Bargain shares: A royal high yielding investment

Annual results from Duke Royalty (DUKE:48p), an Aim-traded company that makes its money by providing capital to companies in exchange for rights to a small percentage of their future revenues, highlight exactly why I included the shares, at 29p, in my market beating 2021 Bargain Shares Portfolio.

Having successfully navigated the Covid-19 pandemic, and provided the requisite support to its royalty partners last year, the group is now seeing the upside. In the 12 months to 31 March 2021, Duke’s cash revenue increased 7 per cent to a record £11m which in turn produced 16 per cent higher operating cash flow of 3.68p a share and free cash flow of 3.1p a share.  The 2.25p a share dividend was covered 1.2 times by adjusted earnings per share of 2.7p, up from 2.44p in 2019/20, but free cash flow cover is the better metric.

Duke also booked £9.9m valuation uplift on its £110m portfolio in the 12 months to 31 March 2021, partly reversing non-cash impairments of £15.6m taken in the 2019/20 financial year. House broker Cenkos Securities is pencilling in a further £3m uplift in the 2021/22 financial year, a conservative estimate. Duke also holds £3.5m worth of equity investments in six of its 11 portfolio companies, another catalyst for shareholder value accretion.

Importantly, Duke is exiting investments at healthy premiums to both cost and carrying value, indicating the conservative nature of its net asset value of 33.3p a share. For instance, since the March 2021 year-end, Duke realised net cash of £6.9m from Irish insurance brokerage BHPC, a specialist in the not-for-profit insurance space, delivering internal rate of return of 29.4 per cent on its investment. This was the fourth exit since IPO, underlining the strength of the business model.

With the global economy rebounding, it’s hardly surprising that more investors are taking an interest in Duke’s business, hence why April’s placing was oversubscribed, and the directors have been able to extend the group’s loan facility. Around £23.2m of April’s placing proceeds have been recycled into three new royalty partners:

• InTec Business Solutions – a company that provides support for UK SMEs outsourcing the installation and maintenance of their IT infrastructure such as cloud based services and data storage.
• Fairmed Healthcare – a provider of high quality generic prescription medicines, over-the-counter pharmaceuticals, and dietary supplements in Europe.
• Creo Tech Industrial – a Canadian holding company that is executing a ‘buy-to-build’ strategy across the country’s engineering, procurement and construction (EPC) services sectors.

These transactions are based on a 30-year royalty term and generate initial cash yields exceeding 13 per cent, in line with Duke’s typical terms, and underpin Cenkos’ expectations that cash revenue will rise to £13m in the 12 months to 31 March 2022, ratcheting up to £17.5m the following year assuming £48m of Duke’s liquidity is deployed. The board is well on the way to achieving these targets as latest guidance is that cash revenue in the current quarter will rise 10 per cent to £3.2m, a sum that exceeds estimated annual operating costs of £2.3m. Prospects for the dividend are to the upside, too, as Cenkos is pencilling in a 2.7p a share annual pay-out in 2022/23, implying a prospective dividend yield of 5.6 per cent.

Source: London Stock Exchange.

Note One: Simon recommended tendering 30 per cent of holdings in Vietnam Holdings at US$4.4528 (322.3p) a share, and tendering for the 3.9 per cent excess application ('Exploiting a tender offer', 4 August 2021). Total return reflects this cash distribution which will be made the week of 13 September 2021.

Furthermore, as royalty partners’ cash payments to Duke are reset as their trading rebounds, and previous Covid-19 induced impairments are reversed to further lift NAV per share, expect the ongoing re-rating to continue. I raise my target from 50p to 55p. Buy.

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