As the year passes the half year mark, it's time to reflect upon what has been a busy second quarter, dominated by geo-political events continuing in Eastern Europe and the Middle East, against a positive backdrop for the UK economy. The FTSE100 was largely unchanged over the period, up less than 1% quarter-on-quarter, but that obscured the performance of the smaller companies. Mid caps underperformed large caps, but the quarter was very poor for small cap companies, with AIM down over 9% during the period. That fall was once again catalysed by drops in large constituent companies such as ASOS (LSE:ASC), but also a drop off in high valuations as companies continued to report earnings and in some cases, disappoint.
There have been a total of nine rating changes during the period, eight of which closed out profitably, one that did not.
The quarter was a period of turnaround for the oil and gas segment of the portfolio, with three legacy companies previously at a loss, all being crystallised as a profit. The first of those was Xcite Energy (LSE:XEL), the North Sea company with discovered resources. Despite announcing a collaboration agreement with two industry majors, along with various technical MOUs, progress has been relatively slow, and the lack of a farmout suggests that the asset is simply not as valuable to other industry participants as previously envisaged. Ultimately, if it was very attractive a farmout would have been concluded rather than the route that Xcite has now opted for. It therefore made sense to cut Xcite from a Buy to No Rating at a 1% profit when the limit sell was triggered. The share price has since dropped back considerably.
The second company within the sector was Leni Gas & Oil (LSE:LGO), which had the biggest transformation, trading at over 4p recently compared to sub 0.8p levels in the previous quarter. The reason for the rise is linked to very positive development well results at their Goudron Field in Trinidad with production above expectations. With regular newsflow and positive drill results, the share price soared as investors took up positions in the stock. Despite the good results, the current market cap looks high relative to other oil and gas stocks in the sector. The move to change Leni Gas & Oil from Buy to No Rating for an 89% profit was premature in hindsight, but it still represents an excellent result against a weak index. That change was followed up by the move of Bowleven (LSE:BLVN) at the end of the month for a 14% profit. Out of all three companies, Bowleven is the the most undervalued given that a proposed farmout near month end crystallised significant value that underpins the current price. However, the market remains unconvinced and I had expected a higher value to be derived from Etinde. That said, with Bomono largely sorted and a much healthier expected cash balance, the shares remain on my watchlist.
The final oil and gas stock was Mosman Oil & Gas (LSE:MSMN). Mosman was added to the portfolio in Q2 with the strategy being to trade the speculative rise prior to the drill results, and cut the stake near the top. The strategy worked particularly well, with a 93% profit captured in short order, although the profit is dwarfed by the profit that would have been made had you held throughout the drill. The shares peaked over 40p, which would have amounted to a rise well over 400% from the review price. However, it is important to recognise that these drills are risky and are on balance a lot more likely to come up dry than hit oil and gas - therefore, the initial strategy works best the vast majority of times. The near 100% profit still represents an appreciable profit compared to the risk adhered to.
Terrace Hill Group (LSE:THG) was at the centre of corporate activity after they undertook a reverse takeover of Urban&Civic. The company was renamed and re-admitted to trading under the ticker UANC, but upon admission I moved it from Buy to No Rating, reflecting the material change in the group's operations and the need for the fundamental case to be re-assessed. That appears to have been a prudent change, as the share price has since slipped back by almost 10%, which would have reversed the 10% profit banked.
Three further companies were moved to a No Rating tag in order to lock-in profits. Israeli-based MTI Wireless Edge (LSE:MWE) was cut after the company re-rated by 70% following a positive results statement combined with increased liquidity. The asset values held on the book underpinned the share price making the investment attractive, and having fallen back from its peak, that attraction looks to be re-surfacing. The company is not news-rich though, so catalysts are few and far between - taking profits during the period of high-liquidity made sense. Of particular note, their current assets total over three times their total liabilities alone, so their balance sheet is robust.
Titon Holdings (LSE:TON) was the second company moved to a No Rating tag having been reviewed as a Buy earlier in the month. The reason for the Buy was that the share price was backed by net tangible assets, and there was an earnings story emerging ahead of the next set of financial result. As it has panned out, the results were positive, but the holding structure of the group meant that a significant chunk of the Korean profits were not actually due to shareholders - that meant that the earnings per share figures were disappointing, and it became evident that the market would not read favourably into that, despite the asset backing. Titon is now trading considerably lower at 52p, where it is valued at around £5.5m. That puts it on a 2014 implied symmetrical PER of just over 10, which, when combined with the asset backing, looks attractive. However, liquidity is once again low, and there are few immediate catalysts.
The final cut was of NetPlay TV (LSE:NPT) following further investigation into the Point of Consumption tax that is planned to come into play at the end of 2014. Whilst that is still not 100% confirmed, the market is taking a risk-averse stance on the stock hence there is no great rush to re-cover NetPlay despite the strong business performance and significant cash balance. There is potential for NetPlay to gain market share should competitors be forced out of the market - the company looks much better placed that 32Red, for example, who have a less flexible business model due to the sub-sector of the gaming market that they operate in.
Clean Air Power (LSE:CAP) was the only share closed out in the period for a loss. The decision was taken after the company released an investor presentation hinting that the unstable situation in Russia had the potential to weaken the company's near term sales outlook - given the company's very high broker expectations for the year, there is far lower chance that the revenue target will be met. The loss totalled circa 14% and was just above the implied stop loss at 7.50p. In addition, the company was clearly facing from selling activity, and the situation was not aided by a recently announced £1m placing at 4p. That was a very steep discount to the 30-day average price, and more importantly it was not backed by Abramovich. Quite why they needed to complete a placing is difficult to tell, as they supposedly had a decent sized cash balance already. Given the recent events, Clean Air Power is no longer on my watchlist, despite the steep price fall.
The portfolio remains well diversified with companies operating in the following sectors:
- Food Producers [FIF]
- Forestry & Paper [AEG]
- Home Construction & Household Goods [TW]
- Mining [BMN]
- Oil & Gas Producers [BPC (S), FAST, PTR, TRIN]
- Oil Equipment, Services & Distribution [THAL]
- Software & Computer Services [PEN]
- Support Services [DRV, NWT, SPSY]
- Technology Hardware & Equipment [AMO]
- Travel & Leisure [PEL]
In line with wider market activity, price movements within the core portfolio companies were limited with many failing to find traction. However, each company remains attractive for their own reasons, and a number of new additions have been made.
Finsbury Food Group (LSE:FIF) was little changed during the period, sliding slightly to 54.75p at quarter end. There was one news statement released of importance, and that referred to a proposed board restructure. As of tomorrow, Peter Baker will become the new Non-Executive Chairman with Martin Lightbody stepping down from the post. The decision makes sense, especially given Finsbury's point of transition following the sale of one of their key divisions last year. Baker not only has an apt surname, but comes with a wealth of experience. The company is still trading on a low rating due to carrying net debt and concerns over growth potential. These concerns are perfectly fair, but a non-adjusted PER between 11 and 13 would suit the company better, especially given the bull market currently - it is perhaps even a takeover target at current levels given that it is trading on a 2014 forecast non-adjusted PER of 8.7, and a 2015 forecast non-adjusted PER of 7.3. Wheat prices trended down over the quarter, although cocoa prices remained strong and reached new medium-term highs.
Active Energy Group (LSE:AEG) had a news rich quarter, which is rounded off by releasing 2013 full-year results today. Details of news between 31st March and 9th May can be found in the latest review of the company. Since then the share price has risen considerably to 2.73p as a result of a new business venture being announced. The deal sees the formation of Active Energy Pelleting - a new company that will seek to commercialise breakthrough fuel granule technology. The technology turns sawdust and other by-products into usable fuel granules at a much lower cost relative to existing technologies. This adds blue-sky potential to the business. Chairman Colin Hill commented: "While this is very much an "in process" development project with new partners, and is a project where there remains much to both do and prove before a full scale commercial system can be put in place, the scale of interest from potential investors, strategic partners and customers has proved to be even greater than first expected."
In the interim the focus remains on the woodchip operations that now span Ukraine, Montenegro and Spain. New unsecured debt facilities were opened with the company's largest shareholder and with a Ukrainian lender to allow Active Energy to expand its operations during the current period of excellent, above-average margins. 2013 results were in-line with expectations with over £5.2m of revenues booked and an operating loss of ~£2.2m - the latter number being skewed downwards by exceptional costs associated with the acquisition of Nikofeso and integration issues. The full-year target remains as being over 325k metric tonnes, which would represent a significant improvement year-on-year if achieved. Clearly that is dependent upon the situation in Ukraine, but if anything, the situation is calming as opposed to heating up. Exchange rates remain favourable and have hovered between 0.084 USD/UAH and 0.086 USD/UAH. Despite the results not reading favourably, that was to be expected, and most of the positive changes have been implemented during calendar year 2014, hence are not reflected in the results. CEO Richard Spinks commented: "Our current operational performance is even more positive, with increased volumes at enhanced margins, which bodes extremely well for greatly improved financial results from the Group in 2014."
With a positive outlook and a capable management team (as noted before), the 2013 results do not give any great cause for concern above what was already known (Ukrainian risks and financing constraints). The fact that the company is seeking to expand operations is perhaps a read-through to current operations, and the set-up of Active Energy Pelleting gives more credibility to that view. After all, why become involved with the pelleting business if the company cannot afford to? A broker note from WH Ireland with the first real expectations is due for imminent release, and should shed light on what figures they expect looking ahead. There is of course much work left to be done, but legacy issues have largely been resolved and cleared.
Taylor Wimpey (LSE:TW) had a lacklustre performance during the period as the market was shaken over the potential for a downturn in the housing market amid new controls introduced by the Bank of England. In reality, the effect of these controls is most probably being exaggerated, although mortgage approvals are tightening with only 61,707 being announced for May (albeit slightly above consensus estimates). The sector has tread water for the last half-year, but could well be set for movement during H2 as the fundamentals looking forward are simply too strong. 2014 consensus estimates are for 10.58p in EPS and a dividend of 2.38p. That translates through to a forward PER of 10.8 and a yield of 2.09%. However, it's the 2015 results that are particularly tempting as the company will start to return cash to shareholders. Estimates for 2015 have been bumped up in recent months to a forecast 13.58p EPS and a dividend of 6.98p, which translates through to a PER of 8.4 and a dividend yield of 6.12% - these are numbers that will attract the market, and should lead to a strengthening of the share price during H2.
Bushveld Minerals (LSE:BMN) was another portfolio constituent that failed to gain any traction, with there being three core reasons. The first was a decline in the iron ore price that has once again hit an already ragged sector. Valuations continue to drift across the board, and some mines are being less and less viable as a result. Importantly, Bushveld has a number of projects and has important credits that should partially offset that decline. In addition, prices for their other commodities (tin and vanadium) remain buoyant, meaning that Bushveld presents investors with a less risky investment proposition on the whole. The second reason relates to selling by Darwin under the instruction of Bushveld, in order to raise funds for further project progress. The funding arrangement under Darwin remains misunderstood, but that is of little relevance as it has contributed to the decline in share price. The third reason relates to a lack of news releases by the company, but those releases remain in the pipeline.
Patience is required with Bushveld as there is no deviating from the fact that the company is trying to juggle numerous balls in the air in a weak sector environment both operationally and for investors. News on Lemur Resources has not materialised, nor have certain pieces of results from their other platforms, but the bottom line is that progress is being made behind the scenes. Once appropriate, that news will be released. In particular, the whole of Bushveld's interest in Lemur is being valued at nil - if the management can unlock value through a cash distribution or acquisition of a near-production asset then there remains material upside. Assuming a continued weak sector background, news is required to lift the company from current levels. More sane valuations will return down the line, although it is perplexing to see companies such as Ironveld (LSE:IRON) hold their valuations whilst Bushveld does not. The major external catalyst remains as being a return of mining sector sentiment, but that will only materialise if metal prices (particularly base metals) rebound. It's important to remember that progress is being made even if it is slower than anticipated.
As noted earlier, a complete review of the oil and gas portfolio companies was completed during the quarter, with four new investments entering the frame. The first was a sell tag that I initiated on Bahamas Petroleum (LSE:BPC) at 3.78p. The share price has since slid rapidly to 2.10p, which largely vindicates the call, yet with a market cap over £20m it still looks fairly expensive. Bahamas Petroleum is suffering from the perfect storm of problems that are blocking a farmout of their hailed Bahamian asset. That will most probably continue to be the case as a token buy by CEO Simon Potter failed to convince the market that the company's future was more positive - in fact, it just signalled that there was no impending news. If I was an investor in BPC, I'd be asking serious questions of Potter's salary and at the very least make contact and ask him for a justification. Quite simply, there is no justification for taking home $400k+ per year when a company is in BPCs state, let alone $1m+.
Fastnet Oil & Gas (LSE:FAST) looks good value on the other hand. Run by a shrewd management team with plenty of experience, the company is heavily cash-backed and is confident of securing a farmout for their Celtic Sea licence in H2. In addition, progress should be made at their onshore Morocco licence and potentially even a second drill in late 2014 offshore Morocco. Otherwise it will be drilled in H1 2015. With the sector brightening, the current valuation of ~£20m is likely to see at least 50% uplift running towards Q1 2015. In the event the share price falls towards 5p, I will double up the half slot. It's worth noting that Executive Director Carol Law purchased around £60k worth of shares during the quarter - she has significant experience as the former exploration director of Anadarko and has been responsible for examining the Celtic Sea licence potential.
The speculative upside of Fastnet was balanced through the introduction of two producing companies: Petroneft Resources (LSE:PTR) and Trinity E&P (LSE:TRIN). Petroneft is set for a brighter future having signed a farmout agreement with Oil India as reviewed earlier in the month. Although the 2013 results were nothing to shout home about, production should start to rise as the company starts an aggressive drilling programme using the $45m of non-repayable funds provided by Oil India. The necessary governmental approvals required for the farmout were received today, so the ball should start rolling from here onwards. The technical picture is extremely bullish and there is huge potential value in the P2 reserves base - value that is yet to be reflected in the share price. There is a similar state of affairs for Trinity E&P. The company boasts a production rate just shy of 4000bopd and has a near 50mmbl P2 reserve base. On most metrics Trinity is significantly undervalued, and looks to be one of the cheapest oil and gas producers at the moment. There is strong potential for M&A potential for Trinity given the chronic undervaluation and high-quality assets.
Elsewhere, in the oil equipment, services and distribution sector, Thalassa Holdings (LSE:THAL) was also added to the portfolio at just above 200p, to add exposure to a high-growth cash-rich company. I expect Thalassa to deploy the cash-pile to either expand their operations through the acquisition of new equipment or through the acquisition of other smaller companies to the group. The share price has stabilised just below 200p, significantly off the 300p highs, as a result of institutional selling, but a low seems to be in the process of being hammered out - confirmation is required on that front. The fundamentals well support 175p and upwards, and the 275p target remains in place. There was also little notable news from Pennant International (LSE:PEN) although an RNS entitled 'Director Incentivisation' does suggest that management may seek a sale of the company in the future.
Driver Group (LSE:DRV) released slightly disappointing half-year results during the period, albeit full-year broker forecasts were held level as the company commented: "In respect of the current financial year the platform created in our fledgling offices, the secured revenues and pipeline of opportunities and the recent review of our ability to deliver second half budgets give the Board confidence in the outlook for this financial year." The balance sheet remained solid with 1.8x more current assets than current liabilities. Broker forecasts are for 8.70p in EPS this year rising to 11.37p next year, which continues to mean that Driver are trading on an undemanding rating. Importantly, the trade payables figure has been reduced post-results as payments from Oman were received. The investment case for Driver remains in the medium-term.
Newmark Security (LSE:NWT) remains particularly undervalued on an earnings basis as noted in the recent review, and market interest is likely to develop towards the results date late in July. There is also potential for a trading update to be released before then. Spectra Systems (LSE:SPSY) on the other hand, has been one of two stand-out performers since review at 18p. Spectra is currently trading at 29.50p up 64% having won a US lottery contract and having unveiled two new Aeris testing agreements with Banco De Mexico and the Indonesian central bank. The share price has re-rated from its very depressed state, but a market cap of sub-£14m still looks attractive given the blue-sky potential of Aeris and the high-quality clients. The only slight detracting factor is that the lawsuit was finally settled at a cost of over $2m, although the bullish comments of the company in the annual report seem to have caught the attention of investors.
"With nearly 150 billion banknotes manufactured yearly at a cost approaching $10 billion annually along with the increasing demands that governments reduce costs, we are poised to capitalise on our banknote cleaning technology. Aeris machines have the potential for generating over $1 billion of hardware sales with ongoing service revenue. Aeris has no competition, and once patents are granted, will be our market exclusively."
CEO Nabil Lawandy has since stated: "Our strategy to bringing this product to market is underpinned by aggressive testing programs which already include two G8 central banks, the Banco de Mexico and the Central Bank of Indonesia. In parallel we are pursuing equipment supply and global service agreements with leading companies in CO2 technology and the banknote equipment industries, respectively"
There were a couple of interesting announcements from Amino Technologies (LSE:AMO) even if it has not been reflected in the share price. Amino is very well backed by cash and rising dividends that give a very healthy low single digit yield, and are likely to continue to do so through to 2016 after the +15% per year dividend policy was extended. It remains the case that the company could acquire another company, but I suspect that valuations for that may be a little stretched. Nonetheless, the company is busy innovating and has developed an interesting new set-top box where it acts as a central hub for a range of household appliances and systems such as fire alarm systems. There is a good chance that this innovation could kick-start revenue growth again. In light of the extended dividend policy I have upgraded the target price for the shares from 106p to 115p.
Indeed, Chairman Keith Todd purchased over £100,000 worth of shares in May at 89p, which bodes well looking ahead. He later commented in a trading update that: "I am encouraged to see that our strategy to target profitable returns from appropriate, high-quality customer mandates continues to bear fruit. Development of our new wider solutions-based portfolio aimed at driving future growth is also progressing well. Given our robust cash position and our confidence in the future, we have today extended our commitment to a progressive dividend policy for a further two years."
The final company added to the portfolio was Paragon Entertainment (LSE:PEL), a niche company that designs and creates a variety of exhibits and attractions. Paragon had its share price knocked severely by legacy institutional holders selling down their stakes into an illiquid market, but as noted at the time, it is often those occasions that present investors with the best opportunities. Having been valued at less than £4m, the shares have already re-rated considerably, and now trade at 4p (vs. 2.13p). That amounts to nearly 100% upside already captured since the review earlier in the month. However, the long-term growth picture remains, and the market cap is still shy of the £8m - £10m base case that I foresee as being fair at the current point in time. Liquidity has increased and that bodes well moving forward - an increased stream of newsflow would be beneficial in maintaining that interest, but the outlook remains positive as the overhang has been cleared.
Looking ahead to the third quarter, it is still difficult to predict what the market conditions will be like. The UK market will most likely continue to consolidate, and I would expect a recovery in the AIM market to materialise - a number of well-performing companies are now materially off their highs, and undeservedly so. Sentiment within the oil and gas market is likely to persist, given the tensions in Iraq, so the site may seek one or two more companies to increase exposure to that sector. I also expect increased newsflow (over the next quarter) from the companies already in the portfolio as many of them emerge from quiet periods - in particular BMN, PTR, and TW with their half-year results. Overall I remain positive on the markets heading into Q3 and foresee new opportunities materialising.