In search of value opportunities

First half revenue soared by more than a third to US$77.4m driven by BATM’s bio-medical division, which reported operating profit of US$4.2m on revenue up two-thirds to US$50m. BATM is a major winner from the Covid-19 pandemic, having acted quickly to launch a new diagnostics antigen molecular test kit to detect Covid-19 and a lab serological test kit that diagnoses if a patient has had Covid-19 by detecting antibodies in their blood. BATM has already shipped several hundred thousand test kits, has a backlog of more than 1m orders and is enjoying robust demand for its instrument readers. In partnership with Israeli life sciences company Novamed, BATM is also developing a rapid Covid-19 diagnostics antigen test kit for home use (results within minutes from a sputum sample test) which will be available for sale next month.  

In addition, BATM has just launched a new molecular diagnostics test kit that can identify in less than one hour the cause (pathogen) of a respiratory illness, enabling the correct treatment or action to be rapidly implemented. It can detect all prominent respiratory viruses as well as the bacteria that cause serious pulmonary illnesses and a secondary infection of Covid-19, such as pneumonia and Legionnaires' disease. The ability to identify the cause of a disease is important ahead of the coming winter when seasonal colds and flu could appear alongside Covid-19 meaning that patients will present with similar symptoms.

Analysts at house broker Shore Capital upgraded their full year cash profit estimate by 11 per cent to US$14.6m (US$10m in 2019) based on 32 per cent higher revenue of US$162m, a result that will drive up annual operating profit by nearly 90 per cent to US$9.2m. Prospects for 2021 are even brighter when you consider the progress BATM is making in 5G. The group's network and cyber security division is accelerating the network function virtualisation (NFV) ecosystem project in partnership with Softbank-owned chip designer Arm Holdings. Vodafone (VOD) is just one of the tier one telecom operators that has conducted successful proof-of-concept trials of the technology which will enable network carriers to deploy their own virtualised software-based networks. BATM chief executive Dr Zvi Marom says the likely acquisition of Arm by US chip maker Nvidia (NVDA) would be very positive for BATM.

The shares are up almost 600 per cent since I included them in my 2017 Bargain Shares portfolio and now trade on an enterprise value to cash profit multiple of 46 times. I maintain the view (‘Bargain Shares opportunities’, 29 June 2020) that BATM is in the early stages of a strong earnings upgrade cycle and one that could see significant value added to its intellectual property. Run profits.

H&T's recovery potential under rated

Pawnbroker and financial services firm H&T’s (HAT:317p) is well placed to rebuild business back to pre-Covid-19 lockdown levels.

Prior to entering the lockdown on 24 March 2020, the company was on track to deliver revenue growth and at an increased level of profitability, having exceeded expectations in the first quarter. However, all stores were forced to close for seven weeks and it took a further three weeks after that before the majority had re-opened. In the circumstances, the 26 per cent decline in first half pre-tax profit to £5m on 20 per cent lower revenue of £55.8m was a credible outcome.

Not surprisingly, H&T’s customers reduced their discretionary spend due to the economic uncertainty, and have been redeeming their pledges. The company’s pledge book declined from £72.7m to £56.3m in the second quarter of 2020. The first half gross profit contribution from pawnbroking held steady at £16.8m, but that was due to the contribution from last summer’s acquisition of 65 stores trading as The Money Shop (TMS), and a £8m pledge book purchased from Albemarle & Bond last autumn. The flip side is that the bumper cash inflow has completely de-geared H&T’s balance sheet. In fact, the company now has net cash of £13.2m, a £25m positive swing on 12 months earlier. It also has access to a £35m borrowing facility, so is well funded to rebuild lending levels as customers return.

The buoyant gold price is highly supportive, too. Gross profit from scrapping unredeemed pledges surged fivefold to £2m on sales up 11 per cent to £11m in the first half, the driver being a 30 per cent year on year hike in the average gold price to £1,306 per troy ounce. The yellow metal has been glistening since the half year end and is currently trading around £1,485 per troy ounce. A rising gold price environment not only reduces bad debt risk on assets pledged, but drives up gold purchasing profits, too. Gross profit contribution from this activity almost doubled to £2.8m in the six-month period.

Of course, it will take time to rebuild profits from both retail and pawnbroking activities, and expect earnings from personal loans to continue to decline after the company suspended lending in March. This explains why brokerage Numis Securities expects annual pre-tax profit of £9m on revenue of £129m and earnings per share (EPS) of 18.3p to be less than half the 2019 outcome.

But the house broker also points out that “given pawnbroking’s counter-cyclical nature, a more uncertain post furlough environment might result in a faster recovery in the pledge book.” Either way, it doesn’t seem unreasonable to expect a 50 per cent earnings rebound in 2021 from an artificially low base, as Numis predicts. On this basis, H&T shares are rated on a forward price/earnings (PE) ratio of 12 and offer a 4.3 per cent prospective dividend yield, assuming the 2020 forecast 6.1p-a-share pay-out is doubled to 13.7p-a-share in 2021, the latter covered two times. The board declared an interim pay-out of 2.5p a share, a sign of intent.

Admittedly, H&T shares are slightly shy of the 338p level when I covered the 2019 annual results (‘Exploit a golden opportunity’, 10 March 2020), and have delivered an underwhelming 16.8 per cent total return since I included the company in my market beating 2017 Bargain Shares Portfolio. However, I still see value on a price-to-book value of one times, and scope for outperformance of Numis’ earnings forecasts, too. A target price around 400p should be achievable in time. On a bid-offer spread of 306p to 317p, H&T’s shares rate a value buy.

High yield value opportunity

Shareholders in Alternative Income REIT (AIRE:57p) would have been pleasantly surprised by this month’s trading update, and the unexpected hike in the quarterly dividend per share from 0.825p to 1.425p. The directors have declared dividends of 5p a share for the 12 months to 30 June 2020, equating to 90 per cent of European Public Real Estate Association (EPRA) EPS of 5.52p.

The reason why the company can afford to pay a healthy dividend is because 88 per cent of the portfolio’s income stream is derived from inflation-linked leases on freehold or long leasehold property (care homes, hotels and serviced apartments, student housing, nurseries, car parks, and small power stations). The weighted average unexpired lease term is 19.4 years, and the tenant quality is high. Indeed, guidance is that at least 84 per cent of rents due for the current quarter will be collected by next month, with the balance subject to deferral arrangements. That compares favourably with rivals.

Admittedly, valuers at Knight Frank clipped the portfolio valuation by 3.7 per cent to £104.8m (30 June 2020) based on an investment yield of 5.77 per cent, but that looks harsh . For instance, the company has just sold its Wet 'n' Wild Water Park, North Shields for £3.2m, representing a £350,000 premium to June 2020 book value. Adjust for that disposal and proforma net debt of £38m implies a comfortable read-through loan-to-value ratio of 36 per cent. The portfolio would have to decline from £105m to £75m before breaching covenants on the company’s low-cost loan (fixed interest of 3.19 per cent) which expires in October 2025. That’s not going to happen.

In fact, as investors come to terms with the paucity of income producing investments in what could be a prolonged zero interest rate policy environment, and try to protect themselves from a spike in inflation as the velocity of money picks up during the economic recovery, then I envisage yield compression on the inflation hedged portfolio.

So, although the holding is 17 per cent under water since I first suggested buying in my October 2019 Alpha Report, the 25 per cent share price recovery since my last article (‘In search of yield’, 10 April 2020) looks set to gain momentum. On a 32 per cent discount to net asset value of 83.6p, and offering a chunky dividend yield, the shares continue to rate a buy on a bid-offer spread of 53p to 57p.

Litigation Capital’s legal eagles worth backing

Litigation Capital Management (LIT:70.5p), a provider of litigation financing which enables third parties to pursue and recover funds from legal claims, has delivered an upbeat trading update ahead of next month’s annual results.

Having launched a US$150m (£115m) third-party fund in March 2020 to take advantage of new investment opportunities, and earn performance fees, the company has already committed US$70m of funding across 17 projects. Specifically, these are insolvency disputes, class actions, arbitration and commercial litigation cases. There should also be decent opportunities to invest the remaining funds, too.

That’s because global economic conditions and industry forecasts point towards a significant increase in insolvency events. Historically, there has been a strong correlation between periods of economic uncertainty and an increase in disputes, highlighting the counter-cyclical nature of the litigation finance industry. The trend is playing out as Litigation Capital is now observing higher levels of insolvency events, and greater interest from corporates looking to preserve their own capital (for core business activities) by seeking alternative methods of funding the costs of disputes.

This backdrop is also positive for scaling up the company’s portfolio of 23 directly held investments which have a current capital commitment of US$95m. They are performing well as Litigation Capital has delivered eight successful resolutions across two corporate portfolios (building, construction and aviation litigation cases) in the financial year just ended. I also note that the company has initiated a second strategic alliance with a major law firm which has “led to our largest ever corporate application”, and has established a disputes finance facility with global law firm DLA Piper. This will enable Litigation Capital to finance a greater number of disputes undertaken by DLA and its clients at a lower capital risk given the portfolio nature of the funding arrangement.

Ahead of the results, analyst Justin Bates at brokerage Canaccord Genuity expects annual pre-tax profits of A$11.2m (A$12.3m in 2019), implying the shares are rated on a PE ratio of 17, hardly exacting for a business that has delivered a nine-year portfolio return on invested capital (ROIC) of 134 per cent and cumulative portfolio internal rate of return (IRR) of 78 per cent. A multiple of 1.65 times June 2020 book value estimates, falling to 1.3 times June 2021 forecasts, is attractive, too.

The shares have rallied 40 per cent since I covered the interim results (‘Three buying opportunities’, 18 March 2020), although the price is 10 per cent shy of the entry point in my 2019 Bargain Shares Portfolio even though management is clearly delivering. However, it’s my strong view that Litigation Capital will be a winner from the Covid-19 crisis, and on a discount to my fair value target of 120p, the shares are worth buying on a bid-offer spread of 69p to 70.5p. Buy.

Pennant targets recovery

Pennant (PEN:33p), an Aim-traded supplier of products and services that train and assist engineers in the defence and civilian sectors, has been impacted by the Covid-19 pandemic more than management had anticipated when I suggested buying the shares, at 35p (‘Small-cap recovery buys’, 20 April 2020). Having traded in a 33p to 53p range since the end of March, the share price is now back at the bottom of that trading range on news that the £12.5m market capitalisation company will report a first half operating loss of £2m (excluding £500,000 of restructuring and one-off costs) on revenue down 12 per cent to £6.3m.

Guidance is for a return to profitability in the second half, but Pennant’s full-year revenue estimate of £14m will fall short of the £16m figure budgeted by management in the May 2020 trading update, and will be 30 per cent below revenue reported in the 2019 financial year.

Delays in key meetings, unavailability of relevant customer personnel, and the disruption and productivity impact of remote working have all held back progress on Pennant’s engineered-to-order programmes, while local lockdowns have prevented delivery and installation of training aids at customer sites overseas. One of these delayed contracts is a £3.4m award to design and build a full-size representation of a training aid for Leonardo Helicopters, of which £2m should have been deliverable this year.

In addition, restrictions in Canada and Australia have reduced budgeted services revenues in those territories. Pennant has government contracts (worth £6m in annual revenue) with the Canadian and Australian defence departments to use its Oracle-based OmegaPS software product that reduces the support cost of major capital equipment.

There is good news though. The latest order book of £36m is 9 per cent higher than at the time of the May trading update, annualised cost savings of £1m have been achieved, the benefit of which will be seen in 2021, and the group is now in a healthy £2m net cash position, representing a £4.2m positive turnaround since the 2019 annual results. Pennant has access to a £4m low-cost overdraft facility with HSBC, too, so there are no financial concerns.

Also, with operating costs taken out of the business, then a higher proportion of gross margin earned on incremental revenue will now drop through to profit as the bumper order book is delivered. It’s worth bearing in mind that prior to the Covid-19 crisis analysts had been pencilling in a two-thirds increase in pre-tax profits to £2.7m and EPS of 6.9p. This gives you some idea of the recovery potential on offer. On a bid-offer spread of 32p to 33p, the heavily oversold and unloved shares rate a 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.