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Riding earnings momentum

Simon Thompson highlights upbeat trading news from five of his small-cap companies
April 16, 2018

High-street clothing retailer French Connection (FCCN:54p), for a long time the laggard in my 2016 Bargain Shares portfolio, has announced the disposal of its 75 per cent stake in Toast, a premium lifestyle brand that sells womenswear, accessories, nightwear, loungewear and homeware.

Toast operates separately from the rest of the French Connection businesses, selling its merchandise through three channels – online, a network of 12 retail stores and through wholesale arrangements with John Lewis – so the disposal is pretty straightforward. Also, other shareholders wanted to crystallise their investment, so this is an opportune time for French Connection to exit too given that Toast has returned to profitability in the past couple of years. In the 12 months to the end of January 2018, the business posted underlying operating profit of £1.5m on revenues of £19m, implying the £21.3m sale price equates to 14 times last year’s operating profit, an attractive valuation in my view.

Net of transaction costs and after settling management awards, French Connection will receive net cash proceeds of £13.9m for its 75 per cent stake when the deal completes later this month. This means that net funds on the company’s balance sheet will double to £23.4m, a sum worth 24p a share and equating to half of net asset value (NAV). This provides a hefty cash buffer to support the ongoing turnaround in French Connection’s retail business and a long-awaited return to profitability. To do so, the company’s management team will need to further downsize the retailer’s high-street presence by exiting lossmaking stores, and focus on growing its highly profitable wholesale and licence operations.

The potential for a turnaround was the key reason why I advised buying French Connection’s shares, at 45.7p, in my 2016 Bargain Shares Portfolio. Admittedly, it has taken longer than expected to materialise, but the business is certainly moving in the right direction. Strip out the contribution from Toast, and French Connection’s underlying operating loss more than halved from £4.8m to £2.1m in the 12 months to the end of January 2018. Its retail division produced modest like-for-like growth and cut losses by £1.5m as non-performing outlets were closed and online sales improved. Encouragingly, both the Spring 2018 and Winter 2018 collections have been well received.

So, with French Connection’s businesses effectively being valued on less than 20 per cent of last year’s annual sales of £134m (excluding Toast) once you strip out net cash on the balance sheet, I see scope for the rerating to continue. Clearly, other investors share this view, which is why the share price surged to a three-year high of 54p on news of the disposal - good news if you followed my buy advice, at 42p, when I covered the full-year results (‘Bargain Shares: Beating the market Part II’, 14 Mar 2018). It’s also added a few percentage points to my 2016 Bargain Shares Portfolio’s performance, which is now showing a total return of 46.2 per cent, well ahead of the 31.5 per cent return on a Deutsche Bank FTSE All-Share index tracker.

So, with a return to profit on the cards, and French Connection more attractive to potential acquirers, I continue to rate the cash-rich shares a buy.

 

Bargain Shares Portfolio 2016 performance 
Company nameTIDMOpening offer price (p) 05.02.16 Latest bid price (p) 10.04.18Dividends (p)Total return (%)
Bioquell (see note one)BQE1253050144.0%
VolvereVLE4199600129.1%
Bowleven (see note two)BLVN18.93532.7078.0%
Gresham HouseGHE312.5404029.3%
Mind + Machines (see note four)MMX89.8027.8%
Juridica (see note three)JIL36.1143227.4%
Oakley Capital OCI146.5169.56.7520.3%
French ConnectionFCCN45.752013.8%
Gresham House StrategicGHS796815154.3%
Walker CripsWCW44.9372.43-12.2%
Average return    46.2%
Deutsche Bank FTSE All-share ETF index tracker (LSE:XASX) 341400.447.9631.5%
      
Notes:
1. Simon Thompson advised buying Bioquell's shares at 149p in February 2016. Bioquell bought back 50 per cent of shares in issue at 200p each in June 2016 through a tender offer and Simon recommended buying back the shares in the market at 145p to give an average buy-in price of 125p (‘Bargain shares updates’, 22 June 2016).
2. Simon Thompson advised banking profits on half your holdings in Bowleven's shares at 33.75p, and running the balance ahead of drilling news at the Etinde prospect in Cameroon in the second quarter of 2018 (‘Hitting pay dirt', 9 Apr 2018). The total return reflects this share sale.
3. Simon Thompson advised buying Juridica's shares at 41.2p in February 2016. Juridica subsequently paid out a special dividend of 8p a share in June 2016 and Simon recommended buying shares in the market at 61p using the cash proceeds to take the average buy-in price to 36.1p (‘Brexit winners', 1 Aug 2016). Juridica then paid out a special dividend of 32p a share in September 2016 and total return reflects this distribution. Simon advised selling the holding at 14p ('Taking Q1 profits and running gains', 4 Apr 2017), hence the price quoted in the table. Please note that Juridica has since paid out a further special dividend of 8p a share and the current share price is 11.1p.
4. Simon Thompson advised buying Mind + Machines' shares at 8p in February 2016. Mind + Machines subsequently bought back 13.22 per cent of the shares in issue at 13p a share. The total return reflects this capital distribution.

Source: London Stock Exchange share prices

 

Kape Technologies in the ascent

Investors are also warming to the merits of Kape Technologies (KAPE:108p), a provider of cyber security software. Formerly known as Crossrider when I included the shares, at 47.9p, in my 2017 Bargain Shares Portfolio, the share price has surged by 37 per cent since I covered the full-year results and surpassed my 100p target price (‘Bargain Shares: Beating the market Part II’, 14 Mar 2018). The rerating has helped the portfolio return 28.4 per cent in the past 14 months, massively outperforming the 5.9 per cent return on a Deutsche Bank FTSE All-Share index tracker.

It’s easy to understand why investors are getting excited as the company offers tangible benefits to almost 900,000 customers, around 30 per cent of whom take out premium subscriptions for Kape’s products, which include: Reimage, a patented Microsoft-based product tool that enables users to clean up their computers; DriverAgent, a PC maintenance software products company offering a device driver search and update service, which scans computers for outdated drivers; and Cyberghost, a provider of secure virtual private networks (VPNs) that securely pass data traffic over public networks.

The company has been outperforming profit guidance, too, helped by some well-timed acquisitions that have been overdelivering, a trend that looks set to continue. Indeed, monthly revenues are at record levels, suggesting analysts’ forecasts for another year of strong profit growth are achievable. These suggest a 36 per cent increase in both pre-tax profit and EPS to $9.1m and 5.2¢ (3.7p), respectively, in 2018. Moreover, Kape’s balance sheet is in rude health: net funds of $69.5m (£50m) equates to more than a third of the company’s market capitalisation of £142m, and is highly supportive of the company making further earnings-accretive acquisitions.

On this basis, Kape’s shares are priced on 19 times 2018 earnings estimates net of cash on the balance sheet. That’s still not too full a rating given that the earnings risk is skewed to the upside, and that’s without factoring in any earnings-enhancing acquisitions. For example, the roll-out of the Reimage subscription model is proving better than Kape’s directors had expected, and the launch of a new Reimage product for Mac users offers scope to boost the user base and generate further cross-selling opportunities. Furthermore, Kape's businesses are highly cash generative, which is why the board is paying out a special dividend of 3.55p a share (ex-dividend: 24 May).

Ahead of news on acquisitions and the first-half trading update in July, I would run with your healthy 119 per cent paper gain.

 

2017 Bargain Shares Portfolio performance
Company nameTIDMOpening offer price (p) 3.02.17Latest bid price (p) 10.04.18DividendsTotal return (%)
Kape TechnologiesCROS47.91060121.2
Chariot Oil & Gas (see note one)CHAR8.2911.5082.8
BATM Advanced CommunicationsBVC19.2528045.5
Cenkos Securities (see note two)CNKS88.4251069.530.6
Manchester & London Investment Trust (see note three)MNL291.653773.028.4
H&T HAT289.753449.622.0
Bowleven (see note four)BLVN28.932.7015.0
Avingtrans AVG2002053.44.2
Management Consulting Group (see note five)MMC6.18360-3.0
Tiso Blackstar Group TBG55220.54-59.0
Average    28.8
Deutsche Bank FTSE All-Share tracker (XASX) 409400.432.825.9
Notes:      
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 Apr 2017). Return reflects the profit booked on this sale. Simon subsequently advised using some of the proceeds from the share sale to participate in the one-for-eight open offer at 13p a share in March 2018, which is taken into account in the total return ('On the earnings beat', 5 Mar 2018).
2. Simon Thompson advised selling the Cenkos Securuties holding at 106p on 3 Apr 2017 ('A profitable earnings beat', 3 Apr 2017).
3. 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 Jun 2017 ('Top-slicing and running profits', 26 Jun 2017), and selling the remaining half at 377p ('Bargain shares second chance', 17 Aug 2017).
4. Simon Thompson advised banking profits on half of your holdings in Bowleven shares at 33.75p, and running the balance ahead of drilling news at the Etinde prospect in Cameroon in the second quarter of 2018 (‘Hitting pay dirt', 9 Apr 2018). The total return reflects this share sale.
5. Simon Thompson advised to sell Management Consulting's shares at 6p in Feb 2018 (‘How the 2017 Bargain Shares Portfolio fared’, 2 Feb 2018).
Source: London Stock Exchange share prices

 

Ramsdens beats guidance yet again

Middlesbrough-based Ramsdens (RFX:185p), a diversified and fast-growing financial services company with operations encompassing foreign currency, pawnbroking and jewellery retail, has reported a strong second-half trading performance and has beaten guidance again.

To put the scale of the earnings upgrade cycle into perspective, when I suggested buying the shares, at 132p, shortly after the company listed its shares on Aim ('A jewel in the north', 12 Jun 2017), analyst Justin Bates at Liberum Capital predicted Ramsdens would deliver pre-tax profit of £4.8m and EPS of 12.6p in the financial year to the end of March 2018. He then upgraded his estimates twice in the autumn to raise full-year pre-tax profit and EPS forecasts to £6.23m and 16.2p, respectively, up from £4m and 10.1p in the 2017 financial year. Ramsdens is likely to have beaten those EPS upgrades by around 3-4 per cent.

Expect good news on the dividend too when the full-year results are released on Thursday 7 June 2018. That’s because Ramsdens is converting a high percentage of its profits into cash flow: net funds increased by £3.7m to £13.4m in the six months to the end of September 2017, a sum worth 43p a share, providing ample funding for its store roll-out programme and underpinning expectations of a full-year payout of 6.5p a share. On this basis, the shares are still only rated on a modest nine times cash-adjusted earnings, and offer a prospective dividend yield of 3.5 per cent.

So, having last advised buying at 184p at the start of this year, when I raised my target price to 210p (‘Value opportunities’, 8 Jan 2018), I maintain my bullish stance ahead of the results. Buy.

 

Cambridge Cognition contract boost

Aim-traded Cambridge Cognition (COG:127p), a company that has developed a suite of computer-based cognitive assessments to improve the understanding, diagnosis and treatment of neurological and psychological diseases, has announced a significant scaling up of a major contract for CANTAB Recruit – an online platform to improve the efficiency of recruitment of patients into clinical trials, initially focused on patients with Alzheimer’s disease. The company has contracts with two of the world’s largest Alzheimer’s disease trials, the first of which has now increased its contract value 24-fold in its first year to over £1.2m.

Patient recruitment accounts for one-third of the total costs in pharmaceutical clinical trials, with around 80 per cent of development programmes delayed due to unfulfilled enrolment numbers. CANTAB Recruit allows sponsors to scale up their recruitment efforts without requiring participants to visit a study site or take part in more invasive testing, saving time and costs and delivering a more patient-centric recruitment experience. Analysts at brokerage finnCap believe revenues from this product will double to £1m this year and account for 12.5 per cent of their full-year revenue estimate.

Add to that the contract win for a major pharmaceutical clinical trial "that will have a material impact on 2018 and 2019 revenues" announced when I covered the full-year results and rated the shares a buy at 118p (‘Profit from corporate activity’, 26 Mar 2018), and I feel a likely move into sustainable profitability is well underpinned to support my 160p target price. I first advised buying the shares at 87p ('Positive thinking', 19 Apr 2017) and remain bullish. Buy.

 

Alpha seeks out PRS partners

The latest trading update from Alpha Real Trust (ARTL:127p), an investor in high-yielding property and asset-backed debt and equity investments in western Europe, made for an interesting read.

The company’s investment advisers have been actively recycling around £50m of cash proceeds from disposals made last year, including £37m realised from the sale of a 70 per cent stake in its wholly-owned H2O shopping centre in Madrid. The retained stake increased by almost 5 per cent in value in the final quarter of 2017, buoyed by record visitor numbers and strong like-for-like sales performance from tenants. In fact, one of H20’s anchor tenants, Mercadona supermarket, has just completed a refurbishment of its entire store, a ringing endorsement of its commitment to the shopping centre.

Alpha also reported uplifts to the value of a 27.6 per cent equity stake worth £6m in Active UK Real Estate, a company listed on the Channel Islands stock exchange (www.cisx.com) and one offering exposure to the high-yielding UK industrial real-estate sector. High-yielding equity in property investments accounts for £24.2m of Alpha’s £114m portfolio.

In addition, Alpha holds a £28m investment in an ungeared UK residential property freehold ground rent authorised fund with an unbroken 24-year track record of producing positive inflation-beating returns. Higher risk is a £10.5m mezzanine loan portfolio the company has been building up, having made seven commercial property loans totalling £9.1m since last autumn, typically over a two-year term and with a maximum loan-to-value ratio of 75 per cent. The aim is to generate a double-digit annual income from these mezzanine loans.

These investments all generate solid returns and a steady income stream, but the main driver of future NAV growth is likely to come from Alpha’s portfolio of three build-to-rent investments that account for a quarter of the portfolio’s value: a five-storey data centre in Frankfurt encompassing 450,000 sq ft which is being actively marketed to tenants and has a gross development value (GDV) of £24.7m; Alpha’s Unity and Armouries residential private rented sector (PRS) scheme in Birmingham which has planning consent for 162 residential apartments and has a GDV of £33m; and a PRS residential development of 307 units in Leeds which has a GDV of £55m.

Alpha is exploring development opportunities with potential partners for the two UK PRS schemes, and should be successful given that it’s cheaper to build them out rather than acquire existing ones, so providing valuation upside. They should also generate a high return on equity assuming sensibly priced debt funding.

True, Alpha's share price is up by more than half since I first advised buying, at 80p ('High-yield property play', 10 Feb 2016), and the board has paid out eight quarterly dividends of 0.6p a share too, but it still trades 24 per cent below NAV of 167p. So, ahead of the full-year results in mid-June and an update on the outcome of the PRS negotiations, I rate Alpha’s shares a buy.

Finally, I am on annual leave from Wednesday 11 April to Friday 20 April and will pick up results from companies reporting in that period on my return.

 

■ Simon Thompson's new book Successful Stock Picking Strategies was published on 15 March and can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source and is priced at £16.95 plus £2.95 postage and packaging. 

Simon's second book Stock Picking for Profit has sold out and is being reprinted later this month. It is available to purchase 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, reduced to £14.99 for orders placed before 15 May.