Bagging a value stock hat-trick

Watkin Jones (WJG:179p), a developer specialising in purpose-built student accommodation (PBSA) and build-to-rent (BTR) housing, issued a pre-close trading update while I was on annual leave earlier this month. It’s worth commenting on for several reasons.

Firstly, a strong second-half recovery means that operating profit for the 12 months to 30 September 2020 will be in the range £48m to £50m on revenue of £350m. Admittedly, that’s still down on the £54m operating profit reported in the 2019 financial year, but it’s bang in line with house broker Peel Hunt’s full-year adjusted pre-tax profit estimate of £45m when I last suggested buying the shares, at 142p, at the interim results (‘Exploit cash-rich value plays, 15 May 2020). Please note that the profit guidance is stated before exceptional items: £6m for Covid-19 disruption; £15m for cladding replacement costs, as previously disclosed; and a £1.9m impairment charge on six legacy leased PBSA assets. On this basis, expect underlying earnings per share (EPS) of 14.4p and a payout of 7.2p a share based on the board’s policy of maintaining two times dividend cover.

Secondly, chief executive Richard Simpson notes “growing evidence that institutional investors are beginning to recover their appetite for forward funding developments in both PBSA and BTR.” He has a point as the directors also announced the forward sale of two PBSA schemes (York and Bristol) for £48.4m (delivery in the 2022 financial year) and are “in negotiations on further potential sales”. Importantly, margins achieved are in line with previously guided levels.

Thirdly, the group’s development pipeline now comprises 4,350 BTR apartments and 8,450 PBSA beds, of which 857 apartments and 3,192 beds are slated for delivery in the 2021 financial year. Watkin Jones has forward sold all schemes for delivery in the 2021 financial year apart from 462 beds, which are in negotiation. The revenue visibility from these schemes underpins Peel Hunt’s expectations of 10 per cent EPS growth to 15.9p to support a 7.9p-a-share dividend. True, those forecasts have been reined backed sharply – Peel Hunt had previously forecast a £70m pre-tax profit – but it’s growth nonetheless and is heavily de-risked given the forward funding business model.

Fourthly, Watkin Jones’ balance sheet remains in a robust state, closing with net cash of £90m at the 30 September 2020 year-end, a sum worth 35p a share. The group is incredibly well placed to capitalise on further selective land acquisitions. It also means that the shares are rated on a cash-adjusted price/earnings (PE) ratio of 9 for the 2020-21 financial year and offer a solid 4.4 per cent prospective dividend yield. That is not expensive by any means especially as analysts are predicting a recovery in pre-tax profits close to the 2019 record high of £52.9m in the 2021-22 financial year, an expectation backed up by the forward development pipeline.

Watkin Jones' asset-light business model, strong cash generation and ability to pay a progressive dividend were major bull points when I suggested buying the shares at the IPO ('A profitable education', 3 April 2016). The board subsequently paid out 26.55p a share of dividends by the time the share price had surged through my 275p target price (‘Building shareholder value’, 14 January 2020), hitting a record high of 299p in mid February this year, or treble the IPO price.

Interestingly, the shares have traded in a range between 126p and 183p since the stock market crash, and are tantalisingly close to breaking out through the upper trading band. It would be a significant move. I also feel that a chart break-out could prompt a rerating to the 240p-250p range, and one warranted on fundamentals. In fact, at the lower end of that range, the shares would still only be rated on a cash-adjusted PE ratio of 13 for the 2021-22 financial year. Strong buy.

Parkmead’s multiple valuation catalysts

• Gas prices rebound sharply since the summer
• Platypus and Pitreadie projects offer potential share price catalysts 

Prospects for Parkmead (PMG:34p), a small-cap oil and gas exploration and development company, are far better than investors are pricing into its low-ball valuation. The company’s market capitalisation of £35m is half net asset value of £71m even though there are potentially strong share price drivers on the horizon.

Firstly, natural gas prices have rebounded to €14 per megawatt hour (MWh) from a low of €5 per MWh in June, having previously fallen from €27.7 per MWh in October 2018. Parkmead owns interests in a low-cost onshore gas portfolio in the Netherlands, which has an average operating cost of $9.9 per barrel of oil equivalent, or less than a quarter of the current spot price. The rebound in prices will produce valuable cash flow in what remains a low commodity price environment. It also supports house broker FinnCap’s pre-tax profit estimate of £0.7m on revenue of £4.8m for the 2020-21 financial year, a sharp improvement on the £0.8m pre-tax loss in the year just ended.

Secondly, even though the move towards renewable energy is clearly gathering momentum, the fact is that the UK will be reliant on gas for decades to come while green energy supply is ramped up and the requisite infrastructure is put in place. Parkmead is well placed to benefit on two fronts as it has a 15 per cent working interest in the Platypus gas field in the UK Southern North Sea, located 10 miles north-west of the West Sole gas field, which is targeting project sanction in 2021. Dana Petroleum, CalEnergy and Zennor Petroleum are its heavyweight industry partners.

Importantly, Parkmead’s cash pile of £25.7m (24p a share) is more than sufficient to fund its estimated $21m (£15.7m) share of development costs based on a two-well sub-sea tie-back to route gas through a 23km pipeline to Perenco’s Cleeton platform and onwards to the Dimlington gas terminal for processing. Analysts estimate Parkmead’s 15 per cent stake has an unrisked net present value (NPV) of $10m (7.4p a share) based on a long-term UK gas price of 45p per therm and a 10 per cent discount rate. Increase the gas price to 55p per therm and lower the discount rate to 8 per cent and NPV doubles to 14.2p, or half Parkmead’s share price.

Thirdly, Parkmead purchased 2,320 acres of land and property in Aberdeenshire for £8.5m last year. Half the land is adjacent to the Mid Hill Wind Farm which operates 33 Siemens wind turbines with a total generating capacity of 75MW. The company is conducting an analysis of the sites to assess the potential for the installation of wind turbines, a solar farm and a biomass production facility. Analysts believe that a 20 MW wind farm on 1,236 acres of the land is conservatively worth £30m at start-up (£1.52m per MW) and supports an unleveraged NPV of £9m (8.6p a share) to Parkmead, and perhaps significantly more .

The point is that Parkmead’s cash pile and the Aberdeenshire land backs up almost all the current share price, so you are getting a free ride on the Netherlands gas fields as well as any upside from Platypus. In fact, the current valuation ascribes nil value to any of the company’s exploration and production blocks in the North Sea (book value of £36m, or 33p a share).

Admittedly, Parkmead’s shares have had a rollercoaster ride since I included them, at 37p, in my 2018 Bargain Shares portfolio, having hit a high of 83p that year before giving back all the gains and more. However, investors are starting to warm to the investment case since my last article (‘Four companies offering value investment opportunities’, 1 April 2020), and I expect that to continue. On a bid-offer spread of 33p to 34p, the shares rate a buy.

Venture Life fundraise scales up acquisition led strategy

• Placing and open offer to raise £34m
• Acquisition targets identified

Aim-traded Venture Life (VLG:92p), a developer, manufacturer and distributor of products for the self-care market, has announced a £34m placing and £2m open offer to fund its successful acquisition strategy.

The company is in an earnings upgrade cycle, the key reason why the shares have more than doubled since I initiated coverage at 45p in my May 2019 Alpha Report. This reflects management’s success in pursuing acquisition-led organic growth by seeking out underinvested brands (UltraDex, Dentyl and PharmaSource), taking manufacturing in house to create synergy benefits and improving sales through its domestic and international distribution networks. Venture has developed its own products successfully, too. Moreover, with 40 per cent spare capacity available at its Italian manufacturing facility, the company can raise production without materially increasing overheads to drive operating margins even higher.

Venture’s board has identified three acquisition targets to do just that:

■ Project Vulcan. The target owns four brands whose main products are focused on oncology support therapies to treat the dermatological and oral side-effects of cancer treatments. Currently they are sold through third-party distributors in the EU, as well as some other global markets with several new territories preparing for launch in 2021. Venture’s directors see an opportunity to increase the distribution of the brands' products into more territories using its own network of local partners, along with new partners. In 2019, Vulcan generated £3.5m in net sales and an estimated cash profit in excess of £1.2m. The £5.5m consideration equates to a reasonable 4.5 times cash profit.

■ Heritage brand within the UK and UK oral care market. Its product can be manufactured internally by Venture and there is scope to expand its niche customer base in the UK and overseas through the company’s distribution network. Last year, the business generated £3m in net sales on a margin of more than 30 per cent. The acquisition price is likely to be in the region of £5m.

■ A well-known heritage dermatological brand. As with the two other acquisitions, Venture plans to expand the product's distribution into global markets through its own network and manufacture products internally. The estimated consideration payable will be in the range of £15m to £20m.

The fact that the £34m placing proceeds have been conditionally placed at 90p with institutional and other investors highlights significant backing for the scaling up of Venture’s acquisition strategy. It’s also likely to lead to material upgrades in due course given the accompanying boost to operating profits and margins.

Please note that in addition to the fundraising Venture’s senior management team intends to sell 8.17m shares, but will retain 6.4m shares – equivalent to 5.1 per cent of the enlarged share capital – that are subject to a 24-month lock-in. I am not unduly concerned as their retained shareholdings and share options provide them with significant skin in the game. The one-for-37 open offer at 90p is worth taking up, and the shares continue to rate a buy.

Finally, I have analysed 13 small-cap companies in the past seven days including four high-growth technology firms at the tail end of last week.

■ 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].

November Promotion: Subject to stock availability, the books can be purchased for the promotional price of £12.50 each plus postage and packaging, or £25 for both books with free postage and packaging.

They 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. Details of the content can be viewed on www.ypdbooks.com.

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