Exploiting ‘margins of safety’

Mr Graham's approach was to focus on companies with strong balance sheets, so can trade through any short-term difficulties. He called it his "margin for safety". In a nut shell, that’s what’s on offer at investment companies CIP Merchant Capital (CIP) and San Leon Energy (SLE), the former fell out of favour after a period of investment underperformance and the latter was shunned due to its exposure to the oil sector. Both companies are now performing well, making their share price discounts to the underlying value of their assets buying opportunities.

Springfield smashes earnings forecasts

• Buoyant private housing demand and land sales to two national housebuilders.
• Profits for 2020/21 financial year to be materially above market expectations.

A pre-close trading update from Springfield Properties (SPR: 168p), a housebuilder focused on developing a mix of private and affordable housing in Scotland, highlights why I selected the shares, at 135.6p, in my 2021 Bargain Shares Portfolio.

A strong rebound in build and sales activity in the first half of the 2020/21 financial has continued into the second half (to 31 May 2021), so much so that both revenue and profit from Springfield’s private housebuilding activities will exceed prior guidance that was already factoring in a material step change in profits.

True, the Scottish housing market is in rude health, as is the case with most regions in the UK, but Springfield is also attracting home buyers because its mid-sized Village community developments are close to fast-growing cities (Dundee, Perth, Stirling, Livingston and Elgin) and offer more spacious homes with gardens and green spaces. A lower entry price makes them highly affordable, too. In addition, Springfield has sold 200 plots to two major housebuilders across its Central Belt developments, a further indication of the strength of Scotland’s housing market.

Analyst Alastair Stewart of Progressive Equity Research has taken note, upgrading full-year pre-tax profit and earnings per share (EPS) estimates by almost 20 per cent to £18m and 14.7p, respectively, implying close to 80 per cent profit growth on 38 per cent higher revenue of £199m. The upgrade is split roughly 50:50 between the private housing division and land sales. Stewart has also slashed his net debt forecast from £42.5m to £25.2m, representing a 63 per cent year-on-year reduction, adding weight to forecasts which point to a hike in the annual dividend from 2p to 4.5p a share when the group releases results next month.

On this basis, the shares are rated on 11.5 times earnings for the year just ended and offer a dividend yield of 2.6 per cent, a rating that fails to factor in the strong likelihood of Springfield realising further value from its high-quality land bank. It is conservatively valued, too, as land and work in progress is in the books at £155m, or less than £10,000 per plot. Moreover, the 15,000-plot land bank equates to 20 years output, so underpinning another step change in pre-tax profits and net asset value (NAV) in the coming years as the hidden value in the land bank is released. Progressive Equity is factoring 33 per cent higher pre-tax profit of £23.9m in the 2022/23 financial year, and a closing NAV of 132p a share, implying the shares are rated on a lowly prospective price/earnings (PE) ratio of nine and 1.3 times NAV estimates.

A triple top chart break-out of the 165p to 170p resistance level looks on the cards and would set up a share price move to my upgraded 220p target price. Buy.

San Leon’s Nigerian adventure to deliver hefty cash returns

• Oza-1 well re-entry imminent and use of horizontal wells to generate significant production and cash flow in short time frame.
• First of three loan note redemptions due next month.

Decklar Resources (CVE:DKL), a Canadian listed company that holds a valuable Risk Service Agreement (RSA) with Millennium Oil and Gas Company on the Oza Oil Field in Nigeria, is making stellar progress on the Oza-1 well re-entry. The use of horizontal development wells should generate significant production levels and cash flow in a short time frame given the existing infrastructure is already in place.

The Oza Oil Field was formerly operated by Shell Petroleum but was never tied into an export facility, nor was it fully developed by Shell and put into commercial production. In 2003, it was awarded to Millennium Oil and Gas during the 2003 Marginal Fields Licensing Round. Millennium has since spent US$50m (£35.2m) on infrastructure in support of a restart of production including an export pipeline to tie the Oza Oil Field production into the Trans Niger Pipeline which goes to the Bonny Export Terminal.

Decklar subsequently entered a RSA with Millennium which provides Decklar the majority share of production and associated cash flow from Oza in exchange for funding and technical assistance to restart commercial production and full field development. The RSA terms include a preferential return of Decklar's costs plus a share of cash flow. After achieving cost recovery, Decklar's profit share is based on a sliding scale starting at 80 per cent and declining to 40 per cent once cumulative production exceeds 10m barrels.

This is highly relevant to San Leon Energy (SLE:35.5p), a Nigeria focused exploration and production company that also owns a 10.58 per cent indirect interest in the vast 1,035 sq km Niger Delta licence, OML 18. Last autumn, San Leon agreed to invest US$7.5m through a loan (10 per cent coupon) to Decklar and subscribe for a 15 per cent equity interest in the Canadian company, with an option to increase to 30 per cent based on drilling results. With the drilling rig on Oza-1 set to be operational within the next 10 days, San Leon will then have 45 days after sight of the well test results to exercise its option.

It’s not the only potential share price catalyst as San Leon is expected to receive imminently the first of three equal instalments (between July and December) totalling US$98m (15.7p a share) on loan notes (17 per cent annual coupon) which enabled operator Eroton to fund its share of the US$1.1bn equity buyout of OML18 from a Shell operated consortium in 2015.

I included San Leon shares, at 27.5p, in my 2021 Bargain Share Portfolio, and priced on a 56 per cent discount to my 80p a share spot US$511m (£360m) valuation of the company’s investment portfolio, the shares are still well worth buying. 

Exploit CIP’s healthy ‘margin of safety’

• NAV per share up almost 10 per cent in 2021.
• Proactis takeover doubles value of CIP’s investment.
• Three new holdings in 2021 deliver 19 per cent total return.

CIP Merchant Capital (CIP:55p), a Guernsey-based closed investment company that takes a private equity style approach to investing, continues to diversify its investment portfolio, is making profitable exits and successfully recycling cash into new holdings. NAV per share has increased by almost 10 per cent to 85.3p since the start of 2021 even though the share price has only edged up slightly.

In the first half of 2021, CIP invested £6.8m in three new holdings: car dealer Vertu Motors (VTU); plant hire group HSS Hire (HSS) and Ixico (IXI), a provider of clinical trials services to pharmaceutical companies. The three investments are now worth £8.3m and I see potential for further upside. CIP has also doubled its money on its stake in Proactis (PHD), an e-Procurement solution provider which has recently received a private equity bid. The £2.1m cash proceeds from that holding will increase CIP’s cash pile to £11.6m (21p a share), representing a quarter of the company’s latest NAV of £47m (85.3p).

Effectively, this means that cash, the value of the above four holdings and a £8.2m stake in CareTech (CTH:586p), a heavily asset-backed provider of social care services and a favourite of mine, are worth £28.1m (51p). This leaves nine other holdings worth £19m (34p) in the price for free, a crazy valuation when you consider that the portfolio also has a raft of promising healthcare investments including: £2.5m holding in EKF Diagnostics (EKF), a point-of-care business that is manufacturing novel Covid-19 testing equipment; £3.4m investment in Nasdaq-quoted medical devices company Orthofix Medical (US:OFIX); and £1.1m holding in Totally (TLY), a leading UK healthcare service provider that works in partnership with the NHS to deliver healthcare services. Totally should do rather well in the current environment as the NHS looks to address record hospital waiting lists caused by the Covid-19 pandemic.

CIP’s shares are trading slightly below my 57p entry point in my 2020 Bargain Shares Portfolio, and I expect the ongoing investment performance to drive a material re-rating. Buy.

Table notes: 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.

2. Metal Tiger shares consolidated on the basis of one share for every 10 shares previously held on 1 July 2020.

Chariot Oil fundraise to accelerate Moroccan gas project

• US$23m net proceeds to turbo charge Anchois gas development.
• Directors participate in equity raise.
• Drilling to start in fourth quarter.

Aim-traded Chariot Oil & Gas (CHAR:5.5p) has raised £11.7m through a placing and subscription including £2.4m from the directors, and proposes to raise a further £3.5m through an open offer (one-for-six at 5.5p) to turbo charge its Anchois gas development, offshore Morocco. It’s a huge resource with an estimated 361bn cubic feet (bcf) of 2C contingent recoverable resources, and 690bcf of 2U prospective resources.

The net proceeds will be used to drill an appraisal well at Anchois to confirm the discovery; progress work programme on the acreage surrounding Anchois for future development; integrate transitional power team and existing project, and fund near-term power project. Chief executive Adnois Pouroulis is underwriting £5.57m of the fundraise through Magna Capital, a company in which he is a substantial shareholder.

Appraisal drilling will start in the fourth quarter at a cost of US$20m to test the discovered sands and explore deeper targets, an important requisite to progress gas sales and project finance ahead of a 2024 start-up. Chariot has already received two development funding approaches from institutional lenders to fund the capital expenditure (US$350m for Anchois A and B sands) to bring the project on stream in mid-2024.

Table 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).

House broker finnCap has a risked valuation of US$216m (23.4p a share) on Anchois contingent resource (A and B sands) after applying a 50 per cent chance of success, and US$3bn (326p a share) unrisked valuation across Chariot’s Lixus licence which includes the Anchois projects.

I included Chariot in my 2017 Bargain Shares Portfolio and highlighted the potential last autumn when I rated the shares a speculative buy at 3.79p (‘Priced for profitable outcome’, 12 October 2020). I view the sell-off from last autumn’s 14.4p high as a repeat buying opportunity and would take up the open offer. Buy.

ONLINE ARTICLES BY SIMON THOMPSON IN THE PAST WEEK:

■ Strix: Buy at 293.5p, target 330p (‘Simmering for a chart break-out’, 27 May 2021).

■ Conygar: Buy at 122p (‘Opportunities in property 26 May 2021)

■ U+I: Buy at 90p (‘Opportunities in property 26 May 2021)

■ Watkin Jones: Buy at 236p, new target 275p (‘Opportunities in property 26 May 2021)

■ Urban Exposure: Vote in favour of de-listing, liquidation and cash returns (‘Opportunities in property 26 May 2021)

■ 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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