Finding Value in AIM

And James Halstead PLC

AIM (formerly the Alternative Investment Market) was founded in 1995 to allow investors access to young companies that could not qualify or would not pay the cost for a listing on the main market of the London Stock Exchange (LSE). Or was it founded to allow companies, which could not qualify or would not pay the cost for a listing on the main market, access to the pockets of Joe Public, thereby giving more jobs to the boys in the City?

According to the LSE, "AIM is the most successful growth market in the world." At the last count there were 1,096 companies listed on AIM compared to a peak of 1,399 seven years ago. Companies have raised 80 billion pounds. Yes, it's been a wonderful source of fees and commissions for brokers, accountants, lawyers and market makers, for all those who count at the LSE. But what about the humble investor?

Looking at the results of the AIM Index (blue) compared to the FTSE 100 (green) for the past 12 years, shows just how rotten AIM shares have been for the investor:

Graph from Yahoo - click on the graph to enlarge.

Yet there are pearls in the midst of all that dung. And AIM shares have one feature that marks them out from the main list: given certain requirements, if funds are held for a minimum of 2 years in AIM stocks, they are exempt from Inheritance Tax on Judgement Day. This tax feature has attracted good family-run businesses that can pass on their shares to the next generation without the 40% tax burden. It is here that one finds the pearls.

As the tax concession is an important incentive to investing in AIM shares, it is important to know what companies will qualify as "business relief" for Inheritance Tax.

1. The company may not also be quoted on a "recognized overseas exchange" (HMRC).

2. The company may not be engaged "wholly or mainly in dealing in securities, stocks or shares, land or buildings, or in making or holding investments" (HMRC).

3. If the company is acquired (or you decide to sell it) before the 2 years are up, provided you reinvest in another AIM company that complies with 1 and 2 above and together they are held for at least 2 years, the funds will be free of Inheritance Tax.

There are other considerations that are peculiar to investing in AIM companies.

As they are usually small cap, the touch - the bid to offer spread - can be very high. Invest in Venn Life Sciences (market capitalization of 7 million pounds), and the stock must appreciate by 18% before you break even. For Verdes Management, who specialise in corporate restructuring, that's 67%.

Stock	Market	Mkt. Capitalization	Touch
Verdes Management	AIM	0.6 million pounds	67%
Venn Life Sciences	AIM	7 million pounds	18%
FW Thorpe	AIM	120 million pounds	11%
Severn Trent	Main market	3.8 billion pounds	0.25%

 

A second consideration is that, unlike the main market, AIM’s listing rules do not require companies to have a minimum free float. "Free float" is the proportion of shares that are freely traded in the market compared to the number held by all parties. Free float is important because companies can be taken private by their owners at the price they choose if they control 75% of outstanding shares.

Camkids Group, a Chinese sportswear manufacturer, came to AIM six weeks ago with a free float of just 8% of its shares. Mr. Zhang Congming owns 66.3% of the company. This leaves the ordinary shareholder defenseless. Camkids could go private tomorrow, leaving shareholders with paper in an unquoted company based in Fujian province. .All AIM companies are obliged to inform the public of their free float on their websites.

A third consideration is that AIM stocks can easily run out of money. Last week's Investors Chronicle reckons 46 junior mining companies on AIM are "up to their necks in financial quicksand". Small and high risk companies often find it impossible to get bank financing and they do not have the option of issuing debt instruments. If in need, they must dilute shareholders via a public offering or shut up shop.

The wise investor will approach an AIM-quoted company with the circumspection a bear approaches  a honey trap:

1. Stick to companies with no debt, a profitable trading record in a niche market and that are cash generative.

2. Be sure management can be trusted to do the best for the company and not just look after themselves.

3. Check whether the company is quoted on an overseas market and is eligible for Inheritance Tax business relief.

4. Ensure that the free float is well in excess of 25%; look for well regarded institutional investors who are invested in the company.

5. Take into consideration the share price's bid to offer spread.

6. Have a clear exit strategy. You might need it.

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James Halstead PLC

It says something for British enterprise that one of the darlings of AIM is a company specialising in commercial, office and industrial flooring. Halstead is the largest company of its kind and the only one which manufactures these floors in the UK. With a market capitalisation of over 600 million pounds, it is one of the 20 largest companies listed on AIM.

The company is managed by the Halstead family (Geoffrey is Chairman and his son Mark is CEO). Two-thirds of sales are abroad, largely in Germany, Scandinavia and Australia, though it has significant businesses in many more.

James Halstead is very profitable - net margins are 18% of sales and average return on equity is a healthy 28%. Earnings per share have increased by a compound 12% p.a. since 2001, and continue to grow despite the slowdown in its major markets.

Halstead consistently generates more cash than it can use. The company buys back shares and pays special dividends, and it still it has 39 million pounds in net cash, equivalent to 6% of its market value. In 2012 the company returned almost 7% of its current market price of 300p in dividends and share buybacks and net cash still increased by nearly 5 million pounds. Capital demands, for plant and warehouses, are relatively light.

Although Halstead closed its defined benefit pension scheme to new members in 2000, its gross pension assets are 35% of all assets and its gross pension liabilities are 90% of all liabilities. As the company's market value is over 11 times the pension scheme's gross liabilities and 60 times its deficit, this is not a serious concern. However, with the application this year of IAS19 amendments (see 30 January post), expect Halstead to take a charge to its balance sheet.

James Halstead is well-managed by a family who see themselves as custodians of the business, in which they have a stake of 34%. And another director has an interest of a further 6%. Despite the construction recession in many developed markets, the company should continue to do well. It is not surprising that the company is highly rated and is currently trading on a PE ratio of 21. The shares yield 2.7%. The company is eligible for Inheritance Tax business relief. But is it good value at 300p a share?

My valuation model gives a value of 242p a share, considerably below the present offer price of 300p. Its shares trade on a bid to offer spread of 7%, 6 times the spread of a similarly capitalised stock on the main list (Diploma Group).  The company has traded between 231p (2 March 2012) and 355p (11 January 2013) in the last year.

The patient investor will note that:

1. The present price of the stock places a valuation on the company that cannot be easily justified, unless he is urgently building a portfolio of AIM stocks for their special IHT exempt status.

2.  Consistently high margins and steady growth in an industry that does not have that many barriers to entry could attract greater competition and a shrinking of margins.

3.  While there is always the risk that AIM listed companies move to the main market, thereby nullifying their special Inheritance Tax status, this seems unlikely for James Halstead. The Halsteads are the first shareholders to want to keep this tax concession going.

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