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Four Bargain Shares buying opportunities

Shrewd management of an engineering group and an inject technology company are working their magic at turning around previously underperforming businesses. Simon Thompson also highlights the undervaluation of a building service contractor and a challenger bank
October 1, 2020

Avingtrans’ (AVG:282p), management team, led by chief executive Steve McQuillan and finance director Steven King, have an enviable track record of acquiring and turning round loss making businesses before selling them on, the reason why I backed them in my 2017 Bargain Shares Portfolio. The engineering company designs, manufactures and supplies original equipment, systems and after-market services to the energy and medical sectors.

The directors have been weaving their magic again on the two acquisitions made in the first half of the 2019/20 financial year: Booth Industries, a Bolton-based designer and maker of fire doors, blast doors and wall systems; and Michigan-based Energy Steel, a manufacturer of machined products to the civil nuclear power industry. They had been starved of investment at the time of purchase, and were ripe for restructuring. Measures taken include eliminating surplus leased space, and investing heavily in working capital.

The fact that these two businesses have completely reversed a combined first half pre-tax loss of £900,000 into a £1.05m second half profit highlights just how well the integration has gone. Moreover, a day before releasing annual results, Booth announced a thumping multi-year contract win worth £36m to supply cross passage doors for the new HS2 rail link to take its order intake to well over £50m in little over a year.

Energy Steel has been reaping supply chain savings, and is also benefiting from cross-selling opportunities with the Vermont based nuclear business that Avingtrans acquired as part of the Hayward Tyler acquisition in 2017. Hayward Tyler has over 600 pumps in active service in nuclear applications globally, so is well placed to take advantage of market demand created by obsolescence, product refurbishment and engineered design solutions for the US nuclear industry which accounts for 30 per cent of the world’s nuclear electricity. It’s prospering in other regions, too. New contract wins awarded in the nuclear sector include one in France worth $1m, and a £2.2m win in Dubai.

Overall, the sector accounted for around 20 per cent of Avingtrans’ £113m record revenue in the financial year. The robust performance from nuclear, and the benefit of acquisitions, helped drive annual pre-tax profit up by 11 per cent to £5.9m and deliver 18 per cent higher earnings per share (EPS) of 16.9p. Moreover, buoyed by an order book that already covers 85 per cent of broker finnCap’s revenue estimate of £119m for the 2020/21 financial year, analysts are forecasting another double-digit rise in pre-tax profit and EPS to £7.3m and 20.1p, respectively. On this basis, the shares are rated on a modest price/earnings (PE) ratio of 14.

Although the dividend was passed – the directors didn’t feel it appropriate to pay one given they had taken around £1m of government support during the Covid-19 pandemic – the board is committed to reinstating it, having paid out 9.6p a share since I first suggested buying the shares at 200p in 2017. Analysts are predicting a 4p-a-share pay-out at a cost of £1.25m, a sum easily covered by forecast free cash flow of £5.4m, the latter should also help halve net debt to £3.8m.

I last suggested buying the shares, at 250p (‘Deep value buys’, 13 July 2020), and priced on an unwarranted 16 per cent discount to my 335p-a-share sum-of-the-parts valuation, I continue to see further upside. Buy.

2017 Bargain shares portfolio performance
Company nameTIDMOpening offer price on 03.02.17 (p)Bid price on 01.10.20 (p) or exit price (see notes)DividendsTotal return (%)
BATM Advanced Communications (see note seven)BVC19.251160547.0
Kape Technologies (formerly Crossrider)KAPE47.91603.55241.4
Chariot Oil & Gas (see note one)CHAR8.293.76047.3
Avingtrans AVG2002741142.5
Cenkos Securities (see note two)CNKS88.4251069.530.6
Manchester & London Investment Trust (see note three)MNL291.653773.028.4
H&T HAT289.7526632.43.0
Management Consulting Group (see note five)MMC6.18360-3.0
Bowleven (see note four)BLVN28.95.515-6.1
Tiso Blackstar Group (see note six)TBG55180.54-66.4
Average    86.5
FTSE All-Share Total Return  64856327 -2.4
FTSE AIM All-Share Total Return 9771106 13.2
Notes:      
1. Simon Thompson advised selling two-thirds of the Chariot Oil & Gas holding at 17.5p on 3 April 2017 ('Bargain shares on a tear', 3 April 2017). Simon subsequently advised using some of the profits  to participate in the one-for-8 open offer at 13p a share ('On the earnings beat', 5 Mar 2018) and to buy shares at 4p ('Chariot's North African adventure', 17 April 2019).
2. Simon Thompson advised selling the Cenkos Securities holding at 106p on 3 April 2017 and the 106p price quoted in the above table is the exit price on the holding ('A profitable earnings beat', 3 Apr 2017). Please note that Simon has since included the shares in his 2020 Bargain Shares Portfolio and  rates the shares a buy ('exploiting cash rich value plays', 21 May 2020).
3. Manchester and London Investment Trust paid total dividends of 3p a share on 2 May 2017. Simon Thompson then advised selling half of the holding at 366.25p on 26 June 2017 ('Top slicing and running profits', 26 June 2017), and selling the remaining half at 377p ('Bargain shares second chance', 17 August 2017). The 377p price quoted in the table is the final exit price.
4. Simon Thompson advised banking profits on half your holdings in Bowleven at 33.75p (‘Hitting pay dirt', 9 Apr 2018). The company subsequently paid out a special dividend of 15p a share on 8 February 2019 and the balance of the holding was sold at 5.5p ('Taking stock and profits', 9 December 2019).
5. Simon Thompson advised to sell Management Consulting's shares at 6p in February 2018 (‘How the 2017 Bargain share portfolio fared’, 2 February 2018). The price quoted in the table is the 6p exit price.
6. Tiso Blackstar has transferred its UK listing to the Johanesburg Stock Exchange. Price quoted is sterling equivalent bid price at current exchange rates. 
7. Simon Thompson advised banking profits on half your holdings in BATM shares at 49.9p ('Bargain Shares: Exploiting pricing anomalies and top-slicing', 3 December 2018) and subsequently bought back the shares at 43.5p ('BATM armed for a re-rating', 11 July 2019). 
Source: London Stock Exchange share prices.

 

Xaar’s recovery on track

I had informative results call with the new management team at Cambridge-based Xaar (XAR: 113p), a leader in the development of inkjet technology and maker of piezoelectric drop-on-demand industrial inkjet printheads. They have been weaving their magic, turning around the fortunes of a business that had plunged into hefty losses under former management.

In the first half, Xaar’s print head and engineered printing solutions (EPS) divisions returned to profitability, reporting combined cash profits of £1m on revenue of £23.6m. Working capital management has improved, too, one reason why net cash of £23.9m (30.5p a share) is only slightly down since the start of the year.

The company is winning new business, too. Chief executive John Mills revealed that Xaar won 30 new accounts in the period, having restructured the bulk printhead business and taken the decision to sell directly to original equipment manufacturers (OEMs), thus avoiding a previous conflict of interest in aftermarket sales. He also highlights “an increasing number of customers in our account pipeline”.

A key take for me is the eye-catching 75 per cent conversion rate on those contract wins. This implies a marked improvement in the attitude of OEMs to do business with Xaar, a clear validation of the new board’s customer-centric strategy. The other take is the new product launches slated to increase the company’s addressable market, and with the engagement of OEMs in this process. The use of aqueous fluids in future products will be a “significant development”, says Mr Mills, adding that the company is also exploiting the valuable IP developed in its Thin Film technology programme to develop new products and give it a competitive advantage.

Admittedly, increased investment in its cutting-edge 3D printing business led to Xaar reporting a pre-tax loss of £1.1m. However, product development and testing is progressing well, and Stratasys, a leading 3D printing company, has a call option (expiring in December 2022) to buy out Xaar’s 55 per cent stake in this operation for £26.4m (34p). I wouldn’t bet against it doing so.

So, even though the share price has surged since I first suggested buying, at 36.4p, when my 2020 Bargain Shares Portfolio was published online (magazine price 38.5p), I feel the re-rating has some way still to run. That’s because Xaar’s market capitalisation of £88m only equates to a 35 per cent premium to net assets of £65m (of which the Stratasys minority interest accounts for £5.4m) even though the trading outlook is positive, both the print head and EPS divisions have returned to profitability, Xaar retains £23.9m of net cash and could realise a further £26.4m cash windfall in a couple of years’ time. Buy.

2020 Bargain shares portfolio performance
Company nameTIDMMarketOpening offer price 07.02.20 Latest bid price 01.10.20 DividendsPercentage change (%)
XaarXARMain 42p110p0.0p161.9%
Metal Tiger (see note two)MTRAim11.8p23p0.0p94.9%
CreightonsCRLMain44p49p0.0p11.4%
NorthamberNARAim54.9p58p0.3p6.2%
Chenavari Capital Solutions (see note one)CCSLMain61.4p35p0.0p-5.5%
Anglo Eastern PlantationsAEPMain570p510p0.4p-10.5%
CIP Merchant CapitalCIPAim57p50p0.0p-12.3%
Cenkos SecuritiesCNKSAim56p46p0.0p-17.9%
Brand ArchitektsBARAim 160p120p0.0p-25.0%
PCFPCFAim33.3p18p0.4p-44.7%
Average      15.9%
FTSE All-Share Total Return index7,7966,327 -18.8%
FTSE Small-Cap Total Return index9,3007,958 -14.4%
FTSE AIM All-Share Total Return index1,0991,106 0.6%
Note 1. Chenavari Capital Solutions made a compulsory capital redemption of 34.73 per cent of the share capital at 85.72p a share in March 2020, and subsequent compulsory capital redemption of 21.9 per cent of the share capital at 72.93p a share in July 2020. The total return takes into account the capital redemptions. The company delisted its shares from AIM on 30 September at a mid-price of 47.5p, and the board plans to make further compulsory capital redemptions in due course.
Note 2. Metal Tiger shares consolidated on the basis of one share for every 10 shares previosuly held on 1 July 2020.
Source: London Stock Exchange. 

 

T Clarke in bullish mood

Building services contractor TClarke (CTO: 90p) has issued a bullish trading update, reinstated profit guidance and declared a maintained interim dividend of 0.75p a share (ex-dividend: 15 October).

The directors anticipate this year’s turnover and underlying operating profit will be around £240m and £6m, respectively. Importantly, having seen operating margins fall from 3 per cent in the first quarter to break-even during the second quarter lockdown, profitability has now returned to pre-Covid-19 levels, albeit this has been helped by £4m of annual costs savings of which £2.5m will benefit this year’s results.

Moreover, with the benefit of a near record forward order book of £410m, and high levels of bidding opportunities, prospects for next year are encouraging, too. A book-to-bill ratio of one times is underpinned by management’s focus on growth sectors, largely in the  public sector, and data centres. The diversified business mix also allays fears that the company would be hit by a downturn in the London office market.

The balance sheet is in decent shape, too, as house broker Cenkos is pencilling in closing net cash of £4.5m. For the 2021 financial year, analysts are estimating a recovery in revenue to £307m (still 8 per cent below 2019) and a 50 per cent surge in operating profit to £9m. On this basis, expect EPS of 15.4p and an annual dividend of 4p per share.

I first suggested buying the shares at 90p (Alpha Research: ‘Profit from a buoyant earnings cycle’, 7 December 2018) and last reiterated that view at the interim results (‘Small-caps under the radar, 27 July 2020). Trading on a less than four times 2021 operating profit estimates to enterprise valuation, backed by a strong bid pipeline and contracted order book, and offering decent dividend prospects, the pricing anomaly is worth exploiting. Buy.

 

PCF’s improving trading prospects

Aim-traded specialist bank PCF (PCF:19.5p) has issued a resilient second half trading update ahead of annual results in early December.

PCF has remained open for business to finance both SMEs and consumers,  focused lending on prime credit grades – prime borrowers accounted for 83 per cent of lending during the year compared to 74 per cent in 2019 – and increased its loan portfolio by 30 per cent to £435m including 9 per cent growth in the second half. The company remains alert to the risk of higher unemployment levels though, so has been underwriting cautiously in terms of loan-to-value and customer quality.

Importantly, the level of forbearance has reduced considerably since the release of interim results, currently accounting for 12 per cent of the portfolio down from 32 per cent in early June (‘Funded for growth’, 3 June 2020). Consumer motor finance represents around half of all lending and requests for payment holidays here are low. New loan demand is being driven by a change in travel preferences by consumers away from public transport, and motorhome finance in the leisure market.

PCF has also seen resilient demand and a healthy pipeline of transactions in its fledgling bridging finance operation, in part due to rivals pulling out of the market owing to liquidity constraints. This has allowed the company to build new introducer relationships and good quality new business on attractive terms.

In business asset finance, forbearance levels have improved gradually with many borrowers having asked for assistance more as a precaution than a necessity. It’s worth noting that SMEs have been supported by considerable government support and PCF has significant asset backing on lending in this segment which mitigates bad debt risk.

True, we will have to await the outcome of PCF’s IFRS9 impairment modelling (against the latest data and for various economic stress scenarios) to find out the level of loss provisioning for the 2020 financial year. However, prior to the Covid-19 pandemic analysts had factored in £3.7m of impairment losses into their pre-tax profit estimate of £10.7m, based on operating income of £29.4m and a closing loan book of £450m. The point being that with £52m of PCF’s £435m loan book currently in forebearance, and PCF’s market capitalisation of £47.5m well shy of its £60.2m book value, the shares are already pricing in an Armageddon scenario whereby all this year’s profits will be wiped out by impairments. I would beg to differ.

The laggard in my 2020 Bargain Shares Portfolio is priced to motor off the market’s bargain basement forecourt, and the shares are worth buying ahead of the annual 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].

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.