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RE:RE:Playing the green energy theme

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February 4, 2021

By Simon Thompson 

Simon Thompson is a British investment banker and business executive.
 

SMALL COMPANIES
Simon Thompson reveals his Bargain Shares for 2021.

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 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 18 out of the 22 years in which we have run them. During that time, they’ve generated an average return of 21.8 per cent in the first 12-month holding period compared with an average increase of 3.9 per cent for the FTSE All-Share index.

As usual, the hidden gems we uncover in the stock market are found amongst the under researched small and micro-cap segment. Targeting smaller cap companies has reaped handsome rewards over the years, so justifying our long-term bias, but it works both ways as companies that disappoint can be punished more heavily given the less liquid nature of these shares. The flipside is that when we get it right, expect substantial long-term outperformance as our track record shows.

And there is no doubt that this investment strategy has stood the test of time with every single one of the last five annual portfolios I selected having outperformed the FTSE All-Share index by more than 30 per cent to date. Some of the share price gains have been mightily impressive.

Simon Thompson's Bargain Shares Portfolios Performance (2016-2020)
Portfolio total return to date
2016 - 87.6% 
2017 - 101.4%
2018 - 65.5%
2019 - 54.8%
2020 - 30.2%

Interestingly, mergers 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.

Rules of engagement

The bargain portfolio is based on the writings of Benjamin Graham, a US investor and writer, who favoured looking for companies that were “out of favour because of unsatisfactory developments of a temporary nature”.

How do we know whether the unsatisfactory developments are indeed temporary? Mr Graham’s approach was to focus on the balance sheet, and specifically the net current assets – stocks, debtors and cash less any creditors. He believed that a bargain share is one where net current assets less all prior obligations exceed the market value of the company by at least 50 per cent. Mr Graham’s theory was that a strong balance sheet will usually see a company through any short-term difficulties; he called it his margin for safety.

Finding companies that match these strict criteria has become more and more difficult over the years as the link between market capitalisation and asset value has become more tenuous. In practice, when we ran our search we found only a handful of the 1,500 listed UK companies had a bargain ratio of one or above and this included relatively illiquid micro-cap companies with market values below £10m that are very difficult to trade. So, to widen the net, the cut-off point has been lowered to 0.3, and we only considered companies with a market value above £15m to avoid liquidity issues.

Finally, market makers could easily raise their offer quotes for smaller companies by 10 per cent plus on publication day. However, prices and spreads have demonstrated a habit of drifting back over subsequent weeks, so please be disciplined in your share buying as these investments are for the long-term as the strong outperformance of the 2016, 2017, 2018, 2019 and 2020 portfolios clearly highlight. It is also important to buy a decent number of our recommendations to diversify risk.

Nearly a century ago, former Prime Minister of Canada, Arthur Meighen, helped create what is today North America's second oldest closed-end fund, Canadian General Investments (CGI). Shares in the company have been dual-listed on both the Toronto and London Stock Exchanges since 1995.

Investment manager Morgan Meighen & Associates has run the $1.26bn fund since 1956 with a remit of generating better than average returns from a diversified portfolio of North American equities. That has clearly been achieved both over the long and short-term by adopting a bottom-up approach to stock selection.

NAV per share increased by 35 per cent to C$50.02 (2,890p) in 2020, and is currently C$50.27. That means CGI’s shares trade on a 30 per cent discount to NAV even though the fund has increased NAV per share 260-fold since 1969, during which time it has delivered a compound annual growth rate (CAGR) of 11.5 per cent and outperformed its benchmark S&P/Toronto Stock Exchange Composite Index benchmark by 2 percentage points per year.

The majority of the portfolio is invested in Canadian companies, although up to 25 per cent may be held in US equities. Morgan Meighen has been doing just that by playing the boom in US Information Technology stocks, a contributory factor behind the doubling of NAV per share in the past five years. The IT sector currently accounts for 28 per cent weighting in CGI’s portfolio of 59 companies, down from 35 per cent at end September 2020, as the investment manager has taken significant profits on holdings in Apple (US:AAPL), Nvidia (US:NVDA) and Shopify (CA:SHOP). Considerable profits have also been taken on holdings in Amazon.com (US:AMZN) and Mastercard (US:MA). Importantly, the cash is being recycled into some exciting new holdings.

Playing the green energy theme

One of CGI’s new positions is Ballard Power Systems (CA:BLDP), a C$12.5bn market capitalisation developer and maker of proton exchange membrane fuel cell products for the portable power, back-up power, material handling and engineering services markets. Ballard is also a leader in the development of hydrogen fuel cells to exploit the advantages it has over electric vehicles.

Another new holding is Xebec Adsorption (CA:XBC), a provider of gas purification and filtration solutions for the natural gas, biogas, nitrogen, oxygen, and hydrogen markets. Xebec designs, engineers and manufactures products that transform raw gases into marketable sources of clean energy. Product segments are biogas plants for the purification of biogas from agricultural digesters, landfill sites and waste water treatment plants; natural gas dryers for natural gas vehicles (NGV) refuelling stations, and helium and hydrogen purification systems for fuel cell and industrial applications. The C$1.6bn market capitalisation company offers high growth potential as highlighted by third quarter results which delivered 39 per cent year-on-year revenue growth.

CGI’s portfolio manager has also taken a new position in Brookfield Asset Management (CA:BAM.A), a C$75bn market capitalisation alternative asset manager which has US$575bn of assets under management across the real estate, infrastructure, renewable power, and private equity markets. Brookfield has a strong balance sheet, offers scope for a special dividend, and should scale up its asset allocation this year.

The addition of lumber group West Fraser Timber (CA:WFT) is interesting, too, as the group is ideally placed to benefit from the US economic recovery as well as reaping benefits from the C$4bn acquisition of Norbord (CA:OSB), the world's largest OSB producer.