Bargain shares: Small-cap buying opportunities

When the company released its 2018 annual results a couple of months ago, and on the back of a robust trading outlook and order book, analyst Paul Hill at Equity Development raised his 2019 pre-tax profit forecast by 17 per cent to £3.5m, based on annual revenues rising to £63m (‘Mpac’s massive earnings upgrades’, 5 March 2019). House broker Panmure Gordon had an identical profit forecast.

However, Mpac ended last year with net cash of £27m, and has found a strategically good home for the surplus capital by announcing the earnings-enhancing acquisition of Tadcaster-based Lambert Automation, a provider of automation solutions to the medical and consumer healthcare markets. Founded in 1973, Lambert works upstream in its customers' product and production lifecycles, which will enable Mpac to offer a more comprehensive and broader range of automation and packaging solutions to its own customers.

The acquisition also provides Mpac with an entry into the medical and healthcare product assembly and packaging market, thus giving it exposure to increasing demand for wellness products. And because less than a quarter of Lambert’s sales are overseas, it can leverage off Mpac’s broader geographic footprint and international customer base (80 per cent of Mpac’s sales are non-UK). Cross-selling opportunities aside, Lambert ended 2018 with a bumper order backlog, having registered its second highest level of bookings at £24.5m.

Mpac is paying £15m for the business, or 8.4 times Lambert’s average cash profit of £1.8m in the preceding three years. There is a capped earn-out, which only kicks in if Lambert’s average annual cash profit exceeds £2.5m in the financial years 2019 to 2021. Lambert would have to generate average annual cash profit of £3m-plus for the maximum £2.5m deferred consideration to be payable. Three of Lambert’s existing shareholders will stay with the business, thus incentivising them to achieve the earn-out.

For good measure, Mpac chief executive Tony Steels notes that “Mpac’s order and quote activity remains strong and the current order book is significantly above the previous year”. Demand from Mpac’s blue-chip client base for the high-speed, cutting-edge packaging machinery and equipment that the company supplies is being underpinned by underlying market growth of 5 per cent, and an ongoing need for large original equipment (OEM) customers to improve efficiency and lower costs and wastage in their production lines.

Analysts have taken note. Both Equity Development and Panmure have upgraded their 2019 pre-tax profit estimates by a third to £4.6m, and raised their 2020 estimates by around a half to £6.6m. On this basis, Panmure Gordon expects adjusted EPS to more than quadruple from 4.5p in 2018 to 19.9p in 2019, rising to 28.6p in 2020.

So, having suggested buying Mpac’s shares, at 156p, in my market-beating 2018 Bargain Shares portfolio, and after taking into account the pension deficit I discussed in my last article, I feel the shares have strong potential to achieve my target price of 225p in the next six months as more investors cotton on to the strong earnings story that is unfolding. In fact, my target could prove conservative as it’s well below Panmure Gordon’s raised target price of 259p (up from 182p) and Equity Development's fair value of 245p (up from 200p). Buy.

First Property posts earnings beat

Mpac is not the only one of my Bargain Shares to prompt analysts to upgrade their forecasts. In a pre-close trading update for the financial year to 31 March 2019, Aim-traded UK and eastern European property fund manager and investor First Property (FPO:52p) has reported a 12.6 per cent rise in assets under management (AUM) to £705m, of which funds managed for third parties increased by more than a third to £611m.

Chief executive Ben Habib notes that the underlying property markets in which the company operates remain buoyant and are offering interesting investment opportunities to capitalise on. The company’s dealmaking at Krakow Business Park, since renamed Eximius, located 15 minutes from the centre of Poland’s second-largest city, which led to a 17 per cent surge in First Property’s net asset value per share in the first half of the 2018-19 financial year, is a case in point as I highlighted when I covered the interim results in the autumn (‘First Property posts eye-watering valuation gains’, 26 November 2018). The share price is little changed since then even though the company is overdelivering.

Indeed, the combination of subsequent valuation gains and property disposals across a number of the funds First Property manages has boosted performance fees earned and prompted house broker Arden Partners to raise its full-year pre-tax profit estimate by 10 per cent to £7.5m. On this basis, expect annual EPS of 4.8p and a 6 per cent hike in the dividend per share to 1.7p. Analysts also edged up their spot net asset value (NAV) to 64.2p per share, rising to 67.4p in March 2020.

I first recommended buying First Property’s shares at 18.5p in my 2011 Bargain Shares portfolio, since when the board has paid out cash dividends of 10.44p a share to produce a 238 per cent return. NAV per share has grown by in excess of 350 per cent in the same period, highlighting the significant shareholder value created from First Property’s shrewd investment activities. Trading on a 19 per cent discount to spot book value, offering a prospective dividend yield of 3.3 per cent and priced on 11 times likely EPS for the year just ended, I remain a buyer ahead of the release of the annual results in June. Buy.

Sylvania releases bumper third-quarter results

Aim-traded Sylvania Platinum (SLP: 30p), a fast-growing and low-cost South African producer and developer of the platinum group metals (PGMs) platinum, palladium and rhodium, has issued an eye-catching set of third-quarter results and is guiding investors to expect a record quarterly output in the final three months of the financial year to 30 June 2019.

Buoyed by a 15 per cent hike in the average gross basket price to $1,383 an ounce (oz), as a result of the upward price move of both palladium and rhodium, and 9 per cent higher quarterly output of 16,256 oz, Sylvania’s net revenues surged by 23 per cent to $18.3m in the three months to end March 2019. Furthermore, with quarterly operating costs only 8 per cent higher at $9.7m, profits accelerated at an even faster rate, so much so that Sylvania’s third-quarter cash profit surged by more than half to $8.2m to deliver a 33 per cent rise in post-tax profit to $5m.

After accounting for capital expenditure and net changes in working capital, the company increased net cash by $3.5m to $23.7m (6.4p a share) in the three-month period. Guidance is to expect an even better performance in the final quarter when Sylvania’s management expects to achieve quarterly output of 21,800 oz, an outcome that would deliver quarterly cash profit in excess of $12m, or as much as Sylvania earned in the first half to 31 December 2018.

On this basis, analysts at house broker Liberum Capital expect full-year pre-tax profit to rise by more than half to $24.7m on revenue of $69m to deliver 60 per cent higher EPS of 6.13c (4.75p), implying the shares are rated on a price/earnings (PE) ratio of 6.5. Strip out net cash and the PE ratio falls to five. Liberum is pencilling in an annual payout of 1.77c, implying the shares offer a prospective dividend yield of 4.4 per cent.

True, Sylvania’s share price has doubled since I included the shares at 14.75p in my 2018 Bargain Shares portfolio. However, having considered the factors driving end-market demand for the PGMs that Sylvania recovers from chrome tailings material from mines in South Africa's North West Province, I feel that my 35p target price is looking too conservative. That’s because management expects output to plateau at around 80,000 oz from 2020 for the next eight to nine years without any further expansion capital expenditure. Indeed, analysts at house broker Liberum Capital envisage capital expenditure declining from $10.6m in the current financial year to only $3.2m in 2021-22. This means that the critical issue is the outlook for the sustainability of current commodity prices.

Bearing this in mind, the palladium market has been in deficit since 2012, with stock levels depleted by an aggregate of 4.6m oz, the market tightness being exacerbated by demand from the automotive sector, a point I have made before. The same factor has also been buoying demand for rhodium, a mining by-product whose major use is as one of the catalysts in the three-way catalytic converters in cars. Indeed, Johnson Matthey has stated that rhodium is between two to three times more effective than platinum in the auto-catalyst. It is also useful in reducing nitrogen oxide emissions, so demand is further underpinned by stricter emission targets as governments look to reduce pollution levels.

Both factors suggest to me that although the rhodium price has risen by half in the past 12 months, and almost trebled in the past couple of years, the combination of growing end-market demand and restricted supply is likely to maintain a tight market at elevated prices for some time yet. That’s important for Sylvania as the company has a relatively large exposure to rhodium, compared with peers.

The bottom line is that as Sylvania’s capital expenditure is set to decline from 2020-21 onwards, its cash pile is going to build very quickly unless PGM prices collapse. Liberum forecasts closing net cash of $59m (£45m) by June 2021, a sum equating to around half Sylvania’s current market capitalisation. A new target price 33 per cent above the current level now looks justified. Buy.

Leaf Energy award to boost Crystal Amber

Shares in Aim-traded clean energy investment company Leaf Clean Energy (LEAF:100p) have trebled in value since last Friday on news that the company has been successful in its appeal against the nominal damages Leaf was awarded last summer in the Delaware Court of Chancery. The appeal relates to the court-ordered redemption of its 2.3 per cent equity stake in Invenergy Wind LLC, North America's largest independently owned wind power generation company. I covered the potential outcomes of the long-running legal case in a detailed analysis last month when I suggested maintaining a financial interest in Leaf’s shares (‘Leaf’s day of judgement approaches’, 1 April 2019).

It proved the right call because the Delaware Supreme Court reversed the Court of Chancery's judgment and held that Leaf is entitled to full damages following the breach (by Invenergy) of the operating agreement between the parties. My understanding is that Invenergy will now have to pay Leaf the full $122.2m claim less the $35.6m already paid in June 2018, implying a further payment of $85.8m, or 124.5p per Leaf share. The Delaware Supreme Court has ordered the Delaware Court of Chancery to enter judgment consistent with its decision and the forthcoming final judgement will factor in pre- and post-judgment interest.

Bearing this in mind, the breach of the operating agreement occurred in December 2015, so I estimate that there will be pre-judgement interest of $21.1m owing on the $122.2m award from December 2015 to June 2018 based on the Delaware Court statutory rate (5 per cent a year above the Fed Funds discount rate), and a further $8.5m interest owing from June 2018 (when the $35.6m was paid to Leaf) until the sum is eventually settled. Potentially the pre- and post-judgement interest to be ordered by the Delaware Court of Chancery could be around $29.6m, or 43p per Leaf share, and that's if it is settled by Invenergy next month. The interest then accrues at over $25,000 per day thereafter.

After allowing for incentive payments to Leaf’s management team, it’s reasonable to expect an ultimate cash return to Leaf’s shareholders at least in the order of £73.5m, or 140p a share. That’s a decent result if you followed my advice to buy Leaf’s shares at 38p (‘Pointing to a successful outcome’, 19 April 2016) after I spotted an investment opportunity while I was running my slide rule over Aim-traded investment company Crystal Amber (CRS: 210p), an activist fund that owns 29.9 per cent of Leaf’s issued share capital. At the time, Leaf had placed a $95m valuation on its 2.3 per cent shareholding in Invenergy, suggesting that the stake was worth 50 per cent more than Leaf’s market capitalisation at the time.

Since then, Leaf has returned £19.5m of the $36.2m (£27.6m) of cash it has so far received from Invenergy by redeeming 55 per cent of its issued share capital at 29.72p a share by way of a compulsory redemption (‘Leaf Clean Energy’s cash return’, 11 July 2018). Taking into account the compulsory redemption, the break-even point on the balance of your holding is 48.1p a share, so you will now have doubled your money and can expect to bank a near-200 per cent gain, assuming a cash return in the order of 140p a share is made in due course. This means that at the current offer price the shares offer 40 per cent further share price upside, thus making them a decent buy.

The same is true of shares in Crystal Amber, a constituent of my 2018 Bargain Shares portfolio. By my reckoning, the company’s spot net asset value (NAV) per share is around 235p, up from 219.4p at the end of March 2019 and my end-April 2019 estimate of 221.5p. The 15.75m shares Crystal Amber holds in Leaf account for 13.8p (4.6p at end of April 2019) of the company’s NAV per share based on Leaf’s current bid price of 90p. A likely final cash return of 140p a share to Leaf shareholders will add an additional £8m to Crystal Amber’s NAV, or 7p a share.

I also note that investors are warming again to currency payment group FairFX (FFX:117p) and bank note printer De La Rue (DLAR:446p), and justifiably so. De La Rue is rated on a forward PE ratio of 10 and offers a 5 per cent-plus dividend yield, and FairFX has one of the lowest PEG ratios on the London stock market, suggesting the potential for the company to double EPS to 9p between 2018 and 2020 is being undervalued by investors given the shares are still only rated on a forward PE ratio of 13 for 2020. These two holdings account for 31 per cent of my estimate of Crystal Amber’s spot NAV, and I view both investments in a positive light.

I am also positive on Crystal Amber’s largest holding, Hurricane Energy (HUR:46.2p), an oil explorer that has a huge resource base in a strategically important part of the North Sea and one that accounts for almost 20 per cent of the company’s spot NAV. Shares in Hurricane are priced on less than half the risked NAV per share estimate of 102p of analysts at Edison Investment Research even though the company is on course to produce net profits of $110m in 2020 and generate operating cash flow of $188m to leave it in a net cash position. Needless to say, I continue to rate shares in Crystal Amber a buy and see potential for a narrowing of the share price discount to NAV. Buy.

Conygar’s planning award to drive profitable gains

Nottingham City Council has granted planning permission for Aim-traded property vulture fund Conygar’s (CIC:160p) mixed-use scheme in the city centre. Conygar originally acquired the 37-acre Nottingham Island site in December 2016 for £13.5m and submitted its outline planning application in July 2018 for a scheme of over 2m sq ft, including office, apartments and student housing. Analysts at Liberum Capital expect the Nottingham property development will be the main driver of Conygar’s NAV performance over the medium term and “has the potential to generate material development gains for the company given the scale of the project”.

By my reckoning, the company has a spot NAV of £114.7m, or 203p a share, based on a share count of 56.5m, of which the net cash pile now accounts for £51.4m (91p a share) after factoring in the disposal in March of an 80-bedroom Premier Inn Hotel at Parc Cybi, on the outskirts of Holyhead, Anglesey. Conygar received net proceeds of £6.9m, which represented a net initial yield of 4.7 per cent. The cash pile will get a further boost later this year when Conygar completes the development of a 20,000 sq ft B&M Retail unit in Ashby-de-la-Zouch, which has already been forward sold for £4.3m.

Trading 20 per cent below NAV per share and in line with the recommended buy-in price in my 2018 Bargain Shares portfolio, I continue to feel the potential for Conygar to reap material gains from its development portfolio is being undervalued by investors. Buy.

Oakley’s astute investment in price comparison websites

Shares in private equity investment company Oakley Capital (OCI:210p) have produced a total shareholder return of 10 per cent since I covered the annual results (‘Alpha alert for financial gains’, 18 March 2019) and are trading at an all-time high.

However, there is still material potential share price upside on offer given that the shares are priced on an unwarranted 25 per cent discount to Oakley’s last reported NAV per share of 281p, even though the company is delivering eye-catching gains on disposals from an equity portfolio of private companies that continue to gain traction. It’s also making some astute new investments too.

'Digital consumer' is one of the key areas Oakley invests in, accounting for almost two-fifths of the portfolio. For instance, it holds investments in European real estate websites Casa.it in Italy and atHome.lu in Luxembourg. In particular, Oakley invests in businesses that have strong brand awareness, and attract lower-cost, direct traffic to their websites, thus helping to drive improved profitability. They are typically highly cash generative and can scale up quickly once they hit an inflexion point. Strong underlying structural market growth, asset-light business models that produce strong cash conversion, and the ability to accelerate performance through effective management are key characteristics of the businesses Oakley’s investment managers are looking for.

Bearing this in mind, Oakley has just announced a £17m investment in a fund that is creating a joint venture with insurance group Admiral (ADM:2,191p) and Spanish insurance group Mapfre (MAP:BME) to combine two of Spain’s most well-regarded digital brokers for insurance and other financial products: Rastreator and Acierto.com.

Founded in 2009, Rastreator is a digital insurance broker that enables consumers to buy insurance, financial products, travel, offers, telephone services, energy, finance and cars by comparing quotations. The business is currently 75 per cent owned by Admiral and 25 per cent by Mapfre. In 2018, Rastreator generated revenues of €29m.

Founded in 2007, Acierto.com is a digital insurance broker that compares prices from more than 30 car, motorcycle, health, life and home insurance companies. Currently, Acierto.com is majority-owned by its two founders, who will retain a stake in the joint venture. In 2018, Acierto generated revenues of €13m.

Importantly, Oakley has considerable expertise in the price comparison market, having previously successfully invested in Verivox, Germany’s leading energy price comparison website, and Facile, the price-comparison market leader in Italy. Interestingly, the Spanish market is at an early stage in its development, with internet usage lagging behind that of more developed markets (UK and Germany), thus presenting a similar growth opportunity to that experienced by Verivox and Facile as consumers migrate online. The car insurance market in Spain is worth €10bn (£8.6bn) of gross written premiums and rising, according to analysts at Liberum Capital. So, by investing in the top two players, Oakley can take advantage of their strong market position, brand awareness and growing market demand while at the same time benefiting from likely cost savings from marketing and central cost budgets. It looks a sound deal to me.

I included Oakley shares, at 146.5p, in my market-beating 2016 Bargain Shares portfolio and after taking into account total dividends of 13.5p, the holding has produced a 51.1 per cent total return on an offer-to-bid basis, outperforming both the FTSE All-Share (total return of 44.6 per cent) and FTSE Aim All-Share (total return of 48.5 per cent. Buy.

Profiting from cyber crime

Kape Technologies (KAPE:91p), a provider of cyber security software and a constituent of my 2017 Bargain Shares portfolio when the shares were priced at 47.9p, has issued a bullish trading update at today’s annual meeting and one that vindicates the bullish investment case I outlined when I covered the 2018 annual results (‘Profiting from cyber security', 20 March 2019).

Kape continues to pull in new subscribers, driven by the acquisition in March 2017 of CyberGhost, a leading cyber security SaaS (software as a service) provider of secure virtual private networks (VPNs), which enable users to securely pass data over public networks. As digital privacy awareness has become mainstream due to the escalation of cyber crime targeting consumers’ data, then demand for encrypted data has soared, so much so that by the end of last year CyberGhost’s customer base had almost trebled to more than 400,000 since acquisition. The growth is showing no signs of slowing either. That’s hardly surprising given that the global cyber security market is now worth $153bn (£117bn) and is growing at 12 to 15 per cent per year.

In fact, Kape reported today that both last autumn’s acquisition, Berlin-based Zenmate – a digital privacy company that is also focused on encrypting and securing internet connections and protecting individuals' privacy and digital data through VPNs – and CyberGhost have grown their respective subscriber bases by 65 per cent year on year in the first quarter of 2019, so propelling Kape’s SaaS subscriber base by 14 per cent to 945,000.

After factoring in organic growth and the contribution from last summer’s acquisition of Intego, a Mac and iOS cyber security and malware protection SaaS business, Kape is on track to deliver a near-50 per cent hike in 2019 annual revenues to $77.3m as house broker Shore Capital predicts. On this basis, expect a 43 per cent rise in full-year pre-tax profit to $12.6m to lift underlying EPS from 5¢ to 6.8¢ (5.2p). Moreover, the company is cashed up to make further earnings-accretive acquisitions, having ended 2018 with net funds of $40.4m, a sum worth 21.5p a share. This means that Kape’s shares are rated on a cash-adjusted forward PE ratio of 13, hardly punchy for a business operating in a high-growth market, and one that is benefiting from increasing market penetration as consumers adopt the technology to protect themselves against cyber crime. Buy.

Please note that the Leaf Clean Energy article was updated at 4.30pm on Tuesday, 7 May 2019 to take into account new information on the interest calculation of the Invenergy judgement.

■ Simon Thompson's new book Successful Stock Picking Strategies and his second book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are priced at £16.95 each plus postage and packaging of £2.95, or £3.75 if you purchase both books. Details of the content of both books can be viewed on www.ypdbooks.com.