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Why I believe the UKOG share price and this other small-cap offer poor value

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Shares of Treatt (LSE: TET) are trading 3.9% higher, as I’m writing, after the ingredients specialist reported “strong revenue and profit growth” in its first-half results this morning. This follows an “exceptional performance” in 2017, as the company’s core business categories of citrus, tea and sugar reduction continue to drive growth.

Treatt has been a terrific performer for investors, its shares having five-bagged over the last five years and 10-bagged over the last 10. At a current price of 483p, this FTSE SmallCap firm is valued at around £280m.

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Ambitious plans

Management has ambitious plans to drive further growth by accelerating US expansion, continuing to focus on higher-growth business categories and continuing to move from lower-margin commoditised sales to higher-margin value-added products.

To this end, Treatt raised £21.6m at 410p a share in November and today announced an £11m cash sale of its non-core Earthoil Plantations business. This will help fund a £46m capital investment programme to expand the group’s US operations (already well under way and completion due by the end of 2018) and a UK site relocation, due to be completed by late 2019.

Valuation too high?

The dilution from the fundraising was already in analysts’ earnings-per-share (EPS) forecasts for Treatt’s financial year ending 30 September. The loss of earnings from Earthoil Plantations wasn’t, but on the other hand, it looks like the benefit of lower US tax rates is better than analysts were expecting.

Ahead of today’s results, a Reuters consensus of two analysts was for full-year EPS of 17.1p, giving a high price-to-earnings (P/E) ratio of 28.2. However, the company did earn 8.58p from continuing operations in the first-half, so perhaps company-paid researcher Edison’s full-year 19.2p forecast will be nearer the mark. If so, the P/E would still be a premium 25.2.

Furthermore, looking ahead to fiscal 2019, Edison is forecasting EPS growth of just 7.8% to 20.7p. While this reduces the P/E a little further (to 23.3) the price-to-earnings growth (PEG) ratio of three is way above the PEG fair value benchmark of one. Much as I like the business, I believe the valuation is simply too high — even with the possibility of a better than expected trading performance — and I rate the stock a ‘sell’.

Cash position?

AIM-listed UK Oil & Gas (LSE: UKOG) is also on my ‘sell’ list, despite the shares at 1.55p now being at a huge discount to their 52-week high of 8.97p. Shareholder dilution here has been significant, partly due to this cash-burning company having to raise £10m last year in a so-called ‘death spiral financing’, which has still to fully play out.

A protracted and ultimately unsuccessful flow-testing programme at what management had previously referred to as its ‘flagship’ Broadford Bridge asset will have been costly. And I see it as ominous that the company released its annual results for its financial year ended 30 September 2017 at the last possible date of 29 March and declined to update shareholders on its current cash position.

UKOG is currently awaiting Oil and Gas Authority permission to return to its Horse Hill asset for extended flow testing, this asset having previously flowed 1,688 barrels of oil per day but over periods of only a few hours. In the circumstances, I believe UKOG is significantly overvalued at its current market cap of close to £60m.

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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