Gresham House (GHE:565p), a fund manager that specialises in renewable energy generation, solar power, wind, forestry, infrastructure funds and public and private equity investment strategies, has been appointed by AXA Investment Managers to manage the fund management group’s newly acquired 4,074 hectare portfolio of mature Irish forests. Located across 185 estates, it comprises one of Europe’s fastest growing wood types and the most valuable commercial conifer species in Ireland and the UK. The portfolio also benefits from good local infrastructure and proximity to a number of saw mills.
Following its appointment, Gresham House is now the UK’s largest commercial forestry manager, harvesting around 10 per cent of the UK’s total softwood annually and managing over 129,000 hectares of forests on behalf of institutions, endowments, family offices and private investors. Moreover, this is a significant first step in Gresham House developing a long-term international business platform, not to mention giving the company a foothold in Ireland, which it can use to its advantage as Brexit unfolds.
The green credentials of forestry aside, managing director of forestry, Olly Hughes, points out that “forestry is a portfolio diversifier and delivers excellent returns, being uncorrelated to stock markets, protected against inflation and possessing significant tax advantages”. He adds that “as the asset class continues to grow in popularity, Gresham House Forestry will be well positioned to meet the increasing demand from investors not only in the UK and Ireland, but also across Europe more generally”. It’s not the only positive newsflow emerging from Gresham House.
Exploiting the renewable energy investment opportunity
Gresham House increased assets under management (AUM) by 250 per cent to £2.28bn last year, partly driven by acquisitions, including Oxford-based FIM Services, a specialist alternative fund manager specialising in forestry and renewable energy; and the earnings-enhancing purchase at the tail end of last year of the fund and investment management business of Livingbridge, the asset manager that runs the Baronsmead VCT and two open-ended vehicles, LF Livingbridge UK Micro Cap Fund and LF Livingbridge UK Multi-Cap Income Fund.
However, the company increased AUM organically by 30 per cent, too, which was driven in part by scaling up its new energy division, including last autumn’s launch of Gresham House Energy Storage Fund (GRID:103p), a specialist investment company that invests in UK energy storage systems (ESS) (‘Gresham House powered up for profitable growth’, 12 November 2018). The fund’s investment in new projects is going very well, so much so that the investment manager expects to have fully invested the £100m proceeds of the IPO by the year-end. As a result the company has raised an additional £50m of equity this morning, having already earmarked a pipeline of ESS projects to fully deploy the proceeds of the follow-on fundraising by the end of the first quarter of 2020.
There is certainly no shortage of investment opportunities for the fund to exploit, given the lack of experienced operators in this market, a situation that will only intensify as demand for energy storage escalates, deployment of renewable energy installations ramp up and traditional coal and gas-fired generating plants are retired. Indeed, development of offshore wind, in particular, is likely to take renewable generation’s share of UK power generation to over 50 per cent within two years, according to government forecasts, generating an even more volatile supply of electricity and power prices and further underpinning the opportunity for ESS.
Bearing this in mind, research from engineering consultancy Pöyry and Imperial College London suggests that total UK energy storage capacity will need to increase by 600 per cent to 20.3GW between 2020 and 2030 in their central case scenario, and perhaps 35GW of capacity will be needed in the high case scenario. That’s an issue, as research by Bloomberg has identified only 694MW of energy storage capacity commissioned to date.
Importantly, the fund can generate multiple revenue streams that are not dependent on renewable subsidies and are uncorrelated with the absolute level of power prices. Currently, the portfolio of ESS projects generates revenue primarily from Firm Frequency Response contracts with National Grid. It successfully exported electricity during each of the three half-hour winter peaks, known as Triads, for which remuneration is particularly enhanced. During 2019, operations will increasingly target asset optimisation (trading) strategy as the business becomes more profitable.
Investor demand for Gresham House Energy Storage Fund is not only underpinned by the compelling logic of the business model as the UK government moves to renewable energy, but also by the board’s commitment to pay annual dividends of 4.5p per share this year, a payout that can be expected to rise in future years. This is good news for shareholders in Gresham House, too, as the company receives an annual management fee of 1 per cent of the fund’s net asset value (NAV) below £250m, 0.9 per cent when NAV is between £250m and £500m, and 0.8 per cent above £500m. This could develop into a lucrative recurring income stream for Gresham House shareholders. It’s not the only one.
Building multiple revenue streams
A few months ago, Gresham House announced a 50:50 joint-venture fund with global asset manager Aberdeen Standard Investments (‘Gresham House lands joint venture with Aberdeen Standard’, 26 March 2019). The new fund will adopt the strategic public equity (SPE) strategy that Gresham House has successfully deployed at Aim-traded investment company Gresham House Strategic (GHS:1,090p), another constituent of my market-beating 2016 Bargain Shares portfolio.
Gresham House has the mandate to run that fund 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 focus is on shares that suggest a company is intrinsically undervalued, such as low valuation multiples and tangible asset cover, with a strong bias to cash generation, scope to improve return on capital and enhance value through strategic, operational or management initiatives.
It’s easy to see why Aberdeen Standard Investments has formed the joint venture. Gresham House Strategic was the top-performing small-cap fund in 2018 versus open-ended investment company (Oeic) and investment trust peers and produced a total shareholder return of 20.4 per cent in the financial year to the end of March 2019, too. Since inception less than four years ago, Gresham House Strategic has outperformed its benchmark by 13.3 per cent. It has also produced a total return of 23 per cent on an offer-to-bid basis since I last highlighted the investment potential at the end of last year (‘How Gresham House Strategic is outperforming’, 31 December 2018). It remains on my buy list, priced on a 16 per cent discount to NAV.
The obvious upside for Gresham House’s shareholders is that the new joint venture will benefit from Aberdeen Standard’s huge distribution network, so has potential to substantially increase AUM. Aberdeen Standard Investments can obviously see this too, which is why it has just subscribed for 1.3m new shares in Gresham House, equating to 5 per cent of its enlarged issued share capital, at a price of 496p. Gresham House shareholders approved the share issue at this month’s annual meeting.
Gresham House also deploys similar investment techniques to the £59.6m (73.8p a share) portfolio it manages for investment company LMS Capital (LMS: 50p), a company I am also positive on, having suggested buying LMS’s shares in my April small-cap report for our Alpha subscribers. The investment risk is heavily skewed to the upside, given that Gresham House’s investment managers are in the process of realising significant disposals from LMS’s legacy private equity portfolio with a view to recycling the cash into new private equity investments.
The addition of the Livingbridge venture capital team to Gresham House has opened up new private equity investment opportunities to exploit, so expect news on this front in the near future. LMS’s shares are trading 30 per cent below NAV of £59.6m (73.8p a share), even though cash and quoted investments (£24.7m) accounts for 60 per cent of LMS’s market capitalisation of £40.7m. Effectively, LMS’s private equity portfolio is priced in at 55 per cent below carrying value, a ludicrously cheap valuation.
These mandates aside, I expect Gresham House’s management fee income to ramp up from other funds it manages, including British Strategic Investment Fund, a closed-ended Guernsey Limited Partnership that invests in relatively illiquid investments in UK housing and infrastructure-related assets. The fund has deployed half the £165m investment commitments to date, and the aim is for a final close later this year to increase the fund size to £250m. Also, Gresham House’s New Energy division has been adding to its wind and solar powered projects too, thus adding a highly scaleable asset class to the mix.
Cash and profits building
The size of the mandates Gresham House has been winning and fee income generation are not the only part of the business growing strongly. The same is true of Gresham House’s cash position.
The company had net cash of £4.1m on its balance sheet at the end of 2018, which has since been boosted by the receipt of a £1m receivable from FTSE 100 housebuilder Persimmon (PSN:1,985p) from a legacy land deal and the £6.5m proceeds from the Aberdeen Standard Investments placing. These are not the only cash inflows, as 222,517 of the company’s shareholder and supporter warrants that expire at the end of 2019, and which have an exercise price of 323.27p, have been exercised this year. This adds a further £719,000 to the cash pile.
Moreover, there are still 1.42m warrants in issue, and clearly holders will take up their rights to exercise them at some point this year given that Gresham House’s share price is 74 per cent above the warrant exercise price. The warrant premium of £4.6m Gresham House will receive on the exercise of these outstanding warrants will increase the company’s pro-forma cash pile to about £16.2m after accounting for the payment of a 3p-a-share maiden dividend to shareholders on Friday, 24 May 2019.
Gresham House also has a valuable listed investment portfolio, which includes a 23 per cent stake in Gresham House Strategic worth £10.6m, a £4m shareholding in Gresham House Energy Storage Fund, and a £300,000 holding in LMS Capital. In addition, the company holds investments of £4.7m, primarily in other funds it manages. In aggregate, Gresham House’s investment portfolio is worth around £19.6m at current market prices.
By my reckoning, cash and liquid resources will swell to almost £35.8m (128p a share) by the year-end, and that’s before accounting for this year’s cash inflow from operating activities. Indeed, a high conversion rate of 2019 forecast operating profit of £9.5m on revenue of £27.8m into net operating cash flow will be enhanced by a negligible corporation tax charge.
So, based on a fully diluted issued share capital of 27.9m shares (assuming exercise of all the outstanding warrants by the year-end), Gresham House has a market capitalisation of £157m and an enterprise value of £115m after deducting the aforementioned net cash pile, liquid resources and this year’s likely net cash inflow from operating activities.
That’s really not a high valuation for an operationally geared fund manager that is set to grow revenues and profit strongly in the coming years from multiple asset classes that have a low correlation to equity markets. Indeed, analysts at investment bank Jefferies forecast that a 6.5 per cent rise in 2020 revenues to £29.7m will lead to a near-13 per cent increase in both adjusted operating and pre-tax profits to £10.7m. Furthermore, expect this year’s forecast operating margin of 36 per cent to make headway towards the board's 40 per cent target rate as revenues ramp up further in coming years.
For good measure, analysts expect a 5.5p-a-share payout for the 2019 financial year, well covered by fully diluted adjusted earnings per share (EPS), which are expected to almost double to 27.8p this year.
Upgraded target price
In the circumstances, it’s hardly surprising that Gresham House’s shares have done well, producing a total return of 79 per cent on an offer-to-bid basis since I included them, at 312p, in my 2016 Bargain Shares Portfolio. They are likely to remain in demand too given that they are effectively only being rated on a 2019 cash-adjusted price/earnings (PE) ratio of 14 and on a modest 1.67 times my closing December year-end NAV estimate of £92m (330p a share on a fully diluted basis).
So, having taken recent newsflow into account, I feel my previous target price of 650p is now looking too conservative and I am upgrading my fair valuation to 700p a share to value the company’s fully diluted equity at £195m, implying a target enterprise value of £150m, or 14 times 2020 operating profit estimates. Please note that if my 700p target price is achieved by the year-end, the Gresham House call warrants (GHEW) – which are priced on a bid-offer spread of 220p-235p in a normal market size of 1,000 warrants – would rise 60 per cent in value to 377p, thus providing a geared play on the ordinary shares for those of you with a higher risk appetite.
Needless to say, I continue to rate Gresham House’s ordinary shares and the call warrants decent buys.
■ Simon Thompson's new book Successful Stock Picking Strategies and his previous 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.
