Time Finance (TIME:31.5p), an alternative provider of finance to the high-street and challenger banks, has upgraded earnings guidance again. The Bath-based group provides three main finance products – invoice finance, asset finance and loan finance – which small and medium-sized enterprises (SMEs) require for day-to-day working capital requirements and to grow their businesses over the longer term.
Business has been booming, as highlighted by a near-quadrupling of pre-tax profits to £4.2mn in the 12 months to 31 May 2023. Moreover, scaling-secured lending activities and transaction size have driven the lending book to a record high of £180mn on 31 October 2023, or a third higher than in May 2022. Importantly, delinquency debt levels remain static, reflecting the focus on lending to more established and credit-worthy businesses.
The operational gearing of the business is such that profit growth strongly outpaces revenue growth in a positive revenue cycle. House broker Cavendish upgraded its revenue estimate from £30.1mn to £30.8mn for the 12 months to 31 May 2024, implying 11.5 per cent annual growth, but pre-tax profit guidance has been raised from £5mn to £5.4mn, implying 28 per cent annual growth. On this basis, the shares trade on a modest forward price/earnings (PE) ratio of 7.1 and on an unwarranted 25 per cent discount to tangible net asset value (TNAV) estimates, too.
So, having suggested buying the shares, at 26.5p (‘Alpha Research: Business is booming for this underrated lender to SMEs’, 18 August 2023), I continue to see upside to my 40p target. Buy.
Downing Micro-Trust plans wind-up
Downing Strategic Micro-Cap Investment Trust (DSM: 59p) is planning an orderly wind-up of the company and to return capital to shareholders. The first distribution will be made early in 2024 and will be at least 20 per cent of DSM’s current net asset value of £34mn (71.5p).
DSM retains a portfolio of 17 well-run, niche businesses that continue to generally perform well even in a more challenging economic environment. The manager has been outperforming a falling stock market, too, reporting an 8.3 per cent decline in NAV since its last financial year-end (28 February 2023), or half the 17.1 per cent decline in the FTSE Aim All-Share Total Return (TR) index over the same period. Moreover, although the holding is 12.9 per cent below the entry-level in my 2021 Bargain Share Portfolio, the FTSE Aim All-Share TR index has shed 39 per cent of its value in the same 32-month holding period, highlighting DSM’s outperformance.
However, there is no avoiding the negative sentiment towards UK small and micro-cap companies that has led to some of the deepest investment trust’s discounts to NAV in the past 20 years, nor the fact that there is little interest in small specialist investment trusts like DSM. This explains the investment manager’s and the board’s decision to pursue an orderly wind-up of the company.
Initial distribution fully funded
Importantly, the board has the cash on hand to make the initial cash distribution. That’s because more than 20 per cent of the portfolio by value is under offer or in a strategic review process.
In recent weeks, portfolio companies OnTheMarket (OTM:110p), an online residential property portal, and FireAngel Safety Technology (FA.:6.73p), a home safety product supplier, have attracted recommended cash offers at bid premiums of 56 per cent and 261 per cent to their previous day’s closing prices. DSM will receive £2.7mn cash proceeds from each holding which, when combined with its cash holdings of £1.9mn, represents 21 per cent of DSM’s net asset value (NAV).
In addition, another investee company, Aim-traded fintech payments group Equals (EQLS:119.5p), has entered talks with potential bidders that could lead to a takeover of the fast-growing challenger brand in banking and international payments. DSM’s holding in Equals is worth £2.1mn, or 78 per cent higher than cost. It could have a 45 per cent further upside if analysts’ 175p fair valuations are hit (‘Equals offers opportunity for 50 per cent upside’, 8 November 2023).
Lowly rated portfolio offers material capital upside
DSM holds positions in three other companies I am particularly keen on: Hargreaves Services (HSP:418p), an industrial group and land developer; Journeo (JNEO:205p), a transport systems provider; and Middlesbrough-based financial services group Ramsdens (RFX: 212p). Combined the holdings are worth £6mn, or 17.6 per cent of NAV. I have target prices materially higher than the current share price for all these holdings, highlighting the value opportunity on offer.
For instance, Hargreaves is being valued on a 33 per cent discount to NAV of £201mn (618p) even though the group’s renewable energy assets (three wind farms, six access agreements and two solar farm leases) have been valued between £27.2mn and £28.9mn (83p to 89p). These assets are in the books for only £6.6mn (20p). The shares are rated on a forward price/earnings (PE) ratio of 6.7 and offer a five per cent dividend yield, too. Sum-of-the-parts valuations are 84 per cent higher than the current share price.
Following two recent earnings upgrades, house broker Cavendish expects Journeo’s full-year pre-tax profit to almost quadruple to £3.7mn to produce earnings per share (EPS) of 19.7p, rising to £4.2mn and 22.7p, respectively, in 2024. On this basis, the cash-rich company’s shares are rated on a 2024 price/earnings (PE) ratio of 9.1, an unwarranted 32 per cent discount to peers. My 300p target price represents a premium of almost 50 per cent to Journeo’s current share price (‘Journeo is en route to quadrupling its profit’, 18 September 2023).
Although Ramsdens continues to outperform analysts’ earnings expectations, prompting another round of upgrades post results last summer, the shares are only priced on a forward PE ratio of nine and offer an attractive prospective dividend yield of 4.9 per cent. A price-to-book value of 1.3 times is modest for a cash-rich company generating a post-tax return on equity of 17 per cent and one that is performing well during a cost-of-living crisis. Liberum’s target of 290p is more than a third higher than Ramsden’s current share price.
It’s worth noting, too, that DSM’s largest holding is a liquid £2.9mn (8.5 per cent of NAV) stake in cable manufacturer Volex (VLX:285p), a £511mn market capitalisation company. In other words, the investment trust’s cash, proceeds from the two agreed takeovers and investments in the above five holdings account for 54 per cent of DSM’s NAV.
Scope for narrowing of share price discount to NAV
The point is that there should be scope for a narrowing of DSM’s share price discount to NAV as cash distributions are made. There is also the real possibility that other portfolio companies will succumb to takeovers or corporate events at share price premiums during DSM’s wind-down process given that their listed market valuations are well below the intrinsic value of the holdings.
Indeed, investment manager Judith MacKenzie has identified key catalysts within investee companies that point to an estimated intrinsic value of the portfolio, which if divestments are carefully managed, indicates an upside of at least 50 per cent to DSM’s current market capitalisation of £28mn (59p). True, a complete wind-down could take time given the nature of some of DSM’s investments and liquidity. However, this could work in shareholders' favour as small-caps have historically outperformed strongly after downturns.
The bottom line is that there is potential for capital returns to shareholders well above DSM’s current NAV of £34mn (71.5p), a factor not reflected in the 18 per cent share price discount to NAV. Buy.
■ 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 at £16.95 each plus P&P of £4.95, or £25 plus P&P of £5.75 for both books.
