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Small-caps under the radar

Simon Thompson highlights a quartet of materially undervalued small-caps
July 27, 2020

Frontier IP (FIPP:59p), a company that provides a range of commercialisation services to university spin-outs in return for ‘free equity’ stakes, has released a raft of bullish announcements since my last update (‘Covid-19: A new frontier for vaccine development’, 30 March 2020).

Investors have yet to cotton onto their importance. When they do, expect a re-rating. That’s because the Aim-traded shares trade on a modest premium to last reported net asset value of £23.6m (46.6p per share) even though annual results for the 12 months to 30 June 2020 will deliver valuation uplifts from several portfolio companies.

Firstly, Frontier IP expects to report a material valuation uplift on the £1.6m carrying value of its 17 per cent equity stake in The Vaccine Group (TVG), a spin-out from University of Plymouth. Backed by £9m of grant funding from the Chinese, UK and US governments, TVG is using its novel vaccine technology to develop animal vaccines to tackle COVID-19. Vaccinating animals offers potential to eliminate SARS-CoV-2 in existing animal sources and prevent new reservoirs developing that may lead to future spill-overs into humans and a re-emergence of COVID-19.

Two of TVG’s vaccine candidates have already enjoyed success in vitro, pre-animal trial laboratory testing and the company is preparing to test the vaccines in animals. Two further vaccine candidates are under development, and TVG is investigating the longer-term potential for human vaccines, too.

The strong progress on the SARS-CoV-2 vaccines mirrors the progress TVG has been enjoying with its other vaccines. For instance, work on a bovine mastitis vaccine has revealed significant potential for new intellectual property and demonstrated the technology's ability to deliver strong, targeted immune responses. In addition, vaccines to combat bovine tuberculosis and African swine fever virus are ready for initial animal trials once testing facilities become available. I understand that US-government backed work on Ebola and Lassa fever virus vaccines has been proceeding well, too.

Secondly, portfolio company Pulsiv Solar, another University of Plymouth spin-out, is making strong progress with its patented technology to improve the energy efficiency of power converters. It has successfully integrated the technology into a standard battery charger, used by a host of devices such as power tools, thus improving the power factor of the charger to over 90 per cent, and reducing the heat generated.

Not surprisingly, the company is attracting interest from potential industry partners given that the technology improves the energy efficiency of photovoltaic solar cells and power converters used in many everyday devices, such as computers and televisions. Pulsiv has now commenced design work funded by a major multi-national company to incorporate the technology into a new product line, and is in discussions with several other multi-nationals about a wide range of industrial applications. Pulsiv is attracting interest from investors, too. In fact, it is in discussions to raise further funds at a valuation pitched at a significant premium to the carrying value of Frontier IP’s 18.9 per cent stake.

Another investee company of great interest is Fieldwork Robotics, a developer of robotic technology to harvest soft fruit and vegetables that addresses the need for heightened food safety as a direct consequence of Covid-19 and the acute shortage of seasonal workers in the UK. Bearing this in mind, Fieldworks has just entered an agreement with global technology group Bosch to develop software aimed at reducing the cost of the robotic arms and increasing their speed. Interestingly, Pulsiv is also working with Bosch to optimise the design of its energy efficient solar micro-inverter. Bosch’s interest is a strong validation of the technology of both companies, and their commercial potential, too. Frontier IP holds a 26.9 per cent interest in Fieldwork that was last valued at £1.35m.

Add to that news that Frontier IP’s largest portfolio company, Exscentia, a leading artificial intelligence-driven drug discovery company, has completed a US$60m Series C financing round backed by GT Healthcare Capital Partners, Evotec and Bristol Myers Squibb, and the forthcoming annual results are likely to make for a highly profitable read. Frontier IP holds a 2.4 per cent stake in Exscentia which was last valued at £5.1m. I understand from sources that the latest fundraise has been pitched at a significant premium to the valuation at the previous funding round.

Frontier IP’s shares made it onto my buy list last autumn at 56p (Alpha Research: ‘A differentiated IP play’, 15 November 2019), and the progress made across the portfolio since then warrants a major re-rating towards my 100p target price. The fact that an oversubscribed placing earlier this month raised £2.3m at a 19 per cent premium to last reported NAV is telling. It also highlights untapped investor demand. On 1.3 times book value (pre-valuation uplifts), and a 12-month trailing price/earnings (PE) ratio of 9, the shares rate a strong buy ahead of the results.

 

TClarke’s bumper bid pipeline

“We’re financially very strong, have a raft of strong opportunities in the pipeline and our bid teams are working flat out” says finance director Trevor Mitchell of building services contractor TClarke (CTO: 86p). In fact, the London-based company has not only increased its contracted order book by 9 per cent to £402m year-on-year, but has submitted £600m of tenders on new contracts since the start of April. More than £100m of tenders are for work on data centres including one worth £60m which Mr Mitchell is “very hopeful of winning.”

In addition, TClarke is currently working on 56 UK government funded projects, worth £70m, across the healthcare and education sector, having just completed a £6.5m contract to deliver the mechanical & electrical infrastructure (including medical gasses, generators, ventilation, heating and cooling equipment) to the new 200-bed Nightingale Hospital in Exeter. TClarke is well placed to pick up new work from the UK government’s bold investment in hospital infrastructure (40 new hospital projects will be built in the next decade) and in the education sector (50 projects and £1bn of funding in the current fiscal year alone).

It’s also well placed to pick up contracts from clients looking to optimise their Environmental, Social and Governance (ESG) commitment. In the first half, TClarke invested £2m in Gooee, a smart buildings software solution that connects a building’s control systems via a ‘single pane’ to reduce energy consumption, cut operational costs, lower carbon footprint, and improve return on investment. Moreover, it can prolong the life of existing estates as Gooee can be retrofitted into existing buildings as well as new builds.

True, the enforced second quarter UK lockdown meant that TClarke’s first half underlying operating profits dipped from £5m to £2.2m on revenue down 38 per cent to £106m, but the business was still profitable in the second quarter. That’s no mean feat and reflects the board’s prompt action to cut annual staff costs by £4m (at a cost of £3m), of which £2.4m of the savings will be seen this year.

It’s not beyond the realms of possibility that with all sites now fully operational TClarke could deliver a normal second half with productivity returning to first quarter levels, when it reported revenue of £70m, albeit maintaining an operating margin of 3 per cent will be dependent on the level of restrictions imposed on sites. It’s also highly likely that TClarke’s financial strength (net cash of £7.5m and access to £25m of debt facilities) will help drive the contracted order book upwards as it wins work at expense of less well capitalised rivals.

Shares in the £38.7m market capitalisation company are slightly below the level of my last buy recommendation after adjusting for the payment of final dividend of 3.65p a share (‘On solid foundations’ 1 June 2020). I first suggested buying at 90p (Alpha Research: ‘Profit from a buoyant earnings cycle’, 7 December 2018).

The disconnect between the strength of the bid pipeline and contracted order book, the modest valuation (enterprise valuation equates to 3.5 times operating profit in a ‘normal’ year) and the board’s commitment to the dividend points to a profitable outcome materialising. Buy.

 

Quantifying Mission’s recovery potential

UK advertising and marketing specialist The Mission Group (TMG: 58p) has issued a robust first half trading update. It has also acquired Inovationbubble, an agency that employs highly qualified behavioural scientists to help businesses better understand what drives the behaviour of their customers and improve their marketing activity. Clients include blue-chips Asda, Aviva, and HSBC.

True, the Covid-19 outbreak resulted in first half revenues declining by a fifth to £29m and the group reporting a loss before tax of £2.2m. However, the strong client roster, seasonal second half bias, and Mission’s exposure to the healthcare and technology sectors (the latest account win being a significant one in the Far East with chemicals group INEOS for delivery later this year) means that the group will return to profitability in the second half.

Analyst Roddy Davidson at house broker Shore Capital has reintroduced forecasts, predicting a second half pre-tax profit of £2.5m on revenue of £35.7m, an outcome that would warrant a final dividend of 1.2p a share. Moreover, Mission enters the recovery phase in a stronger financial position, having cut net debt from £4.9m to £1.2m since the start of 2020, and taken the decision to rationalise its office requirements within the M25 to save £0.7m in annual overheads.

Based on a bounce back in annual revenues to £78.9m in 2021, Mr Davidson predicts pre-tax profits will rise to £9.1m (£10.2m in 2019), to produce earnings per share (EPS) of 7.7p and support an annual dividend of 2.5p a share. The shares have outperformed the FTSE Aim All-Share index by 19 per cent since I initiated coverage ('Alpha Research: Marketing highly profitable growth', 11 October 2018), and are attractively priced on a forward price/earnings (PE) ratio of 8 and underpinned by a prospective dividend yield of 4.1 per cent. Buy.

 

Circle’s high rent collection underpins valuations

Circle Property (CRC:153p) a little known internally managed Jersey-registered property company, has produced a 101 per cent net asset value (NAV) total return since IPO in 2016, making it the top performer amongst UK quoted real estate peers. The portfolio is almost entirely focused on the regional office sector and has no exposure to retail apart from two public houses and one restaurant in Birmingham.

Circle owns 15 office properties of which 90 per cent by value are in four undersupplied locations: Bristol, Birmingham, Maidenhead and Milton Keynes. Majority of commercial lettings are 1,000 to 5,000 sq. ft., a sweet spot for regional lettings given that 70 per cent of leases fall within this range. Tenant quality is high, hence the reason why 91 per cent of rents were collected for the March quarter and that collection rate has been maintained in the June quarter, after taking account of monthly rents.

Circle has been active on the lettings front, recently completing a 10-year lease in Northampton, and the directors also note building tenant interest in its newest asset, Concorde Park, Maidenhead. The property is now 67 per cent let, having previously had 63 per cent voids when purchased in August 2019. The ability of Circle’s experienced management team to target well located short-let, or partly-let, property acquisitions with a view to redeveloping them to maximise the reversionary yield was a key bull point when I initiated coverage (Alpha Research:A deep value property play’, 21 February 2020). Another is the 46 per cent share price discount to end March 2020 NAV of 290p a share.

There are no debt concerns to warrant such a hefty share price discount. The £139m property portfolio is modestly geared on a loan-to-value of 42 per cent (net of £4.3m cash on the balance sheet) and Circle has £37.7m of headroom on its low cost (2.05 per cent above LIBOR) £100m financing facility with HSBC.  There is an option to extend the facility to 2025, too.

So, with the directors expecting to declare a final dividend for the 12 months to 31 March 2020 – Cenkos Securities is pencilling in 3.3p-a-share to lift the annual pay-out to 6.6p-a-share – the rent roll covering debt service costs seven times over, and rent collections robust, the 16 per cent pull-back since the Spring (‘In search of yield’, 27 April 2020) is completely unwarranted. 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].

Special offer: Both books can be purchased for the special price of £25 plus discounted postage and packaging of only £3.95. The books include case studies of Simon Thompson’s market beating Bargain Share Portfolio companies outlining the investment characteristics that made them successful investments. Simon also highlights many other investment approaches and stock screens he uses to identify small-cap companies with investment potential, too. Details of the content of both books can be viewed on www.ypdbooks.com.

Simon Thompson was named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards.