The annual report of Aim-traded investment company Gresham House Strategic (GHS:965p), a constituent of my 2016 Bargain Shares Portfolio, is well worth a read. The £35m market capitalisation company runs a portfolio of up to 15 companies and selects them by applying private equity techniques to UK and European smaller public companies with a view to generating a 15 per cent annualised return over the medium term.
The strategy is to focus on shares that suggest a company is intrinsically undervalued, such as low valuation multiples and tangible asset cover. There is a strong focus on cash generation, scope to improve return on capital and enhance value through strategic, operational or management initiatives.
The investment managers apply a ‘Quality-score’ to investment opportunities by considering: the attractiveness of the market in terms of its characteristics and dynamics; competitive positioning of the company within the market, including product and service offering, barriers to entry, ability to grow, pricing power, and client/customer quality; strength and experience of the board and whether their interests are aligned to other shareholders; and the likely attractiveness of the company to other buyers, be it institutional, trade or private equity. The Quality-score also considers customer concentration, sustainability of margins, capital intensity and the stability and predictability of cash flow.
The investment strategy is clearly delivering. In the 12 months to the end of March 2018, GHS increased its net asset value (NAV) per share by 10 per cent to 1,186p and paid out a 15p a share dividend from part of the proceeds of realisations, made £3.6m of further realisations to book a profit of £1.3m, and put £11m of its cash pile to work through new investments to reduce cash holdings to £3m of NAV of £43m. NAV per share subsequently hit a record of 1,227p earlier this month, and the board have just declared a 15 per cent hike in the dividend per share to 17.25p, justifying my call to rate the shares a buy at 850p ahead of the release (‘Bargain Shares: Another chance to bag some bargains Part II’, 16 May 2018).
There is still value on offer as the shares trade on a deep discount to book value, which chairman David Potter believes is down to the company’s relatively short track record under the new investment mandate; the relatively small size of GHS; and the overweight position in Aim-traded technology company IMImobile (IMO:276p), a £172m market cap company that helps businesses engage with their customers across mobile devices by offering smart software products. GHS’s stake in IMImobile accounts for 44 per cent of the company’s NAV, but it has also been the top-performing holding, too, justifying the overweight stance.
Bearing this in mind, if GHS continues to outperform – NAV per share has outperformed the FTSE SmallCap index by almost 8 per cent under the new investment mandate – then I would expect more wealth managers to increase their stakes in the company, especially as GHS is now almost fully invested. I am reassured, too, that the board has been using surplus cash to make NAV per share accretive buybacks. The directors have also taken steps to trim annual running costs that equate to about 3 per cent of NAV. Of course, the investment team led by Graham Bird, a former fund manager and head of strategic investment at SVG Investment Managers, has to build on last year’s outperformance. The market commentary in the annual report is therefore well worth reading and, in particular, comments made on the UK economy.
| Bargain Shares Portfolio 2016 performance | |||||
| Company name | TIDM | Opening offer price (p) 05.02.16 | Latest bid price (p) 21.06.18 | Dividends (p) | Total return (%) |
| Bioquell (see note one) | BQE | 125 | 305 | 0 | 144.0% |
| Volvere | VLE | 419 | 910 | 0 | 117.2% |
| Bowleven (see note two) | BLVN | 18.935 | 37.7 | 0 | 88.6% |
| Gresham House | GHE | 312.5 | 438 | 0 | 43.1% |
| Oakley Capital | OCI | 146.5 | 182 | 9 | 30.4% |
| Juridica (see note three) | JIL | 36.1 | 14 | 32 | 27.4% |
| Gresham House Strategic | GHS | 796 | 960 | 15 | 22.5% |
| French Connection | FCCN | 45.7 | 52 | 0 | 13.8% |
| Mind + Machines (see note four) | MMX | 8 | 7.5 | 0 | 2.8% |
| Walker Crips | WCW | 44.9 | 35 | 2.43 | -16.6% |
| Average return | 47.3% | ||||
| Deutsche Bank FTSE All-share ETF index tracker (LSE:XASX) | 341 | 424.1 | 47.96 | 38.4% | |
| 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 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 August 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 April 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 current share price is 9.2p. | |||||
| 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. Simon then advised selling the holding at 7.5p which is the exit price stated in the table ('Strategic acquisitions', 9 May 2018). | |||||
| Source: London Stock Exchange share prices | |||||
Positioning for a soft Brexit
GHS’s investment managers have taken the view that the domestic political situation is more stable than current market sentiment suggests. Although ongoing discussions may go down to the wire, they believe “some sort of amicable Brexit deal or at least extension to the transition agreement will come to pass ahead of the deadline”. The likelihood of a softer Brexit environment for 'UK plc', and reduced uncertainty could provide a boon to the UK's economic prospects.
They have a point, as the economic uncertainty has led to “deferred investment in the UK both domestically and from global investors, as most market participants sat on the sidelines, seeking greater clarity and predictability around the outcome of Brexit and the minority government”. As a greater element of predictability returns to the UK economy and political scene, then “these nerves should subside and there will be an element of 'catch up' in UK GDP in the medium-term – supporting both corporate income statements and share prices”.
GHS investment managers also see signs that the devaluation of sterling post the EU referendum, which lifted domestic inflation and eroded consumer spending power, is benefiting the corporate sector, noting that “recent UK industrial production data has accelerated its expansion since the Brexit vote”, adding that “40 per cent of manufacturers are now planning to expand – the most optimistic outlook since 2014.”
In turn, and related to the above points, their view is that the UK stock market “represents value as relative valuations are close to historic lows not experiences since the 1990s... and this represents an opportunity rather than a problem for UK-focused equity investors”. The investment philosophy “is value-oriented, with our holdings, on average, trading at substantial discounts to their peers, whilst our focus on smaller companies means growth projections are higher than the market as a whole”.
The rational for adopting this specific value-orientated approach is the belief that as the “quantitative easing programmes [of global central banks] slows and gradually begins to unwind, coupled with gradually rising interest rates, there is a strong likelihood that 'value' strategies will again outperform, as has been evident in other rising interest rate environments”. I think there is mileage in this investment strategy and also note that GHS’s investment team has taken positions in some of my top-performing recommendations including: fund manager Miton (MGR:52p – ‘Running gains’, 21 May 2018); and specialist bank PCF (PCF:38p – ‘Banking on PCF’, 29 May 2018), a constituent of my 2018 Bargain Shares Portfolio.
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So, with GHS's shares trading on a 21 per cent discount to book value, the investment approach delivering, and the market positioning sensible, a further narrowing of the share price discount to NAV is warranted. I rate the shares a buy on a bid-offer spread of 955p to 965p, and have raised my target price to 1,100p. Buy.
■ 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.
