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Profit from the small-cap bull market

Simon Thompson highlights three TMT small-cap companies that offer share price momentum driven by strong earnings growth
Profit from the small-cap bull market

The current economic environment is ripe for investors to benefit from a dual investment strategy. Namely, focus on reasonably valued technology, healthcare, e-commerce and biotech companies that are set to continue delivering strong growth in the years ahead while at the same time taking advantage of undervalued, more traditional older economy companies that will be major beneficiaries of the global economic recovery.

Media companies are a leading indicator of the state of the economy as they are the first to see any uptick in activity from clients who previously held back on making investment decisions. In the UK, clients have faced the double whammy of Covid-19 and Brexit uncertainties. I want exposure here as I maintain the view that a mountain of cash that has been hoarded by consumers will be unleashed as we are untethered from our lockdown shackles. Marketing groups are one way of playing this theme and UK advertising and marketing specialist The Mission Group (TMG: 75p) is my preferred play.

I also see scope for a strong recovery in construction activity and institutional investment in certain segments of the property sector, another reason why I am so bullish on build-to-rent and student accommodation provider Watkin Jones (WLG:203p).

 

Mission’s recovery gathers momentum

  • 2020 pre-tax profits significantly ahead of market forecasts
  • Net debt slashed to £1.3m
  • Annual dividend reinstated

A strong second-half trading performance from UK advertising and marketing specialist The Mission Group (TMG: 75p) has recouped all of the first-half losses resulting from the Covid-19 pandemic. Annual pre-tax profit will exceed £1m, or three times higher than house broker Shore Capital’s £0.3m estimate. Mission has significant exposure to the healthcare and technology sectors, both of which have proved resilient through the Covid-19 pandemic and have helped the group stay profitable in the face of a 25 per cent fall in annual revenue.

Moreover, year-end net debt of £1.3m is materially below analysts’ £8m forecast, and well within borrowing facilities of £20m. This highlights strong working capital management and the decisive action to reduce the cost base. Around £700,000 a year has been saved by rationalising office requirements within the M25. The improvement in the group’s finances has also enabled the board to reinstate the previously deferred 1.53p-a-share final dividend. Mission’s management owns more than 40 per cent of the equity and is committed to a progressive dividend policy.

The latest forward guidance is another positive for shareholders. The directors predict that “on the assumption that the impact of Covid-19 is now past the worst and that the UK starts to see an economic recovery, the board sees no reason why 2021 pre-tax profit cannot return to pre-pandemic levels in a range between £9m-£10m.” Shore Capital is more conservative given that run rates may not return to pre-pandemic levels until the second half of this year, so has taken a more cautious view in its 2021 forecasts.

Nonetheless, the broking house still expects 2021 revenue to increase by 16 per cent to £71m and deliver a sevenfold rise in both pre-tax profit and earnings per share (EPS) to £7.1m and 6p, respectively. On this basis, a forecast 2.5p-a-share dividend is covered a healthy 2.4 times. This means that the shares are trading on a modest prospective price/earnings ratio of 12, offer a 3.5 per cent forward dividend yield and are priced 30 per cent below year-end book value of 101p.

The shares have produced a 44 per cent total return since I initiated coverage (Alpha Research: ‘Marketing highly profitable growth', 11 October 2018) and are showing strong positive momentum since I last suggested buying, at 58p (‘Simmering up for a strong second half and beyond’, 24 September 2020). In fact, they are on the cusp of breaking out above last summer’s highs around the 75p mark, beyond which a return to the 100p-110p pre-Covid-19 high water mark is a reasonable target. Ahead of annual results on Wednesday, 14 April 2020, I rate the shares a strong buy.

 

Kape Technologies posts earnings beat

  • Cash profits 7 per cent ahead of consensus
  • Integration of PIA ahead of schedule
  • Infrastructure upgrade to significantly reduce costs

Kape Technologies (KAPE:198p), a provider of cyber security software, has released a bullish pre-close update ahead of annual results on Wednesday, 17 March 2020.

It’s hardly surprising given that home working and remote working restrictions due to the Covid-19 pandemic has led to increased adoption of Kape’s cyber security software (which protects data security and privacy against piracy and phishing attacks). Demand for virtual private network (VPN) solutions that encrypt and secure internet connections has been rising notably in both North America and Europe, regions that account for almost three-quarters of Kape’s annual revenue. Kape is also benefiting from the transformational acquisition of Colorado-based Private Internet Access (PIA) at the end of 2019.

These strong drivers have delivered full-year cash profit of $39m, well ahead of previous guidance ($35m-$38m), on 85 per cent higher revenue of $122m. Margins shot up from 22 to 32 per cent, helped in part by a 31 per cent reduction in PIA’s operating expenses. On this basis, analysts at Progressive Equity Research forecast a trebling of full-year pre-tax profit to $34.4m, EPS of 15.8¢ (11.6p), up from 6.4¢ in 2019, and closing net cash of $25.7m.

Furthermore, higher marketing activity in the final quarter of 2020 has laid the platform for accelerated organic growth in 2021. In addition, Kape has completed a cutting-edge infrastructure upgrade that has significantly cut costs as well as enhancing the customer experience for its 2.5m paying subscribers, a tenfold increase since I first advised buying the shares, at 47.9p, in my 2017 Bargain Shares portfolio.

Analysts forecast a further increase in cash profits to $41.5m in the current year, but I expect this to be easily beaten. However, even on this basis, the shares are not highly priced on an enterprise value to cash profit multiple of 13 times, one reason why they have made decent headway since I last suggested buying at 170p (Four tech companies with high growth potential’, 18 November 2020). I expect the positive share price momentum to be maintained. A chart breakout above last summer’s highs around 225p would signal that a share price move towards my 275p target price is under way. Buy.

 

Exploit ThinkSmart’s undervaluation

  • Affirm stock price 145 per cent above Nasdaq IPO listing price
  • Afterpay stock price closes in on record high

Investors have pushed shares in alternative consumer finance provider Affirm (US:AFRM) 145 per cent above this month’s Nasdaq listing price, valuing the group at $29.6bn.

The IPO has also brought into focus the comparable valuation of Afterpay Touch (Aus:APT), a A$40.8bn (£23bn) market capitalisation Australian Stock Exchange-listed technology group that owns 90 per cent of Clearpay, a fast-growing UK payment platform that enables consumers to split the cost of their retail purchases into manageable interest-free payments. Aim-traded finance company ThinkSmart (TSL:85p) owns the other 10 per cent (6.5 per cent fully diluted), a stake that is subject to call/put arrangement between the two parties, the agreed principle in determining the valuation being Afterpay’s market capitalisation.

The carrying value of ThinkSmart’s holding was last valued at £53.7m (50p a share) based on Afterpay’s stock price of A$61 and after applying a liquidity discount. It’s now trading close to a record high of A$143.5, implying a read-through valuation of £126m (118p a share) to which you can add cash and other net assets worth 10p a share to give a sum-of-the-parts valuation of 128p. 

ThinkSmart’s shares are 486 per cent up on the 14p entry point in my April 2020 Alpha Report, and I anticipate further material upside as the valuation anomaly corrects itself. 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.