Four small caps with upgrade potential

Upgrades can also reflect valuation discrepancies, some of which result from information voids in my under-researched small-cap hunting ground. A good example is Aim-traded investment venture capital company TMT Investments (TMT:835¢) which I flagged up when the shares were offered in the market at 580¢ (‘Exploiting share price dislocations’, 7 December 2020). It proved well timed. TMT has since revealed that Bolt, a leading international ride-hailing and transportation company, had raised US$182m in a funding round at a 64 per cent premium to the US$22.1m (76¢ a share) carrying value of TMT’s 1.63 per cent stake. Investors have also reacted positively to an US$87m (300¢ a share) potential profit windfall on TMT’s 10.85 per cent holding in Backblaze, a cloud storage and data back-up company that is eyeing up an US$1bn IPO.

My quartet of small-cap companies this week includes two more Ben Graham-inspired value plays.

SigmaRoc’s earnings momentum underrated

• New enlarged banking facility and placing to support acquisitions.
• Major earnings beat for 2020.

SigmaRoc (SRC:64p), a company pursuing a buy-and-build strategy in the heavy building materials sector, has issued a major earnings’ beat, raised £12.4m in a placing and announced a new expanded £125m five-year banking facility.

The news has been well received as SigmaRoc’s share price has rallied 25 per cent since I covered the interim results (‘Below the radar small-caps navigating the Covid crisis’, 9 September 2020), and has now surpassed the 60p target price I outlined when I first suggested buying, at 46p (Alpha Report: ‘A General Election winner’, 12 December 2019). More importantly, there is scope for further share price upside, so much so that I am upgrading my target price to 80p for multiple reasons.

Firstly, following an 18 per cent profit upgrade, analysts at Peel Hunt now expect 2020 pre-tax profits to rise 31 per cent to £11.8m to deliver earnings per share (EPS) of 4.1p. This follows a 42 per cent earnings upgrade in September, highlighting ongoing strong momentum in the business and the fact that recent lockdowns have not materially impacted operations nor dented customer demand. The upgrade also highlights the operational benefits that are being derived from both management initiatives and acquisitions.

Secondly, SigmaRoc is a highly cash generative business and one that is generating an attractive free cash flow yield of 8.6 per cent. Forecast year-end net debt of £40m is £2m lower than at the start of 2020 even though SigmaRoc spent £15m on acquisitions including the purchase of the outstanding 60 per cent interest in South Wales quarrying group G.D. Harries (GDH). That acquisition was made on a reasonable enterprise valuation to cash profit multiple of 7.6 times. Factoring in a full 12-month profit contribution from GDH, Peel Hunt expects 2021 pre-tax profit and EPS of £15.5m and 4.7p, respectively, with the risk skewed firmly to the upside in my view.

This means that the shares are priced on a relatively undemanding forward price/earnings (PE) ratio of 13.5, a rating that fails to factor in potential for further earnings accretive acquisitions nor upside from a UK government funded infrastructure boom (as part of its Covid-19 recovery strategy) that is set to drive demand for SigmaRoc’s products even higher. The board clearly sees scope for further share price upside as no fewer than six directors purchased 374,000 shares in the placing. Buy.

Hargreaves Services exits coal market

• Speciality coal inventory sold off to de-gear balance sheet.

• Five-year major contract win with Drax.

Hargreaves Services (HSP:270p), a diversified industrial services group and brownfield land developer is reaping the upside from a strategic transformation over the past four years, culminating in the cessation of UK coal mining and the sale of its coal stocks.

The group has just sold off all its speciality coal inventories for £24m and expects to have no material coal inventory by its financial year-end (31 May 2021). HMRS, the German metals trading subsidiary in which Hargreaves owns a 49.9 per cent stake and which contributed a net profit of £2.1m in the 2019/20 financial year, is the counter party to the transaction. Hargreaves will market and arrange for the sale of the coal stock on a commission basis on behalf of HMRS, thus enabling HMRS to establish new commercial trading relationships with major UK purchasers while at the same time enabling Hargreaves to pay off all its bank debt.

The directors also reiterated full-year earnings guidance with analysts at joint house broker N+1 Singer maintaining expectations of a sharp rebound in pre-tax profit from £4.9m to £7m to deliver EPS of 18.6p. Moreover, with bank debt eliminated, and HMRS now able to repatriate dividends to its parent following completion of a carbon pulverisation plant, the board anticipates declaring a special dividend of 12p a share in the 2020/21 financial year. On this basis, analysts expect a 20p a share full-year dividend, rising to 20.5p in 2021/22 and 21p in 2022/23, the generous pay-out supported by a thumping free cash flow yield of 15 per cent for both financial years.

Importantly, Hargreaves is winning new contracts which are strongly supportive of EPS rising to 26.4p in 2021/22 as analysts predict. These include a five-year materials handling and maintenance contract at the Selby plant of power generator Drax commencing in April 2021. In addition, Hargreaves' specialist earthworks subsidiary is a strategic partner to the consortium (Kier/Eiffage/BAM/Forrovial) constructing the Chiltern Tunnels to Brackley section of the new HS2 railway. 

Shareholders can also expect an active second half of land deals as Hargreaves completes the sales of land parcels at Blindwells, East Lothian. The group’s joint venture, Unity, which is developing a 618-acre site surrounding the former Hatfield Colliery near Doncaster, is expected to complete the £25m sale of 32 hectares of land to a national retailer for construction of an 800,000 square feet distribution centre by the middle of this year.

Hargreaves share price has rallied by 31 per cent since I initiated coverage at 206p (Alpha Report: ‘A high yielder offering significant hidden value’, 19 March 2020), but still trades on an unwarranted 33 per cent discount to a conservative net asset value (NAV) of 403p (land is in the books at cost). A chart break-out above the December 2020 high of 278p looks firmly on the cards to set up a likely rally to the January 2020 high of 320p. That former high water mark is also my target price. Buy.

CIP Merchant Capital’s value proposition

• Portfolio outperforms FTSE All-Share in 2020.
• Holdings in CareTech and EKF Diagnostics performing strongly.

CIP Merchant Capital (CIP:52p), a Guernsey-based closed investment company that predominantly invests in listed equities by adopting a private equity style approach, is the laggard in my 2020 Bargain Shares Portfolio even though the company’s NAV per share has only declined from 84p to 80.4p in the past 11 months, far better than the fall in the FTSE All-Share Total Return index.

Moreover, CIP’s investment managers have been making some decent calls lately, hence the reason why NAV is heading back in the right direction. For instance, a couple of months ago they invested a further £2m at 452p a share in CareTech (CTH:522p), a heavily asset-backed provider of social care services with a £590m market capitalisation. It’s one of the largest companies listed on London’s junior market and a favourite of mine. Shares in Caretech have since rallied 15 per cent which means that CIP’s 1.23 per cent stake in the company is now worth £7.25m (13p a share).

CIP’s managers also made a smart call investing £1.1m in EKF Diagnostics (EKF:67p), 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. Following earnings upgrades in mid-November, EKF is now expected to deliver 2020 EPS growth of 176 per cent, implying the shares are rated on a PE ratio of 18. CIP’s stake is now worth £1.35m.

Shares in Orthofix Medical (US:OFIX), a $831m (£610m) market capitalisation Nasdaq-quoted medical devices company, have been flying, too, rising by 50 per cent since late September. CIP’s holding is currently worth £3.6m.

The point is that I estimate CIP currently holds £18m in cash (33p a share) so effectively the rest of its £28.6m market capitalisation is backed up by the stakes in Caretech and Orthofix alone. That gives you a free rideon  £15.6m (28p a share) of other holdings which include listed stakes in automotive services firm Redde Northgate (REDD), Milan-based digital marketing company Alkemy S.p.A, (IT:ALK) and Aim-traded global procurement software provider Proactis (PHD).

The holding in CIP has reduced the total return on my market beating 2020 Bargain Shares portfolio by 1.5 percentage points to 40.5 per cent and a narrowing of the unwarranted 35 per cent share price discount to NAV is well overdue. Buy.

MTI share price hits record high

• Robust end market demand.

• Double-digit profit growth expected in 2021 and 2022.

Shares in Israeli-based MTI Wireless Edge (MWE:76p) have increased 85 per cent in value on an offer-to-bid basis since I initiated coverage (Alpha Report: ‘Tapping into 5G and climate change technologies’, 4 September 2020), and have surpassed my 70p target. I would resist banking profit. That’s because investors are likely to continue to warm to MTI’s strong investment case given that its technology businesses operate in market segments that are displaying attractive structural growth: demand for next generation 5G networks; global warming and climate change; and increased defence budget spending.

Specifically, MTI sells 5G backhaul antennas to support mobile phone operators to roll out their 5G networks, helping to transfer the data from mobile users to the operator’s network; and wireless water control and management systems that address water scarcity by using Motorola's IRRInet state-of-the-art communication technologies. The military segment also provides a reliable income stream and enables MTI to reapply the technology developed in commercial markets. Robust customer demand is not only delivering contract wins, but robust earnings growth, too.

Indeed, house broker Allenby Capital expects 2020 pre-tax profit to increase by 25 per cent to US$4.3m on revenue of US$40.7m to produce EPS of 2.9p and support a 25 per cent dividend hike to 2.5¢ (1.9p). Analysts also forecast double-digit EPS growth to be maintained in 2021 and 2022, pencilling in EPS of 3.39p and 3.79p, respectively. The 2022 dividend is expected to be 20 per cent higher than in 2020. The directors can certainly afford to maintain their progressive dividend policy as MTI’s net cash has increased by 75 per cent in the past two years and is forecast to rise a further 25 per cent to US$9.5m (8p a share) by the end of 2022. On this basis, MTI shares are priced on a forward cash-adjusted PE ratio of 17.5, a rating that’s still not too punchy for a dividend paying technology company operating in market segments displaying material market growth.

In the circumstances, I am upgrading my target price to 90p based on an enterprise valuation to 2022 cash profit multiple of 15. 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].

Promotion: Subject to stock availability, both books can be purchased for the promotional price of £25 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.