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Five small-cap opportunities

Five small-cap opportunities
May 23, 2017
Five small-cap opportunities

Aim-traded shares in stockbroker and financial services outsourcer Jarvis Securities (JIM:460p) are closing in on my target price after the £50m market cap company reported a bullish trading update for the first four months of 2017, during which time revenues soared by 25 per cent, driven by improved market conditions and organic growth in the business.

I first advised buying the shares at 305p ('High-yielding income play with capital upside', 15 November 2016), subsequently raised my target price to 425p ('Value opportunities', 30 January 2017), and raised it again to 475p ('In the ascent', 20 February 2017). My positive stance was based on the strong likelihood of an improved operational performance from both of its business units: a corporate division, which provides outsourced and partnered financial administration services to a number of third-party organisations; and a broking operation that has more than 100,000 retail clients who use its ShareDeal-Active and X-O low-cost online share trading services. And so it has proved, with the business continuing to attract both institutional and retail clients.

Moreover, with revenue growth outpacing cost pressures, the majority of the rise in sales is dropping straight down to the bottom line. The news prompted analyst Nick Spoliar at house broker WH Ireland to hike his current-year pre-tax profit and EPS estimates by 17 per cent to £4.4m and 31.8p, respectively. There could be scope for more upgrades because these forecasts only assume a conservative-looking 10 per cent increase in full-year revenues to £9.2m. The news gets even better because the board has just raised the second quarter payout per share by 41 per cent to 6p, so based on the board’s policy of declaring at least two-thirds of net profits as dividends, Mr Spoliar expects the full-year payout to be hiked by 25 per cent to 22p.

On this basis, the shares are now trading on 14.5 times earnings estimates, and offer a prospective dividend yield of 4.8 per cent. That still looks an attractive valuation to me if, as seems likely, the cash rich company continues to overdeliver. I am raising my target price to 525p and continue to rate the shares a buy.

 

Bilby on the mend

Last week’s trading update from Aim-traded Bilby (BILB:67p), a provider of gas heating appliance installation and maintenance services to residential and commercial properties, is well worth noting. The company revealed that “a number of existing clients have broadened the scope of work to be undertaken by Bilby in advance of the March 2017 year-end, and other contracts that were set to start in the current financial year have commenced earlier than previously anticipated”. As a result, Bilby is now expected to report cash profits of at least £3.6m, or 20 per cent higher than house broker Northland Capital had forecast, based on annual revenues of £62m rather than £60m. Analyst Mike Jeremy has taken note and raised his pre-tax profit estimate by 25 per cent to £3m and lifted his EPS estimate to 6.6p, up from £2.2m and 5.7p, respectively, for the 2016 financial year.

True, this outcome is still miles below the £5.7m profit former house broker Panmure Gordon had forecast last summer, but it’s clearly a step in the right direction following last year’s problems, which I discussed at length when I advised holding the shares for recovery at 49p (‘On a roll’, 19 December 2016). Furthermore, Mr Jeremy expects net debt to be cut to £3.6m from a high water mark of £6.9m last September, implying balance sheet gearing of about 27 per cent, thus allaying financial concerns that had been undermining the share price. I would also flag up that Northland has raised both its cash profit and pre-tax profit estimates by £400,000 to £4.8m and £4.4m, respectively, for the 12 months to end-March 2018 based on revenues of £71.3m, or £1.5m higher than previous estimates.

Admittedly, the company has to build on this positive momentum, but the odds look favourable as it has announced a number of contracts to support a large chunk of the profit growth forecast. These include an eight-year gas servicing contract with East Kent Housing that has just been expanded to cover 16,700 properties and provide a range of building maintenance and electrical works, as well as the installation of 1,500 new boilers each year; a seven year gas servicing contract with Walterton and Elgin Community Housing for work on more than 400 properties; and a three-year gas servicing contract, with a two-year extension option, with Sussex and Hampshire housing association Saxon Weald, for work on more than 4,000 properties. Following these contract wins, Bilby now services more than 300,000 properties, significantly increasing revenue visibility, and the earnings analysts are predicting.

So, having reappraised the investment case, and after factoring in the slew of contract announcements, I now feel that Bilby’s shares are worth buying at the current 67p level and that a fair value of 85p to 90p, equating to 10 times EPS estimates of 8.5p for the 12 months to end March 2018, is warranted. Buy.

 

Marwyn’s windfall

Shares in Marwyn Value Investors (MVI:162p), a closed-end investment company listed on the Specialist Fund Market of the London Stock Exchange, soared 20 per cent after Zegona Communications (ZEG:157.5p), a small-cap company that acquired Telecable de Asturias, the leading quad-play telecommunications operator in north-west Spain, announced the sale of that business to Spanish telecoms group Euskaltel.

It’s justified as Marwyn's stake in Zegona accounts for 35 per cent of its net asset value and the transaction values Telecable at a 41 per cent premium to Zegona's share price, according to analysts at brokerage Liberum Capital. Furthermore, the disposal will generate significant up-front cash proceeds for Zegona's shareholders and the company intends to return excess cash to shareholders quickly and tax-efficiently. The transaction will also allow Zegona to maintain its dividend policy (5p per share for 2017). Shares in BCA Marketplace (BCA:208p), Europe's largest car auction operator and another of Marwyn’s holdings, have been motoring too. Marwyn's investment team clearly expects more upside here as they have just upped their stake to 3.22 per cent in the FTSE 250 company.

Trading on a 30 per cent discount to Liberum's spot net asset value estimate, cashed up for new investments and set to receive a cash windfall from the Zegona disposal, I feel the re-rating of Marwyn's shares has further to run. So, having last advised buying the shares at 135p ('Five small-cap buys', 29 March 2017), I believe a target price between 180p to 200p is not out of place. Buy.

 

Primed for ascent

I feel investors are missing a trick with aircraft leasing company Avation (AVAP:203p). The company has just signed a term sheet to supply 50 ATR 72-600 aircraft to Indian budget airline Indigo. That’s interesting because analyst John Cummins at brokerage WH Ireland notes that “Indigo plans to introduce up to 20 aircraft by the end of 2018, taking further available capacity out of the ATR supply chain over the next couple of years. This follows on from last month’s announcement that ATR and Iran Air have signed contracts for 20 ATR 72-600 aircraft orders plus a further 20 options”.

A backdrop of rising demand and relatively fixed supply is positive for Avation, which has firm orders for nine ATR 72-600 aircraft and a further 27 options, making it the largest holder of ATR 72-600 options globally. In the past, the company has either taken up the orders or traded them at a profit when market conditions have allowed. And the board is freeing up capital to fund new aircraft by selling off six of its existing leased ATR 72 aircraft to a single commercial lessor, Chorus Aviation Inc. (TSX: CHR), in a transaction at a premium to book value - and one that will release $31m (£23.8m) in net cash proceeds. Mr Cummins notes that “the disposal provides the opportunity to deliver additional scale of fleet assets and diversification, both of which drive improved credit ratings and ultimately reduce the cost of funds, which represents the largest cost to a lessor”.

The point being that this is not being priced in. That’s because Avation’s shares are trading 15 per cent below last reported net asset value per share of 310¢, or 238p at current exchange rates, and that’s before factoring in the premium valuation being achieved on the aforementioned disposal which should close by end-June. To put this into some perspective, the international aircraft leasing peer group is rated in-line with book value. Also, Mr Cummins is pencilling in an 18 per cent rise in pre-tax profit to $21.5m in the 12 months to end-June 2017, giving EPS of 32.6¢, or 25.7p based on an average exchange rate of £1:$1.27, implying the shares are rated on a forward PE ratio of 8, a deep discount to rivals. Shareholders can expect a decent full-year dividend after banking a payout per share of 3.25¢ last year.

So, having last advised buying the shares at 220p ('Four small-cap buys', 21 March 2017), I feel Avation’s shares are primed to take out the 229p record high, the catalyst being the closure of the Chorus deal and the release of a bumper set of full-year results. Offering 23 per cent upside to my price target of 250p, I rate the shares a buy.

 

1pm acquisition and fundraising

1pm (OPM:50p), a specialist Aim-traded provider of finance to small- and medium-sized enterprises (SMEs) and a constituent of my 2014 Bargain Shares Portfolio, is raising £13m at 45p a share through a placing and open offer (1:8 basis), which will increase its issued share capital by 52 per cent. The proceeds will be used to fund the purchase of Tracx Finance, a leading invoice finance provider to SMEs, provide the initial £4.5m cash consideration on a further possible £9m acquisition, and strengthen its balance sheet.

Tracx Finance posted pre-tax profits of £900,000 on revenues of £2.6m in 2016 by lending £12m on a receivables book of £30m, so a cash consideration of £5.25m seems fair. It has 140 clients, and lends an average of £90,000 to each one over a four-and-a-half-year term. Recurring annual service fees account for half of revenue and interest is the second-largest contributor; typically charged at three to four per cent a year and accounting for up to a fifth of annual revenue.

It’s a sensible use of funds as 1pm’s directors believe that invoice discounting and factoring are an obvious product to be offered alongside its existing asset finance and business loan products, and the best way of expanding the business into these areas is through the acquisition of independent, well-run businesses. They also point out that it is typical for debt facilities to be provided on a 5:1 basis for established invoice finance businesses such that the original equity can generate a return of 30 per cent a year or more. The two acquisitions made combined pre-tax profits of £2m on revenues of £6.7m last year, and are expected to be earnings accretive within two years post completion.

True, 1pm’s share price has fallen on news of the placing and is below the 60p level at which I last advised buying ('Funded for growth', 15 February 2017). However, they are heavily oversold and are at the 50p support level, so I feel the risk is to the upside given the company is expected to deliver a 16 per cent hike in full-year pre-tax profit to £4.3m in the 12 months to the end of May 2017, and the equity is only being valued on eight times likely earnings. Buy.

 

MORE FROM SIMON THOMPSON...

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