Exploiting cash rich value plays

Gresham House’s unlisted British Strategic Investment Fund (BSIF), a closed-ended Guernsey Limited Partnership that invests in relatively illiquid investments in UK housing and infrastructure-related assets, raised a further £100m at its final close, accounting for almost half the £192m of net fund inflows. The acquisition of the £184m management contract of Residential Secure Income (RESI), an investment company that owns portfolios of shared ownership, retirement and Local Authority housing, was the other major contributor to the net £360m growth in AUM.

It’s worth noting that the £2.4bn portfolio of real assets only suffered a tiny £5m negative investment performance in the four-month trading period, highlighting the segment’s uncorrelated returns to equity markets. Also, although the £758m strategic equity division suffered a £104m negative investment performance, this was more than offset by £61m of net fund flows and £92m of net mandates and/or funds acquired, the latest being the £21m investment management contract to Strategic Equity Capital (SEC).

The drivers of ongoing organic and acquisitive growth, combined with the operational leverage of the business model, are key attractions and explain why the holding has almost doubled in value since I included the shares, at 312p, in my 2016 Bargain Shares Portfolio. However, there is still value on offer. That’s because after taking account of the £8m raised through a placing after I covered the annual results (‘Coronavirus winners’, 9 March 2020), settling the cash consideration for the acquisition of Trade Risks (manager of RESI), and £1.35m cost of the 2019 dividend of 4.5p a share which was paid this month, I estimate that Gresham House’s net cash and its investment portfolio account for 44 per cent (144p a share) of proforma net asset value of £98.2m (327p).

This means that a fund management business that analysts at Jefferies believe can deliver current year earnings per share (EPS) of 35.9p (factoring in the placing shares issued) is valued on a cash-adjusted PE ratio of 13, a harsh rating given that three quarters of AUM generate uncorrelated returns to equity markets, and offer enticing yields to attract new fund flows in a zero-interest rate policy environment. Offering material upside to my 800p target price, the shares are worth buying.

Cenkos unloved, and undervalued

I feel investors are being far too conservative with their miserly valuation of corporate broker Cenkos Securities (CNKS:42p), a constituent, at 52.5p, of my market beating 2020 Bargain Shares Portfolio.

Not only is the company’s market capitalisation of £24m below tangible net asset value of £24.6m, and well below the 10-year price-to-book value average of 2.3 times, but annual results revealed that cash has risen to £23.8m (42p a share) since the December year-end. Effectively the business is in the price for free even though it has generated a five-year average return on equity of 17 per cent.

That’s harsh given that Cenkos was still profitable in 2019, a dire year for corporate activity on AIM, and made decent progress in the second half when it reported a pre-tax profit of £341,000 on revenue of £15.3m. This year started well, too. Cenkos completed a £80m placing for the largest IPO on London’s junior market, debt and corporate advisory firm FRP Advisory (FRP:128p). Investors backing that company have already made a 70 per cent gain on their investment.

Of course, the Covid-19 pandemic subsequently sent financial markets into turmoil, but founder shareholder Jim Durkin – who returned to the role of chief executive last summer – notes that “our pipeline is good, so I look forward to 2020 with tempered optimism.” He has a point as Cenkos has just pulled off a £69.4m capital raise for Diversified Gas & Oil (DGOC: 102p), the U.S. based owner and operator of natural gas and oil wells that moved its listing from AIM to the Main Board. Cenkos will have earned a chunk of the £3.3m placing fees. There is also money to be earned by raising capital for companies needing to bolster their balance sheets due to the impact of Covid-19.

In addition, as broker to 100 companies, of which 78 are listed on Aim and 45 per cent have been clients for five years, Cenkos earns a recurring revenue stream from nomad, broking and research activities. This segment accounted for more than a quarter of last year’s revenue. New clients have been added to the roster this year, too.

The other point worth flagging is that Cenkos cut £3m off its cost base in 2019. Analysts at Edison believe that the reduction in overheads means that the business can break-even on annual revenue of £18.5m, and pre-tax profits would rise six-fold to £0.8m if the company maintains last year’s revenue at £25.9m. The benefit of a relatively low fixed cost base, and a remuneration structure geared to performance, means that profit increases sharply in a positive operating cash cycle. A track record of paying dividends – the 2019 payout was 3p a share – is another attraction. Buy.

Watkin Jones’ pipeline underpins investment opportunity

Property development group Watkin Jones (WJG:142p), a specialist in developing purpose-built student accommodation (PBSA) in top university towns, and build-to-rent (BtR) housing across the UK, is in far better shape than the market is giving it credit for.

All seven PBSA schemes (2,609 beds) slated for delivery in the financial year to 30 September 2020 have been forward sold and the work programme has been accelerated to make up for time lost during the Covid-19 shutdown. Only one scheme could miss its scheduled completion date, and finance director Phil Byrom says that two of the three blocks at that site should still be ready on time to enable a phased handover. Dependent on student pre-bookings, the group could yet avoid a late penalty. Although two sites in Scotland (638 beds for delivery by September 2021) have yet to resume due to the Scottish governments shutdown, the contract enables a time extension. Overall, construction sites are working at 75 per cent of their pre-Covid 19 resource levels.

Furthermore, Watkin Jones has forward sold six schemes (2,730 beds) for the 2021 financial year with only the Leicester site (462 beds and gross development value of £33m) to sell, and has secured five further sites (1,437 beds) for delivery in later years, thus offering solid earnings visibility in these uncertain times. It’s not as if there isn’t underlying demand for new student accommodation. For instance, post the March half year end, Cranfield University signed an on-campus partnership agreement for the development of 613 beds. It will generate £48m of revenue for Watkin Jones over the next 30 months. Chief executive Richard Simpson sees the reconstruction of dated on-campus PBSA, accounting for half of the current UK stock, as a new opportunity given that Watkin Jones has specialised in off campus accommodation to date.

The decision to scale up BtR activities has proved wise, the key contributor to the 6 per cent rise in first half pre-tax profits to £26.6m on revenue of £185m. Watkin Jones has secured 10 sites for the construction of 2,660 apartments, of which 782 have been forward sold for delivery in the 2020/21 financial year. Combined with the PBSA developments, the contractually committed development pipeline is worth £390m through to September 2021, and £690m beyond that date.

Net cash more than doubled year-on-year to £37.5m and should more than double again by September as Mr Byrom says half of the £100m contract assets and trade receivable balances will unwind in the second half as new schemes are delivered. The group has ample headroom on credit lines, having secured a £100m five-year revolving credit facility and £10m overdraft facility with HSBC. To put the robust state of the balance sheet into perspective, under a full lockdown with no income the business has a monthly cash burn of only £2.5m.

Analysts are taking a sensible approach to their modelling. Clyde Lewis at Peel Hunt expects full-year pre-tax profit of £45m and EPS of 14.4p, having pushed back £10m of profit and £80m of revenue to the 2020/21 financial year, mainly for the four or five schemes (for delivery in 2022 and 2023) that would ordinarily have been forward sold in the second half of this year. The flip side is that Peel Hunt’s 2021 pre-tax profit and estimates increase to £70m and 22.5p, respectively. Shareholders can expect a reinstatement of the suspended pay-out (8.4p a share in 2019) in due course.

Trading on a current year price/earnings (PE) ratio of 10, I maintain my positive stance, having suggested buying at the IPO around 100p ('A profitable education', 3 Apr 2016), banked dividends of 26.55p and seen the share price achieve my 275p target price after the annual results (‘Building shareholder value’, 14 Jan 2020). When the Covis-19 uncertainty lifts, and institutional investors regain their poise – Mr Simpson says that “institutions [looking to forward fund projects] are starting to talk to us again” – the lowly rated shares could re-rate sharply. Mr Simpson certainly thinks that way as he spent £75,000 buying shares, at 152.5p, post results. 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.