When I compiled my 2020 Bargain Shares portfolio, I focused on companies with strong balance sheets, and made a conscious decision to take financing risk off the table. In fact, all bar one of the 10 small-caps I selected are cash-rich.
For instance, CIP Merchant Capital (CIP:44p), a Guernsey-based closed investment company that predominantly invests in listed equities by adopting a private equity style approach, held half its portfolio in cash when I published my portfolio. The hefty cash backing proved a drag on performance last year when NAV declined slightly to £46.2m (84p a share). However, by keeping its powder dry for more attractive investment opportunities, CIP has been shielded from the worst of the stock market crash. Indeed, the portfolio outperformed the FTSE Aim All-Share index by 11 percentage points during the first quarter of 2020, albeit it took some hits as the latest NAV of £37.5m (68.2p) highlights.
What this means is that net cash of £18.6m (33.8p) now backs up 77 per cent of CIP’s market capitalisation of £24.2m, so effectively CIP’s portfolio of investments are in the price for £5.6m, or 70 per cent below their £18.9m market valuations. To put the ‘margin of safety’ into some perspective, CIP’s stake in CareTech (CTH:380p), a heavily asset-backed provider of social care services and one of the largest companies listed on London’s junior market, is worth £3.5m alone.
CareTech’s shares are rated on a modest forward price/earnings (PE) ratio of 9 after factoring in 11 per cent likely earnings growth this year, buoyed by the operational benefits from the October 2018 acquisition of Cambian. CareTech’s net debt of £291m is backed by a freehold estate worth £774m, and debt service is not an issue as annual interest costs are covered six times by cash profit. Importantly, the majority of service users in care are children and adults with a learning disability, mental health diagnosis and/or with challenging behaviours, so do not fall into a high-risk group or frail and elderly. It’s business as usual.
CIP’s portfolio also includes valuable stakes worth a total of £4.5m in Orthofix Medical (US:OFIX), a $500m market capitalisation Nasdaq quoted medical devices company, and Aim-traded Circassia Pharmaceuticals (CIR), a cash-rich speciality biopharmaceutical company focused on allergy and respiratory diseases. I can see upside to both investments, and several other of CIP’s holdings, too. The decision to widen the investment manager’s sector remit is sensible in light of the value opportunities across the whole market. Buy.
An inspired disposal highlights Oakley’s undervaluation
Last week I made the case that shares in private equity investment company Oakley Capital Investments (OCI: 199p) are being significantly undervalued (‘Four companies offering value opportunities’, 1 April 2020). The ‘margin of safety’ I outlined in that online-only article is even greater now following this morning’s announcement of the disposal of Oakley’s remaining stake in Inspired, a co-educational independent school group.
The sale realises net proceeds of £99m and adds around £20m (10p a share) to Oakley’s 2019 year-end net asset value (NAV) of £686m (345p a share). This means that Oakley now has £250m (128p) of cash on its balance sheet, a significant sum in relation to the company’s market capitalisation of £389m. Effectively Oakley’s portfolio of debt securities, equity and fund investments are in the price for £139m, or an eye-watering 68 per cent below my proforma book value estimate of £433m after adjusting for last month’s NAV accretive share buy-back, foreign exchange movements and marking to market its listed investments. That level of discount is anomalous for a company that has consistently exited investments above book value, and one that has an enviable track record of value creation for shareholders. Buy.
PCF shares priced to motor
Aim-traded specialist bank PCF (PCF:17p) has been hit by the market crash, shedding half its market value. The scale of the de-rating is massively overdone for multiple reasons.
Firstly, PCF has been focusing on prime lending. Over £220m of PCF’s own-book new business originations were in prime credit grades in the 12 months to end September 2019, and the segment accounted for 79 per cent of all new lending in the first five months of the 2019-20 financial year. In motor finance, an area of concern for investors given the hardship faced by millions of furloughed employees and the newly unemployed, around 93 per cent of all new business was prime in February.
Importantly, PCF doesn’t offer a personal contract plan product, so is not exposed to residual market risk on softening car prices. Also, a specialisation in niche, leisure vehicles such as horseboxes and motor homes where consumers put down hefty deposits, so are less likely to default, has been a key driver behind growth in the consumer finance division.
Secondly, all lending to SMEs is heavily asset-backed. This segment, accounting for 58 per cent of PCF’s loan book, includes light and heavy commercial vehicles, plant and equipment. SMEs have been given access to billions of pounds of government loans to help them trade through the lockdown, thus providing a source of cash flow which mitigates to some extent default risk on financing agreements.
Thirdly, PCF’s residential property bridging finance unit, accounting for £21m of the £395m loan book, is based on a conservative average loan-to-value ratio of 59 per cent. This mitigates the likelihood of impairments arising.
Fourthly, PCF is well financed. In the past six months, retail deposits have surged by almost 30 per cent to £346m and have an average term of three years. This provides PCF with mainly fixed term and low-cost funding (2.2 per cent average interest rate) to recycle into own book lending at a healthy net interest margin of 7.8 per cent. Retail demand for PCF’s savings products is not going to change anytime soon and it also has access to £19m of wholesale bank credit lines, in addition to £25m of the Bank of England’s low-cost Term Funding Scheme. The common equity tier 1 ratio (CET1) of 18 per cent is well ahead of the regulator’s minimum requirement.
Fifthly, PCF’s market capitalisation of £42.5m is now a third below equity shareholder funds of £59m, the implication being that profits will be obliterated by loan delinquencies. I would beg to differ. In the 2019 financial year, PCF reported pre-tax profits of £8m after accounting for £2.2m of impairments on operating income of £22.2m, but the loan book is 16 per cent higher than at 30 September 2019 which underpins profit growth.
Bearing this in mind, Panmure has factored in £3.7m of impairment losses into its 2020 pre-tax profit estimate of £10.7m, based on operating income of £29.4m and a closing loan book of £450m at the September 2020 year-end. This means that PCF would have to make a £14.4m impairment charge on its loan book for this year’s profits to be wiped out. That’s simply not going to happen given the high proportion of prime credit borrowers who will avoid trashing their credit ratings at all costs.
The directors were certainly comfortable enough to pay out the 0.4p-a-share final dividend at a cost of £1m. Ahead of a pre-close trading update at the end of April, the laggard in my 2020 Bargain Shares Portfolio is priced to motor off the market’s bargain basement forecourt. Buy.
Avation pre-emptive action plan protects shareholder interests
Aircraft leasing company Avation (AVAP:127.5p) has issued a reassuring trading update and put in place a number of initiatives to help its airline customers navigate the COVID-19 crisis.
Avation’s commercial fleet of 48 aircraft is leased out to 18 airlines in 15 countries across Europe, Latin America, Asia Pacific and Australia. In light of the current restrictions on air travel, the majority of governments across these regions have offered support to their local airlines. Avation is offering a package of short-term interest-bearing facilities to its airline clients on the basis that they still make ongoing monthly cash payments on lease agreements. Several clients have declined the offer of financial support as they are financially strong enough to weather the downturn – easyJet, Air France, Air India, Philippine Airlines, Mandarin Airlines, and Virgin Australia account for 40 per cent of lease revenue – but most have accepted.
Importantly, the company can afford to offer short-term financial relief agreements as it has ample liquidity including cash of US$129m, trade receivables of US$11m and five unencumbered aircraft valued at US$54m. The directors believe that Avation can operate on this basis as ongoing cash income will be sufficient to cover its financial obligations. It has no aircraft lease expiries before August 2021, and is compliant with all bank covenants on its debt facilities. Sensibly, all aircraft purchases have been deferred, operating expenses have been cut and dividend payments have been put on hold.
It’s important to note that 28 of the 48 planes in Avation’s US$1.3bn fleet are ATR 72-600s and ATR 75-500s, aircraft that are typically used on regional routes, the segment of the market that will recover first given that governments, essential and health services are major users of domestic air travel. I would also stress that some of these ATR aircraft are operating as normal.
Admittedly, the shares have fallen during the market rout, so much so that having first suggested buying, at 159p ('Get on board for blue-sky gains', 11 September 2014), and banked 25p a share of dividends to date, my 100 per cent paper profit has been wiped out this year. However, the selling is way overdone as Avation still has a profitable business that would in normal circumstances be producing almost £20m of net profit. Furthermore, its market capitalisation of £80m is 63 per cent below book value of £219m even though the board remains engaged in offer talks with several interested parties to realise value from the leasing portfolio, having initiated a formal sale process in January. Recovery buy.
■ Simon Thompson's latest 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 £3.25 [UK].
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Simon Thompson was named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards.