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Octopus’s Power on three hidden gems which will double their profits within five years

09 August 2017

Richard Power, who is lead manager of the FP Octopus UK Micro Cap Growth fund, discusses the under-the-radar stocks he has recently bought and why he believes they will thrive over the long term.

By Lauren Mason,

Senior reporter, FE Trustnet

There is a wealth of opportunities for UK investors much further down the cap spectrum which are under the radar, according to Octopus's Richard Power, who has made a number of recent additions to the 'core' part of his FP Octopus UK Micro Cap Growth fund.

The manager, who has run the mandate since its launch in 2007, explained to FE Trustnet that he buys under-researched UK growth stocks which he believes will double their profits over the next three-to-five years.

Part of this process involves dividing the £26m fund into a 'core' bucket – which accounts for approximately 75 per cent of the overall portfolio – and a 'satellite' bucket which accounts for the remaining 25 per cent.

The stocks that fall under the latter are companies with promising fundamentals but, once they have proven that they will significantly increase their profits over time, will be moved into the core part of the portfolio.

In the below article, Power discusses three 'hidden gem' stocks relative to the broader market which, while they have performed well over the years, he believes could significantly improve their earnings over the long term and have therefore won a place within the core part of FP Octopus UK Micro Cap Growth.

 

Inspired Energy

First up is Inspired Energy, which was founded at the turn of the millennium and floated onto the Alternative Investment Market (AIM) market in 2011. It provides consultancy for commercial and industrial clients who are looking to reduce energy costs and usage.

Since its IPO, the stock has outperformed its FTSE AIM All-Share index by almost eight time with gains of 457.03 per cent.

Performance of stock vs index since IPO

 

Source: FE Analytics

"Inspired Energy did a placing in June this year of 14.5p to raise money to acquire a competitor in Ireland," Power explained.

"We started investing in this company in our EIS [Enterprise Investment Scheme] portfolios about seven years ago when the company was making a profit of £1m. Today it's making profit of £10m and, with this Irish acquisition, that will jump to £14m so it will be very earnings-enhancing for them.

"With a £75m market cap it's just under the radar of the bigger small-cap investors so, on the back of this acquisition they've completed and some share price appreciation following the acquisition, we expect it to appear on the radar screen and re-rate to nearer 12x or 14x earnings.

"We think you will see this company continue to make acquisitions and to do well. We think it will make profits north of £20m over the next few years."

Inspired Energy is trading on a P/E ratio of 15.65x and has an earnings per share (EPS) of 1.27p.


Animalcare Group

Another example of a stock the team has been familiar with for several years – but which has only recently won a place in its micro-cap portfolio – is veterinary services company Animalcare Group.

The £211m company is an AIM-listed sales, marketing and product development company which operates across Europe. It currently has direct sales in seven countries and exports to 50 markets globally.

Since its IPO in 2008, the firm has returned a stellar 767.31 per cent compared to the AIM market's return of 9.37 per cent.

Performance of stock vs index since IPO

 

Source: FE Analytics

Power explained that the business was backed by Octopus 12 years ago within its VCT vehicles and, over this time frame, expanded ten-fold from an initial market cap of £7.5m.

"It has been successful in what it does, but it was getting to a point where it was struggling to grow ad break through a glass ceiling that it had," the manager explained.

"What it needed to do was create greater distribution channels globally and it has found what I think is an ideal transaction for them. It is based in Belgium but has distribution infrastructure throughout Europe. It will be a reverse takeover and Animalcare will go from a £75m company to a £220m company. But, more importantly, it will have a greater distribution network for all of its products.

"The Belgian business also has some products that Animalcare will take ownership of as well so it's strategically great, it solves a lot of problems for both companies and, again, it's a business we have had really good knowledge of for 12 years."

Animalcare Group is trading on a P/E ratio of 127.12x, yields 1.84 per cent and has an EPS of 13p.


Next Fifteen Communications

While the two aforementioned stocks came from Octopus's VCT vehicles into the micro-cap fund, PR agency Next Fifteen Communications came through its AIM inheritance tax service. The £331m company has a bias towards digital marketing and currently has 32 offices operating across 14 countries.

Since it floated onto the AIM market in 2000, the stock has returned 173.28 per cent while its index has fallen 26.25 per cent.

Performance of stock vs index since IPO

 

Source: FE Analytics

While the stock has outperformed the FTSE AIM All-Share by more than seven times over the last three years with a 312.5 per cent return, the performance gap has narrowed over the last 12 months - it has returned 46.66 per cent while the index is up 32.46 per cent.

"The share got sold off about a year ago which we thought was unnecessary," Power said. "This is predominantly a PR agency and marketing business, it's very US focused - about 75 per cent of its revenues come from the US. It operates among big West Coast technology companies – the Facebooks, Googles and Alphabets are their best customers.

"When it got sold down just over a year ago, we saw a post-Brexit opportunity to get involved within the micro-cap fund on the basis that it was undergoing earnings acquisitions.

"Not only could we see share prices reacting to that, there was also the following tailwind they'll get from the currency benefit of the devaluation of sterling post Brexit."

Next Fifteen Communications has a P/E ratio of 17.72x, yields 1.18 per cent and has an EPS of 25.4p.

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