10. Dart
The European airline sector is a crowded market. Overcapacity has seen airlines such as Monarch and Flybe go under. This doesn’t appear to be deterring Jet2holiday owner Dart (DTG) from its expansion plans. During the first half of its financial year Dart increased capacity nearly a quarter to 9.47m available seats, and carried a quarter more passengers at 8.93m. So far this has not yet hit the load factor, which rose 1.2 percentage points so that 94.4 per cent of seats were filled.
But “increased losses” are expected in the second half of the year as Dart ups its spending on new planes and marketing campaigns, and adds staff. It’s also exposed to fluctuations in fuel prices and sentiment around Brexit. There’s been speculation that some Brits are putting off booking a summer holiday given the uncertainty around Brexit and ensuing flying and visa rules. This may put pressure on ticket yields, which, coupled with excess capacity, could be disastrous. At 961p or 10 times forward earnings, sell. JF
9. Clinigen
Last month, Clinigen (CLIN) completed the acquisition of the US rights to Proleukin following US anti-trust clearance, having been granted the rest of world rights in July 2018. The drug is utilised in the treatment of metastatic kidney cancer or metastatic melanoma and is currently being used in around 80 active clinical studies within the US across multiple disease areas.
Developments like this can have a galvanising effect on mid-tier operators such as Clinigen (market capitalisation of £1.35bn), but the speciality and services group had alerted investors to a scale transformation already under way two months earlier, when it reported a quarter rise in revenue, adjusted cash profits and shareholders’ funds at the half-year mark.
The group defines its main aim as providing “ethical access to medicines” through a unique combination of complementary businesses – Proleukin is the latest in a line of many. The group already has commercial links with 29 of the top 50 pharmaceutical companies, but its ability to “manoeuvre around product changes, drug shortages and logistical hurdles” was enhanced in the final quarter of 2018 through the acquisition of CSM, a provider of packaging, labelling, warehousing and distribution services with operations in the US, Belgium and Germany. A week later, Clinigen stepped in to acquire iQone, a Switzerland-based speciality pharmaceutical business, further supporting the expansion of its clinical pharma portfolio in key EU markets, while diversifying the global client base.
Commercial medicines now account for 41 per cent of adjusted gross profit and the group is a leader in the ethical sourcing and distribution of unlicensed pharmaceuticals, in addition to the supply of drugs for clinical trials. The global market for unlicensed medicines is worth in the region of $5.5bn, but is predicted to grow rapidly due to the proliferation of online medical information (‘Dr Google’) and increases in patient awareness of treatment options, together with the increased take-up of western pharmaceutical products in emerging markets economies. This part of the business delivered 10 per cent organic gross profit growth – and its proportion of the group total is almost guaranteed to increase.
The shares were marked up following the $210m acquisition of US rights to Proleukin from Swiss pharma heavyweight Novartis (Sw:NOVN) However, at 1,011p, they still trade at an implied discount of 8 per cent based on their historical PE ratio relative to peers. Buy. MR
8. Secure Income REIT
Some parts of the real estate sector have come under pressure, but Secure Income REIT (SIR) runs a portfolio of assets that is, as the name suggests, extremely robust. These include a string of freehold private hospitals and leisure assets, including Alton Towers and Thorpe Park. Crucially, these are tied to long leases with no breaks. Making several acquisitions meant net assets were up by almost half last year, with purchases funded by a share placing that was oversubscribed. All rents are index-linked or with a fixed rate increase built in, and the average lease length of nearly 21 years is the longest in the sector.
Secure Income started out in June 2014 with a loan-to-value ratio of almost 80 per cent, but with a continued valuation uplift, this is expected to drop below 40 per cent this year. Running costs remain low, with tenants responsible for maintenance and insurance expenses. Given the quality of the revenue stream, the share price premium to NAV is justified, and there is a 3.4 per cent dividend yield. Buy. JC
7. RWS
Since listing on Aim in 2003, language, intellectual property (IP) and localisation specialist RWS (RWS) has reported 15 consecutive years of revenue, profit and dividend growth. With a “promising” start to FY2019, the group is confident of delivering another record year.
Now fully integrated, the acquisition of Moravia has increased the group’s global presence, creating a dedicated localisation division that enables clients to maintain brand consistency as they grow internationally. In 2018, it was the main driver of the 87 per cent increase in revenue to £306m. Moving forward, management intends to diversify revenues from a “big five” to 15 major accounts. Although a standalone division, Moravia’s strengths are being harnessed to benefit the wider group. As the language services industry increasingly adopts machine translation, Moravia’s extensive knowledge of this technology is being utilised across RWS to counter the risk of current platforms becoming outdated.
With a diversified, international blue-chip client base, the group is seeking to exploit growth opportunities across divisions, cross-selling services to increase client ‘stickiness’. Offering RWS’s full suite of services to clients is considered a priority for 2019, in particular, leveraging Moravia and life sciences’ customer relations to generate new business wins for IP services.
RWS is pursuing an international growth strategy. Following the acquisition of Alpha Translations Canada, a leader in expert legal and financial translations, the group now benefits from an expanded presence in the key growth areas of North America and Germany and an enhanced legal client base. The IP services division is looking to capitalise on the increasing maturity of the Chinese IP market as it transitions from ‘made in China’ to ‘designed in China’, as well as US and European patent filers seeking patent protection there. Half-year results indicate that like-for-like Chinese sales in Patent Cooperation Treaty translations (international patent applications) increased by 27 per cent. Planning further inroads into the Asia Pacific region, the group notes an “excellent pipeline of prominent new clients” moving into the second half.
Net debt stood at £63.9m at the half-year stage, with analysts at Berenberg forecasting a net cash position by September 2020. Strong cash generation leaves the group well placed to capitalise on consolidation opportunities and to continue its acquisitive growth strategy. Currently at 29 times forecast earnings, RWS shares trade at a slight premium to their two-year historical averages. But a successful long-term track record and further growth potential keeps us convinced. Buy. NK
6. Boohoo
Online fashion retailer Boohoo’s (BOO) growth has been impressive in recent times, with its latest update bringing the shares to within striking distance of their all-time high of 266p, reached in June 2017. Its recent success has been down to the growth of PrettyLittleThing, which management says has grown faster than any other brand it has ever seen. However, as PrettyLittleThing’s growth begins to cool – as it must in the fickle world of fashion – the question is where the growth will come from next.
Management is still refraining from introducing a dividend payment, preferring to invest heavily in growth. It plans to do this through both external acquisitions and investment in growing existing brands organically. Thankfully, the group’s highly cash-generative business model – which more than doubled free cash flow to £65.1m in the latest update – gives it the firepower to do so. We worry high expectations will lead to a share price fall if growth slows, but for now, the offering remains compelling. Buy. TD
5. Abcam
Investing in biotech stocks entails significant risk, so prices can be unduly vulnerable to missing earnings expectations. Abcam (ABC) saw its market valuation pull back sharply at the half-year mark after it moderated expectations on annual revenue growth and the adjusted operating margin – but was the market intemperate in its response?
Cambridge-based Abcam, a specialist in protein research tools for global life sciences researchers, subsequently unveiled a highly promising collaboration in the US. It has teamed up with New Jersey-based Visikol, a contract researcher focused on advancing drug discovery, to develop new reagents and kits for improved tissue clearing and 3D imaging (visualisation of opaque organs and tissues). Tissue clearing methods are utilised in the analysis of complex structures such as the brain and nervous system, greatly enhancing our understanding of neuroscience. It also remains a key growth area of the market. In addition, it has agreed a partnership with fellow life science tools provider NanoString Technologies of Seattle. Two-thirds of global researchers utilise the company’s technologies, but that clinical affirmation is also reflected in market support – hence the demanding forward rating of 38 times forecast earnings. Hold. MR
4. Asos
Investors are staking a lot on Asos’s (ASC) potential. The online fashion group’s latest half-year results were, in some ways, dreadful. Investments in technology and logistical capabilities caused pre-tax profits to fall close to 90 per cent, while management said the group was “capable of achieving more”. However, the market welcomed the results, sending the shares up above 4,000p in the weeks that followed, from a little over 3,000p in the days prior.
The reason was that for all the group’s market was more competitive, it maintained sales, profit and margin guidance for the full year, indicating stability that the UK retail industry has been lacking in recent times.
Over the longer term, the group has started to scale down its investments, with £200m-worth expected in the current year, falling to £150m in 2020. Management said the group would start to feel the benefits in the second half of the year, and evidence of this will be crucial to maintaining investor confidence. Hold. TD
3. Hutchison China MediTech
Midway through last month, Hutchison China Meditech (HCM), which already trades on Aim and Nasdaq, declared that it had submitted a listing application to float on the main board of the Stock Exchange of Hong Kong. The estimated $400m-$500m global offering of its shares, including a secondary share sale by parent CK Hutchison Holdings, will provide additional capital to fund late-stage clinical development of its drug candidates, five of which are now in development outside China. In what amounts to an indirect challenge to Aim, the Hong Kong Stock Exchange now allows emerging biotech stocks – those without revenues – to list their shares on the market.
Chi-Med closed out 2018 with net cash of $274m, but it is likely to outlay between $160m and $200m on R&D through this year. Aside from a highly prospective clinical programme, it’s worth noting that over a fifth of the company’s stock is now in institutional hands, suggesting that analysts have confidence in prospects for the candidates, although the flipside is that volatility can ensue if institutional support weakens on the back of negative clinical updates. Buy. MR
2. Fevertree Drinks
Investors considering buying shares in Fevertree Drinks (FEVR) may have trouble justifying its valuation. Not only do the company’s signature drinks mixers trade at a premium, but so do the shares. At 3,195p, the shares trade at 50 times forward earnings – a stark premium to other UK-listed drinks makers, but it actually represents a discount to the company’s two-year historical valuation.
Fevertree mixers, especially its tonic waters, have become a staple across UK pubs and supermarkets alike. It’s the number one mixer brand by value in the UK off-trade market and has continued to gain share in the on-trade sector. Sales in the UK were up 53 per cent to £134m in 2018, with its dominant spot in the UK retail market at 42 per cent of the sector’s sales. Gin has arguably never been so popular in the UK – more gin was sold during the three months of summer 2018 than in 2014 and 2015 combined. This is much to the benefit of Fevertree’s tonic waters. The extension of the “refreshingly light” range of mixers should appeal to the more calorie or sugar-conscious drinker.
Those willing to buy in at the current valuation may be betting that Fevertree will be able to replicate its UK outstanding performance in the US. The company has set up a North American headquarters in New York that has full control over sales, marketing and distribution in the region. Last year Fevertree signed an exclusive on-trade national distribution agreement with Southern Glazer’s Wine and Spirits (SGWS), the largest wine and spirits distribution company in North America. The agreement took effect from August last year and includes operations in 29 states, with the remainder covered by regional distribution agreements. The US premium mixer category is said to be immature, but the scale of the market could be difficult to crack.
So far, expansion in the US is progressing well, with sales up 21 per cent in the last financial year, or 24 per cent at constant currency, to £35.8m. While tonic water is the most popular product among British punters, the ginger range is the focus for American drinkers, who have more of a preference for dark spirits. Further expansion in Europe is also expected to drive revenue growth over the long term.
Fevertree has minimal capital expenditure requirements as it outsources production and bottling, meaning it also has few fixed assets. This provides flexibility, even when entering new markets, and means the company is highly cash generative. Still, we can’t justify the hefty valuation. Hold. JF
1. Burford Capital
After enjoying a spectacular run in the prior two years, shares in BurfordCapital (BUR) endured a rockier rideafter last year’s equity market downturn. However, that comes with the territory given the stock’s high-growth status and belies the litigation finance specialist’s track record of impressive returns. Last year the return on its core portfolio jumped 85 per cent, with realisations from 26 different investments helping boost total income by a quarter.
Since 2018, Burford Capital has been joined by litigation finance providers Manolete Partners (MANO) and Litigation Capital Management (LIT) on London’s junior market. However, those groups are minnows in comparison to Burford, which had net assets of $1.36bn at the end of December.
The funding firepower backing Burford also puts it head and shoulders above peers, after it secured an additional $1.6bn (£1.3bn) in funding during 2018 for litigation finance investments, including $667m from entering a strategic relationship with a sovereign wealth fund. Under the agreement, a $1bn pool of capital will be invested on a 2:1 basis, with Burford providing the remaining $333m in exchange for 60 per cent of profits generated once the initial investment has been recovered.
Encouragingly, for a group deploying such a high level of capital, Burford only tapped investors for further funds in October last year, raising nearly £200m via an oversubscribed share placing. That cash was raised to finance geographical expansion, including moves into Australia and Germany. Up until 2016, the group had financed new investments using cash receipts from existing business.
Investing in litigation finance providers like Burford carries a natural level of high risk and assessing the value locked up in the portfolio is more difficult than traditional financial services groups. However, Burford only alters the fair value of ongoing cases in the event of a secondary market transaction, where it sells part of an interest in a matter to third parties, or if there is a significant development in the legal process of a case.
Despite the rate of share price growth slowing since the final quarter of last year, we remain encouraged by the large amount of capital ready for deployment and the group’s track record of doing so profitably, with the portfolio generating a 31 per cent internal rate of return since its inception a decade ago. We remain buyers. EP
