The idea behind our annual Bargain Shares Portfolio is simple. It’s to invest in companies where the true worth of the assets is not reflected in the share price, usually for some temporary reason, but where we can reasonably expect that it will be reflected in due course.
Our portfolios are based on the investment ideas of Benjamin Graham (see box ‘Rules of Engagement’) and they have certainly withstood the test of time, beating the FTSE All-Share index in 17 out of the 21 years in which we have run them. During that time, they’ve generated an average return of 21.4 per cent in the first 12-month holding period, compared with an average increase of 4.5 per cent for the FTSE All-Share index.
My 2019 Bargain Shares proved no exception, generating a 12-monthly positive total return of 33.1 per cent on an offer-to-bid basis and including dividends. By comparison, the FTSE All-Share Total Return index, the index against which we benchmark our annual performance, produced a total return of 13.4 per cent and the FTSE Aim All-Share Total Return index rose by 6.7 per cent. That’s not to say this investment strategy is a one-way bet. Investing rarely is; the laggard in the 2019 portfolio, North Sea oil exploration company Jersey Oil & Gas (JOG), has lost more than a third of its value, thus highlighting the benefits of having a diversified portfolio.
As usual, the hidden gems we uncover in the stock market are found in the under-researched small and micro-cap segment. Targeting smaller-cap companies has reaped handsome rewards over the years, justifying our long-term bias here, but it works both ways as companies that disappoint can be punished severely given the less liquid nature of these shares. The flipside is that when we get it right we can expect substantial long-term outperformance, as our track record shows.
It’s worth pointing out that no portfolio can be immune to a market crash: the collapse in share prices in the global financial crisis in 2008 wreaked havoc, but readers who kept faith subsequently recovered all their paper losses, which again highlights the solid asset backing of the companies. In fact, two of those companies from the 2008 portfolio – Indian Film Company and Raven Mount – both succumbed to takeovers. It was a similar story in 2011, a year when the eurozone debt crisis reached its peak. However, the 2011 portfolio subsequently recouped all its paper losses, and went on to reward investors with some mightily handsome gains in later years.
The 2016 portfolio highlights the long-term nature of our portfolios. It returned 11 per cent in its first year, well shy of the 19.4 per cent return on the benchmark FTSE All-Share index, but has been racking up the gains ever since, buoyed by the takeover of bio-decontamination specialist Bioquell, hefty cash returns from investment company Volvere (VLE), a doubling of the share price of asset manager Gresham House (GHE), and a storming performance from Gresham House Strategic (GHS), the investment fund it manages. In fact, the 2016 portfolio has produced a four-year total return of 85 per cent, outperforming both the FTSE All-Share and FTSE Aim All-Share indices by more than a third. Moreover, I have advised banking capital returns equating to 112 per cent of the portfolio’s starting capital, so the risk-adjusted return is even more impressive.
The 2017 portfolio has been on a tear, too. Having returned 30 per cent in its first 12 months, it has now produced a total three-year return of 54 per cent, which is 34 and 42 percentage points more than the total return on the FTSE All-Share and FTSE Aim All-Share indices, respectively. The gains have been driven by two technology companies: cyber security firm Kape Technologies (KAPE) and BATM Advanced Communications (BVC).
It’s a similar story with the 2018 portfolio, which has turned a first year return of 12.5 per cent in a down market into a 24-month return of 25.7 per cent; South African mining group Sylvania Platinum (SLP) being the star of the show. Over the same two-year period, the FTSE All-Share index has produced a total return of 9.6 per cent, and the FTSE Aim All-Share index has actually lost 7.8 per cent of its value.
Interestingly, merger and acquisitions (M&A) activity has been a regular feature of all my portfolios, as predators, attracted by the asset backing on offer, run their slide rule over the numbers. It’s understandable, as in some cases valuations are so depressed that we are getting all the fixed assets in the price for free, thus offering the substantial “margin of safety” Benjamin Graham was aiming for.
So, once again, I have run the rule over around 1,500 listed companies on Aim and the main market of the London Stock Exchange to come up with a portfolio of companies where the asset backing should be strong enough to overcome any short-term trading difficulties and, in time, reward our loyal following of long-term value investors.
|Bargain Shares Portfolio: 21-year track record|
|Year||Bargain Shares portfolio 1-year performance (%)||FTSE All-Share index 1-year performance (%)|
|Average one-year return||21.4||4.5|
|Source: Investors Chronicle|
|Bargain Shares Portfolio 2020|
|Company name||TIDM||Market||Activity||Mid-price||Market value||Bargain rating|
|CIP Merchant Capital||CIP||Aim||Closed-end investment company||51.5p||£28.3m||1.63|
|Xaar||XAR||Main||Industrial inkjet technology company||35.9p||£28.1m||1.62|
|Chenavari Capital Solutions||CCSL||Main||Closed-end investment company||61p||£20.5m||1.38|
|Metal Tiger||MTR||Aim||Investor in natural resources||1.275p||£19.6m||1.02|
|Brand Architekts||BAR||Aim||Beauty products||153p||£26.1m||0.90|
|Cenkos Securities||CNKS||Aim||Corporate broker||52.5p||£29.8m||0.82|
|Anglo Eastern Plantations||AEP||Main||Crude Palm Oil producer||550p||£218m||0.33|
|Source: London Stock Exchange RNS and company accounts.|
CIP Merchant Capital
Aim: Share price: 51.5p
Bid-offer spread: 50-53p
Market value: £28.3m
In chapter seven of The Intelligent Investor, the seminal 1949 work of Benjamin Graham, the father of value investing explains: "If we assume that it is the habit of the market to overvalue common stocks which have been showing excellent growth or are glamorous for some other reason, it is logical to expect that it will undervalue – relatively, at least – companies that are out of favour because of unsatisfactory developments of a temporary nature. This may be set down as a fundamental law of the stock market, and it suggests an investment approach that should be both conservative and promising." Mr Graham's theory was that a strong balance sheet will usually see a company through any short-term difficulties and provide a "margin for safety".
That’s exactly what’s on offer at CIP Merchant Capital (CIP), a Guernsey based closed investment company that takes a private equity style approach to investing. It predominantly invests in listed equities and seeks to achieve enhanced returns by capitalising on the performance-focused characteristics of a private equity approach.
CIP Merchant Capital listed its shares, at 100p, on Aim in December 2017 when it raised £52.4m (95.3p a share) net of £2.6m (4.7p a share) listing costs. Since then the company’s investment manager has created a £26.3m (47.9p) investment portfolio across eight different investee companies. It also retains an estimated cash pile worth £21m (38p), implying a live net asset value (NAV) per share of 84.8p after accounting for the company’s likely operating costs of £720,000 since the 30 June 2019 half-year end. However, the share price has headed south and is trading close to its all-time low, or 41 per cent below NAV per share.
This means that the combined value of cash and the investment portfolio less all liabilities exceeds CIP Merchant Capital’s market capitalisation by 65 per cent, thus creating the “margin of safety” Mr Graham so desired. Furthermore, deduct the £21m cash pile from the company’s market capitalisation of £28.3m and CIP Merchant Capital’s £26.5m investment portfolio is effectively in the price for 72 per cent less than its book value even though seven of the eight investments are listed on a major exchange and include stakes in Orthofix Medical (US:OFIX), an $882m market capitalisation Nasdaq quoted medical devices company, and FTSE Aim 50 constituent CareTech (CTH), a heavily asset-backed provider of social care services. CIP Merchant Capital’s holding in Orthofix has a current market value of £3.65m and the investment in CareTech is worth £4.4m.
CIP Merchant Capital portfolio breakdown
Net asset value
Oil & Gas
Oil & Gas
Oil & Gas
Cash and short dated government bonds
Estimated operating costs Q3 and Q4 2019
Net asset value
Shares in issue
Net asset value per share
Source: CIP Merchant Capital RNS filings. Quoted investments priced at market prices on 28 January 2020 on the following exchanges: London Stock Exchange, Nasdaq (Orthofix Medical) and Luxembourg MTF Market (Coro Energy Eurobond). Unlisted assets valued at 30 June 2019. Allowance made in operating costs for Merchant Capital third and fourth quarter management fee and group operating costs for second half of 2019.
Admittedly, some of the holdings in the portfolio haven’t performed well, including its largest investment, Aim-traded Coro Energy (CORO), a southeast Asian upstream oil and gas company. CIP Merchant Capital invested £6m in purchasing 150.2m shares (19 per cent of the equity) in a placing in April 2018 and a further £3m in a €22.5m eurobond issued by Coro in April 2019. I reckon these two investments have a combined value of £5.6m, although the company was also issued with call warrants on 85.2m Coro shares which have an exercise price of 4p and expire in April 2022.
The region possesses some of the world's fastest developing economies where demand for gas currently significantly outstrips supply and is supportive of commensurate growth in energy demand. Coro’s growth strategy is being targeted on countries such as Indonesia, Malaysia and Vietnam where there is significant 'yet to find' hydrocarbon resources as well as numerous fallow discoveries for commercialisation and development. Clearly investors are more cautious, hence the underperformance of Coro’s share price.
Also, CIP Merchant Capital has taken a hit on its investment in Milan-based digital marketing company Alkemy S.p.A. (It:ALK), which designs and implements solutions for the digitalisation of business-to-business (B2B) and business-to-consumer (B2C) channels. Shares in the company have fallen by 23 per cent since late September. The holding is worth £2.5m.
In addition, CIP Merchant Capital holds a £0.84m stake in Aim-traded Brave Bison (BBSN), a company that works with brands, creators and platforms to create, distribute and monetise video and derives its revenue from advertising and fee-based services. Brave Bison retains net cash of £3.9m, a sum that backs up half of its market capitalisation. This means that the business is effectively being valued on a single-digit multiple of annualised cash profit, a valuation that CIP’s investment managers believe fails to acknowledge the company’s growth potential from its market leadership, with the benefits of the operating leverage still to be exploited.
Other holdings include a £1.26m investment in Proactis (PHD), a global procurement software provider that last summer received a preliminary unsolicited approach from a US-based investor with regard to making an offer for the company. It also received a number of preliminary unsolicited expressions of interest from other parties and remains in a bid situation.
CIP Merchant Capital’s most recent investment was made only last month when the company acquired 12.8m shares, or 3.4 per cent of the equity, in Aim-traded Circassia Pharmaceuticals (CIR), a speciality biopharmaceutical company focused on allergy and respiratory diseases. Circassia’s directors expect revenues for the 2019 financial year to be in the middle of their previously issued guidance of £60m to £65m, representing significant growth compared with the previous year (2018: £48.3m). The board also expects to report growth in sales of both NIOX (asthma management product) and Tudorza (maintenance treatment of chronic obstructive pulmonary disease (COPD)), and a modest contribution from Duaklir, another COPD product launched in October 2019.
It has been a well-timed purchase as the holding is already showing an £800,000 paper profit on CIP Merchant Capital’s £2.8m purchase price. Circassia’s year-end cash position was better than expected, helped in part by the timing of certain payments and third-party rebates. Also, it will not have gone unnoticed that Michael Roller, the former finance director of Bioquell, the star of my 2016 Bargain Shares portfolio – a 372 per cent total return on the holding by the time the company was taken over in January 2019 – has just been appointed Circassia’s new finance director.
CIP Merchant Capital’s final investment is in an unlisted Italian company that commenced operations in 2017 with one veterinary hospital, under the brand Happy Friends, in Lombardy, North Italy. It is expanding operations through the opening of further veterinary hospitals and clinics in northern Italy. CIP Merchant Capital invested a total of £4m for a 35.4 per cent equity and shareholder loan.
CIP Merchant Capital’s investment manager, Merchant Capital, an affiliate of Continental Investment Partners, has a mandate to invest primarily in equity and equity-linked securities, as well as debt, convertible debt and other financial instruments with equity characteristics, in companies that typically have at least two or more of the following characteristics:
■ Potential to achieve a superior risk-adjusted return with a medium/long-term target internal rate of return (IRR) of 20 per cent.
■ Cash generative, or forecast to generate cash, within a reasonable investment horizon.
■ Attractive management track record.
■ Strong fundamentals.
■ Potential for liquidity event or exit within identified time frame.
■ Investee companies to have a competitive advantage.
Investments are predominantly in the following industries: oil and gas; healthcare; pharmaceutical; and real estate.
The investment management team is led by 55-year old Carlo Sgarbi. He has over two decades of experience in investment banking, including as head of debt capital markets at Banca IMI, the investment bank of Intesa Sanpaolo, a leading Italian banking group, as well as global head of fixed income and derivatives at the bank. From 2007 to 2013, Mr Sgarbi was responsible for managing all investment activities within a Swiss family office. In 2013, he co-founded Continental Investment Partners with Marco Fumagalli.
Mr Fumagalli was previously a global partner at private equity firm 3i Group (III), where he managed investments in both private and listed companies. From 2010 to 2013, the 49-year-old was responsible for managing the private equity activities within a Swiss family office before co-founding Continental Investment Partners. He is a non-executive director of Aim-traded companies Sound Energy (SOU), Echo Energy (ECHO) and Coro Energy (CORO).
Frankly, Mr Sgarbi and Mr Fumagalli would need to invest the balance of the company’s cash disastrously for investors buying at the current level not to make a decent long-term return. Clearly, they believe in their ability, having spent £688,000 purchasing 1.23m shares at 56p in May 2019 and a further £718,000 purchasing 1.23m shares at prices between 56p and 60p in October 2019 to take their combined holdings to 8.1 per cent of the share capital. Their shareholdings in CIP Merchant Capital are almost entirely held through a company, Goldfinch SA, which is owned in equal proportions between the two directors.
Exploiting a valuation anomaly
True, the investment manager receives a management fee equating to 2 per cent of NAV, which is rich considering that £21m of assets are still in low-yielding cash. The poor investment performance to date will deter some investors, too. However, the downside risk looks minimal considering the company’s hefty cash position of 38p a share, while any positive valuation movement on its listed holdings and successful deployment of the rest of the bumper cash pile could kick-start a rerating to narrow the share price discount to book value. Clearly, they have some talent in stockpicking as the company’s holdings in CareTech and Circassia have both performed well to date. Buy.
Main: Share price: 35.9p
Bid-offer spread: 35.4-36.4p
Market value: £28.1m
Half-year results from Cambridge-based Xaar (XAR), a world leader in the development of inkjet technology and a manufacturer of piezoelectric drop-on-demand industrial inkjet printheads, were catastrophic. The main issue was a £39m write-down of the company’s heavily lossmaking Thin Film printhead business, which remains years away from achieving meaningful scale and would have required a strategic investment partner with deep pockets to fund the business before it becomes commercial. Sensibly, Xaar’s directors decided to cease all activities and seek licensing deals to exploit the intellectual property (IP). But even ignoring the hefty non-cash impairment charge, the company still reported a first-half operating loss of £13m on revenue down a third to £22.5m. The dividend was axed, and don’t expect a payout when the annual results are released on 24 March 2020 either. The headline numbers will not make for a pleasant read. Analysts at Peel Hunt expect a 2019 pre-tax loss of £25m (excluding exceptional items of £47m).
However, rather than looking through the rear-view mirror, it pays to look at the road ahead and the transformation of the business under the new management team led by new chief executive John Mills. He joined Xaar last summer as head of the printhead business unit, and took up his new role at the helm at the start of this year. Mr Mills has extensive experience in the digital print market, having worked at Domino Printing Sciences from 1994 to 2001.
Xaar also has a new finance director, Ian Tichias, who joins from Ibstock (IBST), a maker of concrete products, where he held the same role.
Other board changes include the departure in March of chairman Robin Williams, who has held the position for nine years. He will be replaced by Andrew Herbert who was Domino Printing Sciences' finance director from 1998 to 2015 when it was taken over for £1bn. Mr Herbert also held a number of director roles in operations, planning and business development. He has a track record of delivering sustained international growth across a wide range of market sectors through the acquisition of technology-based businesses and creation of sales channels.
Understanding the business
Xaar’s technology is used in a wide range of manufacturing applications, including graphics, labelling, packaging, product decoration, ceramic tile and glass decoration – as well as printing with specialist functional fluids for advanced manufacturing techniques.
Specifically, the technology drives the conversion of analogue printing and manufacturing methods to digital inkjet which is more efficient, more economical and more productive than traditional methods. The company designs and manufactures printheads, as well as systems for product decoration and industrial 3D Printing.
Upside from restructuring
The new brooms are restructuring Xaar’s lossmaking printhead division to generate annual recurring cost savings of £8m at a one-off cost of £2.5m, and have removed £7.4m of related items from the Xaar 1201 product in the Thin Film business. This should go a long way to stabilising and simplifying the structure of the printhead unit and cut the cost base to a level that should support a marked improvement in profitability this year. There are growth areas to exploit within the printhead unit, too.
For instance, the industrial printheads segment reported 12 per cent sales growth in the first half, driven by demand in ceramics, decor and advanced manufacturing. Xaar’s 2001 product, the most versatile printhead for ceramic tile and glass decoration, was a key driver. Also, the packaging printhead segment reported 8 per cent growth as volumes of Xaar 501 ramped up, a product designed to deliver industrial reliability and robustness in applications such as printing large exterior banners or indoor point-of-sale material. Admittedly, the 52 per cent first-half reported sales growth for Xaar 2001, a product designed specifically for new printer installs, was offset by pressure in the replacement ceramics market for which Xaar 1003 was designed as orders from original equipment manufacturers (OEMs) were directed at new printer installs.
Nonetheless, with substantial costs being taken out of the business, and the Thin Film unit ceasing production, prospects for the printhead operation are arguably far better than the market is suggesting. The same is true of Xaar’s product print systems business. This division increased first-half revenue by 22 per cent, with equipment sales growing by 26 per cent and consumables up by 15 per cent. This activity provides a more stable and predictable revenue stream and offers scope to scale up through acquisitions.
Strong and liquid balance sheet
Even after taking into account the thumping first-half loss of £52m, Xaar’s NAV of almost £80m is more than double its market capitalisation of £28.1m even though the company announced a few weeks back that it ended the financial year with net cash of £25.4m (32.5p a share). The balance sheet is incredibly strong, with property, plant and equipment accounting for £24m of NAV; last reported current assets of £61m is more than four times greater than total liabilities of £14m, thus indicating a strong liquid ratio, which supports Xaar’s ability to meet its financial obligations. In fact, even if you write off all of the £10m of intangible assets and goodwill on the balance sheet, net tangible assets of £70m still equate to 89.5p a share, or more than double Xaar’s current share price.
Uncovering hidden value
There is hidden value in the balance sheet, too. That’s because Xaar holds an incredibly valuable 55 per cent stake in Xaar 3D, the company’s cutting edge 3D printing business. Eighteen months ago, Xaar formed a partnership with Stratasys to develop 3D printing solutions based on its high-speed sintering technologies. Stratasys is one of the world’s leading 3D printing companies, working with global leaders in aerospace and automotive industries. Stratasys clearly sees the potential for the technology, so much so that it paid Xaar $10m (£7.7m) last autumn to purchase a further 20 per cent equity stake in Xaar 3D and has a three-year call option to buy the balance of Xaar’s 55 per cent stake for $33m (£25.4m), placing a value of $60m on the venture.
In other words, the combined £51m value of Xaar’s year-end cash pile and the read-through valuation of its retained stake in Xaar 3D is 81 per cent greater than the company’s own market capitalisation of £28.1m. This implies nil value is being ascribed to the rest of Xaar’s businesses even though it has £61m of hard assets: inventories of £22.9m; receivables of £14m; and property, plant and equipment of £24m.
Trading on a bargain ratio of 1.6 and on a 65 per cent discount to last reported book value, I feel the investment risk is skewed to the upside. Interestingly, the share price is in oversold territory and trading close to its 2008 bear market lows around 35.8p, suggesting that the risk premium embedded is at extreme levels. Peel Hunt predicts a 2020 pre-tax loss of £15m on revenue of £44m to produce a cash loss of £8.3m (after accounting for non-cash depreciation and amortisation charges of £6.7m) and a free cash outflow of £9m to reduce net cash to £16m. However, if the new management team is successful in turning around the printhead operations faster than the market expects, then Xaar’s share price has potential to rise sharply given its cash backing and the substantial hidden value in its Xaar 3D shareholding. Bargain buy.
Aim: Share price: 53p
Bid-offer spread: 51-55p
Market value: £14.5m
Founded four decades ago by late chairman David Phillips, Northamber (NAR) is widely recognised as the largest UK-owned trade-only distributor within the IT equipment industry. The business has more than 100 strategic alliances with the industry's leading manufacturers and distributes a comprehensive range of electronic products to provide solutions for the IT and communications needs of small and medium-sized enterprises (SMEs).
Northamber is not directly involved with the ultimate users of the products it sells, rather it acts as a hub through which manufacturers provide products to resellers for sale to the ultimate end user. As a result it has to develop strategies with both suppliers and resellers to satisfy the needs of the ultimate users of the products. The strategy is to assess their requirements, source quality products and services from reliable brand-named manufacturers, and make them available to resellers at the best prices in the most efficient time frame. Moreover, with an ever-changing product range coming onto the market, the company needs to seek out fresh new products that will prove attractive to end users.
The company operates from its head office in Chessington, Surrey which is home to more than 50 sales and customer support staff and teams working in purchasing, credit service, commercial web and marketing. The IT products are held in an 80,000 sq ft warehouse in Weybridge, which has more than 7,500 pallet bays and 13 loading bays, enabling Northamber to deliver 98.9 per cent of orders the next working day.
However, it’s a cut-throat industry, one reason why Northamber has failed to report a profit in any one of the past seven financial years, racking up cumulative pre-tax losses of £6.4m on aggregate revenue of £433m since 30 June 2012.
Given this dire performance, and the fact that 85 per cent of the 27.333m shares are held by the top five shareholders, it’s hardly surprising that the shares have underperformed, falling from a dot.com peak of 255p two decades ago. In fact, until last summer the share price was trading around its 2009 bear market low of 28p.
Despite the chronic underperformance, and a poor operational track record, there are reasons to believe that the share price move since last summer’s lows is the real deal rather than another false dawn.
Reasons for optimism
Firstly, in the annual results released at the end of last year, acting chairman Geoff Walters made the important point that the planned exit from low-margin and commoditised products is starting to pay off. Gross margin increased from 8.4 per cent in the first half of the financial year to 8.8 per cent on 7 per cent higher six-monthly revenue of £26.1m in the second half. This has been helped by the expansion of audio-visual solutions products. Indeed, increasing profitable product ranges helped drive a reduction in the six-monthly pre-tax loss from £353,000 to £245,000. Also, one reason for the loss is that a supplier of a new product breached its contract with Northamber, which led to lost sales and contribution. Northamber swiftly took action against the supplier and a related party, which has resulted in an interim award judgement of £431,000 plus costs in its favour.
Secondly, the company has a cash-rich balance sheet and one that has been boosted significantly following the £16.4m cash sale (post the 30 June 2019 financial year-end) of the aforementioned Weybridge facility. The property was purchased by Northamber for £6.35m in April 2012 and is valued in the company’s accounts at £6m. This means that Northamber’s cash pile will have soared more than fivefold to £19.8m when the sale completed, a significant sum in relation to the company’s market capitalisation of £14.5m and its last reported NAV of £16.6m.
Admittedly, Northamber has agreed to pay rent of £175,000 to the vendor of the Weybridge property for the next two years as part of the sale agreement, but it has also recently acquired a 51,000 sq ft freehold warehouse on a two-acre site in Swindon for £3.2m and one that meets the company’s current requirements. It is much closer to its courier partner, too. I would flag up that Northamber holds one other unencumbered freehold property which has a book value of £1.8m and is conservatively valued in the accounts.
The point being that even if you ignore the £5m value of these two unencumbered freehold properties, I reckon Northamber’s pro-forma current assets of £29.5m are four times higher than its last reported current liabilities of £7.4m, so the company’s working capital position is incredibly strong and offers investors the “margin of safety” that Ben Graham was looking for. Furthermore, net current assets of £22.1m are 1.5 times the company’s market capitalisation of £14.5m. Factor in the value of the freehold properties and I estimate a live NAV of £26.6m, or 97p a share. That’s almost double the current share price.
Thirdly, with the benefits of a cash rich balance sheet, Northamber completed earlier this week the £2.1m acquisition of audio-visual distributor Audio Visual Materials (AVM), a company that reported a pre-tax profit of £300,000 in its 2018 financial year. Northamber’s directors feel the business will help expand its own audio visual segment and drive higher growth for IT and audio visual resellers in certain key areas including professional displays, video conferencing, and room booking systems. After taking into account the improvement in Northamber’s trading results, the contribution from AVM certainly supports a move back towards operating profitability for the enlarged entity.
The bottom line
Northamber is a debt free company which will have £14.5m of cash once the Swindon warehouse purchase completes, will own two unencumbered freehold properties that are conservatively worth £5m and perhaps significantly more on the open market, and is trading in line with cash even though the business is showing signs of improvement and earlier this week completed the AVM earnings’ accretive acquisition. Also, there is a possibility that Northamber could itself become a target after founder and 63 per cent shareholder Mr Phillips passed away in December at the age of 74. He is survived by his wife, son Alexander (who has a director role at the company) and daughter.
Please note that although the shares are tightly held – excluding the top five shareholders there are only 4.1m shares in issue – it’s possible to trade in bargain sizes well in excess of the London Stock Exchange normal market size of 1,000 shares. Indeed, in the past month trades of up to 25,000 shares have passed through the market between the official bid-offer spread. Bargain buy.
Chenavari Capital Solutions
Main: Share price: 61p
Bid-offer spread: 60-62p
Market value: £20.5m
Shrewd institutional investors have been stake building in a little-known Guernsey-registered closed-end investment company, Chenavari Capital Solutions (CCSL).
In the past month, Weiss Asset Management has raised its stake from 16.21 per cent to 29.58 per cent and Global Value Fund, a Sydney-based investment fund, has taken a 5.47 per cent shareholding. Loyal readers of my weekly columns will note that Weiss also holds a 29 per cent stake in Leaf Clean Energy (LEAF), an investment company that delivered eye-watering cash returns to shareholders in 2019. Weiss appeared on Chenavari’s share register at the end of February 2019 when it disclosed a 5.17 per cent shareholding and has been stake building since then.
Interestingly, one of Chenavari’s directors, 56-year old Robert King, is also a non-executive director for a number of open- and closed-ended investment funds, including CIP Merchant Capital and Weiss Korea Opportunities Fund.
The reason why the smart money has been investing in Chenavari is because the company is in the final stages of selling down its investment portfolio and returning the cash to shareholders, having made three cash returns last year totalling £16.6m through compulsory share redemptions. Importantly, all the compulsory share redemptions have been made at NAV, so shareholders are receiving the full value of the underlying investments.
The realisation process commenced in January 2017 and to date the company has returned £86.6m of cash through nine compulsory capital redemptions and paid out £12.8m of dividends, in the process redeeming 75 per cent of the shares issued at the time of the IPO in 2013. True, the divestment process will undoubtedly have tested the patience of some shareholders. But the end is in sight.
Moreover, with Chenavari’s share price trading on a 30 per cent discount to end 2019 NAV of 86.45p, and the company paying out regular quarterly dividends – 2.2p a share was declared in the 12 months to 30 September 2019 – there is a valuation anomaly to exploit given that spot NAV of £29m is 41 per cent higher than Chenavari’s market capitalisation of £20.5m even though the company currently holds £5.8m of net cash and has minimal liabilities.
Understanding the risks
The lengthy divestment process aside, the other reason why some investors may be deterred is the composition of the company’s investment portfolio. Chenavari holds a portfolio of financial assets (SME loans, corporate loans, mortgages and asset-backed securities), which it entered into through transactions with UK and European banks.
This introduces several risks, including collateral risk, namely credit losses incurred through customer default on loans and non-recovery of the full amount lent; counterparty risk with the banks; and investment concentration risk given that three of its investments now account for £23.5m, or 76 per cent of NAV of £29m. There is a risk that the remaining investments in the portfolio could become more difficult to dispose of and some of the assets may need to be held to maturity in order to obtain an acceptable exit valuation.
In addition, there is Brexit risk as the UK's exit from the EU could lead to significant disruption in trade and lead to a general market downturn, both directly and indirectly impacting the value of its investments. Indeed, a 5 per cent movement in prices of the underlying securities held impacts the company’s total assets by around £1.2m. Potential for a widening of credit spreads between risk-free government bonds and the underlying assets Chenavari has invested in is another risk worth considering. Currency risk is hedged out as policy.
Also, as the company’s NAV declines fixed costs will naturally form a larger part of the overall operating costs resulting in an increased total expense ratio. Although the board has taken steps to reduce both operating costs during the divestment process and fees paid to directors, Chenavari still incurs annual operating costs of £800,000 including an annual management fee that equates to 1 per cent of NAV.
This is a small-cap company, too, with the top eight shareholders controlling more than two-thirds of the 33.58m shares in issue, so Chenavari’s free float is below average. However, it’s still possible to deal in bargain sizes well above the 3,000 London Stock Exchange normal market size, and a bid-offer spread of 2p is tight enough.
Assessing potential upside
Having taken into account all of these risks, I still feel that there is a decent buying opportunity here. That’s because at the end of 2019, Chenavari’s £29m investment portfolio consisted of cash and hedging instruments (£5.7m); a regulatory capital position of £11.4m, which has a scheduled maturity later this month; three small investments worth £1.45m, which represent capital held back following the realisation of previous regulatory capital positions and which the company expects will be repaid and distributed to shareholders by November 2020; and two Spanish non-performing loans which are in the books for £8.7m and £1.9m, respectively.
What this means is that cash on the balance sheet and the scheduled capital inflows from the aforementioned regulatory capital investments back up £18.5m of Chenavari’s £20.5m market capitalisation. It also means that the two Spanish loans are effectively in the price for £2m, or 80 per cent less than their combined book value of £10.6m. This offers the hefty margin of safety that Ben Graham so desired. As soon as the directors have firmed up their exit strategy on the two Spanish loans they will revert to shareholders with plans for the return of capital. Bearing that in mind, it’s worth noting that the two Spanish loans have already been written down by £3m since 30 September 2018, so should more accurately reflect a likely disposal value.
Please note that Chenavari’s shares are intended for knowledgeable investors or professionally advised investors who have sufficient resources to be able to bear any losses that may result from such an investment, not that there is much downside risk here based on my analysis of the company. The shares can be held in both a self-invested personal pension (Sipp) and individual savings account (Isa) and are suitable for investors who are able to take a long-term view as part of a diversified investment portfolio. Having said all that, I expect the company to be fully divested by the middle of 2021 and for the majority of your invested capital to be returned this year. However, your broker may still require you to pass a sophisticated investor assessment prior to dealing in the shares.
It would pay to do so. That’s because as the investment manager works through the final divestment process, even after accounting for monthly operating costs of £70,000 between now and the middle of 2021, and likely winding-up costs, it’s not unrealistic to expect 90 per cent of Chenavari’s NAV of 86.45p a share to be realised and returned to shareholders. This suggests potential for a 25 per cent investment return in a 17-month holding period. Buy.
Aim: Share price: 1.275p
Bid-offer spread: 1.25-1.30p
Market value: £19.6m
There is a value opportunity to exploit in the shares of Metal Tiger (MTR), an Aim-traded investment company primarily focused on undervalued natural resource opportunities.
Not only do the shares trade on a 25 per cent discount to the company’s last reported fully diluted NAV per share of 1.71p, but there is massive hidden value in the balance sheet, too. Furthermore, following last autumn’s takeover of Australia-listed MOD Resources by Sandfire Resources (Aus:SFR), a A$1bn market capitalisation cash-rich and dividend-paying Australia-based mining and exploration company listed on the Australian Stock Exchange, Metal Tiger now holds 6.3m shares in Sandfire, which have a current market value of A$36.3m (£18.8m) on which the company earns a tidy A$1.5m (£0.8m) annual dividend. Metal Tiger received a £540,000 final dividend from Sandfire shortly after the MOD Resources takeover completed at the tail end of last year.
In effect, the value of the Sandfire stake and net cash on Metal Tiger’s balance sheet backs up all of the company’s market capitalisation of £19.6m, leaving the rest of its investment portfolio in the price for free. That’s anomalous as it implies there is nil value in Metal Tiger’s other seven listed holdings which have a combined value of £3m, nor any value in its unlisted holdings which I calculate have an aggregate value of £8.5m based on their acquisition cost, latest earn-in valuations or read-through valuations based on recent transaction multiples.
By my reckoning after accounting for the A$2.4m (£1.3m) Metal Tiger has invested in last week’s Australian Stock Exchange IPO of Cobre Pty (Aus:CBEXX), a company offering exposure to the Perrinvale copper project in Western Australia, its total investment portfolio net of all liabilities is worth around £31.9m, or 63 per cent more than its own market capitalisation.
|Metal Tiger's listed investments|
|Investment||Listing||Description||Securities held||Market value|
|Sandfire Resources||Australian Stock Exchange||Australia-based mining and exploration company. Flagship DeGrussa Copper-Gold Mine, located 900 km north-east of Perth in Western Australia, produces copper concentrate and copper grade with notable gold and silver credits. It also owns the T3 Copper-Silver copper exploration and development project in the Kalahari Copper Belt, Botswana.||6.3m shares||A$36.3m (£18.8m)|
|Cobre Pty||Australian Stock Exchange||Cobre is the 80 per cent owner of Toucan, which holds a group of tenements consisting of the Perrinvale Copper Project, covering 382km2 of the Panhandle and Illaara Greenstone Belts in Western Australia. The Perrinvale Project was previously owned by Fortescue Metals Group and includes three prospects called Schwabe, Zinc Lago and Ponchiera, over which Fortescue retains a 2 per cent net smelter royalty on future copper production.||19.35m shares||A$3.9m (£2m)|
|Thor Mining||AIM/Australian Stock Exchange||Molyhil tungsten project||96.55m shares||£352,000|
|Greatland Gold||AIM||Gold exploration||9m shares||£268,000|
|Arkle Resources||AIM||Zinc exploration||9.67m shares||£108,300|
|4.8m warrants (1.8p expiry 10/9/2020)||-|
|4.8m warrants (7p, expiry 9/3/2020)||-|
|Aurelius Minerals||Toronto Stock Exchange||Gold exploration||2m shares||£46,500|
|2m warrants (Can$ 0.06, expiry 16/4/2021)||£23,000|
|Sable Resources||Toronto Stock Exchange||Gold and silver exploration||1m shares||£58,140|
|iMetal Resources||Toronto Stock Exchange||Gold and copper exploration||0.67m ordinary shares||£42,850|
|0.67m warrants (C$ 0.20, expiry 13/3/2021)||£9,000|
|Total valuation of listed holdings and cash||£23.4m|
|Source: Metal Tiger Annual Report & Accounts; London Stock Exchange; Australian Stock Exchange; and Toronto Stock Exchange. Prices correct on 28 January 2020.|
Management’s eye for a deal underrated
It’s not as if Metal Tiger hasn’t had success with its investments either, the change of fortune resulting from the appointment just over three years ago of chief executive Michael McNeilly and chief investment officer Mark Potter.
Mr McNeilly is an experienced corporate financier who advised several private, main market, Aim-quoted and ISDX-listed companies on a variety of corporate transactions during his tenure at broking houses Arden Partners (ARDN) and Allenby Capital.
Mr Potter is the founder of Sita Capital Partners, an investment management and advisory firm specialising in investments in the mining industry. Metal Tiger made a small strategic investment in Sita in 2018 in order to benefit from favourable deal flow. He was formerly chief investment officer of Anglo Pacific Group (APF), a £330m market capitalisation natural resources royalty company listed on the London Stock Exchange’s main board, where he successfully led a turnaround of the business through acquisitions, disposals of non-core assets, and successful equity and debt fundraisings.
Metal Tiger makes its money by investing in high-potential mining exploration and development companies that are significantly undervalued and where there is substantial upside potential through exploration success and/or development of a mining project towards commercial production. Directly held equity investments generally comprise companies that are at exploration, pre-feasibility and definitive feasibility study stage. No mining companies in the investment portfolio are currently at production stage. As a result, the portfolio should be considered high-risk as the future value of investments is often dependent on financing and/or exploration success. But risk brings rewards, too.
Investment strategy offers potential to realise material gains
The takeover of MOD Resources, which completed in October 2019, is a case in point. The offer by Sandfire valued Metal Tiger’s holding at a 200 per cent premium to the company’s aggregate investment of £7.7m. It’s not the only smart dealmaking by the directors, either; Metal Tiger acquired A$500,000 of shares in Cobre pre-IPO last summer at an average price of A7.5¢, a discount to last week’s A20¢ IPO price, so has already made a A$1m paper profit.
Metal Tiger also holds a 7.62 per cent stake with a book value of £463,000 in unlisted Pan Asia Metals, a Singapore company that is planning an IPO on the Australian Stock Exchange in April 2020, thus offering a liquidity event to realise value from its balance sheet holding. Pan Asia Metals is focused on the exploration and development of speciality and base metal projects in Southeast Asia’s tin tungsten belt through four wholly owned projects: Reung Kiet Lithium Project, Thailand; Khao Soon Tungsten Project, Thailand; and Bang Now Lithium Project, Thailand. The strong growth of electric vehicle and battery manufacturing in Thailand, supported by positive government policy, represents an opportunity for Pan Asian Metals to position itself as an important supplier of Thai battery metals. The company also has an interest in the Minter Tungsten Project in the Lachlan Fold Belt, New South Wales, Australia.
It’s also worth flagging up that pursuant to Metal Tiger selling its interests in the Tshukudu Exploration project in the Kalahari Copper Belt, Botswana to MOD Resources as part of the Sandfire transaction, Metal Tiger now retains a 2 per cent uncapped net smelter royalty over any future production from Tshukudu, and a capped US$2m royalty from another major copper project in the country.
Moreover, Metal Tiger has retained exposure to the projects through its Sandfire shareholding in order to benefit from the value created as it moves towards commercial production. That’s worth considering because Sandfire is in a far better position than Metal Tiger or MOD Resources to raise the requisite funding to finalise the developments. In addition, Sandfire’s more diverse asset base offers Metal Tiger greater exposure to the potential value creation from the larger group’s high-grade copper development and exploration projects, both in Australia and overseas.
Hidden value in unlisted investments
Metal Tiger’s most exciting unlisted investment is its 59 per cent equity stake in Kalahari Metals Limited, a company that holds interests in 12 highly prospective exploration licences covering a total area of 8,595 km2 in the Kalahari Copper Belt, consisting of two 100 per cent-owned exploration licences (the Ngami Copper Project and the Okavango Copper Project); five exploration licences subject to a binding earn-in agreement with Triprop Holdings (Pty) Limited; and five exploration licences held by Kitlanya Ltd, which Kalahari Metals has entered into a binding agreement to purchase.
Between June 2018 and May 2019, Metal Tiger invested a total of US$2.7m (£2.07m) in four tranches to acquire a 59.8 per cent shareholding in Kalahari Metals. The most recent purchase of a 9.81 per cent stake in May 2019 cost the company US$1.1m, implying a US$11.2m equity value for the whole of Kalahari Metals. Once the Kitlanya acquisition is completed, Metal Tiger’s stake will be reduced to 53.17 per cent, but that’s still worth around US$6m (£4.6m), or more than double its total acquisition cost.
In fact, it could be worth significantly more because when MOD Resources acquired Metal Tiger’s 30 per cent stake in Tshukudu Exploration’s 8,000 km2 licensing area in Botswana, it was undertaken at a valuation of almost £2,100/km2. On this basis, Kalahari Metals’ 8,595 km2 licensing area in the country could be worth £18m, valuing Metal Tiger’s £2.07m investment in Kalahari Metals at £9.5m. I have been conservative in my sum-of-the parts valuation, applying a 30 per cent discount to that read-across valuation. However, it still equates to a £6.6m valuation for Metal Tiger’s 53 per cent stake in Kalahari Minerals post the completion of the Kitlanya acquisition.
Expect regular newsflow from the project throughout this year as drilling is due to commence shortly to test structural targets within the Kitlanya East area, while the findings from recent regional soil sampling and airborne electromagnetic geophysics surveys in Kitlanya West include the delineation of seven compelling targets that warrant drill testing.
|Metal Tiger's unlisted investment portfolio|
|Investment||Description||Valuation basis||Market value|
|Kalahari Minerals||Metal Tiger has invested to date £2.07m for a 59 per cent equity stake to gain interests in 12 highly prospective exploration licences covering a total area of 8,595 km2 in the Kalahari Copper Belt, Botswana.||Transaction multiple using MOD Resources acquisition of Metal Tiger’s 30 per cent stake in Tshukudu Exploration’s 8,000 km2 licensing area in Botswana as comparable and applying 30 per cent discount.||£6.6m|
|Boh Yai Mining Company Ltd||The Boh Yai and Song Toh silver-lead-zinc mines and processing plant are located in the Silver-Lead-Zinc Belt of Kanchanaburi Province, western Thailand. They have good infrastructure, including paved roads, grid power and benefit from excellent geotechnical conditions. Metal Tiger controls the surrounding exploration ground to the mines and is in advanced discussions with the joint venture owners.||Cost of investment||£731,000|
|Pan Asia Metals Ltd||Metal Tiger holds a 7.62 per cent equity interest in Pan Asia Metals, a company focused on the exploration and development of specialty and base metal projects in Southeast Asia’s tin tungsten belt through four wholly owned projects. The strong growth of the electric vehicle and battery manufacturing in Thailand, supported by positive government policy, represents an opportunity for the company to become an important supplier of Thai battery metals.||Book value in 2019 interim accounts.||£463,000|
|Veta Resources Inc||Exploration company focused on the Chilean Coastal Range. Metal Tiger holds 9.99 per cent of the equity and a Toronto Stock Exchange listing is planned, offering potential for a liquidity-driven event to realise value.||Book value in 2019 interim accounts.||£150,000|
|Logrosan Minerals Ltd||Joint venture vehicle held by Metal Tiger and Mineral Exploration Network (Finland), a low-cost exploration project developer and incubator with a portfolio of exploration holdings in Spain and Finland. The Logrosán Exploration Project covers an area of 310 km2 and consists of the Antonio Caño, Zorita, San Cristóbal, Mari Hernandez Exploration and San Cristóbal Sur Exploration licences in Central Spain.||Metal Tiger acquired a 50 per cent stake after the company funded €1m of exploration costs between 2015 and 2017.||£430,000|
|Tally Ltd||Non-core holding. Consumer banking platform for its own gold-backed currency. Physical gold is held in Zurich and each Tally is backed by one milligramme of the physical metal.||Book value in 2019 interim accounts.||£58,001|
|Sita Capital Partners||UK-based investment adviser in the mining sector. Metal Tiger's chief investment officer, Mark Potter, is also chief investment officer of Sita Capital.||2018 acquisition cost.||£115,385|
|Total valuation of unlisted holdings||£8.5m|
|Source: Metal Tiger Annual Report & Accounts and London Stock Exchange RNS.|
Smart investors on board
Metal Tiger conducted two equity raises in the first quarter last year, which raised net proceeds of £2.8m, at 1.45p a share, and were backed by Rick Rule, senior managing director of Sprott Inc (TOR:SII), a Toronto-based global asset management group with more than 200,000 clients and US$9bn of assets under management.
A professional investor in natural resources and gold for almost five decades, Mr Rule purchased 60m shares on his personal account at the placing price. In addition, Exploration Capital Partners, a fund of which he is portfolio manager, added 69m shares to its holding to lift its stake in Metal Tiger to 206m shares, or 13.25 per cent of the 1.53bn shares in issue. Both parties were issued with 30m and 34.5m warrants, respectively, exercisable at 2p a share and which expire in 12 months' time.
Metal Tiger’s board also invested £210,000 in the February 2019 share placing, and Mr Potter acquired 300,000 shares, at 1.27p, in an on-market purchase around the same time. In aggregate, the directors own 132.7m shares, or 8.6 per cent of the 1.53bn shares in issue, so have significant skin in the game.
Cashed-up for new investments
Importantly, Metal Tiger has cash available to make new investments even though it has decided to hold on to the valuable stake in Sandfire.
That’s because the company has recently entered into an equity derivative collar financing arrangement with a global investment bank that is secured on 1.67m of the 6.3m shares Metal Tiger holds in Sandfire. Under the terms of the arrangement, Metal Tiger entered into a stock lending arrangement with the lender, pursuant to which: the bank can borrow up to 1.67m Sandfire shares from Metal Tiger; the company has the right (but not the obligation) to sell 1.67m Sandfire shares to the lender in three years’ time at 80 per cent of the reference price, being A$6.10; the company granted the lender the right (but not the obligation) to buy 1.67m Sandfire shares from Metal Tiger in three years’ time at A$8.84; and the company borrowed A$8.2m secured on the combination of the above with a maturity date of 16 December 2022.
Costs of A$675,000 associated with the financing arrangements were deducted from the loan proceeds to leave Metal Tiger with A$7.5m of cash to fund a NAV per share accretive buyback of 10 per cent of its equity; participate in the Cobre IPO (cost of A$2.4m); make new investments; and for general working capital requirements. Please note that Metal Tiger’s £1.7m pro-forma net cash position is stated after taking the aforementioned £4.2m financing loan into account as I estimate pro-forma gross cash of around £5.9m.
In addition, Metal Tiger can agree with the lender to utilise the balance of its Sandfire shareholding to increase the size of the financing arrangement at a later date. If the total loan balance outstanding on 30 June 2020 is less than A$20m, Metal Tiger will be required to pay a commitment fee to the lender, the maximum amount payable being A$118,254.
The benefit of this innovative funding arrangement is that the financing is cost-effective, doesn’t include any share price based triggers and enables Metal Tiger to continue to benefit from any capital upside in its Sandfire shareholding.
Bargain basement buy
So, with positive newsflow expected on multiple fronts in the coming year, the holding in Sandfire and net cash backing up all of Metal Tiger’s market capitalisation, conservative sum-of-the-parts valuations more than 50 per cent higher than the company’s share price, and the board addressing the valuation gap by making NAV-accretive share buybacks (16.3m shares have been purchased to date in the ongoing programme), there could and should be material upside in Metal Tiger’s shares in the coming year, and beyond.
Interestingly, the share price has traded in a tight range between 1p and 1.65p for the past 13 months, a breakout above 1.65p would confirm completion of the base formation and support a move towards the June 2018 highs north of 3p. Bargain buy.
Aim: Share price: 150p
Bid-offer spread: 150-155p
Market value: £26.1m
Investors have yet to cotton on to the compelling value on offer at Brand Architekts (BAR:160p), an Aim-traded beauty brands business formerly known as Swallowfield that has developed a portfolio of beauty product brands in the past four years both organically (Bagsy, MR. and Tru) and through three acquisitions. Its products are sold through major high-street retailers and supermarkets, online and for export (North America, Australia, Turkey and the Nordics) with all manufacturing outsourced to suppliers in China and the UK.
In 2015, the company acquired male grooming business The Real Shaving Company from Creightons (CRL), another constituent of my 2020 Bargain Shares portfolio, in an earnings-enhancing £1.17m deal. The purchase price equated to four times The Real Shaving Company’s annual cash profit of £0.3m on sales of £0.8m.
Twelve months later, the company paid £11m for the Brand Architekts business from its two owners, which brought in key brands Dirty Works, Kind Natured, Argan, Happy Naturals, Dr Salts, Superfacialist and Sensa. Together these brands generated in excess of 75 per cent of the acquisition’s annual sales of £10.7m in the 2015-16 financial year, a trading period in which it reported both a cash profit and pre-tax profit of £2m.
The most recent purchase, men’s grooming brand Fish, was acquired for a consideration of £3m, including a 12-month £300,000 earn-out in February 2018. It was another earnings-accretive deal as Fish, which is sold in Waitrose, Superdrug and Boots, had reported annual cash profit of £400,000 on net sales of £1.7m.
The contribution from all these three acquisitions, and internal growth from new product launches, helped Brand Architekts’ brands business deliver total revenue of £19.7m and an underlying profit of £3.6m (before central overheads of £1.26m) in the 12 months to 30 June 2019. However, what investors have failed to grasp is that this high-margin and highly profitable business is effectively in the price for free.
Sale of manufacturing operations
That’s because Swallowfield sold off its manufacturing business for £35m late last summer, a move that enabled the company to de-gear its balance sheet completely and free up cash to accelerate growth of its higher-margins brands business internationally. The disposal completed after the 30 June 2019 financial year-end, which is why investors have failed to realise that the sale price not only represented a £10m premium to the carrying value of the assets being sold in the 2018-19 annual accounts, but that the newly renamed Brand Architekts will be in a hefty net cash position of £24m when it reports its first-half results for the 2019-20 financial year.
I estimate that Brand Architekts’ current assets are five times its current liabilities, indicating a strong liquid ratio, and are more than double its total liabilities. Pro-forma net current assets of £23.5m account for more than 60 per cent of the company’s pro-forma NAV of £38m, too, implying that its market capitalisation of £26.1m represents a 31 per cent discount to NAV despite the chunky £24m net cash position.
A key focus of the company is to develop new products to attract both retailers and consumers. For instance, digital channels and social media are used to communicate with consumers through well-targeted, fast and flexible communication campaigns. Consumer trends studies and competitor benchmarking were used to generate ideas for new products, such as Superfacialist for Men and for re-launches in the Dirty Works, MR, Kind Natured, The Real Shaving Company, Argan+ and Dr Salts brands. Over 80 new products were launched across 11 brands in Brand Architekts’ last financial year.
In addition, the owned brands business continues to work with a range of third-party suppliers to develop, formulate and distribute new products, including the company’s former manufacturing business. Importantly, all current product supply from the manufacturing business has been secured as part of last summer’s disposal agreement.
There is an obvious opportunity to grow sales through online distribution channels, too. Brand Architekts now has eight of its brand websites offering full e-commerce functionality, with internet sales fulfilled from its internal distribution centre. The company has also strengthened its direct-to-consumer efforts by establishing certain of its brands on Amazon.
Another focus is on developing sales across new international markets and building relationships with distribution and retail partners. While international growth is still at a nascent stage, overseas sales in the 2018-19 financial year increased by 8 per cent year on year, highlighting the opportunity for further growth. For example, bilingual pack formats have been developed for specific brands to maximise the business opportunity while managing inventory levels. The launch of the Dirty Works brand (skincare, bodycare and bathing products) into France and Belgium has been followed by new distribution in the Middle East. The range of therapeutic bath solutions, Dr Salts, has launched successfully in South Africa; and the Real Shaving Company has launched in New Zealand.
The disposal of the manufacturing business resulted in chief executive Tim Perman, finance director Matthew Gazzard and sales and marketing director Jane Fletcher all leaving the company. However, Chris How, who was chief executive of Swallowfield from July 2013 to June 2018, has since joined Brand Architekts as interim chief executive. Having acquired the Brand Architekts business in June 2016 during his previous tenure, he already has detailed knowledge of the business and management team, which will enable him to provide both leadership and support.
Chairman Brendan Hynes offers a steady hand to Brand Architekts senior management team, many of whom have been with the company for more than a decade, including commercial director Jo Butcher. Mr Hynes has been chair since his appointment in July 2013 and was formerly chief executive of drinks maker Nichols from 2007 to 2013. Prior to that, he was finance director at William Baird, a branded clothing business.
I also note that Roger McDowell is a non-executive director. He won The Sunday Times Aim non-executive director of the year award in 2017 for his chairmanship of Avingtrans (AVG), a precision engineering business and a company that has produced a 50 per cent total return for shareholders since I included the shares in my market-beating 2017 Bargain Shares portfolio.
|2017 Bargain Shares portfolio performance|
|Company name||TIDM||Opening offer price on 3.02.17 (p)||Bid price on 29.01.20 (p) or exit price (see notes)||Dividends||Total return (%)|
|Kape Technologies (formerly Crossrider)||KAPE||47.9||175||3.55||272.8|
|BATM Advanced Communications (see note seven)||BVC||19.25||44.4||0||147.6|
|Chariot Oil & Gas (see note one)||CHAR||8.29||3.15||0||40.4|
|Cenkos Securities (see note two)||CNKS||88.425||106||9.5||30.6|
|Manchester & London Investment Trust (see note three)||MNL||291.65||377||3.0||28.4|
|Management Consulting Group (see note five)||MMC||6.183||6||0||-3.0|
|Bowleven (see note four)||BLVN||28.9||5.5||15||-6.1|
|Tiso Blackstar Group (see note six)||TBG||55||19.6||0.54||-63.4|
|FTSE All-Share Total Return||6485||7769||19.8|
|FTSE AIM All-Share Total Return||977||1092||11.8|
|1. Simon Thompson advised selling two-thirds of the Chariot Oil & Gas holding at 17.5p on 3 April 2017 ('Bargain shares on a tear', 3 April 2017). Return reflects the profit booked on this sale. Simon subsequently advised using some of the proceeds from the share sale to participate in the one-for-8 open offer at 13p a share in March 2018 which is taken into account in the total return ('On the earnings beat', 5 Mar 2018). Simon turned buyer of the shares at 4p on 17 April 2019 when he suggested using the profit banked to reinvest in the shares ('Chariot's North African adventure', 17 April 2019).|
|2. Simon Thompson advised selling the Cenkos Securities holding at 106p on 3 April 2017 and the 106p price quoted in the above table is the exit price on the holding ('A profitable earnings beat', 3 Apr 2017).|
|3. Manchester and London Investment Trust paid total dividends of 3p a share on 2 May 2017. Simon Thompson then advised selling half of the holding at 366.25p on 26 June 2017 ('Top slicing and running profits', 26 June 2017), and selling the remaining half at 377p ('Bargain shares second chance', 17 August 2017). The 377p price quoted in the table is the final exit price.|
|4. Simon Thompson advised banking profits on half your holdings in Bowleven shares at 33.75p, and running the balance ahead of drilling news at the Etinde prospect in Cameroon in the second quarter of 2018 (‘Hitting pay dirt', 9 Apr 2018). The company subsequently paid out a special dividend of 15p a share on 8 February 2019 and Simon then advised selling the balance of the holding at 5.5p ('Taking stock and profits', 9 December 2019).|
|5. Simon Thompson advised to sell Management Consulting's shares at 6p in February 2018 (‘How the 2017 Bargain share portfolio fared’, 2 February 2018). The price quoted in the table is the 6p exit price.|
|6. Tiso Blackstar has transferred its UK listing to the Johanesburg Stock Exchange. Price quoted is sterling equivalent bid price at current exchange rates.|
|6. Simon Thompson advised banking profits on half your holdings in BATM shares at 49.9p, and running the balance for free ('Bargain Shares: Exploiting pricing anomalies and top-slicing', 3 December 2018). Simon then advised reinvesting the profits back into the shares at 43.5p ('BATM armed for a re-rating', 11 July 2019). Total return takes into account these trades.|
|Source: London Stock Exchange share prices.|
There are some smart fund managers backing Brand Architekts, including Gresham House Asset Management. I rate its investment team highly and so do other investors, as asset manager Gresham House and small-cap fund Gresham House Strategic have produced shareholder returns of 107 per cent and 75 per cent, respectively, since I included both shares in my 2016 Bargain Shares Portfolio. Gresham House Strategic holds a 3.4 per cent stake.
|Simon Thompson's Bargain Shares Portfolio 2016 performance|
|Company name||TIDM||Opening offer price (p) 05.02.16||Closing bid price (p) 29.01.20 or exit price (see notes)||Dividends (p)||Total return (%)|
|Bioquell (see note one)||BQE||125||590||0||372.0%|
|Volvere (see note six)||VLE||419||1150||0||188.2%|
|Gresham House Strategic||GHS||796||1350||43.35||75.0%|
|Bowleven (see note two)||BLVN||18.935||5.5||15||43.2%|
|Juridica (see note three)||JIL||36.1||14||32||27.4%|
|Mind + Machines (see note four)||MMX||8||7.5||0||2.8%|
|Walker Crips (see note five)||WCW||44.9||25||5.59||-31.9%|
|FTSE All-Share Total Return||5180||7769||51.6%|
|FTSE AIM All-Share Total Return||747||1092||48.4%|
|1. Simon Thompson advised buying Bioquell's shares at 149p in February 2016. Bioquell bought back 50 per cent of shares in issue at 200p each in June 2016 through a tender offer and Simon recommended buying back the shares in the market at 145p to give an average buy in price of 125p (‘Bargain shares updates’, 22 June 2016). Company was taken over at 590p cash per share in January 2019.|
|2. Simon Thompson advised banking profits on half your holdings in Bowleven shares at 33.75p, and running the balance ahead of drilling news at the Etinde prospect in Cameroon in the second quarter of 2018 (‘Hitting pay dirt', 9 Apr 2018). The company subsequently paid out a special dividend of 15p a share on 8 February 2019 and Simon then advised selling the balance of the holding at 5.5p ('Taking stock and profits', 9 December 2019).|
|3. Simon Thompson advised buying Juridica's shares at 41.2p in February 2016. Juridica subsequently paid out a special dividend of 8p a share in June 2016 and Simon recommended buying shares in the market at 61p using the cash proceeds to take the average buy in price to 36.1p (‘Brexit winners', 1 August 2016). Juridica then paid out a special dividend of 32p a share in September 2016 and total return reflects this distribution. Simon advised selling the holding at 14p ('Taking Q1 profits and running gains', 4 April 2017), hence the price quoted in the table.|
|4. Simon Thompson advised buying Mind + Machines shares at 8p in February 2016. Mind + Machines subsequently bought back 13.22 per cent of the shares in issue at 13p a share. The total return reflects this capital distribution. Simon advised selling the entire holding at 7.5p which is the exit price stated in the table ('Strategic acquisitions', 9 May 2018).|
|5. Simon Thompson advised selling Walker Crips shares on Monday, 4 March 2019 at 25p ('Bargain Shares Portfolio updates', 4 March 2019). This is the exit price quoted in the table.|
|6. Simon Thompson advised rendering 41.18 per cent of your holdings back to company at 1290p a share. Tender completed 19 June 2019 ('Tenders, takover and hitting target prices', 3 June 2019), and balance of the holding at 1,150p ('Taking stock and profits', 9 December 2019).|
|Source: London Stock Exchange share prices|
Interestingly, fund managers Fidelity, Canaccord and River & Mercantile have all lifted their stakes in Brand Architeckts and control a combined 17.3 per cent of the shares in issue. The Business Growth Fund increased its holding from 5 per cent to 9.1 per cent last July. The fund manager bought into Aim-traded IXICO (IXI), a London-based company that uses proprietary artificial intelligence (AI) software algorithms to analyse images from brain scans, around the same time as I highlighted its potential to Alpha subscribers ('Alpha Report: Simon Thompson spies opportunity in cutting edge technology', 23 July 2019). Shares in IXICO have increased by 157 per cent in value since then.
True, the top nine shareholders control 59 per cent of the 17.13m shares in issue, which reduces liquidity. However, you can deal well within the official bid-offer spread, and in decent bargain sizes, too, so don’t be put off. Also, although the 6.5p-a-share annual dividend will be rebased following last summer’s disposal of the company’s manufacturing operation, the shares still have their attractions for income-seekers.
On a bargain ratio of 0.9, and with the owned brands business effectively in the price for free, there is obvious scope for a material rerating of the shares, especially if the new management team can redeploy the cash sensibly on earnings-accretive acquisitions. Buy.
Aim: Share price: 52.5p
Bid-offer spread: 51-54p
Market value: £29.8m
Corporate broker Cenkos Securities (CNKS) made it into my 2017 Bargain Shares portfolio and the holding duly produced a 30 per cent return within a couple of months when I suggested taking profits in April 2017. The upside this time around could be potentially even greater given that the share price appears to have formed a strong base formation in the second half of last year, having fallen from a high of 255p in the summer of 2014.
Interestingly, the 2019 share price low also coincides exactly with the low point in June 2012 before an upsurge in the corporate broker’s trading activity sent the share price up 500 per cent over the next two years. Another positive is that the relative strength indicator (RSI) on the monthly chart hit the same oversold levels in the second half of last year as it did at previous lows in June 2012 and December 2016. In both cases this was a precursor to a strong share price rally.
There is obvious value on offer with Cenkos’ market capitalisation of £30.6m representing a modest premium to last reported NAV of £26m. Net cash of £14.7m (26p per share) backs up exactly half the share price. The company’s regulatory capital position remains strong, too, as the company reported a capital resources surplus of £15.9m above the regulator’s Pillar 1 requirement at 30 June 2019.
Potential for recovery in corporate broking activity
The key reason why the shares have been battered is because 2019 was an annus horribilis for fundraising activity on the junior market. Cenkos is at the coal face as a financial adviser and nominated broker to 110 companies and investment trusts of which 77 are quoted on Aim.
Although Cenkos’ nominated adviser and broking retainer fees were flat at £2.5m in the first half of 2019, highlighting recurring revenue earned from long-term relationships – nearly half of corporate clients have been with the firm for more than five years – corporate broking fees halved to £6.2m due to lower transaction volumes and deal sizes. IPO activity virtually ground to a halt as institutional investors shunned new offerings on London’s junior market given the uncertain political environment and Brexit fears. In fact, there were just five IPOs on Aim in the first half of 2019, down from 28 in the same period of 2018.
However, with UK equity markets in a far healthier state since the general election, Cenkos’ fortunes may be about to turn for the better as the Brexit risk premium embedded in the UK equity market unwinds, and life returns to London’s junior market. In December, the corporate broker led the £51.9m equity raise of Creo Medical Group (CREO), a company focused on the field of surgical endoscopy, and the £29.3m IPO of MJ Hudson (MJH), a Jersey-based asset management consultancy.
The investment case is certainly supported by the resilient nature of Cenkos’s business model, a reason why the company only posted a modest loss of £200,000 on revenues down more than 40 per cent to £10.6m in the first half of 2019. Activities include providing corporate broking and research services to small- and mid-cap growth companies across a wide range of industry sectors, and making markets in the securities of clients where it has a broking relationship. The business model has been designed to minimise the impact of lower revenue by ensuring that performance-related pay for Cenkos’ staff falls as was the case last year. The flipside is that with the benefit of a relatively low fixed cost base, and a remuneration structure highly geared to performance, profit increases sharply in a positive operating cash cycle.
Admittedly, full-year results for the 2019 financial year will not be a pretty sight given subdued corporate broking activity – the segment accounted for an average of 72 per cent of Cenkos’ total revenue between 2016 and 2018.
Analysts at Edison predict that Cenkos’ annual pre-tax profits will fall by two-thirds from £3.1m to £1m on 28 per cent lower revenue of £32.5m. On this basis, expect earnings per share (EPS) to crash from 4.2p to 1p, albeit Edison is still forecasting an uncovered dividend of 4p a share after the board declared an interim payout of 2p. Based on the assumption that fundraising activity returns to more normal levels this year, Edison is pencilling in a surge in pre-tax profits to £3.5m on revenue of £37.5m, the improvement in profitability also being driven by £2m of annualised cost savings targeted by the board and the natural operational gearing of the business.
On this basis, expect 2020 EPS to rise fivefold to 5p and support a dividend per share of 4.5p, implying the shares are rated on a forward price/earnings (PE) ratio of 10.5, or on a miserly cash-adjusted PE ratio of five. A prospective dividend yield of 8.5 per cent is likely to attract income-seekers, too. Indeed, the company has rewarded shareholders handsomely over the years, having paid out total dividends of £87.6m (136p a share) in the 13 years since IPO in October 2006, and repurchased £25.4m of shares for cancellation.
Founder returns to the hot seat
The return last summer of founder shareholder Jim Durkin to the role of chief executive is another bull point. He held that position from 2011 until July 2017 and boasts a 30-year career in the industry, during which time he executed a number of large corporate finance transactions across multiple industries. Mr Durkin holds an 8.79 per cent stake in the business, so has a decent slug of equity, as does Paul Hodges, head of the equity capital markets team and another founder shareholder of Cenkos. Mr Hodges holds a 9.3 per cent stake. Joe Nally, head of the natural resources team and a stalwart of the industry, owns 2.1 per cent of the equity.
Julian Morse, Cenkos’ head of its growth companies team since 2016, has been appointed to the board, too. He has over 25 years experience in the industry and has advised on a range of IPOs and secondary issues.
Former chief executive and founding shareholder Andy Stewart clearly sees value in the company he previous led, having made a hefty purchase of shares on 20 December and another large purchase on 16 January. He now holds 8.21 per cent of the issued share capital.
The point being that the insiders are heavily incentivised to revitalise the business, as are the 100-plus members of staff. That’s because the company’s average fixed remuneration of £100,000 per employee is significantly below pay levels at rivals Numis Securities (£180,000) and Shore Capital (£166,000), so variable staff costs account for a greater slice of employee remuneration. To put this into perspective, Edison has assumed that variable staff costs will account for 65 per cent of Cenkos’ total staff costs of £24.6m in its current-year forecast and that a £2.5m variance in revenue around its £37.5m estimate will increase or decrease pre-tax profit by £1m.
The downside of the fee structure is that rivals can attempt to poach staff in what is a highly competitive business. For instance, certain members of Cenkos’ investment companies team left the company last summer. That said, half of employees have been with the company for five years or more, suggesting a degree of loyalty among key personnel.
Potential for upside
Of course, there is no certainty that the corporate broking market will return to life after last year’s freeze, but equally it would be a surprise if some of the IPOs and capital raises that were postponed due to the uncertain UK market conditions don’t re-emerge in the coming months.
It’s only fair to point out that some investors may shun Cenkos given that three years ago the broker was fined £530,500 by the Financial Conduct Authority (FCA) for regulatory breaches following an investigation into its role as sponsor to insurance services outsourcer Quindell with regards to its proposed move from Aim to the main market in June 2014. I have taken this factor into account when making my recommendation.
So, with the board having significant skin in the game, and financial markets more benign, a recovery in Cenkos’ profitability this year looks a distinct possibility and one that should drive the share price upwards from its multi-year lows. Trading on a bargain ratio of 0.8 and on 1.1 times book value the risk:reward ratio is tilted to the upside. Buy.
Aim: Share price: 33.5p
Bid-offer spread: 33-34p
Market value: £83.8m
Aim-traded specialist bank PCF (PCF) made it into my my 2018 Bargain Shares portfolio when the shares were priced at 27p, and they offer an even more attractive investment proposition now given the significant operational progress made by the company in the past two years.
|2018 Bargain Shares portfolio performance|
|Company name||TIDM||Opening offer price on 02.02.18 (p)||Closing bid price on 29.01.20 (p) or exit price (see notes)||Dividends (p)||Total return (%)|
|U and I Group||UAI||205||182.2||25.5||1.3|
|Crystal Amber (note one)||CRS||207.2||140||7.5||-28.8|
|FTSE All-Share Total Return index||7088||7769||9.6|
|FTSE AIM All-Share Total Return index||1184||1092||-7.8|
|Source: London Stock Exchange share prices.|
|1. Simon Thompson advised selling Crystal Amber's shares at 140p ('Crystal Amber takes a hit', 10 December 2019)|
Annual results released in early December revealed a 55 per cent hike in the company’s lending portfolio in the 12 months to 30 September 2019, almost hitting the board’s £350m lending target 12 months ahead of schedule. Importantly, an increasing proportion of new business originations are to prime borrowers, representing almost three-quarters of all new loans made in the 12-month trading period. This has helped to diversify the loan book, which is now spread across 21,250 customers, up from 17,000 customers at the same stage in 2018. A key driver in the improvement in the quality of PCF’s loan book has been the lower cost of funding provided by its banking licence.
PCF’s retail deposit base surged from £191m to £267m in the 2018-19 financial year, thus enabling PCF to recycle the low-cost funding – on average the bank’s 6,250 (4,500 in 2018) retail deposit customers earn an interest rate of 2.2 per cent on a deposit of £42,400 over a term of almost three years – into both business lending to small and medium-sized enterprises (SMEs), mainly for vehicles, plant and equipment, and consumer lending concentrated on nearly new and used cars.
Importantly, credit quality remains sound. Impairments remain unchanged at 0.8 per cent of receivable balances, a satisfactory level of write-downs at this point of the credit cycle after taking into account the accelerated portfolio growth rate. It’s worth noting, too, that PCF’s net interest margin (NIM) only dropped from 8.2 per cent to 7.8 per cent year on year even though there was a higher proportion of lower-margin and lower-risk prime lending in the mix.
Successfully diversifying lending lines
PCF’s business finance loan portfolio has been the key driver of the growth, increasing from £121m to £178m last financial year. The fact that 71 per cent of all new business originations are from prime borrowers is reassuring, as is the move to diversify revenue streams. For instance, the autumn 2018 acquisition of Azule, a specialist funding provider to individuals and businesses in the broadcast and media industry, generates annual fee income of £1m through its hybrid brokerage and ‘own book’ business model. PCF has also dipped its toe into residential property bridging finance, making £14m of loans last financial year.
In consumer finance, PCF’s core used car market has been much more resilient to the weakening of consumer demand for cars, which has primarily hit new car sales. Around 96 per cent of lending here is on nearly new or used cars and PCF avoids taking on residual risk as it doesn’t offer a personal contract plan (PCP) product. The company’s success in consumer finance – the motor finance portfolio increased from £98m to £128m in the 2018-19 financial year – is in part due to a specialisation in niche, leisure vehicles such as horseboxes and motor homes, which helped boost consumer lending by 18 per cent to £73m in the latest 12-month trading period. The portfolio has a high customer retention rate, too, as 10 per cent of consumer finance volumes are derived from existing customers, implying a higher than average level of customer satisfaction.
Solid trading prospects
Chief executive Scott Maybury, who has led the transformation of PCF, confirms that new business originations remain strong, and the company continues to maintain prudent underwriting standards, adopting a cautious risk appetite and offering customers sensible terms of business.
The board’s goal is to generate sustainable returns from a lending portfolio that has a wide spread of risk with a focus on having a greater proportion of prime quality customers. Though not sanguine about the economic outlook, the directors feel the company’s larger scale, agility and well-established business model provide them with confidence for the future.
They certainly have reason to feel this way as September was a record month for the company and the momentum continued in October. Also, SMEs are likely to feel more confident in their future capital investment plans when Brexit uncertainty recedes and the UK’s future trading arrangements with the EU are agreed. There is a real possibility that could happen later this year, thus unleashing pent-up loan demand and in turn underpinning the board’s next target of achieving a loan portfolio of £750m and return on equity of 15 per cent by September 2022.
Critically, PCF has the capital in place to fund lending growth towards that target. The company’s NAV increased by 38 per cent to £58.8m following a £10.75m equity raise last year, and PCF’s Common Equity Tier 1 Ratio (CET1) of 18 per cent is comfortably ahead of the banking regulator’s minimum requirement. The capital position has been supplemented with a new £15m Tier 2 capital facility which can be drawn as required.
Double-digit earnings growth being undervalued
Not surprisingly, with impairments low and the quality of the loan book improving, PCF is seeing a step change in its profitability, driven by the operational leverage of the business as lending volumes ramp up at a faster rate than the company’s cost base.
Pre-tax profits surged by 54 per cent to £8m on revenue of £22.2m (2018: £14.7m) in the 12 months to 30 September 2019 to produce a post-tax return on equity of 12.6 per cent, ahead of the company’s medium-term target of 12.5 per cent. EPS surged by 35 per cent to 2.7p to support a 33 per cent hike in the dividend to 0.4p a share (ex-dividend date 19 March 2020).
Analyst Shailesh Raikundlia at house broker Panmure Gordon is pencilling in 31 per cent growth in current-year revenue and pre-tax profits to £29.2m and £10.5m, respectively, based on the loan book rising to £450m by September 2020. These forecasts assume that PCF’s administration costs increase from £12m to £15m, and net loss provisions rise from £2.2m to £3.7m, the net £4.5m rise in these costs being less than the estimated £7m increase in interest income and fees earned. This explains why pre-tax profit is forecast to rise from £8m to £10.5m. On this basis, expect 2020 EPS of 3.5p and a payout of 0.6p a share, implying the shares are being rated on a modest forward PE ratio of 9.5, and offer a prospective dividend yield of 1.8 per cent.
Trading on a current-year price-to-book value (PBV) of 1.3 times, I feel that the Brexit discount embedded in PCF’s modest valuation is set to unwind in the year ahead, driven by the ongoing strong operational performance and greater clarity on the UK’s departure from the EU. Offering almost 50 cent upside to my 50p fair value of the equity – equivalent to a September 2021 PBV of 1.6 times – and on a bargain rating of 0.6, PCF’s shares are worth buying.
Main: Share price: 41p
Bid-offer spread: 40-42p
Market value: £26.5m
The market is materially undervaluing the positive earnings cycle of Creightons (CRL), a company that develops, markets and manufactures toiletries and fragrances. Its product portfolio includes bath and shower care, haircare, body care, and fragrances that are sold through private labels for high-street retailers and supermarket chains (Asda, Tesco, Aldi and Superdrug are just a few of its customers), contract manufacturing on behalf of third-party brand owners, and branded lines. Brands include Frizz No More, Volume Pro, Argan Body and Smooth, Keratin Pro, Perfect Hair, Bronze Ambition, Sunshine Blonde, Beautiful Brunette and Just Hair.
In the first half of the current financial year, Creightons’ revenues increased by 6 per cent to £23.8m, driven by demand from the private label division (accounting for half of sales) as key retail customers looked to differentiate their product offers. Sales through e-commerce doubled in the period, albeit from a low base. It’s a more profitable business, too, as gross margins increased by almost four percentage points to 42 per cent following a review of all low-margin business to improve their profit contribution. The review led to a series of measures being implemented, including targeted price increases, product re-engineering and a focus on sourcing alternative suppliers. Also, both contract manufacturing (30 per cent of sales) and the branded division (20 per cent of sales) delivered an improved sales mix. In the branded division, the focus is on higher-margin brand sales, which have substituted low-margin sales at the value end of the market, particularly with single-price retailers.
Margins are also benefiting from Creightons’ focus on reducing costs through all areas of the business, from sourcing, to manufacturing and investment in plant and machinery. The upshot has been that the operating margin improved from 6.3 to 7.7 per cent in the six-month trading period to drive an eye-catching 28 per cent increase in pre-tax profit to £1.77m and boost EPS by 22 per cent to 2.4p. To put this performance into perspective, the company made more operating profit in the first half of the 2019-20 financial year than it did in the whole of the 2017-18 financial year.
True, last summer’s £500,000 acquisition of Balance Active Formula contributed to the sparkling headline numbers. It contributed £304,000 of the £1.4m sales increase in the trading period, exceeding management’s expectations by 20 per cent. The acquisition extended Creightons' reach into the skincare market, introduced new internet retailing customers and offers export opportunities, too. Manufacturing of the majority of Balance Active Formula products has been moved to Creightons' manufacturing facilities in the UK.
Strong trading prospects
However, the key profit drivers were a focus on cost control, investment in brands and improving profit contributions from all product lines. This is an ongoing strategy and a successful one, too, as operating profit margins have quadrupled in the past four financial years. Expect more of the same to be delivered in the second half, and beyond.
For instance, Creighton plans a global launch of its Body Bliss natural ingredient and vegan range of bath and shower products later this month; Curl, a professionally formulated product for curly hair, launches early this year in both Tesco in the UK and CVS Pharmacy, one of the largest pharmacy chains in the USA; and BAM Beautiful, a thin hair revitalisation product, has recently launched in Clicks, a leading pharmacy chain in South Africa, and on Television Shopping Network, Australia. The product will also be stocked in Boots in the spring.
Acquisitions are set to drive profits, too, as the board is looking to make further value-accretive acquisitions. It can afford to do so, as net cash of £1.75m at 30 September 2019 reversed a £1.9m net debt position only 12 months earlier. The dramatic turnaround in the cash position not only reflects retained profits, but much improved working capital management – debtors decreased by 10 per cent, debtor days improved from 61 to 49 days, and stock turn was stable at 3.8 times on flat inventories even though sales have increased in the first half of the 2019-20 financial year.
Factoring in the second-half profit contribution, my financial models suggest that the company should be able to report a pre-tax profit of at least £3.5m for the 12 months to 31 March 2020, up from £2.9m in the 2018-19 financial year, implying a net profit of £3m and EPS of 5p. On this basis, Creightons’ shares are rated on only 8 times likely earnings, a bargain basement rating for a business that is performing so well.
Smart property purchase
Organic sales and self-help measures aside, Creightons made the sensible decision last autumn to purchase the freehold of its Peterborough manufacturing facility for £3.8m plus £300,000 of professional fees and stamp duty.
The purchase cost was funded from £1.1m of cash on its balance sheet and a £3m mortgage from Barclays over a 15-year repayment term at a fixed annual interest rate of 3.13 per cent for the first 10 years. Creightons had previously been paying £350,000 in annual rental costs to its landlord and the lease was due to expire in March 2020, so this secures the property, generates free cash flow, and enables the company to invest in the facility for the benefit of shareholders rather than the landlord.
The annual loan repayments are £254,000, so after taking into account £12,000 of rental payments earned from mobile telecom operators for telecoms masts on the site, the company will generate £100,000 of additional cash flow. After taking into account an annual non-cash depreciation charge of £218,000 on the property, the purchase also enhances full-year operating profits by £45,000.
Importantly, the eight directors are sensibly paid – the board was paid a total of £764,000 including bonus payments of £335,000 in the 2018-19 financial year, a sum that is not out of step with the £2.9m pre-tax profit the company made. The directors also hold 24.25m shares between them, or 37 per cent of the 64.75m shares in issue, and have 5.65m share options, the majority of which are exercisable between 2021 and 2028.
This means that the directors not only have significant skin in the game, but the interests of the board are aligned with those of outside shareholders. Indeed, reflecting the much improved financial performance and strong trading prospects, the board almost doubled the final dividend to 0.4p a share in the 2018-19 financial year and paid out an interim dividend of 0.15p at the tail end of last year, too.
Creightons is a company that is generating free cash flow to recycle back into the business, is delivering organic sales growth on improved margins, and has the opportunity to scale up both international sales (exports accounted for 11 per cent of revenue in the last financial year) and online. A post-tax return on equity of 23 per cent highlights the attractive returns that can be made by reinvesting surplus cash into the business. Despite this, the company is trading on a modest 1.9 times my 31 March 2020 year-end book value estimate of £15m, a low rating given the high return on capital and double-digit earnings growth being delivered.
The balance sheet is in great shape, too, so there are no financial concerns to warrant the shares trading on 8 times forward earnings. Indeed, current assets of £18.5m are more than double current liabilities of £8m, highlighting a strong liquid ratio.
On a bargain ratio of 0.36, and offering 83 per cent upside to my fair value target of 75p, Creightons’ shares represent a solid addition to this year’s portfolio. They are liquid, with bargain sizes of 10,000 shares regularly being traded in the market and between the official 2p bid-offer spread, too. Buy.
Anglo Eastern Plantations
Main: Share price: 550p
Bid-offer spread: 545-555p
Market value: £218m
Anglo-Eastern Plantations (AEP) may be a £218m market capitalisation company, but it is well below the radar and offers a value opportunity to exploit given the share price is trading significantly below book value even though a major profit recovery is on the cards this year.
The company’s primary activities are crop production and processing of crude palm oil (CPO) and some rubber from 16 plantations across Indonesia and one in Malaysia. AEP has extensive landholdings amounting to 128,200 hectares, of which 70,503 hectares is planted. CPO, together with its related product, palm kernel oil, is derived from the fruit of the oil palm. It is widely used in domestic cooking in Asia and more generally as an ingredient of processed foods. It is one of the four major vegetable oils.
By volume of world production, CPO is second only to soya oil, but is the most traded oil internationally. Principal uses of CPO are in cooking oil, particularly for frying because of its superior heat-resistant properties; margarine; and bakery shortening. Non-food applications include use in bio-diesel and oleochemicals – of which detergents are one of the main final products. Palm kernel oil is used in speciality fats, such as cocoa butter substitutes; shampoos; cosmetics; and ice-cream. Palm kernel meal is used as animal feed.
Oil palms, which like a humid climate, regular rainfall and sunshine, are grown near the equator. It’s big business: in Indonesia, the industry employs 4m people directly and a further 12m indirectly. An oil palm tree usually takes about three years from planting to harvest of the first crop and will reach full production after five years. AEP has around 9,320 hectares of recently planted immature plantations, accounting for almost 13 per cent of its acreage, and replanted 481 hectares in the first half of last year.
The company also operates six palm oil mills in Indonesia, which process up to 295 metric tonnes (mt) of fresh fruit bunches (FFB) per hour. Three mills are equipped with biogas plants to capture methane gas to generate electricity, which is sold to Indonesian state authorities. This reduces the reliance on fossil fuels and improves the company’s carbon footprint. A fourth biogas plant is being constructed in North Sumatra at a cost of $3.8m (£3m), thus providing a useful source of additional revenue with surplus electricity sold back to the grid. Construction of AEP’s seventh mill in North Sumatra is under way at a cost of $19m and is scheduled to come on stream next year.
The company also buys in FFB for processing through its mills from third-party palm oil producers, mainly small plantations and local farmers. Annual throughput at the mills is around 2m mt, split equally between third-party processing and crop from AEP’s estates, which in turn produces more than 400,000 mt of CPO each year. The company has capacity to store up to 48,400 mt of CPO at its mills.
In addition, 262 hectares of established rubber plantations produce raw latex and rubber lumps (637 mt in 2018), but the size of these plantations is reducing as the company replaces ageing rubber trees with oil palm.
A combination of oversupply and competitive pricing of other vegetable oils placed significant pressure on the CPO price in recent years. It coincided with the move by some members of the EU, the second largest consumer of palm oil, to ban or phase out the use of palm oil and palm biodiesel. Around 46 per cent of total palm oil imports of 6.5m mt into the EU were previously used in biofuels. The imposition of hefty levies on the import of CPO by the Indian government, and adverse perception of palm oil due to issues such as deforestation, emission of greenhouse gases, planting on peatland and land rights, has not helped either.
To put the extent of the pricing pressure into perspective, the CPO price ex-Rotterdam averaged $718 per mt in 2017, a year when AEP reported an annual pre-tax profit of $70m (before movement in biological assets) on revenue of $291m and delivered EPS of 91¢ (70p). The company processed 1.93m tonnes of FFB through its mills and sold 390,000 mt of CPO.
In 2018, although AEP achieved higher CPO production of 2.03m mt and CPO sales of 418,000 mt, revenue and profitability were both materially lower due to the drop in the CPO price; the average CPO ex-Rotterdam price declined by 17 per cent to $595 per mt in 2018. This resulted in a 14 per cent fall in AEP’s annual revenue to $251m and a halving in the company’s pre-tax profits to $33.2m.
There wasn’t any respite in the first half of 2019 either as the CPO price ex-Rotterdam opened at $517 per mt and slumped to a low of $477 by the end of June, the impact of which was to reduce AEP’s first-half revenues by 26 per cent to $97.8m and a small pre-tax loss. It averaged $528 for the first nine months of 2019, representing a 16 per cent decline on the same period in 2018.
Importantly, this looks like a major low point as there has been a dramatic increase in CPO prices since early July 2019, rising by 84 per cent from a low of $477 to a high of $880 at the start of 2020. The current price is around $772, so the commodity has largely held onto the gains.
There are several reasons for the sharp rally in the CPO price.
Firstly, there has been a reduction in supply coming onto the market due to a reduction of fertiliser applications by planters, the impact of dry weather and biological tree stress after a bumper harvest in 2018. Also, the slowdown in new planting due to low prices in the past few years will inevitably keep a lid on production growth in the next few years given the time it takes for palm oil plants to mature.
Secondly, both Malaysia and Indonesia have pushed through increases in their biofuel mandates. Indonesia now requires diesel to contain 30 per cent palm-based biofuel, up from 20 per cent previously. Industry experts estimate Indonesian biodiesel production of 8.5m mt this year driven by the higher biofuel demand, representing a 1m mt increase year on year and accounting for almost all of the 1.2m mt forecast rise in Indonesian domestic palm oil consumption to 15.7m mt. Malaysia's biofuel mandate has doubled to 20 per cent. The increased demand for biofuel occurs at a time when demand for CPO from China has been increasing after African swine fever slashed hog herds and reduced domestic demand for soybean meal, the impact of which is that fewer beans are crushed and less oil produced.
Thirdly, recent floods in Johor, Pahang and Negri Sembilan in Malyasia have hampered the harvesting of FFB from the palm oil tree,s which will lower the oil extraction rate of CPO. Malaysia's palm oil stocks dropped 11 per cent to 2m mt in December 2019 compared with the previous month, and have declined from 3.22m mt since 31 December 2018.
Fourthly, market watchers are concerned that the El-Nino effect (decline in rainfall and dry weather) could emerge later this year and adversely impact CPO production, thus restricting supply.
Fifthly, India needs an additional 1m mt of vegetable oil annually to feed its growing population and because of rising per capita growth. Palm oil accounts for two-thirds of India's edible oil imports and although annual imports could drop by around 500,000 mt in the coming year due to the sharp rise in CPO prices, the country will still need around 9.5m mt of CPO in 2020. That’s an issue because although demand in India has started to shift to soybean oil, from CPO, soybean oil production constraints mean that soybean is unable to meet the additional demand.
AEP’s focus is on maximising yield per hectare above 22mt per hectare, achieving mill production efficiency of at least 110 per cent, minimising production costs below $300 per mt and streamlining estate management. In the 2018 financial year, AEP achieved a yield of 17.9mt per hectare, mill efficiency of 134 per cent and a production cost of $281 per mt on Indonesian operations. A mill achieves 100 per cent mill production efficiency when it is operational for 16 hours a day for 300 days per year.
So, with the CPO price trading at a 9 per cent higher level than the average in the 2017 financial year when AEP reported pre-tax profit of $70m and EPS of around 70p, then even after taking into account potential for lower weather-related yields, we are guaranteed a material profit recovery in 2020.
This is simply not being reflected in the company’s valuation, with AEP ending the third quarter of 2019 with net cash of $81m and last reported current assets of $160m more than double total liabilities of $67m. Adjust for other receivables and deferred tax assets totalling $29m, both of which are held under non-current assets on AEP’s balance sheet, and effectively this leaves $350m (£269m) of property assets in the price at a 54 per cent discount to their book value even though the profits they will generate this year are set to soar back towards levels last seen in 2017.
Every time the CPO price has hit a major trough, AEP’s share price has soared. Having hit a bear market low in March 2009, the share price rallied 242 per cent from a low of 223p to a high of 815p by the summer of 2011, during which time the CPO price rallied from a low of $475 per mt in October 2008 to a high of $1,300 in January 2011.
It was a similar story in 2016 when AEP’s share price bottomed out at 380p in June that year and subsequently rallied by 134 per cent to 888p over the next 12 months, during which time the CPO price increased from a low of $505 per mt to $810.
On both these occasions AEP’s shares were in heavily oversold territory when the CPO price move started its upmoves. Interestingly, the relative strength indicator (RSI) on the monthly share price chart had an identical reading at the June 2016 low point as it did in October 2019. So, although AEP’s share price has risen by 29 per cent since hitting last autumn’s multi-year low of 425p, the confluence of demand drivers and historical precedents suggest that the share price rally still has a long way to run, and that the pullback on profit-taking since hitting a high of 600p in January represents a buying opportunity.
In fact, a return to the October 2017 all-time high of 888p is not out of the question, especially as price moves are accentuated given that 31.6m of the 39.6m shares in issue are in the hands of the five largest shareholders. There should be scope for a hike in the annual dividend of 3¢, too.
So, having taken into account AEP’s social, corporate and environmental responsibility, such as good agricultural practices (zero burning, integrated pest management, and terracing and recycling of biomass) and measures put in place to protect the rights of the company’s 17,000 workers, I rate the shares a bargain buy.
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Simon Thompson was named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards.