On the financial results beat

Duke Royalty (DUKE:34.5p), 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, has delivered a bumper cash flow performance in the 2021/22 financial year, and looks well set to maintain the progress.

In the 12 months to 31 March 2022, the group made £75mn of investments, of which £61mn was in five new royalty partners. This not only diversified the portfolio to 13 royalty partners, but it boosted total cash revenue by two-thirds to £18.4mn and lifted recurring cash revenue by 69 per cent to £14.9mn, realised gains on equity investments explaining the difference between the two metrics. Moreover, Duke booked £10.8mn of unrealised gains on its portfolio, up from £3.5mn in the prior year, hence why net asset value increased by more than 50 per cent to £133mn after factoring in an oversubscribed £35mn equity raise during the financial year.

Since the period end, Duke has raised a further £20mn of equity capital (‘Levelling the playfield’, 4 August 2022), of which £5.4mn has been deployed in two follow-on investments with existing partners in the healthcare and IT services sectors. Although the balance of the funds will be deployed in a pipeline of investment opportunities, Duke has sensibly repaid a portion of its £48mn year-end borrowings to save on interest costs in the short term.

House broker Cenkos Securities expects total interest income to increase by 55 per cent to £21.7mn in the current financial year, rising to £25.1mn in 2023/24 when Duke’s available capital should be fully deployed. On this basis, total cash revenue is predicted to rise to £22.5mn (2022/23) and £25.9mn (2023/24), which underpins free cash flow per share forecasts of 3.2p and 3.6p, respectively. In turn, the ongoing robust cash flow performance supports dividend per share estimates of 2.9p and 3.2p. The current 0.7p a share quarterly dividend annualises to 2.8p a share, adding weight to analysts’ forecasts.

On this basis, the shares offer prospective dividend yields of 8.4 and 9.3 per cent, and trade on a price-to-book value ratio of 0.94 times, well below the pre-Covid-19 range (1.1 to 1.4 times). Although the macro environment creates uncertainty, Duke’s business model has proved its resilience through the Covid-19 downturn, and with balance sheet leverage sensible – loan to value ratios on debt facilities are capped at 30 per cent – then the group looks on course to deliver on analyst forecasts. Also, the current inflationary environment is driving revenue of portfolio companies higher, thus creating a positive tailwind for royalty resets and portfolio valuation uplifts.

Duke’s shares have produced a 30.5 per cent total return (TR) since I included the company in my 2021 Bargain Share Portfolio, during which time the FTSE Aim All-Share TR index has shed 26.9 per cent of its value. The attractive dividend and 6 per cent discount to spot net asset value (NAV) of 36.7p a share points to further share price upside. Buy.

Oakley Capital’s record first-half performance

• Half-year NAV per share up 17 per cent to 630p
• Total NAV return of 94p since start of 2022
• Period end cash of £97mn
• £110mn of cash realisations since 30 June 2022

Half-year results from private equity investment company Oakley Capital Investments (OCI:399p) highlight why the shares have delivered a 189 per cent total return since I suggested buying, at 146.5p, in my 2016 Bargain Shares Portfolio. In fact, an annualised NAV per share return of 23 per cent over the past five years is the highest in the listed private sector.

As has been the case in previous reporting periods, growth in cash profit of Oakley’s investee companies has been the key driver of the valuation uplifts (72 per cent of valuation movement), with multiple expansion accounting for 28 per cent of the increase. The movement in multiples is warranted, as highlighted by £64mn of portfolio realisations made in the six-month trading period.

For instance, Oakley’s holding in SME cloud hosting platform Contabo was sold in June 2022 for double its March 2022 carrying value, and the sale of the stake in Italian online price comparison website Facile was transacted at a 23 per cent premium to book value. Since the 30 June 2022 period end, Oakley has agreed a partial exit from contextual advertising business Seedtag, at 70 per cent above June 2022 carrying value, a transaction that adds a further 4p a share to NAV.

Importantly, the ongoing strong operational performance of Oakley’s investee companies warrants their valuation uplifts. The group’s holding in IU Group, the largest university group in Germany, now accounts for 18 per cent of NAV after the company reported 34 per cent growth in student numbers and 23 per cent higher annual cash profit.

It’s worth noting that although the group’s portfolio companies have delivered 18 per cent cash profit growth in the past 12 months, Oakley only values them on an average cash profit multiple of 13.7 times to their enterprise valuations. That rating is the lowest in the private equity sector and is even more anomalous given that 70 per cent of Oakley’s portfolio is weighted towards digital businesses and the majority of companies generate recurring or subscription-based revenue streams.

Despite the outperformance of peers, the shares are priced on a 36.5 per cent discount to June 2022 NAV of 630p, the widest in the sector, and 41 per cent below Liberum Capital’s year-end NAV estimate of 679.6p. A maintained dividend of 4.5p a share provides a small income stream for shareholders, while surplus cash is being deployed on a NAV per share accretive share buyback programme.

So, although Oakley’s share price has drifted a little since I covered the first-quarter results (‘Primed for new highs’, 28 April 2022), the ongoing strong operational performance and robust cash realisations from its portfolio point towards significant re-rating potential when equity market conditions are more benign. Buy.

Cenkos trading hit by equity market downturn

• First-half underlying operating profit falls 29 per cent to £1.9mn
• Reported operating loss of £0.4mn
• Adjusted EPS declines a third to 3.3p and dividend cut 20 per cent to 1p a share
• Net cash of £15.9mn equates to half market capitalisation

Corporate broker Cenkos Securities (CNKS:54.5p) has been hit by the downturn in equity markets, albeit a first-half reported operating loss of £0.4mn masks what was still a respectable underlying operating profit of £1.9mn on 30 per cent lower revenue of £12.7mn. The reported result is stated after £1.9mn of non-cash mark-to-market losses on options and warrants, a reflection of the sharp stock market downturn which gathered pace in the second quarter, and costs for restructuring and incentive plans.

In the first half, corporate finance revenue fell a third to £8.6mn and net trading gains of £0.8mn were down two-thirds on the same period of 2021. Cenkos completed nine placing transactions, raising £380mn including £310mn on Aim, or 23 per cent of the total raised on London’s junior market in the period. The broker delivered two of the eight IPOs on Aim, too, but pickings have been slim. In the first 10 weeks of the second half, Cenkos has only completed three transactions, and expects subdued transaction volumes to persist.

A cash-rich balance sheet means the group is well capitalised to ride out weaker market conditions, but there is no getting away from the fact that sentiment is poor and the shares lack a share price catalyst. Moreover, although the board declared a 20 per cent lower half-year dividend per share of 1p, with last year’s annual underlying pre-tax profits of £5.9mn likely to be greatly reduced, then don’t expect a repeat of the final payout of 3.25p.

In the circumstances, I am reversing my last buy call (‘Broking on highly profitable deal flow’, 21 March 2022), and suggest banking what remains of the 14 per cent paper gain if you have been following my market-beating 2020 Bargain Shares Portfolio. Sell.

Simon Thompson was named Journalist of the Year at the 2022 Small Cap Awards.

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