Significant Value Opportunities in UK Small-Cap Stocks

The recent results update from the £155m Odyssean Investment trust (LON: OIT) revealed some interesting views on the prospects for UK smaller companies. Odyssean is well placed to comment as it holds a highly concentrated portfolio of these sorts of stocks, with the manager looking to identify securities that are trading below their intrinsic value where there is a catalyst for change.

Over the six months to the end of September the trust made an NAV total return of -8.7% compared to a loss of 18.5% by its benchmark. Longer term however the performance is more impressive with a 52% gain since the IPO in March 2018, a period in which the UK small cap index has made little progress.

It is very much a stock picking vehicle with the ten largest holdings at the reporting date accounting for 72% of the total assets. These include: Elementis, a leading producer of speciality chemicals; NCC group, which provides software escrow services; SIPP administration services provider Curtis Banks, as well as Xaar that designs and manufactures inkjet print heads.

Plenty of takeover interest

A sure sign of the value on offer is the high level of takeover activity experienced by the portfolio. During the six month period, Euromoney, the fund’s second largest position, received a bid that allowed the trust to make a 50% internal rate of return on the investment, while two further holdings – Devro and Curtis Banks – have experienced takeover interest since the reporting date.

Devro has announced a recommended all-cash bid at a 65% premium and if the deal completes it would mark the eighth portfolio company that has been taken over in the last three years, at an average premium of more than 50%. Curtis Banks, one of the top ten holdings, has also received a bid approach that may or may not move forward.

Writing in the accounts, Chairman Jane Tufnell said that the numerous takeover approaches at very significant premia, demonstrates that the portfolio manager can identify and execute investments in often illiquid companies at attractive valuations. “These events are further validation of the differentiated investment approach and the underlying value potential in the company’s portfolio.”

Positive outlook

It is a really interesting strategy that consists of a private equity philosophy – a highly focused, long-term engaged ‘ownership’ style approach − applied to public markets. This is being bolstered by the sharp de-rating of the UK equity market that has led to more international interest.

Managers Stuart Widdowson and Ed Wielechowski believe that UK smaller companies with substantial overseas operations look inexpensive, even taking into account the prospect of some earnings weakness. They say that in the absence of a re-rating back to typical levels, many look vulnerable to overseas predators.

“Over the past few weeks, the nature of selling has changed, with share price behaviours indicating more forced selling of shares, regardless of fundamentals. We believe that such conditions are consistent with the last phases of a bear market. Sentiment will improve and our suspicion is that the latter part of 2022/early 2023 may end up being a good vintage for long-term returns.”