Investors are underestimating prospects for a major re-rating of Circle Property (CRC:150p), an internally managed Jersey-registered property company. The shares are trading back at the 150p IPO price even though Circle has increased net asset value (NAV) per share by 90 per cent to 285p in the subsequent four years, including 3 per cent growth in the latest 12-month period, making it a top performer among UK-quoted real estate peers. It also pays a dividend.
The outperformance reflects the ability of Circle’s management, led by chief executive John Arnold, a stalwart of the property industry, to target well located short-let, or partly-let, property acquisitions with a view to redeveloping them to maximise the reversionary yield. Importantly, Circle’s portfolio is almost entirely focused on the regional office sector (97 per cent) and is generating high levels of income. Tenants representing 87 per cent of the £8.7m annual rent roll paid up in the second quarter, the shortfall reflecting rent deferrals due to the UK government's temporary rent relief measures that prohibit lease forfeiture for non payment. Mr Arnold expects a similar outcome this quarter and is comfortable with the credit quality of the tenants deferring payments.
Circle has been active on the lettings front, almost doubling occupation rates at its newest asset, Concorde Park, Maidenhead, from 36.6 to 67.6 per cent since the newly refurbished but underlet property was acquired for £14.6m in August 2019, and has received proposals from two tenants to occupy part of the 22,308 square foot (sq ft) vacant space. The property's annual contracted rent of £1.1m could rise to £1.6m when fully let. It accounts for £20m of Circle’s £139.5m investment portfolio, the latter valuation is based on a net initial yield (NIY) of 6.2 per cent and a 7.8 per cent reversionary yield.
The directors have also been working their magic at the Kent Hills Business Park, Milton Keynes, a 244,000 sq ft complex encompassing offices, hotel, health centre and conference facilities. Circle purchased the site for £11m in December 2013 and has spent more than £10m on refurbishments. It’s now worth £49.5m. FTSE 100 food and support services group Compass (CPG) is a major tenant, accounting for £1.6m of rental income. It’s a valuable lease as Circle renegotiated it so that it has annual RPI-linked uplifts and expires in 2041.
The Compass element of Kent Hills has been valued by Savills at £35m, and Mr Arnold is looking to put the high-quality covenant property on the market in the spring to deleverage Circle’s balance sheet and help improve investor sentiment. That said, Circle is well funded as it has £39.3m of headroom on a low-cost £100m four-year financing facility with HSBC (2.05 per cent above Libor), and net debt of £57.7m equates to a 42 per cent loan-to-value ratio. Other opportunistic disposals will be considered, too, which will help the board to address the unwarranted 48 per cent share price discount to net asset value (NAV). NAV accretive share buybacks, and raising the annual dividend of 5.3p a share are options being considered.
So, although the timing of my buy call was not ideal (‘A deep value property play’, 21 Feb 2020), coming the week before the stock market crashed, I am confident that the 25 per cent share price fall since then will be reversed. Buy.
A Ben Graham value play
I recommended buying shares in CIP Merchant Capital (CIP:51p), a Guernsey-based closed investment company that predominantly invests in listed equities by adopting a private equity style approach, at around the current level in my 2020 Bargain Shares Portfolio. Although the company’s NAV per share has fallen by almost 10 per cent to 75.77p a share since then, this is less than half the 19.4 per cent decline in the FTSE All-Share Total Return index.
One reason for recommending the shares in the first place was the hefty ‘margin’ of safety on offer. This is still the case. After taking into account this month’s disposal of CIP’s stake in Aim-traded Circassia Pharmaceuticals (CIR), a speciality biopharmaceutical company focused on allergy and respiratory diseases, CIP has over £21m (38p a share) of cash to invest and holds a portfolio of investments in nine companies, worth £20.8m (37.8p a share). CIP invested £2.7m in Circassia in January and made a £1.1m net profit on the holding when it realised £3.9m earlier this month.
It’s also doing well with its stake in CareTech (CTH), a heavily asset-backed provider of social care services. It is one of the largest companies listed on London’s junior market, and one I remain keen on. The holding in CareTech is now worth £4.2m, or 20 per cent more than at the time of my last update (‘Deep value buying opportunities’, 8 Apr 2020). CIP’s portfolio also includes a valuable £2.6m stake in Orthofix Medical (US:OFIX), a $553m (£430m) market capitalisation Nasdaq-quoted medical devices company. Effectively, CIP’s cash pile and the highly liquid stakes in Caretech and Orthofix back up 100 per cent of its market capitalisation.
This means you are getting a free ride on seven other holdings that have a combined valuation of £13.6m (25p a share). The latest addition to the portfolio being a £1.1m investment in EKF Diagnostics (EKF), a £289m market capitalisation point-of-care business. EKF has achieved meaningful growth thanks to its capability to manufacture and deliver novel Coronavirus testing equipment across the globe. Given that its production facilities are also located in the UK, US and Germany, CIP’s investment managers believe that EKF represents a valuable hedge against the downturn risk of the wider market should the Covid-19 pandemic accelerate, or a vaccine be available later than the market expects. EKF is rated on a 2020 forward price/earnings (PE) ratio of 18 based on Panmure Gordon’s expectation of its earnings per share rising 154 per cent this year. The shares have risen by 15 per cent since the start of last month, so CIP is already well into profit.
The point is that the scope for CIP’s investment managers to replicate the success they have enjoyed with their investments in CareTech and Circassia is simply not being priced into the shares, which are rated on a 33 per cent discount to book value. Or to put it another way, strip out cash of 38p a share and holdings worth almost 38p are in the price for only 12p, or two-thirds below their market values.
That’s anomalous especially as three-quarters of the portfolio is invested in healthcare (57 per cent) and software (18 per cent) companies, sectors that should be prospering in the current economic environment. CIP’s other investments in these two sectors are:
■ Aim-traded Brave Bison (BBSN), a company that derives its revenue from advertising and fee-based services by working with brands and platforms to create and monetise video and derives its revenue from advertising and fee-based services. CIP's stake is worth £0.83m.
■ Milan-based digital marketing company Alkemy S.p.A. (It: ALK) designs solutions for the digitalisation of business-to-business (B2B) and business-to-consumer (B2C) channels. CIP's stake is worth £2.06m.
■ Proactis (PHD), an Aim-traded global procurement software provider. CIP's stake is worth £0.89m.
■ Happy Friends, an Italian company that is expanding its operations by opening veterinary hospitals and clinics in northern Italy. It now has three, having just opened one in Verano Brianza. CIP's stake is worth £4m.
CIP’s shares are priced for a profitable outcome. Bargain buy.
A value proposition
The new management team at Brand Architekts (BAR:115p), an Aim-traded beauty brands business, have had a baptism of fire, having taken the reins in the middle of a global pandemic. However, backed by a solid balance sheet boasting net cash of £18m (105p a share) following the disposal of its manufacturing business, and a well laid out strategic plan, they look well placed to turn around the company’s fortunes.
Importantly, they have the relevant industry experience. Chief executive Quentin Higham was formerly managing director of Yardley of London Consumer Care prior to joining the company in May, and finance director Tom Carter who joined a month later has held roles at Alliance Boots, and Procter and Gamble. New chairman Roger McDowell has a record of backing decent companies. He is chairman of engineering group Avingtrans (AVG) and a non-executive director of finance firm Thinksmart (TSL), companies which I follow and maintain a favourable view on.
As flagged up at the pre-close trading update, the company was unable to completely offset the full impact of the Covid-19 crisis despite growing online sales and enjoying higher demand from UK grocers. Overall, full-year revenue declined 17 per cent to £16.3m. That was mainly due to the lengthy lockdown on UK high street outlets, but also because some orders in overseas markets were only placed in the final quarter of the financial year. The trade war between China and the USA didn’t help either. International sales declined by a quarter to £2.4m, but Mr Higham does note that “there is a lot of going on”, highlighting the recent [unreported] placement of the company’s Kind Natured brand in Walmart stores in Mexico.
Inevitably, there has been some ‘kitchen sinking’ as highlighted by a £2.5m stock write-down and a £928,000 goodwill impairment on the carrying value of men’s grooming business Real Shaving Company, a business that was inevitably impacted by the pandemic. Before exceptional charges, the company made a small operating profit of £121,000.
The plan now is to focus investment on key market segments – facial skin care, bath and body care, and hair care – launch new products to reinvigorate the 20 brands, and increase their online presence by scaling up digital marketing and e-commerce teams. Improving direct to consumer sales channels will help enhance gross margin, too. Super Facialist has been singled out as a key brand and one which Mr Higham plans to grow into a brand generating £10m a year of net sales by 2025.
Interestingly, Mr Higham also notes that having secured gift set orders for the all-important autumn/winter trading period, and with plans in place for strong promotional programmes, the fourth quarter will only be down slightly year-on-year. I don’t think investors looking through their rear-view mirror have grasped this, nor the fact that internal cash flow will be used to fund investment in the brands rather than tapping the hefty cash pile.
The point is that with gross margin stable at 35 per cent, and operating costs and central costs relatively fixed at £5.7m, then once annual revenue hits £16m then operating profit rises sharply given the operational gearing of the business. The possibility of a better outcome this year is simply not being priced into the shares which are trading on a 15 per cent discount to book value and are backed 90 per cent by net cash on the balance sheet.
So, although the shares are one of the laggards in my market-beating 2020 Bargain Shares portfolio, the potential for a sales recovery this financial year, coupled with scope for earnings accretive acquisitions, make them a very interesting 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.
