Exploit this double-discounted small-cap fund

Logistics Development Group (LDG:13.9p), an investment company managed by asset management firm DBay, has made small additions to its portfolio in the first half of this year but has mainly kept its powder dry. That’s a sensible tactic given the general market backdrop.

The company follows a value investing approach, and invests in listed equities across Europe, as well as in private-equity-style control investments – wherein the buyer, as the name implies, takes a controlling stake. They are made primarily in undervalued companies, with a focus on those that generate or have the potential to generate significant cash flows, where there is a high degree of revenue visibility and a strong and distinctive market position.

At the half-year end (31 May 2023), LDG’s net asset value (NAV) was flat year on year at £110.9mn, the portfolio consisting of four holdings worth £59mn and had net cash of £52mn. Although the stake in Alliance Pharma (APH), a distributor of consumer healthcare and pharmaceutical products, has since dropped in value from £34.2mn to £27mn in the past three months, it has been largely offset by gains in the three other holdings: Finsbury Foods (FIF), a speciality bakery manufacturer of cake, bread and morning goods; SQLI S.A. (FR:SQI), a leading pan-European digital transformation business; and Trifast (TRI), an international distributor of industrial fasteners.

The four holdings are still worth £59mn (10.9p), modestly above the £56.9mn cost, after accounting for a post-period-end additional investment of €0.65mn ((£0.56mn) in SQLI and the scrip dividend received from Alliance Pharma. Adjusting for £1.54mn of share buybacks in the second half, net cash is around £50mn (9.2p). This means that, although NAV of £109mn is down 1.7 per cent since 31 May 2023, NAV per share is steady at 20.1p, a reflection of the lower share count and the boost to NAV per share from buying back shares at a 30 per cent discount to NAV.

It also means that excluding cash of 9.2p a share, the four holdings are effectively in the price for 4.7p, or less than half their open market prices. That’s far too deep a discount considering the value already on offer from these investee companies, the key reason why I suggested buying the shares, at 14.7p, in my 2023 Bargain Share Portfolio. The investment case is as strong now as it was then.

A portfolio with promise

Finsbury Foods offers value on any basis. Based on Panmure Gordon’s forecasts for the 12 months to 30 June 2024, the shares trade on a forward price/earnings (PE) ratio of 7.9, a hefty discount to the pre-Covid-19 average of 10.3, and offer a prospective dividend yield of 3 per cent.

The food group has leading positions in four categories within the UK bakery market, namely celebration cakes (an attractive category given its high prices and lack of promotional activity), round/sharing cakes, artisanal bread (a growing category) and buns and rolls. Current-year sales are expected to grow by almost 9 per cent to £449mn and deliver 11 per cent higher pre-tax profit of £18.1mn. Key drivers are the ongoing recovery in foodservice, strong performance from the group’s international division, inflationary price rises and incremental volume from Lees Foods, a £5.7mn bolt-on acquisition made at the start of 2023. It has not only performed in line with management’s expectations, but has diversified the group’s revenue base, too.

Importantly, the £116mn market capitalisation company maintains comfortable gearing levels with annual cash profit exceeding net borrowings, thus offering the potential for internal cash flow and debt facilities to finance further earnings-accretive acquisitions. LDG has made a 14 per cent paper profit so far on its original £9mn investment in Finsbury Foods with further gains likely.

A nuts ‘n’ bolts recovery play

Trifast is interesting, too. It’s also a holding of the smart investment team at Rockwood Strategic (RKW), a constituent of my market-beating 2016 Bargain Share Portfolio. The company is an international manufacturer (30 per cent of sales) and distributor (70 per cent) of fasteners (nuts and bolts).

Operating across 34 locations, of which seven are high-volume manufacturing sites, Trifast sells 15bn parts every year. The company has a long history of profitability and cash generation, is well invested in plant and machinery and has substantial net assets. However, returns have fallen in recent years, and return on capital employed (ROCE) is poor. So, to boost Trifast’s operating margin, which declined from 6.7 to 4.9 per cent in the 2022-23 financial year, management is carrying out a restructuring to deliver savings. Also, a keener focus on cash generation and working capital management should help drive down the group’s elevated borrowings.

If all goes according to plan, there is potential to materially increase Trifast’s cash generation, reduce leverage and improve both ROCE and profits to drive a normalisation of the rating. To put the potential into some perspective, analysts at brokerage Zeus Capital expect operating profit to increase 70 per cent over the next two financial years from £12mn to £20.4mn. Their prediction is based on an expansion in Trifast’s operating margin from 4.9 to 7.5 per cent and factoring in 11 per cent sales growth.

Moreover, with net debt (including leases) forecast to be slashed from £53.8mn to £35.9mn, then more of the economic interest in the £108mn market capitalisation company will be transferred from debt holders to shareholders, a catalyst for a higher rating. The shares are priced on forward PE ratios of 12.3 (2024) and 8.6 (2025), highlighting the scale of the potential re-rating, assuming of course that the restructuring is well executed.

A lowly rated life science play

Analysts at Peel Hunt believe last summer’s weakness in Alliance Pharma’s share price has been driven by their concerns over mid-long-term growth rates of acquired products (namely, not delivering a return on invested capital), the return of growth in China as well as counterfeiting in the same territories. The share price has pulled back 23 per cent to 47.5p in the past 14 weeks and is now below LDG’s 59p break-even point.

However, the directors of Alliance Pharma reiterated full-year earnings guidance over the summer which implies high single-digit growth in pre-tax profit and earnings per share (EPS). The shares are now rated on a modest 2023 price/earnings (PE) ratio of 10 and offer a dividend yield of 3.6 per cent, multiples that suggest the de-rating has gone too far.

A growth story on Euronext

LDG’s investment in private holding company Synsion, which holds shares in SQLI S.A. (FR:SQI), a leading pan-European digital transformation group that is listed on Euronext, has made good a chunk of the paper loss on Alliance Pharma. LDG’s 9.5 per cent read-through equity stake in SQLI was acquired for €15mn (£12.8mn) and is now worth €21.5mn based on SQLI’s current market capitalisation of €226mn.

Based in Paris, SQLI has leading positions in the fast-growing ecommerce/omni-channel integration space and its blue-chip clients include LVMH, Airbus, Nestle, L'Oreal, Bridgestone and Adidas. The company continues to perform well, almost doubling its normalised operating profit to €21.5mn on 9 per cent higher revenue of €246mn in 2022. SQLI generated €15mn of free cash flow in the year, too.

In a positive annual results’ statement, the directors noted that “demand for digital experience services shows no signs of losing steam”. It hasn’t been lost on investors as SQLI’s share price has rallied 12 per cent since LDG’s half-year-end. The company reports its next results on 21 September 2023 after close of trading, a potential share price catalyst.

The bottom line is that LDG’s shares are being anomalously priced once you factor in the substantial cash backing, the underlying value in its four holdings and their re-rating potential. Effectively, you are getting those stakes at less than half their book value even though their intrinsic value is materially above their current market prices. That double discount is worth exploiting. 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 £3.75, or £25 plus P&P of £5.75 for both books.