer of a cloud-based platform that collects and analyses valuable consumer data ('Six small-cap plays', 22 January 2018).

Mr Anderson says that it made commercial sense for Bango to acquire Audiens, part-funded by the proceeds of a £5m placing, as it accelerates the company’s own data strategy and will enable its customers and advertisers to market more efficiently. It also means that the company can target a new revenue stream from monetising this valuable data, “an asset we can really exploit”, says Mr Anderson.

It’s worth noting that Bango is in discussions with more than 30 mobile operators who are considering switching their Google Play routes to the Bango payment platform. “Some of these are really juicy,” says Mr Anderson, and with reason as the total upgrade opportunity is worth in excess of $3bn (£2.1bn) of end-user spend (EUS) on which Bango would take a small cut. I can also report that last summer’s groundbreaking direct carrier billing (DCB) agreement with Amazon Japan is making “very encouraging progress”. Indeed, it was the precursor to Bango’s expansion into Korea, a country that shares many of the same characteristics with Japan.

The bottom line is that having more than doubled its EUS for three consecutive years – EUS was £465m at the end of February – and turned profitable last November, I feel there is every chance of Bango boosting EUS to £915m by the end of 2018 to deliver gross profits of £9.3m and a cash profit of £2.8m, as analysts at Cenkos Securities predict. Moreover, because the £35m investment in its platform has already been made, and tested to process in excess of £5bn of transactions a year, then almost all of the £4.5m forecast increase in gross profit in 2019 drops straight down to the bottom line. This explains why pre-tax profits are predicted to increase by almost 400 per cent to £5.4m in 2019.

True, the share price is down a fifth since the Audiens acquisition and is below the 180p placing price. However, in my book a rating of 21 times cash-adjusted 2019 EPS estimates of 7.8p represents excellent value for such a fast-growing company. Buy.

Manx Telecom cash generation supports progressive dividend

High-yielding shares of Manx Telecom (MANX:184p), the incumbent telecoms operator on the Isle of Man, have flatlined since I rated them a buy at 192p last summer ('Simon Thompson's equity market roadmap', 15 August 2017), having first advised buying at 164p when they listed on London’s junior market ('High-yield telecoms play', 15 May 2014). A primary bull point at the time was Manx Telecom's operating cash flow, which supports a stable and rising dividend, and underpins investment in its data centres, superfast broadband, and fixed and mobile telecoms offerings.

That’s still the case as the board has paid out total dividends of 35.1p a share since listing, and the 2017 payout of 11.4p a share equates to a dividend yield of 6.2 per cent. The £13m cost of the dividend is covered 1.5 times by underlying free cash flow of £20m. Admittedly, revenue growth is proving hard to come by, so Manx’s management is targeting net annual cash savings of £3m from headcount reductions and by investing in new IT systems to cut maintenance capital expenditure. The £11m programme completes this year, which is one reason why analysts at Liberum Capital predict earnings will return to growth, pencilling in adjusted EPS of 13.6p in 2018 and a dividend per share of 11.9p, rising to EPS of 14.5p and a dividend per share of 12.5p in 2019. A return to revenue growth in Manx’s data centres is another factor. Income buy.

■ Simon Thompson's new book Successful Stock Picking Strategies was published on 15 March and can be purchased online at www.ypdbooks.com for £16.95, 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's second book Stock Picking for Profit can also 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.