The idea behind my Ben Graham inspired annual Bargain Shares Portfolios is simple: to invest in under-researched special situations where the true worth of a company’s assets is not reflected in its share price, usually for a temporary reason, but where there is a reasonable chance that it will be in due course.
In the same way that investors are inclined to overpay for a slice of high-growth companies, they have a habit of undervaluing asset-backed enterprises that have dropped out of favour. Of course, not all constituents of my portfolios deliver profitable outcomes, that’s the nature of investing and highlights why a portfolio approach is critical in diversifying risk.
But not every company needs to be a winner. That’s because my balance sheet approach has an uncanny knack of consistently uncovering under-researched companies on modest price-to-book valuations where likely catalysts could, and regularly do, drive a material rerating. In fact, my last five Bargain Shares Portfolios have each outperformed the FTSE All-Share index by at least 40 percentage points to date, and considerably more in some cases. Earnings momentum is by far the strongest catalyst.
For example, Cambridge-based technology group Xaar (XAR:151p) was a fallen angel when I included the shares in my 2020 Bargain Shares Portfolio. New management has successfully turned the business around, which has not only wiped out the previous share price discount to book value, but resulted in a premium rating. The holding has returned 250 per cent since portfolio launch in February. A big hat tip to stock screening guru Algy Hall who put me on the scent.
In fact, earnings momentum is why healthcare products manufacturer Creightons (CRL:57p) is one of the stars of this year’s portfolio and the laggard, specialist bank PCF (PCF:25p), should make up lost ground. I also flag up a valuation anomaly worth exploiting in another classic Ben Graham asset-backed play, Aim-traded finance company ThinkSmart (TSL:60p).
| Simon Thompson's Bargain Shares Portfolios Performance (2016-2020) | |||
| Year | Portfolio total return | FTSE All-Share total return | FTSE Aim All-Share total return |
| 2016 | 84.5% | 37.4% | 65.4% |
| 2017 | 91.0% | 9.8% | 26.4% |
| 2018 | 42.6% | 0.4% | 4.3% |
| 2019 | 49.7% | 3.9% | 20.7% |
| 2020 | 33.9% | -8.7% | 12.4% |
| Source: London Stock Exchange, FTSE International, Bargain Shares Portfolio total return calculated on offer-to-bid basis with dividends uninvested. Prices correct at market close on 9.12.20. | |||
Creightons’ eye-catching returns point to higher rating
■ Hygiene product sales drive 36 per cent first-half revenue growth.
■ The business is Brexit proofed.
Creightons (CRL:57p), a Peterborough-based manufacturer of beauty and healthcare products, has delivered record half-year results, a performance that more than warrants including the shares, at 44p, in my 2020 Bargain Shares Portfolio.
Buoyed by sales of hygiene products, sanitising gels and hand washes, primarily through its reinvigorated 'Pure Touch' brand, that are mainly sold to major UK retailers and Department of Health and Social Care as part of the NHS PPE procurement plan, Creighton’s first-half revenue surged by 36 per cent to £32.3m.
Admittedly, the boost to hygiene sales was partially offset by lower sales to private label and contract manufacturing customers that were impacted by Covid-19 related store closures. However, revenue through the company’s branded division, excluding hygiene-related products, continues to grow, driven by 180 per cent growth in internet sales, a full six-month contribution from Balance Active, the brand acquired in June 2019, and increased sales from the launch of its Body Bliss brand.
Although gross margin dipped slightly to 39.3 per cent due to Covid-19 related staff costs, increased use of air freighting to satisfy demand and a scarcity of raw materials that drove up prices, it is still highly respectable. The directors note that supply chains have normalised, and staff costs have reduced following some fine-tuning, so expect a better margin performance in the second half.
In any case, the £2.8m incremental gross margin earned easily covered Creighton’s higher administration and distribution costs, with the balance dropping through to profits. This operational gearing effect explains why half-year pre-tax profit surged 64 per cent to £2.9m, so outpacing revenue growth. Cash-flow generation is impressive, too. Operating cash flow of £3.8m enabled Creightons to increase investment in inventories by a quarter to £9.2m and trade debtors by more than a half to £13.1m. Closing net debt of £146,000 is minuscule and the company should return to a strong net cash position in the second half as stock and debtor balances decline from peak activity levels.
Importantly, the company has Brexit proofed its business, registering a new subsidiary in Ireland and establishing a German subsidiary to facilitate trading within the EU.
On a trailing price/earnings (PE) ratio of 9, and price-to-book value of 2 times, Creightons’ ability to generate an impressive 20 per cent-plus post-tax return on equity is still significantly underrated. A small dividend adds to the attraction. Buy.
PCF primed for 2021 profit recovery
■ Forbearance requests decline by almost half in past two months.
■ Consumer finance and bridging loans driving loan book growth.
I had an informative results call with Scott Maybury, chief executive of Aim-traded specialist bank PCF (PCF:25p), the laggard in my 2020 Bargain Shares Portfolio.
As I noted at the pre-close stage when I rated the shares a buy at 19.5p (‘Four bargain share buying opportunities’, 1 October 2020), the company has remained open for business to finance both small- and medium-sized enterprises (SMEs) and consumers, focusing lending on prime credit grades – prime borrowers accounted for 85 per cent of the £270m new business originations in the 12 months to 30 September 2020. Since the period end, Mr Maybury says that PCF has been lending £20m per month at similar credit grades, but remains alert to the risk of higher unemployment levels, so has been underwriting cautiously in terms of loan-to-value and customer quality. This explains why PCF’s net interest margin (6.9 per cent) is expected to trend towards 6.5 per cent in the 2020/21 financial year. The higher credit quality reduces default risk, no bad thing.
He also highlights a minuscule 2.3 per cent impairment charge in PCF’s £168m consumer loan book, where 93 per cent of lending volume is in prime grades and the average loan size is £18,000 for its 12,700 customers. Divisional lending grew by 14 per cent in the second half, buoyed by demand for used car finance (as people opt for private travel during Covid-19) and leisure finance (horseboxes, motorhomes and classic cars).
Bridging loans have also been in strong demand, the loan book here has grown from £13m to £59m in the past 12 months, with lending based on a sensible average loan-to-value ratio of 59 per cent. PCF generates interest income and fees of just shy of 8 per cent on that book.
The reason PCF’s annual underlying pre-tax profits halved to £3.9m on £26.6m of net interest income reflects £7.8m (£2.2m in 2018/19) of impairment charges on its loan book. Majority of impairments reflect IFRS9 provisioning on PCF’s £206m SME loan portfolio, where £18.7m of loans (accounting for 800 of the 5,800 business customers) are in forbearance, albeit that’s a marked reduction since May. Moreover, as trading for SME borrowers returns to some form of normality in 2021, then forbearance requests should decline further. Mr Maybury expects “significantly reduced impairments this year”.
Analysts at Equity Development reckon that PCF should be able to generate net interest income of £30.3m in the coming year to lift the loan portfolio to £552m. Deduct operating costs of £17m and impairment loss provisioning of 1.3 per cent of the loan book, and pre-tax profit could recover to £6.8m, an outcome that is not being priced into PCF’s market capitalisation of £62m, nor a modest price-to-book value of one times. The board will consider the payment of a dividend at the next interim results.
So, although PCF has reduced my 2020 Bargain Shares Portfolio’s total return by three percentage points to 33.9 per cent, albeit the portfolio is still handsomely outperforming the FTSE All-Share and FTSE Aim All-Share indices by 42 and 21 percentage points, respectively, I feel potential for an earnings recovery is being woefully underpriced. Buy.
Afterpay highlights ThinkSmart’s undervaluation
■ Hefty cash dividend paid out.
■ Afterpay share price closes in on record high post trading update.
Aim-traded finance company ThinkSmart (TSL:60p) has paid out a A$6.5m (3.3p a share) dividend from its A$18m (£10m) cash pile. Shareholders also received good news from Down Under after Afterpay Touch (APT:ASX), a A$31.3bn (£17.7bn) market capitalisation Australian Stock Exchange-listed technology group, announced a bullish trading update that has pushed its stock price close to a record high.
Afterpay’s stock price is material to ThinkSmart because the Australian technology group has a call option to buy out the UK company’s minority 10 per cent (6.5 per cent fully diluted) stake in Clearpay, a fast-growing UK payment platform that enables consumers to split the cost of their retail purchases into manageable interest-free payments. The agreed principle in determining the valuation is Afterpay’s market capitalisation. ThinkSmart has a put option to sell to Afterpay, too.
Bearing this in mind, Afterpay’s first-quarter trading update to 30 September 2020 revealed that Clearpay’s sales increased by 346 per cent year on year to A$300m. The growth of new customers has accelerated since then in both the US and the UK as the pipeline of new merchants goes live on its platforms. In fact, the UK business quadrupled sales to A$200m in November, a fourfold rise year on year, the segment accounting for around 10 per cent of both Afterpay’s record A$2.1bn monthly sales and the group’s customer base. Analysts at Sydney broking house Bell Potter tweaked up their target price on Afterpay’s shares to A$140.
The point is that the carrying value of ThinkSmart’s holding in Clearpay is set to materially increase in the UK’s company’s next accounts. The fully diluted stake was last valued at £53.7m (50p a share) at 30 June 2020 based on Afterpay’s stock price of A$61 and after applying a 20 per cent liquidity discount. It’s now A$110, implying a read-through valuation of £97m (91p a share) to which you can add cash and other net assets (mainly finance lease receivables) worth a combined 10p a share. On this basis, my sum-of-the-parts valuation is 101p a share.
I considered ThinkSmart for my 2020 Bargain Shares Portfolio, but in the event held off for a better entry point in my April 2020 Alpha Report. The share price is up 314 per cent on my 14p recommended buy-in price and is poised to break through last autumn’s all-time high of 69.5p. Buy.
Finally, I am now on annual leave until the first week of January.
■ 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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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.
