Bargain Shares: On the hunt for micro-cap bargains

The savage bear market in small-cap stocks has hit the performance of Downing Strategic Micro-Cap Investment Trust (DSM:53p). Although the company’s NAV per share held up relatively well in the first half to 31 August 2022, falling by 6.7 per cent to 79.7p – less than half the fall in the FTSE Aim All-Share Total Return index – the market carnage in the 10 weeks since the period end has sent NAV per share down to 70p.

Investors have become more risk averse, too, hence why the share price discount to NAV has widened by almost 10 percentage points to a hefty 24.3 per cent since February. The two factors explain why the company’s share price has declined from around my 69p entry point when I reviewed the performance of my 2021 Bargain Share Portfolio in mid-February this year. On any measure the well diversified portfolio is undervalued.

For instance, the median enterprise valuation to cash profit multiple of the portfolio was less than seven times at the end of August, a 40 per cent discount to the microcap universe. The portfolio is also trading on a discount of around 50 per cent to intrinsic valuations at current prices. Effectively, you are getting a double discount because of the trust’s own 24 per cent discount to NAV – on a cash-adjusted basis, the discount is 28.3 per cent – or more than double the five-year average of 11.6 per cent. That’s anomalous given the £29.5mn equity and bond portfolio (at current prices) contains some decent holdings, and the company also has free cash of £5mn (10p a share) for investment manager Judith MacKenzie to go bargain hunting with.

In fact, around 20 per cent of Downing’s portfolio is invested in four companies on my own active buy list: Hargreaves Services (HSP), industrial services group and brownfield land developer; financial services group Ramsdens (RFX); Aim-traded fintech payments group Equals (EQLS), a leading challenger brand in banking and payments; and Venture Life (VLG), a manufacturer and distributor of self-care products.

I also feel that Centaur Media (CAU), a provider of market intelligence, learning and specialist consultancy, is undervalued. The company offers a potential 16 per cent free cash flow yield in 2023, retains a cash-rich balance sheet, and is expected to produce 40 per cent earnings growth next year through self-help improvements in profit margins and organic revenue growth. The shares only trade on a forward price/earnings (PE) ratio of 11.8 for 2023. The holding accounts for 7.5 per cent of the fund’s total assets.

Electronics equipment group Volex (VLX) has a similar portfolio weighting and is modestly rated, too. A forward PE ratio of 11.6 is hardly expensive for a group that is not only forecast to deliver 20 per cent higher annual earnings growth in the 12 months to 31 March 2023 buoyed by structural growth drivers in key end markets (data centres, electric vehicles and healthcare), but free cash flow is expected to treble to £12mn, doubling again in 2023-34.

In a more benign market environment, Downing’s share price discount to book value should mean-revert to its historic average while the portfolio is likely to be more sensibly priced to better reflect the intrinsic value of the constituent holdings, thus offering NAV upside. Buy.

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