Aim-traded shares in SRT Marine Systems (SRT:28p), a global leader in AIS, an advanced identification communications technology used to track and monitor maritime vessels, rallied 50 per cent to achieve my 55p target price at the start of this year (August Alpha Report; and ‘Get on board for a profitable passage’, 20 November 2019).
Another buying opportunity has presented itself after the company announced the delay of two Middle East system contracts (aggregate value of £65m) that were scheduled to start during March. This is due to the respective governments' reprioritising their short-term operational focus on the coronavirus outbreak, a consequence being the restriction of movement of goods and people. It means that £14m-worth of revenues that SRT had expected to book in the financial year to 31 March 2020 in relation to the delivery of its GeoVS data centre systems (within the first few weeks of the contract signings) will fall into the 2020-21 financial year. The balance of the system will then be delivered across multiple milestones over an 18-month period.
The impact on the 2020-21 financial year will be to substantially increase SRT’s revenues and the directors will provide market guidance once these contracts are signed. Analyst Lorne Daniel at house broker FinnCap “feels that these contracts could see revenues exceed £50m to deliver pre-tax profits in double figures.” This means that the £43m market capitalisation company is being priced on four times likely net profit for the 2020-21 financial year even though the contracts have only been delayed due to a global issue. Buy.
Urban Exposure plans exit and capital return
Specialist residential development finance firm and asset manager Urban Exposure (UEX:69p) is trading around the entry point in my March 2019 Alpha Report, during which time the FTSE Aim All-Share Total Return index has fallen 27 per cent. The shares have also held steady since I flagged up the company had received bid approaches (‘Catalysts for releasing shareholder value’, 19 November 2019).
The business clearly appeals to Pollen Street Capital, a specialist finance lender with £2.6bn assets under management. Its subsidiary Honeycomb Holdings has agreed to buy Urban Exposure’s loan book for £113.8m. The founders of Urban Exposure’s asset management company will acquire that operation for £1.6m and have net working capital of £7.1m (4.5p a share) made available to them.
Assuming shareholders approve the disposals at a general meeting on 30 March 2020, and after factoring in liquidation costs, expect a first capital distribution of 72p a share on 7 May 2020, and a final distribution of 1p a share by April 2021. The shares will then delist on 27 April 2020. The capital return is 10p a share shy of net tangible net asset value (NAV) of 82.7p, but I can see institutions voting in favour of the disposals so reluctantly accept.
Duke’s high yield worth locking in
Duke Royalty (DUKE:30p), an Aim-traded company that makes its money by providing capital to companies in exchange for rights to a small percentage of their future revenues over a typical term of 25-40 years, is putting the £16.5m net proceeds from last autumn’s equity raise to good use. Duke has made follow-on investments totalling £17.3m across five of the 12 royalty companies in its £91m portfolio, including one this morning, but still retains £30m of headroom on its £50m new debt facility.
Importantly, the directors confirm that the cash flow generation from royalty companies and its loan portfolio covers the £7.2m cash cost of the annual dividend. The next quarterly payout of 0.75p a share goes ex-dividend on 26 March. Cenkos expects annual net operating cash flow of £7.6m (3.2p a share) to increase to £9.9m (4.1p a share) in the 12 months to 31 March 2021 after taking into account the new follow-on investments made, leaving ample surplus cash to cover annual interest costs of about £1.6m.
I suggested buying shares, at 41.4p, in my Alpha Report ('Duke Royalty: A royal high-yielding investment', 18 February 2019), and the holding had been performing well until last week's market crash. Clearly, the economic impact of coronavirus could make trading more challenging for some (but not all) of Duke’s portfolio companies. However, that is more than priced in, with Duke’s shares yielding 10 per cent and rated on seven times earnings per share (EPS) estimates of 4.2p for the 2020-21 financial year. Buy.
Defaqto delivers for SimplyBiz
Shares in SimplyBiz (SBIZ:146p), a provider of compliance, business and technology services to almost 6,000 financial intermediaries, rallied 35 per cent to within pennies of my 272p target price after I covered the interim results (‘SimplyBiz’s growth underpriced’, 16 September 2019), having first made the investment case in my July 2018 Alpha Report. The pull-back since the end of last year makes this an interesting juncture to consider the business case.
The annual results were much as I had expected. Defaqto, a financial technology business operating a fintech platform for 5,800 advisers and providing independent ratings of 21,000 financial products and funds, contributed £4.9m of cash profit on a healthy 41 per cent margin in the nine months since SimplyBiz’s £74m acquisition. House broker Zeus expects Defaqto to report 2020 cash profit of £6.6m, an outcome that seems realistic and covers three-quarters of the 15 per cent expected increase in group pre-tax profits to £17.3m in 2020.
Expect an identical cash profit contribution (representing £1m profit uplift) from SimplyBiz’s intermediary services business, which is benefiting from strong underlying growth in membership fee income from its 3,728 intermediary firms. New regulations continue to be the key driver here as financial intermediaries seek out professional advice. The introduction of the 5th Money Laundering Directive and the Senior Managers and Certification Regime for all Solo-regulated firms augurs well. The division is also benefiting from higher software licence sales following the launch of Centra, a ‘one-stop shop’ for financial planning that was developed on Defaqto’s platform.
SimplyBiz’s distribution channel division incorporates the third-largest mortgage club in the UK. It’s doing brisk business. Mortgage completions increased 14 per cent to £16bn and earned SimplyBiz almost 20 per cent higher fees. The unit also provides a marketing services channel for 135 financial product providers to enable them to gain access to more than 25 per cent of the retail financial service market place. There have been no cancellations of SimplyBiz’s events to date and the 2020 roster is pretty full. Generally these events have 50 to 75 attendees, so are not mass gatherings, and can be streamed online in any case.
The strategic aim this year is to drive margins higher by maximising the profit potential of Defaqto’s huge customer base, targeting higher-value sales in intermediary services, and maximising upselling more products as new regulations bite. Analysts at Zeus expect high single-digit rises in EPS and the dividend per share to 14.6p and 4.6p, respectively, which seems a realistic outcome to me. Rated on a forward PE ratio of 10, and underpinned by a prospective dividend yield of 3.1 per cent, SimplyBiz’s shares should rally hard when the market malaise abates. The directors have just bought more than £200,000 of stock between them, too. Buy.
Jarvis reports record results
Aim-traded Jarvis Securities (JIM:428p), a financial services outsourcer and retail client stockbroker, has announced record annual results, lifting EPS by 13 per cent to 35.8p and paying out 26.25p in normal dividends plus a special payout of 15p. Jarvis’ corporate division, which provides outsourced and partnered financial administration services to pension funds and wealth managers, has been driving the growth, benefiting from the exit of rival firms from this business segment, and improved pricing, too.
Since I turned buyer (‘Jarvis offers medium-term value’, 15 August 2018), the holding has produced a total return of 6 per cent, during which time the FTSE Aim All-Share Total Return index has shed 37 per cent of its value. Expect the outperformance to continue after house broker WH Ireland pushed through high-single digit 2020 EPS and dividend upgrades (to 37.6p and 27.8p, respectively), implying the shares are rated on a modest forward price/earnings (PE) ratio of 11 and offer a prospective dividend yield of 6.5 per cent. Income buy.
Brand Architekts builds platform for growth
Brand Architekts (BAR:105p), an Aim-traded beauty brands business that has developed a portfolio of beauty product brands both organically and by acquisitions (Bagsy, MR. and Tru), is a classic Ben Graham recovery play.
Last summer’s disposal of its manufacturing business proved a significant distraction for management, hence the first-half working capital build, but what remains is still a profitable brands business. True, first-half underlying operating profit of £1.64m (excluding central overheads of £484,000) was less than I had anticipated when I included the shares in my 2020 Bargain Shares portfolio. US tariffs on goods from China and a major UK grocery retailer withdrawing from certain lines were the main reasons why. However, product launches and entry into other overseas markets (Australia, New Zealand and Nordic countries) have real potential to reinvigorate sales under new chief executive Quentin Higham when he joins in early May.
Importantly, £3m of excess working capital build is now unwinding, and the £1.3m retention on the disposal will be received in the coming weeks, so N+1 Singer expects net cash to increase from £15m to £19m (111p) by 30 June 2020, a sum exceeding the company’s £18m market capitalisation. Effectively, the brands business is in the price for free even though the new management team has firepower to make earnings-accretive acquisitions in a buyers’ market, the other benefit of which is to spread central overheads across a wider revenue base and create economies of scale. Buy.
Oil price plunge hits producers
Saudi Arabia’s decision to launch a price war to punish Russia and US shale producers, coupled with softer global oil demand due to the economic impact of the coronavirus, has created carnage across the listed oil sector. Shares in Royal Dutch Shell (RDSB) have collapsed 55 per cent this year, and the minnows haven’t fared any better. Trinity Exploration & Production (TRIN:5.5p), an independent oil and gas explorer and producer focused on Trinidad and Tobago, has mirrored the sector pull-back, losing half of its value since my article in early January (‘Profiting from a surging oil price’, 6 January 2020).
All is not lost. That’s because Trinity has hedges in place for 46 per cent of its exit 2019 production for the first half of 2020, and 28 per cent for the second half, so receives an additional $6 per barrel for each hedged barrel if West Texas Intermediate (WTI) trades below $50 a barrel. Operating break-even of $26 per barrel is still well below the WTI spot price of $29 per barrel. Also, Trinity avoids paying Supplemental Petroleum Tax when WTI averages below $50 a barrel each quarter, overriding royalties on production are slashed when WTI falls below $40 a barrel, and 75 per cent of taxable profits are sheltered from Petroleum Profits Tax.
So, with year-to-date average output rising by 10 per cent to 3,300 barrels a day, the company set to generate positive free cash flow even in a depressed market environment and well funded, too – net cash of $13.9m equates to almost half of Trinity’s market capitalisation – I would hold your nerve. Hold.
Trading tough for French Connection
French Connection (FCCN:11p) has released results that hardly inspire confidence. The annual loss of £2.9m was deeper than guidance at the end of January (‘Exploiting market anomalies’, 10 February 2020), and the clothing retailer’s cash pile of £8.1m halved year on year. Furthermore, the retail environment has become even more challenging since the outbreak of the coronavirus and the real possibility of heavy discounting across the sector could further undermine the company’s turnaround. Sell.
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Simon Thompson was named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards.
