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Five small-caps with Character

Simon Thompson assesses news from five small-caps.
Five small-caps with Character

The key point to note in results from Character (CCT:480p), the owner of a portfolio of 10 iconic toy brands targeting the niche pre-school market, is not the shortfall in revenues, which declined £11m to £50.5m in the six months to the end of February 2018, nor the decline in pre-tax profits from £7.1m to £4.5m. That was expected given the disruption caused by the demise of retailer Toys R Us, which accounted for 8 per cent of Character’s annual sales of £120m in the financial year to the end of August 2017. It also had a knock-on impact in every market where Character trades

Far more informative was news that the stock overhang caused by the demise of Toys R Us has worked its way through the system and Character started the 2018 calendar year with virtually no excess stock. Moreover, sales from its UK business exceeded budget in both January and February this year, and hit record levels too, suggesting that its product lines are gaining traction. Indeed, the near 30 per cent increase in inventory levels reflects stocks in transit to service higher UK demand this year. Guidance from the directors points to “a record second half from the domestic business”.

Their optimism looks justified as Character’s leading in-house ranges Peppa Pig, Stretch, Teletubbies and Scooby Doo and its exclusive, third-party lines Little Live Pets and Mashems are all trading well. The offering is also being augmented by a collection of new “hot craze” items, including Soft and Slo memory foam toys, Make your own Slime, Cup Cake Cuties and Mine It. The exciting pipeline includes a new line up of Pokémon products to be launched in the coming months.

Analyst Andrew Blain at brokerage Panmure Gordon has taken note and says that “a significant number of additional listings have already been won across key accounts”, adding that the all-important Christmas 2018 trading period “is shaping up well”. Furthermore, following a strong start to the 2018 calendar year and good visibility through to the August financial year-end, Mr Blain has upgraded his full-year pre-tax profit and EPS estimates by 5 per cent to £11m and 39.1p, respectively. His confidence is shared by the directors, who hiked the half-year dividend from 9p to 11p a share (ex-dividend date 5 July), supporting Panmure Gordon’s full-year forecast of a 21p-a-share payout. On this basis, Character’s shares are rated on 10.5 times full-year earnings estimates net of a cash pile worth 67p a share, and are supported by a 4.4 per cent prospective dividend yield. For good measure, the board has been making earnings-accretive share buybacks.

So, with the ongoing second-half recovery expected to feed through to the 2019 financial year when Panmure Gordon predicts a bounce back in EPS to 46.7p to support a 23p-a-share dividend, Character’s share price has some catching up to do. Having first advised buying the shares at 415p ('Playtime', 1 June 2015), and banked 45p a share of dividends to date, and last rated them a hold at 460p (‘Primed for gains’, 29 January 2018), I am turning buyer again and introduce a 550p target price. Buy.

 

Hitting record highs

Shares in Trifast (TRI:275p), a small-cap manufacturer and distributor of industrial fastenings, with operations across 28 locations in 18 countries across Europe, Asia and North America, have hit my 275p long-term target price, having first advised buying, at 51.9p, in my 2013 Bargain Shares Portfolio. The board has also paid out a total dividend of 10.6p a share. I last recommended running profits, at 259p, ahead of a likely positive pre-close trading update and on the basis that earnings could get a lift if the company made a bolt-on acquisition (Bargain Shares: Beating the market Part II’, 14 March 2018). The directors achieved both, one reason why the share price is trading at a record high.

Trifast is paying £8.5m including a future earn-out of £2.5m to acquire East Grinstead-based Precision Technology Supplies (PTS), a distributor of stainless steel industrial fastenings and precision turned parts, primarily to the electronics, medical instruments, petrochemical, defence and robotics sectors. The business delivers high-quality products and services, selling into 80 countries directly through its distributor network, and an e-commerce platform that offers over 43,000 products for sale. PTS has delivered strong sales growth over the past three years and reported pre-tax profits of £720,000 on revenue of £5.1m in its last financial year. Analyst Henry Carver at brokerage Peel Hunt believes that PTS “will be able to grow at a mid-to-high single-digit growth rate” and the directors say the acquisition will be earnings accretive in the financial year to March 2019.

The board has also guided investors to expect pre-tax profits slightly ahead of expectations for the year just ended. Following upgrades, analysts at Peel Hunt, Edison and FinnCap expect EPS in the range of 13.4p to 13.6p when Trifast reports its results on Thursday 12 June 2018, up from 12.8p in the 2017 financial year, and have raised their 2019 EPS forecasts to a range between 14p to 14.2p. On this basis, the shares trade on a forward PE ratio of almost 20, and offer a 1.3 per cent prospective dividend yield. That seems fair in my view.

So, having top-sliced half the holding, at 223p, a year ago to crystallise a 342 per cent return including dividends of 6.7p a share ('Hitting target prices', 2 May 2017), I am taking the opportunity to top-slice again to crystallise the 446 per cent total return generated in the past five years. The reason for maintaining some financial interest is based on three factors: the possibility of Trifast making further earnings-accretive bolt-on acquisitions to boost EPS; scope for margin upside from the capital investment made in its manufacturing facilities in Singapore; and an order pipeline that offers potential for outperformance against consensus forecasts. Top-slice.

 

Record offers repeat buying opportunity

Currency manager Record (REC:43p) made it into my 2018 Bargain Shares Portfolio, and the shares were performing well until the company issued its fourth-quarter trading update ahead of the release of the full-year results on Friday 15 June 2018. There are two issues.

Firstly, assets under management equivalent (AUME) fell from US$63.9bn to US$62.2bn in the three months to the end of March 2018, reflecting US$1.6bn of net client outflows, all bar US$100m of which were lower-margin passive hedging mandates which account for $53bn of the total. It’s worth noting that Record’s closing AUME was still US$4bn ahead of the level in March 2017. I am less concerned with these flows as Record also reported US$2.2bn passive hedging and US$300m multi-strategy mandate awards, both of which are expected to commence in the current quarter. So, even after allowing for the termination of a US$1.7bn passive mandate that was also announced in the release, these new awards will make up half the outflows experienced in the last quarter.

Of more importance is news that some passive hedging clients have changed their mandates from management fee only to a lower management fee and a performance fee basis. The effect in the financial year to the end of March 2018 is minimal, which is why analysts at Edison Investment Research expect Record to deliver a slight increase in pre-tax profits to £8m on revenues of £24.4m to lift EPS from 2.9p to 3.07p and support a normal dividend per share of 2.3p (half was paid as a half-year in December 2017) and a special dividend of 0.79p. The board has a policy of paying out all its net profits in light of the fact that Record retains around £27m of net cash on its balance sheet, a sum worth 13.5p a share, including £8.9m of cash required for regulatory capital.

The impact in the financial year to the end of March 2019 is material as passive hedging management fee revenues are likely to be 10 per cent lower than they would have been otherwise. This explains why Edison have clipped their revenue forecast from £25.2m to £22.5m, which feeds through to a new pre-tax profit and EPS estimates of £6.2m and 2.49p, respectively. The major point here is that these forecasts do not factor in any performance fee income from passive management mandates, nor any further mandate wins. Potential performance fees earned could provide material positive upside to forecasts. For example, Edison estimates that if Record can maintain a stable fee margin on passive mandates of 3.4 per cent, then EPS will rise sharply to 2.9p.

In the short term, investors reacted  by marking Record’s shares down from 49p to 43p, and back to the level at which I suggested buying in early February. They are now rated on 12 times EPS estimates of 2.49p net of cash on the balance sheet, and offer a prospective dividend yield of 5.8 per cent based on Edison’s new dividend estimate of 2.42p for the 12 months to the end of March 2019. That’s not a punchy rating and Record’s shareholders can still look forward to a combined payout equating to 10 per cent of the company’s share price over the next 12 months or so.

Moreover, there is upgrade potential if the passive mandates generate performance fees, or if Record wins further mandates. Bearing this in mind, chief executive James Wood-Collins says his company “continues to engage with existing and potential clients on currency management strategies across the full product suite, and is optimistic about making further progress in the current financial year”. Buy.

 

2018 Bargain shares portfolio performance
Company nameTIDMOpening offer price on 02.02.18 (p)Latest bid price on 27.04.18 (p)Dividends (p)Total return (%)
MpacMLIN156228046.2
ParkmeadPMG3753.8045.4
Shore CapitalSGR213270529.1
PCFPCF27310.1915.5
TitonTON159.86182013.8
Sylvania PlatinumSLP14.516010.3
U+I GroupUAI205213.504.1
Crystal AmberCRS207.22060-0.6
RecordREC43.342.40-2.1
ConygarCIC1601470-8.1
Average    15.4
Deutsche Bank FTSE All-share tracker (XASX) 427.3414.516.540.9
Source: London Stock Exchange share prices.    

 

U+I on solid foundations for bumper gains

Full-year results and the outlook statement from U+I (UAI:215p), a specialist property developer and investor in regeneration projects, were truly eye-catching, so it’s no surprise the share price is starting to gain traction.

The numbers speak for themselves: trading and development gains almost doubled to £68m in the financial year to the end of February 2018, a record and at the top-end of guidance the directors had given when I suggested buying the shares, at 205p, in my 2018 Bargain Shares Portfolio; net asset value (NAV) per share increased by 9 per cent to 303p which, when combined with dividends paid, equates to a total post-tax return of 12 per cent – one of the highest returns in the real estate sector; and £53m of the disposals were at or above book value, thus highlighting the quality of the portfolio.

Moreover, guidance from the directors points towards trading and development gains of £45m to £50m being realised in the current financial year, rising to £45m to £55m the year after. Alongside the results, U+I announced the sale of its holding at Charlton Riverside in Greenwich for £58m, developed with joint-venture partner Proprium Capital Partners, a price at the top-end of guidance.

Importantly, U+I isn’t generating these bumper returns by overleveraging its balance sheet as net borrowings of £119m equates to balance sheet gearing of 31 per cent, and is covered by an investment portfolio worth £139.5m (accounting for a third of U+I’s total assets), which produces a contracted rent roll of £8.9m, and has an estimated rental value of £10.7m.

Shareholders are receiving their chunk of these gains, highlighting the board’s policy of returning around 40 to 50 per cent of free cash flow as supplementary dividends. In fact, U+I has just declared a special payout per share of 12p, in addition to a final dividend of 3.5p, which takes the total to 17.9p for the financial year including the half-year payout of 2.4p. But even after those dividends are paid, analysts at both Liberum Capital and Peel Hunt believe net asset value (NAV) can rise to 305p by the new financial year-end of March 2019, highlighting the chunky net profits the company is set to realise this year from nine projects in development. Furthermore, analysts at Liberum are pencilling in annual dividends of 13.9p a share for both the 2019 and 2020 financial years and predict a NAV of 317p by March 2020.

On this basis, U+I's shares are trading on a 30 per cent discount to NAV and offer a prospective dividend yield of 6.4 per cent, an anomalous valuation in my view given that the company is set to pay out dividends (including those just declared) representing a fifth of its market capitalisation over the next two years, and is also growing its NAV. Buy.

 

Housebuilders first-quarter trade update

It has paid to run with my FTSE 350 housebuilder trade through April as I suggested four weeks ago (‘Housebuilders trading updates’ 4 April 2018). The 10 mid-cap companies I recommended buying in January (‘Alpha alert for housebuilders’, 3 January 2018) are now only 3.6 per cent in the red after taking into account dividends. That’s still more worse than the 0.8 per cent loss on a Deutsche Bank FTSE All-Share index tracker, but far more palatable. Moreover, with the likelihood for a Bank of England base rate rise in May now markedly reduced in light of the UK's weak first quarter GDP figures released last Friday, the sector rally could continue into May. In the circumstances, I would run with your holdings.

 

■ 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.