It’s important to distinguish between valuation anomalies and value traps. Some companies are lowly rated for a reason. For instance, if quality of management, pricing power, profit margins, cash flow generation, return on capital and economic value added – the rate of return (ROR) over a company's cost of capital – are below par, then don’t expect investors to pay a full valuation for a slice of the action.
However, as I pointed out in my 2021 Bargain Shares portfolio, investors regularly overlook decent under-researched small-cap companies to such a degree that they can trade on unwarranted ratings discounts to larger peers. Of course, you need a catalyst to narrow the valuation discrepancy, so it pays to identify when one is likely to materialise. Nonetheless, when investors cotton on to the anomaly, the discounts can narrow markedly.
That’s exactly what I expect to happen with ThinkSmart (TSL), which is trading well below the value of its assets after accounting for all liabilities. In the case of currency manager Record (REC), prospects for a ramp-up in earnings is simply not reflected in a cash-adjusted forward price/earnings (PE) ratio of 9, nor a prospective dividend yield of 9 per cent. It’s a similar story at Hargreaves Services (HSP:296p), a diversified industrial services group, while building materials group SigmaRoc (SRC:70p) is in a strong upgrade cycle that continues to gain traction.
ThinkSmart’s anomalous share reversal on FCA ruling.
- UK financial regulator advises regulation of 'buy now, pay later' credit deals
- Share prices of Clearpay owners Afterpay Touch and ThinkSmart diverge markedly
Investors in Aim-traded finance company ThinkSmart (TSL:79p) have overreacted to the UK financial regulator’s recommendation that'buy now, pay later' (BNPL) credit deals offered by internet retailers should be covered by its rules. It’s actually good news for BNPL fintech companies such as Klarna, Paypal and Clearpay, which take a commission from the online retailer to fund a customer’s retail purchase and then collect the full purchase amount from the customer through more manageable interest-free payments.
The finances of 5m consumers in the UK who opted to use BNPL finance to make £2.7bn of online purchases since the start of the Covid-19 pandemic will be subjected to greater scrutiny in future, albeit it could take 12 months for UK legislation to be passed. BNPL finance agreements don’t currently show up on hard credit searches, which has enabled some over indebted consumers to take out multiple short-term credit agreements with different fintech finance providers. Clearly this increases the risk of them defaulting. By regulating the sector, the default rate will diminish. This can only be good for both consumers and BNPL companies. Moreover, tighter regulation creates a compliance requirement and a barrier for new BNPL funders, so should act to protect market share of reputable operators such as Clearpay.
This helps explain why the stock price of Afterpay Touch (Aus:APT), a A$43bn (£23.9bn) market capitalisation Australian Stock Exchange-listed technology group that owns 90 per cent of Clearpay, has risen by 11 per cent to a record high of A$151 following the Financial Conduct Authority’s recommendation. However, ThinkSmart’s share price has fallen 5 per cent even though the company’s 10 per cent (6.5 per cent fully diluted) stake in Clearpay is subject to call/put arrangement between the two parties, the agreed principle in determining the valuation being Afterpay’s market capitalisation. Effectively, ThinkSmart’s shares are trading on a 42 per cent discount to the 125p-a-share read-through value of the Clearpay stake (after applying a liquidity discount) and 10p a share of the company’s other net assets.
As the dust settles, and Clearpay continues to deliver its explosive growth – there is no reason for consumers to stop using BNPL interest-free finance at the point of sale just as they will continue to use credit cards offering interest-free purchases – I fully expect ThinkSmart’s shares to recover the lost ground and make significant new highs above 88.5p, too.
Having first suggested buying the shares, at 14p, in my April 2020 Alpha Report, this is a repeat buying opportunity. Buy.
A record result
- Assets under management equivalent (AUME) exceed $70bn for first time
- US$5.9bn high-margin dynamic hedging and multi-strategy inflows
Third-quarter results from currency manager Record (REC:51p) highlight a business that is starting to gain real traction under the leadership of chief executive Leslie Hill, who was appointed last year. The $8bn (£5.8bn) dynamic hedging mandate win announced last autumn added $4.7bn to AUME in the latest quarter, and Record also enjoyed $1.2bn of inflows from higher-margin multi-product strategies. AUME increased 13 per cent to a record high of $74.6bn in the three months to 31 December 2020. Mrs Hill also notes Record is making good progress in developing a market-first Dublin-based Currency Impact/ESG fund [in collaboration with a European wealth manager] with launch expected before the 31 March 2020 financial year-end.
The higher base of AUME and more favourable revenue mix prompted house broker Panmure Gordon to push up its earnings per share (EPS) estimates to 2.8p (from 2.6p) and 4.5p (from 3.8p) for the 2020-21 and 2021-22 financial years, respectively. Expect identical payouts, too – a reflection of the board’s policy of paying out almost all post-tax earnings to shareholders as dividends. The board can afford to do so because shareholders’ funds of £25.7m includes cash of £19.3m (9.7p a share) and the business is highly cash-generative. On this basis, Record’s shares are rated on a cash-adjusted forward price/earnings (PE) ratio of 9, and offer a prospective dividend yield of 9 per cent.
The shares have delivered a 33 per cent total return since I included them in my market-beating 2018 Bargain Shares portfolio, and are also well up since I covered the interim results (‘Deep value and high yielding value opportunities’, 25 November 2020). More importantly, with the tailwind of multiple AUM and profit growth drivers, the outlook from both an operational and investment perspective remain positive. For good measure, Record’s shares are on the verge of registering a major chart break-out, confirmation of which would be a move above the three-year high of 51.3p. Panmure’s 65p target price should prove conservative, so much so that I am raising my own target price to 75p. Buy.
SigmaRoc’s earnings momentum building up
- Third earnings beat since September
- Positive order momentum has continued into 2021
SigmaRoc (SRC:70p), a company pursuing a buy-and-build strategy in the heavy building materials sector, has issued its third earnings beat since September.
In a pre-close trading update released ahead of annual results on Tuesday, 13 April 2020, the directors revealed that the group has maintained strong trading since the last update in early December. Raised guidance points to a 64 per cent rise in annual cash profit to £23.8m on 77 per cent higher revenue of £124m, both of which represent mid-single-digit percentage points ahead of house broker Peel Hunt’s previously upgraded forecasts. In December, Peel Hunt pushed through an 18 per cent profit upgrade and that followed a 42 per cent upgrade in September. That’s quite some momentum, a reflection not only of the positive market backdrop, but also the operational benefits being reaped from management initiatives and acquisitions.
More importantly, the positive tailwind driving end-market demand has continued into 2021, especially across repair, maintenance and improvement (RMI) and infrastructure products. SigmaRoc is capitalising on the favourable trading conditions as all operations apart from its temporarily closed Channel Islands sites remain fully operational during the current national lockdowns. The group is well funded to take advantage of further earnings-accretive bolt-on acquisitions – net debt equates to less than a third of the group’s new £125m credit facilities – and well placed to continue beating analyst estimates. Indeed, predictions that a 13 per cent rise in 2021 revenue to £140m will drive up cash profit to £27.7m and lift EPS to 4.7p look conservative.
Trading on a relatively undemanding forward PE ratio of 14.5, I maintain the view that the potential for further earnings-accretive acquisitions and upside from a UK government-funded infrastructure boom (as part of its Covid-19 recovery strategy) are not priced in. An enterprise value to cash profit multiple of eight times based on 2021 forecasts is below the sector average, too.
So, having made a strong case to buy the shares, at 46p (Alpha Report: ‘A general election winner’, 12 December 2019), and subsequently upgraded my target to 80p at the start of this year (‘Four small-caps with upgrade potential’, 5 January 2021), I am raising my fair value target again to 85p, implying potential for 20 per cent additional share price upside. Buy.
Hargreaves Services banks another land deal
- Sale of 12.9 acres of land to Persimmon
- All bank debt eliminated
Interim results from Hargreaves Services (HSP:296p), a diversified industrial services group and brownfield land developer that is reaping the upside from a strategic transformation over the past four years, were in line with the full-year profit expectations I outlined when I last suggested buying the shares, at 270p (‘Four small-caps with upgrade potential’, 5 January 2021).
Of far more interest to me is the conditional sale of a further 12.9-acre land parcel at Blindwells, a major 1,600-unit residential development site located 15 miles to the east of Edinburgh. FTSE 100 housebuilder Persimmon (PSN) is paying £9.3m for the land, which has planning consent for 192 new homes. Completion is expected in the second half of the financial year to 31 May 2022. Hargreaves completed the sale of a slightly larger parcel to Bellway (BWY) on similar terms last month. The profit from these land deals provides further support for house broker N+1 Singer’s pre-tax forecasts of £7m and £10m for the 2020-21 and 2021-22 financial years, up from £4.9m in 2019-20. On this basis, expect annual dividends per share of 20p and 20.5p, respectively, with the 2022 payout covered 1.3 times by forecast EPS of 26.4p. At the current price, Hargreaves’ shares are priced on a modest forward PE ratio of 11 and offer an attractive prospective dividend yield of 6.9 per cent.
Moreover, elimination of all bank debt in December coupled with the receipt of dividends from HMRS, the German metals trading subsidiary in which Hargreaves owns a 49.9 per cent stake and which contributed a net profit of £0.9m in the latest half-year, adds further support to N+1 Singer’s payout forecasts.
Trading on an unwarranted 26 per cent discount to net asset value (NAV) of 400p and a conservative looking one, too (land is in the books at cost), I feel that the 320p target I outlined when I initiated coverage, at 206p (Alpha Report: ‘A high yielder offering significant hidden value’, 19 March 2020), will be surpassed. My new target of 350p is based on a fair value target PE ratio of 13.5 and dividend yield of 5.9 per cent based on 2021-22 forecasts. 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].
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Simon Thompson was named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards.
