ShareSoc Company Seminar - October 2016

After an enjoyable summer off I returned to Sharesoc refreshed and looking forward to another interesting line up of small-cap companies. Unlike many seminar providers the companies that Sharesoc attracts are always changing and often entirely new to me; this time around I'd only heard of SRT Marine Technology and even then purely in passing. So I made doubly sure to take my seat in plenty of time for the show!

OPG Power Ventures

Foreign companies listed on AIM aren't exactly popular at the moment following a number of Chinese frauds. However OPG appears to be one of those rare beasts: a real overseas business which listed in London to achieve a decent valuation. Since 2008 the company has designed and constructed two coal-fired power stations in India with these supplying commercial and industrial customers. The attraction for clients is a more reliable and slightly cheaper supply than they get elsewhere while OPG generates a reasonable return on investment with some security from medium-term contracts. For investors OPG intends to offer a decent dividend (payout ratio growing to 35% in 3-4 years) from a stable, moderately geared, long-term utility business.

However despite these attractions the share price has languished (down 30% in the last year) and I think that there are a few reasons for this. One is that OPG are actively moving into the solar power market as apparently it can be profitable at certain tariff levels (>4 rupee per kWh) as a result of falling capital costs and the availability of brownfield sites for construction. There is also the possibility of OPG taking on half-completed thermal assets in distressed sales although this isn't key to their goal of growing to around 1200MW+ in five years (from the current base of 750MW).

Solar is a bit of a change in focus and appears to have been on and off the agenda a few times. At the same time Arvind Gupta, the founder and chairman, still owns 51% of the business and this level of control is always a concern (even for a business located in the UK). So far all parties have been treated fairly, the board have delivered operationally in a professional way and the shares are cheap if forecasts of >50% earnings growth in 2017 are met: an interesting way to gain exposure to Indian economic growth and foreign earnings then.

SRT Marine Technology

This is a name familiar to many small-cap investors with the company offering so much potential over the last decade and yet generally failing to deliver. Simon Tucker, the CEO, makes no attempt to skirt this history to his credit. As he tells it SRT has been a very slow burn story from 2000 when the potential of the Automatic Identification System (AIS) specification was recognised. In that time SRT has created this market from scratch by designing their own hardware and software while educating customers and working with the governments who make this kind of kit compulsory. The upside from this is that SRT lead the market with their proven, mature technology which leads to high and defensible margins. The downside is that orders are lumpy and drawn-out with demand being driven by legislation and effective enforcement.

What is clear is that Maritime Domain Awareness (which relies on AIS) forms a global and growing market. Governments want to track and identify vessels in their territorial waters for security and commercial reasons: there are other ways of doing this but AIS + radar seems to be leading the field with customers like Saudi Arabia etc. As a result (and this is the big, recent news) SRT have a current validated order pipeline of ~£200M and a forward order book of ~£70M. Given that the company has fixed overheads of around £10M per annum, earns a ~50% margin on turnover above this base and has limited working capital requirements then a lot of this revenue could convert directly into cash - eventually. When this happens Simon Tucker stated that this will lead to shareholder dividends as he has no interest in acquisitions and believes that companies should primarily generate free cash-flow. Sounds great if you can put up with inevitable uncertainty in the timing of contract completions!

Frenkel Topping

Jason Granite, CIO & Chairman, kindly made his way to the seminar today despite suffering from a heavy cold. This Manchester based company has flown under the radar for many investors, despite listing back in 2004 and being reasonably profitable for at least half of that time. Quite possibly this is down to the company working in the un-sexy niche of managing the affairs of people who have suffered catastrophic brain injuries and also being seen as a failed IPO (with the share price down by 90% in the first two years). Recently though Granite, along with co-investor Michael Spencer, acquired almost 30% of this sleepy, lifestyle company with a view to shaking it up and turning it into a fund manager for vulnerable clients rather than a simple intermediary. This involves bringing externally managed funds in-house and creating joint-ventures with law firms to generate a steady flow of new money.

The plan is to migrate £350M of assets to their internal, risk-managed portfolios in 2016 with another £100M per year after that; doubling profits this year alone and driving future growth both organically and through the acquisition of other 'Court of Protection' asset business. This model works despite management costs being kept low at 1.15% (0.65% of advice, 0.35% management fee and 0.15% to Cannacord for investment research) as the portfolios are angled towards matching inflation and achieving low volatility and so don't require superstar fund managers. One question mark is that Frenkel Topping have only been investing in-house for a year (which means a short track-record) and this might put off risk-averse clients; apparently though there is high demand as such guarded assets have been poorly invested for years and no one else in this fragmented market is offering this service. Maybe the time is right here and Granite is just grasping the opportunity to shake up this industry? I wouldn't bet against him!

United Cacao

Last up came Dennis Melka, founder and CEO of United Cacao, with unlimited enthusiasm for this cocao bean story. The set-up is that the world is at a turning point with regard to chocolate in that demand is in a secular up-trend while global supply from traditional suppliers (such as Ghana and Indonesia) is falling. This means that bean prices are rising which creates an opportunity for United Cacao in the birthplace of the bean - South America. Here the company has 1,837 hectares of trees planted out of the 3,760 hectares that they own (with the possibility of gaining another 12,000 hectares). As a result production is just starting to ramp up after many years of struggle; with plantations like this it's tough to get going but there's a long-tail of revenue as trees live for 50-100 years. That said it'll be another couple of years before the company generates meaningful cash-flow and a fund-raising will be taking place soon to keep the company solvent.

Despite this Dennis talked a good story and he has the experience to back up his enthusiasm; previously he headed up Asian Plantations, a palm oil producer, which was sold for a decent premium in 2014. So he knows how to construct an agricultural business and United Cacao appears to be proceeding sensibly by choosing a high-yield, durable strain of cacao bean and planting it at a slow enough pace (200h p.a.) to ensure quality preparation while partnering with small farmers to cultivate links with the local community. So why is the share unloved? Well accusations of illegal logging still linger around the company, although Dennis was vigorous in denying that these have any basis in fact, and a specific environmental certification has not been signed-off due to lengthy delays. It's possible that all of these issues will be resolved by the end of the year, with a new government coming to power in Peru, but with this company more than most I guess that there's no need to rush into buying its shares!

Postscript: United Cacao has now delisted from AIM and is in some limbo as it attempts to raise additional funds. A disappointing end but also a warning of the risks involved in investing via the junior market.

Disclaimer: the author holds none of the shares discussed here.

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