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Beating the market with three deep value stocks

Our small-cap stockpicking expert has been beating the market by focusing on technology, healthcare and deep value stocks
February 19, 2021
  • Deep value picks have helped drive Simon's outperformance 
  • Recent results from Avingtrans and Northamber prove company's stingy valuations
  • Land at a bargain price

I have been number crunching the investment returns from the 20 monthly Alpha Reports I have published since March 2019. Benchmarking performance is a good exercise for any investor to ascertain how much a rising market has enhanced your performance, and to what extent poor decisions have contributed to underperformance. It also helps to identify the sector winners and losers.

In the event, the average total return (after factoring in all losses) has been 52 per cent with only five of the 20 selections under water, of which three are marginally so. By comparison identical investments in the FTSE All-Share and FTSE All-Share indices have returned 7.7 per cent and 32 per cent, respectively.

The hefty outperformance, or ‘alpha’ as it is referred to in investment terms, reflects a bias towards small-cap technology and healthcare (12 selections), and deep value stocks (6 selections). I have also looked for companies displaying strong earnings momentum to ride their earnings upgrade cycles. I intend to continue with these themes as well as looking for undervalued special situations to play both the economic recovery, and a likely increase in mergers & acquisitions (M&A) activity. These investment characteristics are also a feature of several my Bargain Shares Portfolio constituents, three of which I highlight this week.

 

Avingtrans: Engineered for profitable gains

  • Interim pre-tax profits almost double.
  • Rapid turnaround gather pace at Booth Industries and Energy Steel acquisitions.

The directors of engineering group Avingtrans (AVG:310p) have an impressive track record of acquiring and turning round lossmaking businesses before selling them on. This was a key reason why I backed them in my 2017 Bargain Shares Portfolio, since when the shares have produced a 55 per cent total return

Chief executive Steve McQuillan and finance director Steven King have been working their magic again. In the six months to 30 November 2020, adjusted pre-tax profit almost doubled to £3.5m on flat revenue of £54.1m. The improved financial performance partly reflects the elimination of £0.8m of operating losses made in the previous half-year by two acquisitions: Booth Industries, a Bolton-based designer and maker of fire doors, blast doors and wall systems; and Michigan-based Energy Steel, a manufacturer of machined products to the civil nuclear power industry. Both businesses are complementary to the rest of the group’s activities, which are mainly focused on designing, manufacturing and supplying original equipment, systems and after-market services to the energy and medical sectors.

Booth is now on a rapid recovery curve, having landed a multi-year contract worth £36m to supply cross-tunnel doors for HS2, and secured a £2.9m extension to another UK government contract. Booth’s multi-year record order book exceeds £50m and the business has strong prospects of growing aftermarket sales, too.

Energy Steel has been reaping supply chain savings, and is benefiting from cross-selling opportunities with the Vermont based nuclear business that Avingtrans acquired as part of the Hayward Tyler acquisition in 2017. Both operations form part of the group’s engineered pumps and motors (EPM) division, which continues to generate solid order intake in the nuclear life extension market. Hayward Tyler has more than 600 pumps in active service in nuclear applications around the world, so is benefiting from the market demand created by obsolescence, product refurbishment and the need for engineered design solutions in the nuclear industry. A combination of 5 per cent growth in aftermarket sales, 63 per cent uplift in original equipment manufacturer (OEM) sales and the elimination of Energy Steel’s losses propelled EPM’s operating profit up from £0.7m to £2.4m on 17 per cent higher revenue of £26m.

It’s only reasonable to expect another positive outcome for the full year, too. House broker finnCap predicts an 18 per cent increase in both pre-tax profits and earnings per share (EPS) to £8.4m and 20p, respectively, on revenue up 4 per cent to £119m. Forecast free cash flow of £3.9m should enable the board to declare a 4p-a-share annual dividend at a cost of £1.25m, and still have surplus funds to slash half-year net debt of £7.8m to £5m by the financial year-end.

On this basis, the shares are rated on a reasonable price/earnings (PE) ratio of 15.5 and offer a prospective dividend yield of 1.3 per cent. However, any asset disposals are likely to command a much higher exit earnings multiple, which is why I am upgrading my sum-of-the-parts valuation to 375p-a-share, the equivalent of a 2021/22 PE ratio of 17. Buy

2017 Bargain shares portfolio performance
Company nameTIDMOpening offer price on 03.02.17 (p)Bid price on 19.02.21 (p) or exit price (see notes)DividendsTotal return (%)
BATM Advanced Communications (see note seven)BVC19.251150541.4
Kape Technologies (formerly Crossrider)KAPE47.91973.55318.7
Chariot Oil & Gas (see note one)CHAR8.296.820160.3
Avingtrans AVG2003001155.5
Cenkos Securities (see note two)CNKS88.4251069.530.6
Manchester & London Investment Trust (see note three)MNL291.653773.028.4
H&T HAT289.7528532.49.5
Management Consulting Group (see note five)MMC6.18360-3.0
Bowleven (see note four)BLVN28.95.515-6.1
Tiso Blackstar Group (see note six)TBG5520.40.54-61.8
Average    107.3
FTSE All-Share Total Return  64857257 11.9
FTSE AIM All-Share Total Return 9771390 42.3
Notes:      
1. Simon Thompson advised selling two-thirds of the Chariot Oil & Gas holding at 17.5p on 3 April 2017 ('Bargain shares on a tear', 3 April 2017). Simon subsequently advised participating in the one-for-8 open offer at 13p a share ('On the earnings beat', 5 Mar 2018) and buying back the shares sold at 4p ('Chariot's North African adventure', 17 April 2019). Total return reflects these transactions.
2. Simon Thompson advised selling the Cenkos Securities holding at 106p on 3 April 2017 and the 106p price quoted in the above table is the exit price on the holding ('A profitable earnings beat', 3 Apr 2017). Please note that Simon has since included the shares in his 2020 Bargain Shares Portfolio and  rates the shares a buy ('Ben Graham recovery plays', 5 October 2020).
3. Manchester and London Investment Trust paid total dividends of 3p a share on 2 May 2017. Simon Thompson then advised selling half of the holding at 366.25p on 26 June 2017 ('Top slicing and running profits', 26 June 2017), and selling the remaining half at 377p ('Bargain shares second chance', 17 August 2017). The 377p price quoted in the table is the final exit price.
4. Simon Thompson advised banking profits on half your holdings in Bowleven at 33.75p (‘Hitting pay dirt', 9 Apr 2018). The company subsequently paid out a special dividend of 15p a share on 8 February 2019 and the balance of the holding was sold at 5.5p ('Taking stock and profits', 9 December 2019).
5. Simon Thompson advised to sell Management Consulting's shares at 6p in February 2018 (‘How the 2017 Bargain share portfolio fared’, 2 February 2018). The price quoted in the table is the 6p exit price.
6. Tiso Blackstar transferred its UK listing to the Johanesburg Stock Exchange. The shares were then delisted on 23 November 2020 when shareholders received an exit cash payment of R415 per share on cancellation of their shares.
7. Simon Thompson advised banking profits on half your holdings in BATM shares at 49.9p ('Bargain Shares: Exploiting pricing anomalies and top-slicing', 3 December 2018) and subsequently bought back the shares at 43.5p ('BATM armed for a re-rating', 11 July 2019). 
Source: London Stock Exchange. Latest share prices at 09:30am on 19 February 2021.

 

Northamber returns to profit

  • Return to profit.
  • Gross margin increases markedly.
  • Growth for IT and audio visual resellers in professional displays and video conferencing.

Northamber (NAR:66p), one of the largest UK-owned trade-only distributors within the IT equipment industry, has reported an operating profit of £223,000 on 13 per cent higher revenue of £29.7m in the second half of 2020, reversing an operating loss of almost £400,000 in the same six-month period of 2019. Please note that I have stripped out £10.2m of one-off property disposal gains which flattered the previous year’s outcome. A move into profitability was the key reason why I suggested buying the shares, at 54.9p, in my market beating  2020 Bargain Shares Portfolio.

I also note that gross margin improved by four percentage points to 12.8 per cent. This reflects an evolving product mix towards higher margin products as well as the last year’s acquisition of audio-visual distributor Audio Visual Materials which is driving growth for IT and audio visual resellers in areas such as professional displays and video conferencing. 

An improved cost base is another positive following management initiatives put in place last year, as is Northamber’s warehouse move – the company acquired a 51,000 sq ft freehold warehouse in Swindon for £3.2m, having previously sold its Weybridge facility for £10.4m. A small interim dividend of 0.3p-a-share is covered almost three times by interim EPS of 0.84p, a sign that shareholders will earn a distribution from the long-awaited move back into profit.

The point is that with Northamber’s market capitalisation of £18m well below book value of £25.1m, and fully backed up by £10.8m of net cash and £7.1m of property (including three unencumbered freehold assets), then you’re getting a free ride on £7m worth of assets and a profitable operational business. As profitability continues to improve then expect the 28 per cent share price discount to a conservative net asset value (NAV) of 92.3p to narrow markedly. Buy.

Simon Thompson's 2020 Bargain Shares Portfolio Performance
Company nameTIDMMarketOpening offer price 07.02.20 Bid price 19.02.21 DividendsPercentage change (%)
XaarXARMain 42p131.5p0.0p213.1%
Metal Tiger (see note two)MTRAim11.8p20.5p0.0p73.7%
CreightonsCRLMain44p66p0.0p50.0%
Cenkos SecuritiesCNKSAim56p66p0.0p17.9%
NorthamberNARAim54.9p64p0.3p17.1%
Anglo Eastern PlantationsAEPMain570p598p0.4p5.0%
Chenavari Capital Solutions (see note one)CCSLMain61.4p35p0.0p-1.0%
CIP Merchant CapitalCIPAim57p55p0.0p-3.5%
Brand ArchitektsBARAim 160p140p0.0p-12.5%
PCFPCFAim33.3p22p0.4p-32.7%
Average      32.7%
FTSE All-Share Total Return index7,7967,257 -6.9%
FTSE Small-Cap Total Return index9,27410,372 11.8%
FTSE AIM All-Share Total Return index1,0991,390 26.5%
Note 1. Chenavari Capital Solutions made a compulsory capital redemption of 34.73 per cent of the share capital at 85.72p a share in March 2020, and subsequent compulsory capital redemption of 21.9 per cent of the share capital at 72.93p a share in July 2020. The total return takes into account the capital redemptions. The company delisted its shares from AIM on 30 September at a closing bid-price of 35p. Approximately 17.9 percent of each holding was then redeemed on 9 November 2020 at 65.26p per share. The board plans to make further compulsory capital redemptions in due course.
Note 2. Metal Tiger shares consolidated on the basis of one share for every 10 shares previously held on 1 July 2020.
Source: London Stock Exchange.

 

Inland’s land holdings at a bargain price

  • Revenue guidance missed due to accounting policy change in recognition of contract income.
  • Post period end land sales to degear balance sheet and support strong recovery in earnings.

Shares in Inland Homes (INL:52p), a south-east England-focused housebuilder and brownfield land developer, have lost a fifth of their value since the company announced annual results earlier this month. In the process the share price has fallen below the 58p mark when I last suggested buying after the pre-close trading update (‘Six small-cap value picks’, 16 November 2020), and is below the 57.75p entry point in my 2019 Bargain Shares Portfolio. The shares now trade on a 50 per cent discount to European Public Real Estate Association (EPRA) NAV of £235m (104p a share). There are three primary reasons for the sell-off:

■ Annual revenue of £124m was well shy of the £135m guidance in the pre-close update due to a change in the accounting policy in recognising contract income.

■ Net borrowings were reduced by only £4.1m to £148m, a £10m shortfall against guidance. This implies net gearing of 63 per cent on EPRA NAV.

■ The revenue shortfall meant that annual turnover fell by £24m year-on-year, the effect of which was that pre-tax profit fell 85 per cent from £25m to £3.5m.

Undoubtedly, these three factors have negatively impacted investor sentiment. However, there are sound reasons to expect sales, profits and debt reduction to all make significant headway this year.

Firstly, since the financial year-end Inland has made two major sales to Build to Rent (BTR) funds of which the £31.5m disposal of 123 units at Centre Square, High Wycombe is slated for completion in March. The £21.3m sale of 85 units at Buckingham House, High Wycombe should complete in early 2022. The proceeds from these disposals will provide significant cash flow. Moreover, Inland’s management is targeting further BTR sales to release value from its record 11,045 plot land bank which has a £3.1bn gross development value.

The directors also announced the sale of 53 plots at its flagship Wilton Park development in Beaconsfield in January and a £34.5m partnership housing contract at its Cheshunt Lakeside scheme. Inland currently has 1,302 partnership homes under construction (contracted future income of £105m) and a further 415 private homes which have a gross development value well in excess of £100m.

Inland has a rapidly growing asset management business, too, which has six schemes with potential for 3,100 homes. The group acts on behalf of third-party property investors to procure sites and provides planning and management services. The transactions are structured so that they require significantly reduced investment and working capital from Inland and are generally non-recourse to the group. The sites are then sold on receipt of planning consent and the sale may also lead to a partnership housing contract for Inland.

The asset management accounted for £24.4m of Inland’s annual revenue last year, and accrued management fees [from planning and management services] accounted for £28.6m of the £60.9m trade and other receivable balance in current assets at the financial year-end. As third-party transactions complete, then accrued income will be released to Inland and can be used to pay down group debt. 

In addition, income from land sales and current construction work should drive a reduction in net debt, too, as well as supporting a recovery in profits. In fact, house broker Panmure Gordon predicts free cash flow of £54m will reduce net debt to £98m in the 12 months to 30 September 2021 and pencils in a sharp recovery in pre-tax profits from £3.7m to £13.4m on 25 per cent higher revenue of £125m. On this basis, the shares are priced on a forward PE ratio of 11.5.

The modest rating also ignores the possibility of Inland’s recovery continuing into the 2021/22 financial year when Panmure expects pre-tax profit and EPS to surge almost 50 per cent to £19.9m and 6.9p, respectively, based on revenue of £190m. If these forecasts are achieved, then net debt could halve to £70m by September 2022 as land holdings are converted into cash and profits banked. It will help investor sentiment no end, and with the shares trading so far below the value of Inland’s land holdings, I wouldn’t discount the possibility of M&A activity either. Recovery buy.

Simon Thompson's 2019 Bargain Shares portfolio performance
Company nameTIDMOpening offer price 01.02.19Bid price 19.02.21 or exit price (see notes)DividendsPercentage change
TMT Investments (note one)TMT250¢625¢20¢371.7%
Futura Medical (note two)FUM14.85p34p0p129.0%
Augmentum FintechAUGM102.4p149.5p0p46.0%
Bloomsbury Publishing (note four)BMY229p281p16.2p29.8%
Jersey Oil & GasJOG205p243p0p18.5%
Mercia Asset Management (note three)MERC29.57p27.5p0p-7.0%
Ramsdens HoldingsRFX165p145p7.5p-7.6%
InlandINL57.75p51p0.85p-10.2%
Litigation Capital ManagementLIT77.5p66.6p0.71p-13.1%
Driver GroupDRV74p50p2.00p-29.7%
Average     52.7%
FTSE All-Share Total Return index6,8527,257 5.9%
FTSE AIM All-Share Total Return index1,0231,390 35.8%
Note 1: Simon advised taking profits on TMT Investments at 580c a share to bank 140 per cent gain including dividend of 20c ('Takeovers, tender offers and taking profits', 9 September 2019), and subsequently advised buying the shares back at 318c ('On the hunt for recovery buys', 6 July 2020). 
Note 2: Simon advised taking profits on Futura Medical at 34p a share on Monday, 14 October 2019 ('Bargain Shares: golden opportunities', 14 October 2019). The selling price is used in the performance table.
Note 3: Simon advised selling Mercia Asset Management at 27.5p a share on Monday, 9 December 2019 ('Taking stock and profits', 9 December 2019). The selling price is used in the performance table.
Source: London Stock Exchange opening offer prices at 8am on Friday, 1 February 2019 and latest bid prices or on date when Simon advised exiting the holding.

 

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.