How the 2018 Bargain Shares Portfolio fared

It was always going to be a tough ask to emulate the performance of my 2017 Bargain Shares Portfolio, which returned in excess of 30 per cent in its first 12 months, or 20 percentage points more than the return on a FTSE All-Share index tracker fund. But the motley crew of Bargain Shares I selected for my 2018 Bargain Shares Portfolio have done me proud, especially in light of the market sell-off in the final quarter last year.

Eight of the 10 constituents in the portfolio are Aim-traded shares, and it was the small-cap segment of the market that took the greatest hit. The FTSE Aim All-Share index has lost 14 per cent of its value on a total return basis in the past 12 months. However, my portfolio produced a 12.5 per cent positive total return, thus outperforming London’s junior market index by 26.5 percentage points. It also outperformed the benchmark FTSE All-Share index by 16.5 percentage points.

The outperformance was helped in no small part by the decision I made 12 months ago to select two Aim-traded shares with exposure to the commodity complex in the portfolio.

Parkmead (PMG)

Aim: Share price: 55.8p

Bid-offer spread: 55-55.8p

Market value: £55.2m

Website: parkmeadgroup.com

A year ago I made the point that it is rare for shares in a company to be priced on a 50 per cent discount to risked net asset value (NAV) when 85 per cent of the share price is backed by cash on the balance sheet, and liquid resources. However, that’s what was on offer at Parkmead (PMG), a small-cap oil and gas exploration and development company led by 19 per cent shareholder, Tom Cross, the founder and former chief executive of Dana Petroleum until its sale to the Korea National Oil Corporation in 2010.

Parkmead produces gas from a portfolio of four fields across the Netherlands, and holds oil and gas interests spanning 30 exploration and production blocks in the North Sea, several of which have the potential to be transformational for the company, albeit this was not being recognised by investors a year ago. For that matter it’s not being fully recognised by investors now even after a near 50 per cent re-rating in Parkmead’s share price.

That’s because the company had net funds of $31m (£24m) when it reported financial results in mid-November 2018, and has since received £6.2m of cash for its shareholding in oil and gas producer Faroe Petroleum (FPM) following the latter’s takeover by Norwegian oil investor DNO ASA. Strip out cash and liquid assets from Parkmead’s market capitalisation of £55.2m, and its exploration and production assets are effectively being valued at £25m, a fraction of their balance sheet value and analysts' risked valuations too. 

Commercial potential for GPA underrated

Importantly, a detailed engineering study carried out by Nexen Petroleum has confirmed the technical feasibility of a potential subsea tie-back of Parkmead’s Greater Perth Area (GPA) project to the Nexen-operated Scott platform and associated facilities in the UK Central North Sea. Parkmead is in ongoing commercial discussions with the Scott field partners to explore terms for a tie-back of GPA to Scott with the scope to reduce the capital expenditure needed to bring the project onstream, and lower operating costs too.

If the GPA project progresses, then it’s likely to propel Parkmead’s share price significantly higher given that analyst Colin Smith at house broker Panmure Gordon places a risked valuation of £50m, or 50.5p a share, on Parkmead’s undeveloped oil resources, or £372m on an unrisked basis. Furthermore, Mr Smith forecasts that Parkmead should make a pre-tax profit of £1.2m in the financial year to the end of June 2019, thus de-risking the investment case and providing operational cash flow to direct towards exploration activities.

Priced on a 35 per cent discount to Panmure Gordon’s total risked NAV estimate of 85p a share, and with potential for corporate activity in the price for free, Parkmead’s cash-rich shares remain a buy.

Sylvania Platinum (SLP)

Aim: Share price: 20.5p

Bid-offer spread: 20-20.5p

Market value: £58.5m

Website: sylvaniaplatinum.com

Sylvania Platinum (SLP) is a fast-growing and low-cost South African producer and developer of the platinum group metals (PGMs) platinum, palladium and rhodium, with two distinct lines of business: the re-treatment of PGM-rich chrome tailings material from mines in the North West Province; and the development of shallow mining operations and processing methods for low-cost PGM extraction.

The company’s dump operations comprise seven active PGM recovery plants that treat chrome tailings from surrounding chrome mines. The chrome tailings re-treatment plant is located at Kroondal, and is managed by Aquarius Platinum Corporate Services. The operations are hugely profitable, a point that was not being recognised by investors 12 months ago.

Rising output for low-cost producer

Sylvania is also one of the lowest cost producers in the world – average basket price of $1,135 per ounce (oz) in its last financial year was more than double the $543 per oz cash cost from its dumping operations – which is why both net revenues and net profits increased by almost a quarter to $62.8m and $11m (£8.6m), respectively, in the 12 months to the end of June 2018. The company has also been benefiting from pricing tailwinds – the rhodium price has risen by almost 140 per cent in the past 18 months – and by a favourable production mix too. That’s because Sylvania’s rhodium share of production is between two and three times that of its peers at 14 per cent, and revenues from by-products are being buoyed by higher prices for Iridium and Ruthenium.

A key take for me is the 76,000 to 78,000 oz production target for the current financial year to the end of June 2019, markedly higher than last year’s record output of 71,000 oz, and supportive of a sixth consecutive year of production growth. The company is highly cash generative. Cash generated from operations in the last financial year was almost $23m before $4.5m negative working capital movements, slightly ahead of annual cash profits of $22.2m. The bumper cash flow enabled Sylvania to invest $6.3m in Lesedi, a PGM dump operation with an operational concentrator plant and 2.4m tonnes of tailings dump resources of a similar grade and recovery potential as Sylvania’s neighbouring Mooinooi dump operation; a further $7.6m on capital projects; and $1.4m on a share buyback programme.

Maiden dividend and low ball valuation

The board also declared a maiden annual dividend of 0.35p a share at a cash cost of $1m. The directors could afford to do so as net cash of $14m on the company’s balance sheet at the end of the 2018 financial year increased to $17.7m (£13.8m) by the end of the first quarter of the current financial year. The cash pile equates to around a quarter of Sylvania’s market capitalisation.

The bottom line is that the combination of rising output and a favourable pricing environment are still not fully reflected in the company’s valuation even though the share price, at 20.5p, is 40 per cent higher than 12 months ago with the shares currently trading on an historic cash-adjusted price/earnings (PE) ratio of five.

Moreover, even if my 28p-30p target price is achieved, Sylvania’s shares would still only be trading on a cash-adjusted PE ratio of eight, and that ignores the possibility of another year of profit growth in 2019. Buy.

PCF (PCF)

Aim: Share price: 38p

Bid-offer spread: 36-38p

Market value: £81.3m

Website: pcf.bank/investors

At the tail end of last year, Aim-traded specialist bank PCF (PCF) delivered the bumper set of annual results I had anticipated when I included the shares, at 27p, in my 2018 Bargain Shares Portfolio. In fact, the company over-delivered by increasing its annual pre-tax profits by 44 per cent to a record £5.2m, all of which was organic growth, beating forecasts from house broker Panmure Gordon by 7 per cent to lift earnings per share (EPS) by a third to 2p. This supported a 58 per cent hike in the payout per share to 0.3p.

Business model well underpinned

Having gained a banking licence in the summer of 2017, the challenger bank ended the financial year to 30 September 2018 with retail deposits of £191m from 4,500 bank customers who receive an average interest rate of 2.1 per cent on their money. These deposits provide PCF with a reliable low-cost funding source to ramp up its lending portfolio and target higher-quality prime customers.

The bank’s loan book is also growing strongly. Receivables increased by half to £219m in the 12-month trading period, reflecting a 75 per cent rise in new business originations to £148m, of which 70 per cent is to the prime market. Loans to the small- and medium-sized enterprises (SME) market, principally for asset finance, account for 60 per cent of the loan portfolio, and the balance is consumer lending.

In consumer markets, PCF has been diversifying its customer base by targeting specialist markets within consumer finance, including lending on horse boxes and motor homes, a sound strategy as these customers put down big deposits, have a good-quality asset and borrow for longer, around seven to eight years. About a third of the £62m new business originations in the financial year were from specialist consumer markets.

Importantly, PCF has no exposure to Personal Contract Plans (PCPs) within its consumer motor finance business, nor does it lend to the subdued new car market – instead it is focused on lending into the far healthier used car market. The fact that the impairment charge was unchanged at 0.5 per cent of the loan portfolio highlights a low level of delinquencies and strict financial discipline in making lending decisions.

The post-period-end acquisition of Azule, a specialist funding provider to individuals and businesses in the broadcast and media industry, is a smart deal and one that is immediately earnings enhancing. Furthermore, Azule has the capacity to generate north of £50m-worth of annual asset finance originations with very low impairments given the nature of its lending.

PCF’s management is also entering the direct to market property bridging finance market and is aiming to achieve £20m of lending to this segment in the financial year ending 30 September 2019. The risk weighting of property is lower than on its current lending lines, but it should achieve net interest margins of around 8 per cent, in line with PCF’s existing loan portfolio.

Hitting lending targets early

The combination of originations from new credit lines and strong new business originations explains why the directors believe PCF can hit their £350m lending target 12 months ahead of the original September 2020 target date. On that basis, Panmure Gordon analysts anticipate another step change in PCF’s profitability, pencilling in a 50 per cent increase in both pre-tax profit and EPS to £8.1m and 3.1p, respectively, in the 12 months to 30 September 2019 to support a 33 per cent hike in the dividend per share to 0.4p.

On this basis, PCF’s shares are rated on a forward PE ratio of 12, on 1.6 times forward price-to-book value, and offer a prospective dividend yield of 1.1 per cent. That’s not expensive for a fast-growing challenger bank that is over-delivering and diversifying its lending lines, nor for a bank that earns a post-tax return on equity of 10.3 per cent (internal target of 12.5 per cent) and has a healthy common equity tier one ratio of 19 per cent to support the 50 per cent-plus lending growth targeted in the current financial year. Buy.

Titon (TON)

Aim: Share price: 203p

Bid-offer spread: 187-203p

Market value: £22.5m

Website: titonholdings.com

When I suggested buying shares in Colchester-based Titon (TON), a little known small-cap designer and maker of domestic ventilation systems, and door and window hardware, they were priced on less than 10 times historic earnings even though the company had posted record annual results for the fourth year in succession. The operational performance since then has more than justified including the shares in my 2018 portfolio.

A bumper 2018 financial year

In the 12 months to the end of September 2018, Titon’s revenues increased by 7 per cent to a record £29.9m, all of which was organic growth. Moreover, with gross margins rising by almost one percentage point to 26.8 per cent, and growth in sales outpacing operating costs, pre-tax profit increased by a fifth to £3m, to lift earnings per share (EPS) by 16 per cent to 19.2p.

Robust cash generation and tight working capital management were positives, too. Net cash of £1.8m generated from operations enabled the directors to invest £900,000 in capital expenditure and cover the £531,000 cost of declaring a 13 per cent rise in the dividend per share to 4.75p, the sixth consecutive year the payout has risen. Year-end net cash increased by £150,000 to £3.4m, a sum equating to 18 per cent of net assets. Titon also edged up its return on capital employed (ROCE) to 15.3 per cent. A quick ratio (current assets less stocks divided by current liabilities) of almost two indicates a strong liquidity position.

Titon’s UK operations accounted for £1m of the company’s 2018 operating profits, up from £706,000 the year before. The South Korean operations had yet another outstanding year: operating profit rose by more than a quarter to £2.08m, buoyed by 51 per cent-owned South Korean subsidiary, Titon Korea, a maker of natural window ventilation products that has a 75 per cent share of the national market. It contributed £1m to Titon’s post-tax profits of £2.6m. Titon’s other South Korean associate company, Browntech, lifted its net profits by almost a quarter to £778,000. 

Investment case still holds

Titon’s exposure to South Korea, the 12th-largest economy in the world, was one of the reasons I was attracted to the shares in the first place. Demand for products in South Korea has been driven by the introduction of building regulations for ventilation that stipulate that all new houses and apartments have to be adequately ventilated. The use of natural ventilation products over mechanical ventilation is championed by the major South Korean social housing authorities and it is predominantly this factor that has helped Titon to achieve high levels of growth over the past few years. I also like the fact that management has proved adept at navigating through a more subdued domestic construction market in the UK.

I wouldn’t bet against another record performance this year, either. Nor would analyst Tony Williams at equity research firm Hardman & Co. He is predicting another rise in pre-tax profit to £3.2m on revenue of £31m in the 12 months to the end of September 2019. That’s good news for dividend prospects especially as the interests of the directors, who hold a third of the issued share capital, look well aligned to those of outside shareholders.

On a price-to-book value of 1.1 times, trading on a PE ratio of 10 and offering a dividend yield of 2.3 per cent, Titon’s shares are still attractively priced. Buy.  

U+I (UAI)

Main: Share price: 209p

Bid-offer spread: 206.5 -209p

Market value: £262m

Website: uandiplc.com

Clearly, deputy chief executive Richard Upton believes shares in U+I (UAI), a specialist property developer and investor in regeneration projects, are undervalued. Since mid-November 2018 he has spent £152,945 of cash purchasing shares at an average price of 211p.

The company has a £9.5bn pipeline of complex, mixed-use, community-focused regeneration projects, and owns an investment portfolio worth £145m that generates a contracted annual rent roll of £12.5m. The strategy is to unlock the value in urban sites in the London, Manchester and Dublin city regions.

Development pipeline building

New projects won since I included the shares in last year’s Bargain Shares Portfolio include a £3.5bn gross development value (GDV) regeneration scheme in north Cambridge, which is expected to generate £20m to £30m of development and trading gains to the business over 10-15 years. It will encompass the transformation of a water recycling centre in north Cambridge, over 120 acres, into a large mixed-use urban area with 5,200 homes, 1m sq ft of office space and a mix of retail, community and leisure space.

It’s not the only smart looking deal that U+I has pulled off as at the end of last year it completed a part-funding deal with Quinn Estates to acquire the 12-acre brownfield site in Ashford town centre, known as Newtown Works, which is located a walk away from the 35-minute high-speed rail link into London St Pancras station. Design work is under way to transform the site into a mixed-use scheme including film and studio floorspace, and a hotel. 

U+I has also completed the off-market acquisition of the 'Arts Building', a 50,000 sq ft warehouse-style building located 100m from Finsbury Park station in North London.  The company will refurbish the five-floor building and convert warehouse space to offices with the aim of offering affordable and convenient office space targeting the creative sector. Once fully let it should produce a net initial yield of 8 per cent.

As the pipeline grows U+I should be able to secure a lower cost of capital by extending its strategic and capital partner relationships. The directors have already appointed advisers to identify partners to help fund three major pipeline PPP projects.

On course to hit profit guidance and pay out hefty dividends

In the meantime, U+I continues to realise hefty gains from its development portfolio and the directors reiterated guidance last autumn to expect £45m to £50m of development gains to be realised by the February 2019 year-end, having banked £12.8m in the first half of the financial year. 

Importantly, with the balance sheet lowly geared – analysts at broking house Liberum Capital estimate closing net debt of £114m on 28 February 2019, implying a gearing ratio of 30 per cent of shareholders' funds – the board can pay out a chunk of forecast underlying full-year EPS of 21p as dividends. Analysts at Liberum are pencilling in an annual dividend of 13.9p a share, implying U+I's shares offer a 6.6 per cent prospective dividend yield. The high dividend yield and a modest PE ratio of 10 aside, U+I's shares trade 30 per cent below forecast NAV of 301p at the February 2019 year-end.

So, although U+I's shares are trading around the level I suggested buying at 12 months ago, there remains potential for a narrowing of the share price discount to NAV and solid prospects of the board recycling development profits back to shareholders through chunky dividends – Liberum’s payout and underlying EPS forecasts for the 2020 financial year are more or less the same as for the 2019 financial year. In fact, U+I has paid out dividends of 17.9p a share since I recommended buying the shares around 206p, so the total return is almost 10 per cent. Buy.

Conygar (CIC)

Aim: Share price: 173p

Bid-offer spread: 170-173p

Market value: £97.7m

Website: conygar.com

I was attracted to the investment potential of Aim-traded property vulture fund Conygar (CIC) based on prospects for its development pipeline, and the fact that the shares were trading well below NAV despite the company’s significant cash backing and its valuable stake in Regional Reit (RGL), which has since sold for £25.5m.

Around £11.8m of Conygar’s cash pile was used to buy back 10.7 per cent of its share capital at a 16 per cent discount to NAV in the financial year to the end of September 2018. Since then Conygar has repurchased a further £5.6m shares. So, by my reckoning, the company has a spot NAV of £114.7m, or 203p a share, based on a share count of 56.5m, and a pro-forma net cash pile of £44.5m equating to 79p a share. Factor in sales of a B&M Retail unit in Ashby-de-la-Zouch (£4.3m) and a Premier Inn Hotel at Holyhead (£6.9m) due for completion early this year, net cash will equate to half spot NAV of £115m.

In addition, a pre-let has been agreed with discount retailer Lidl for 23,000 square foot (sq ft) at Conygar’s Cross Hands retail park, South Wales. Completion is scheduled for the autumn, leaving only 15,000 sq ft of the 90,000 sq ft of space at the retail park to let, so it’s only reasonable to expect a decent uplift on the £9.6m carrying value of the development in Conygar’s accounts.

Near-term focus on flagship asset in Nottingham

Importantly, there is a catalyst on the horizon for Conygar’s share price discount to NAV to narrow further. That’s because a planning decision is due imminently on a proposed 2m sq ft development on the former Boots headquarters in the centre og Nottingham city centre. Conygar’s planning application encompasses a mix of office, residential, student accommodation and leisure facilities. The company acquired the site for £13.5m in December 2016 and it’s in the books for £15m. I firmly believe this site could create material development profits for shareholders.

It’s no coincidence that the asset hurdle under a new profit sharing plan for senior management has been set at a fully diluted NAV per share of at least 250p before any payout can be made. Also, Conygar’s mid-market share price must average at least 230p in the three months prior to any payment under the scheme, so the directors are clearly well incentivised to get both the share price, and NAV per share moving towards those targets.

The bottom line is that I anticipate that Conygar's share price will continue to outperform as it has done so in the past year, as gains are realised from the portfolio, and cash is recycled into new development opportunities. Buy.

Crystal Amber (CRS)

Aim: Share price: 215p

Bid-offer spread: 210-215p

Market value: £207m

Website: crystalamber.com

I have not changed my positive stance on Aim-traded activist fund manager Crystal Amber (CRS), the shares of which I included, at 207p, in my 2018 Bargain Shares Portfolio. 

Crystal Amber’s largest holding is a 5.1 per cent stake in Hurricane Energy (HUR), an oil exploration company that is building up a huge resource base in a strategically important part of the North Sea by targeting naturally fractured basement rock reservoirs in the West of Shetland. The Lancaster field is Hurricane's most appraised asset, with five wells drilled by the company to date. It has 2P reserves and 2C contingent resources of 523m stock tank barrels of oil, and Hurricane is proceeding towards the first phase of development, which is expected to produce 17,000 barrels of oil per day when first oil comes on stream in the first half of 2019.

Hurricane also owns or holds stakes in five other major fields to give it total combined 2P reserves and 2C contingent net attributable resources of 2.3bn barrels of oil equivalent. The company has been commercialising these assets, having announced a 50 per cent farm-in with Spirit Energy of its Lincoln and Warwick licences, covering the Greater Warwick Area. Despite the operational progress made, Hurricane’s shares trade on less than half analysts’ risked NAV estimates of around 100p, so there is scope for a narrowing of the discount driven by positive operational progress. Crystal Amber’s stake in Hurricane accounts for 45p a share of its own NAV of 221p a share, so the holding has a major influence on the fund’s portfolio.

Crystal Amber’s next four largest holdings are a 20 per cent shareholding in foreign currency payment services provider FairFX (FFX), a company I remain favourable on, a 6.4 per cent stake in van hire firm Northgate (NTG), a 19.7 per cent holding in media group STV (STVG), and a 5.4 per cent stake in banknote and passport maker De La Rue (DLAR). Combined, the top five shareholdings account for three quarters of Crystal Amber’s NAV.

Ultimately, an investment on Crystal Amber is a call on the prospects of these five companies, and on the ability of the fund’s investment advisers to replicate their success last year when they enhanced NAV per share by 33 per cent to 252p by the end of July 2018 before stock markets fell out of bed. I think they can. Add to that an annual dividend of 5p, and the shares remain on my buy list.

Shore Capital (SGR)

Aim: Share price: 220p

Bid-offer spread: 210 -220p

Market value: £47.5m

Website: shorecap.co.uk

Investors continue to place a very conservative valuation on Shore Capital (SGR), an investment bank and asset manager.

Shore Capital has a broad-based offering of activities to diversify its revenue and profit mix. The company is the fourth-largest market maker on the London Stock Exchange by number of stocks covered; has over 70 retained corporate clients and worked on transactions raising more than £5bn in equity capital markets since January 2014; and offers equity research on over 200 companies to an extensive institutional client base.

Despite having multiple revenue streams, Shore Capital’s market capitalisation of £47.5m is about 30 per cent below its last reported NAV of £66m even though the company holds £27.6m of cash, gilts and bonds; £4.3m of quoted equities; £4.9m in various Shore Capital Puma Funds; and £3.1m of unquoted holdings. So, even without factoring in a net £28m of other assets held on Shore Capital’s balance sheet, cash and the aforementioned investments back up 84 per cent of the company’s market value of £47m. That’s anomalous given that these operating activities make annual operating profit of around £5m. The low-ball valuation aside, a 4.5 per cent annual dividend yield is attractive too.

Earnings from asset management business now significant

It’s worth pointing out that asset management is a major part of Shore Capital’s activities, generating half of group pre-tax profits in the first half of last year, and is a reliable source of income to counter earnings from more volatile market making and capital markets activities. A good example of how Shore Capital is growing its revenue streams is the £200m new institutional funding line its Puma Property Finance business secured at the end of last year to support demand for secured lending to developers on residential schemes, hotels, leisure, and care homes. For its role in originating, executing and managing loans, Puma will receive management and transactional-related fees on loans executed over a four-year period.

True, around 70 per cent of Shore Capital’s issued share capital is held by the six largest shareholders, which reduces liquidity, and means share price moves can be accentuated. However, this factor is already priced in with the shares so lowly rated, and it is possible to deal within the bid-offer spread. Buy.

Mpac (MLIN)

Aim: Share price: 137p

Bid-offer spread: 132-137p

Market value: £27.6m

Website: mpac-group.com

I was reassured by last month’s pre-close trading update from Mpac (MPAC), a small-cap niche packaging engineering business supplying customers in the pharmaceutical, healthcare, nutrition and beverage industries.

The company issued a profit warning last summer when it revealed problems relating to cost over-runs on two technically challenging legacy contracts. I understand these issues have been sorted and 2018 profits will be in line with estimates of analyst Paul Hill at Equity Development, who predicts a 15 per cent rise in 2018 adjusted pre-tax profits to £1.3m on revenues of £57m to deliver EPS of 4.9p, up from 4.2p in 2017.

Mr Hill is maintaining his closing net cash position of £25m, a sum worth 124p a share and one that backs up 90 per cent of Mpac’s share price. Net cash accounts for almost half of Mpac’s last reported NAV of £52m, albeit the company has a pension deficit so movements in bond yields have a disproportionate impact on its NAV. I have taken this pensions issue into account in my investment analysis.

New contracts de-risk 2019 earnings estimates

More importantly, the company continues to win new contracts for delivery in 2019, having won a major contract win last autumn that accounts for up to a third of Equity Development’s 2019 revenue forecast of £60.4m (‘Mpac back on track’, 5 Sep 2018). It goes without saying that growing visibility on the sales book de-risks 2019 earnings estimates, and is likely to help investors to regain their poise and attribute a higher valuation to Mpac’s income stream. Growing the sales line is also important to enhance the level of Mpac’s profitability. That’s because a higher proportion of incremental revenue drops to the bottom line given the operational gearing of the business. To put this factor into perspective, based on a 6 per cent rise in revenues to £60.4m in 2019, analysts expect operating margins to increase from 2.6 per cent in 2018 to 4.9 per cent and for 2019 operating profits to almost double to £3m.

I was first attracted to Mpac due to the operational gearing of the business, a blue-chip client base, underlying market growth of 5 per cent for the high-speed, cutting-edge packaging machinery and equipment that Mpac supplies, and its overseas exposure as 85 per cent of sales are derived from outside the UK. These bull points have not changed despite the hiccup last summer. Recovery buy.

Record (REC)

Main: Share price: 31p

Bid-offer spread: 30.5-31p

Market value: £61.7m

Website: recordcm.com

Currency manager Record (REC:31p) may be the laggard in my 2018 Bargain Shares Portfolio, but I feel that the shares have been harshly treated.

One reason for the underperformance is that the company announced last year that its low-margin passive management fees had come under pressure due to greater competition. Record sensibly offered passive hedging clients the opportunity to change their mandates from management fee-only to a lower management fee and a performance fee basis, the effect of which was to lower earnings estimates as analysts excluded performance fees from their forecasts until they had been realised.

The strategy paid off

However, the strategy has worked as the company earned £1m of performance fees in the first quarter of the financial year to the end of 31 March 2019. Moreover, Record has just announced a £1.3m performance fee for the second half of the financial year, which means that analyst Rae Maile at house broker Cenkos now expects Record to report a rise in full-year pre-tax profits from £7.3m to £7.6m on 4 per cent higher revenues of £24.7m to produce EPS of 3p. Furthermore, Record has a strong balance sheet – net cash of £22.8m equates to 11.5p a share – so the directors can pay out all net profits as dividends. This explains why Cenkos predicts a full-year dividend per share of 3p.

True, some previously announced client terminations and negative market movements resulted in Record’s assets under management equivalent (AUMe) ending last year at $57.8bn, down from a record high of $63.9bn only 12 months earlier. AUMe will decline by a further $1.7bn when a commercial relationship representing two clients terminates shortly. That’s the nature of currency hedging as some clients enter and exit the market. More important is that Record still has 63 clients and its business remains highly profitable. Also, revenues earned from its stickier passive mandates cover all of Record’s annual overheads.

Take a macroeconomic view to understand currency flows

Clearly, prospects for currency hedging are dependent on exchange rate volatility across financial markets to create conditions for attracting new clients, and retaining existing ones. Bearing this in mind, at the start of the year I set out my stall and predicted that the US Federal Reserve will ease off the central bank’s monetary tightening policy in response to the message being sent out by chairman Jay Powell (‘A game changer’, 7 Jan 2019). The implication of this not only points towards a weaker dollar, but a rally in risk assets, too.

That’s worth noting because roughly half of Record’s hedging fees earned relate to equity assets, and 30 per cent to fixed income assets. So, if the dollar does indeed weaken, then the increased currency volatility is highly supportive of demand for Record’s hedging strategies as overseas investors look to protect their US dollar-denominated investments from the currency’s devaluation. Around 60 per cent of Record’s AUMe are from Swiss clients; 16 per cent from those in the UK; and 11 per cent from the US.

I feel the combination of Record benefiting from positive market movements in the 2019/20 financial year, and the likelihood of the business earning significant performance fees on passive mandates are not being factored into the share price, which is priced on a PE ratio of 10, or on a cash-adjusted PE ratio of seven. The shares also offer a prospective dividend yield of 9.5 per cent. Recovery buy.

■ Simon Thompson's new book Successful Stock Picking Strategies and his second book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £2.95, or £3.75 if you purchase both books. Details of the content of both books can be viewed on www.ypdbooks.com.