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From yachts to clean energy

Simon Thompson highlights six small-cap investment ideas
April 25, 2018

Chief executive Remy Millott and finance director Gloria Fernandez of GYG (GYG:123p), the market leader in new-build and refit superyacht painting, were in upbeat mood during our results call.

The company listed its shares, at 100p, on Aim last summer when I suggested buying them (‘Floating a profitable passage’, 4 Jul 2017), attracted by the fact that the number of 40-metre-plus yachts has doubled to 2,000 in the past decade, and is predicted to grow by a further 14 per cent by 2020, according to industry analysts, buoyed by the steady growth in the number of billionaires. The boats are getting bigger too with the average GYG client owning a yacht 78m in length, and with an average painted surface of 3,500 sq metres.

That’s good news for the specialist companies catering for the maintenance of these huge ocean going vessels which require a major survey every five years to comply with certain class, maritime laws and insurance requirements. Indeed, GYG’s refit and new build revenues increased by 16 per cent to €53.7m (£47.1m) last year, and there was a useful contribution from its supply business which sold almost €9m worth of marine products and maintenance equipment through its retail and yacht supply divisions.

It hasn’t all been plain sailing though as last autumn’s unprecedented US hurricane season forced yacht owners to extend their Mediterranean sailing season before transferring their prized vessels to the Caribbean for the winter months which subdued business on the east Coast of the USA. However, no contracts were lost, one reason why I continued to rate the shares a buy at 123p at the time (‘Exploiting buying opportunities, 22 Nov 2017).

Importantly, the directors are comfortable with market expectations that GYG’s revenues can ramp up by 18 per cent to €74m this year to lift pre-tax profits by more than half to €8.6m and deliver EPS of 12.9p. These bullish forecasts seem justified as a record forward order book of €20.4m at the turn of the year has grown sharply since then, and is likely to continue to make waves buoyed by a pipeline of work now worth €375m and underpinned by GYG’s eye-catching historical conversion rate of 32 per cent.

Shareholders are being rewarded with a dividend per share of 3.2p, and analysts expect the payout to rise to 6.6p this year, covered almost two times by EPS estimates. Net debt of €6.7m is expected to be slashed by more than half in 2018, reflecting the fact that almost two thirds of forecast annual cash profits of £9.9m could be turned into free cash flow. Bolt-on acquisitions are being considered too.

Trading on 10 times forward earnings, and offering a 5 per cent plus prospective dividend yield, I maintain my 170p target price. Buy.

 

Telford on a roll

London housebuilder Telford Homes (TEF: 439p) has proved a cracking investment since I recommended buying the shares, at 289p, in the summer of 2016 ('London property trading play', 22 Aug 2016). The board has paid out 25.7p a share in dividends too. I last reiterated my positive stance when the price was 421p at the start of the year (‘Alpha alert for housebuilders’, 3 Jan 2018), backing the management team led by chief executive Jon Di-Stefano. They continue to deliver.

A pre-close trading update for the 12 months to end March 2018 revealed a record revenue and profit performance, prompting analysts at Peel Hunt and Equity Development to nudge up their pre-tax profits expectations to between £44.5m to £45m, representing 30 per cent year-on-year growth, on revenues ahead by 8 per cent to £315m. On this basis, expect a full-year dividend of 17p a share covered by EPS of 48p when Telford reports full-year results on Wednesday, 30 May 2018.

Prospects for the new financial year look well underpinned by an undersupplied London housing market; Telford’s affordable pricing – for example, sale prices at its 109-unit Bow Garden Square development start around the £390,000 mark and is attractive for owner occupiers; and the board’s shrewd move to de-risk its £1.5bn plus development pipeline of 4,000 new homes (of which 2,900 are currently under construction) by entering into build-to-rent (BTR) funding arrangements with large institutional investors.

This strategy accelerates profit recognition, drives a higher return on capital as the company no longer needs to fund these BTR developments, and releases capital from its land bank and working capital. For instance, having secured a 3.16 acre site in Walthamstow for the development of 257 open market homes, and 80 affordable homes, Telford is about to start the marketing process to find a BTR investor ahead of construction commencing later this year on the £33.8m site.

Importantly, Telford’s contracted sales already cover two thirds of analysts’ gross profit forecasts for the 2018/19 financial year, adding weight to their predictions of a sharp rise in pre-tax profits from £45m to £52m on revenues up 40 per cent to £440m. On this basis, they expect EPS of 55.7p to support a dividend of 19p, implying Telford’s shares are rated on 9 times earnings estimates and offer a 4.3 per cent prospective dividend yield. A forward price-to-book value of 1.3 times doesn’t seem exacting either which is why I continue to rate Telford’s shares a buy ahead of next month’s results. Buy.

 

Hitting target prices

Shares in Scisys (SSY:155p), a supplier of bespoke software systems to the media, broadcast, space, defence and commercial sectors, hit my 155p target price this week. I initiated coverage on the shares at 102p last autumn (‘Tune into a media play’, 11 Oct 2017), and maintained my positive stance at 132p when I covered the full-year results (‘On a profitable earnings beat’, 3 Apr 2018)

The cracking results aside, investor sentiment has been buoyed by news of a €3.9m (£3.4m) contract award from Airbus for work on EGNOS, Europe's regional satellite-based augmentation system that improves the performance of global navigation satellite systems, such as GPS and Galileo. Scisys' space division in Germany will supply command and control technology, as well as maintenance and support facilities. The development stage starts this month and will continue until the third quarter of 2020, with the maintenance phase of the contract lasting five years.

The award not only extends the company’s position as a key solutions provider at the heart of European satellite-navigation programmes, but adds weight to analysts’ expectations which point towards a near 20 per cent hike in current year EPS to 11.7p to support a dividend of 2.4p a share. Trading on a forward PE ratio of 13, or less than half the rating of much larger specialist IT software companies, I would definitely run your healthy profits ahead of the next trading update on Thursday, 28 June 2018.

 

Solid State ‘under’ supplies in the US

Shares in Redditch-based Solid State (SOLI:276p), a supplier and design-led manufacturer of specialist industrial and rugged computers, battery power packs to the electronics market, microwave systems and advanced antenna products, have been on a roller coaster ride since I first suggested buying them at 410p (‘A trio of small-cap buys’, 10 Jul 2017).

My target price of 480p was duly hit and I then suggested running profits at 530p ('High-yielding opportunities', 8 Aug 2017), before turning buyer again last autumn at 395p (‘Exploiting buying opportunities, 22 Nov 2017). That decision was based on the company’s robust order book at the time, and positive news from its high-margin manufacturing segments, both of which suggested the likelihood of a return to profit growth in the 2018-19 financial year.

In a pre-close trading update released while I was on annual leave, Solid State confirmed a 6 per cent rise in its closing open order book to £19.6m and pre-tax profits in line with market consensus of £3m on revenues up 15 per cent to £45.5m in the 12 months to end March 2018. The company’s power and distribution businesses actually outperformed, but profits were flat overall due to a change in the product mix and longer lead times in its higher margin communications business. The situation is unlikely to change near-term as softer export volumes from Solid State’s US communications and antennae business are set to be subdued this year as defence organisations in the region are being strongly encouraged to “source domestically.”

Analysts at WH Ireland and finnCap predict a minimal contribution from the division, slashing their current year pre-tax profit and EPS estimates by a quarter to £2.5m and 25.5p, and pencilling in a flat dividend of 12p a share. Solid State’s share price tanked to 276p, and I am crystallising the loss. Sell.

 

First Property’s third-party mandates surge

Aim-traded UK and eastern European property fund manager and investor First Property (FPO:49p) has announced an eye-catching 31 per cent increase in its funds under management to £625m in the 12 months to end March 2018.

The company’s £171m portfolio of 10 high-yielding commercial properties in Poland and Romania accounts for just over a quarter of the total. Based on an average yield of 9.8 per cent, well in excess of the 2.46 per cent weighted average cost on non-recourse borrowing, and a loan-to-value of 68 per cent, these properties generate very healthy profits to support a progressive dividend policy while the company ramps up its third party fund management business.

Indeed, First Property now has £454m of third party fund mandates, up from £313m on 31 March 2017 and £382m at the end of September 2017. Almost all of the increase has come from new UK property investments including Fprop Offices LP, a £181m fund launched last summer to invest in office blocks and business parks across England.

The point is that First Property’s fast-growing fund management business is in the price for free given that the shares are rated on a 10 per cent discount to my spot net asset value (NAV) estimate of 54p a share, up from 47.6p in March 2017, and the £53m equity held in its high yielding overseas properties equates to the company’s market value. The shares are also attractively priced on 8 times likely EPS of 5.9p for the year just ended, almost all of which is recurring, and are supported by a 3.3 per cent prospective dividend yield. It’s worth taking note when chief executive Ben Habib says that “the markets in which we operate are generally buoyant and offer interesting investment opportunities to capitalise on.” I reckon the company has around £10m free cash on its balance sheet to exploit co-investment opportunities to bolster the fund management business. I also expect another positive trading update when First Property reports its full-year results on Friday, 8 June 2018.

So, having first recommended buying the shares, at 18.5p, in my 2011 Bargain Shares Portfolio, since when the board has paid out dividends of 8.84p a share, and last advised buying at 45p (‘Repeat buying opportunities’, 26 Feb 2018), I see decent investment upside to my 65p target price. Buy.

 

Leaf Clean Energy court setback

I note the announcement from Aim-traded clean energy investment company Leaf Clean Energy (LEAF: 22p) with regards to the litigation claim it filed in the Delaware Court of Chancery relating to its investment in Invenergy Wind LLC, North America's largest independently owned wind power generation company, and an alleged breach of the terms of an operating agreement Invenergy entered with Leaf. The trial court held that Leaf is only entitled to nominal damages as a result of the breach, and ordered both parties to complete a put/call arrangement whereby Leaf’s investment in Invenergy has been valued at $50.7m, well below its $99.1m carrying value. On this basis, Leaf’s NAV per share is 39.7c (28.2p), or almost half the end December 2017 figure.

However, given that almost all of Leaf’s assets will be in cash once the put/call arrangement completes, and having rated the shares a hold, at 27p, ahead of the court ruling (‘Investment company watch’, 12 Feb 2018), I maintain that view. Hold.

■ 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 now been reprinted and 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 all orders placed before 15 May.