[A Discord server invite, to see all this week’s discussions, is here.]
Large Caps Live Monday 7th June
Anglo American/Thungela (TGA.L) - Spin-Off
This week on large Caps Live WayneJ had a special guest: The Boatman Capital, who came on to discuss a critical report they had written on Thungela. This is what Boatman had to say:
Thungela is a spin-off from Anglo American, the FTSE 100. It is a South African thermal coal producer. Anglo has been under pressure from large institutions to get out of coal and demerging Thungela is part of that strategy.
The first problem that Thungela has is that it is producing coal, which is a pretty unloved commodity at the moment. We think there will be downwards pressure on coal prices for the foreseeable future as the world moves to greener energy.
So obviously lower coal prices in the future will be a big hit to valuation for a pure thermal coal producer. But we also think that the company has massively underestimated its environmental liabilities. Those liabilities are now so enormous that they exceed the value of the business.
So the demerger has been pitched as good for Anglo because it is ESG positive from the point of view of greenhouse gas emissions. But we think there is nothing positive about dumping enormous environmental cleanup costs onto a smaller, less well-capitalised company. That's why we called this greenwashing. Anglo gets to look good while dumping the clean-up liabilities onto investors.
A comment on the share price today...They listed at 150p, which was a market cap of roughly £205m. Versus analyst predictions of £315-670m and adviser guidelines of £500m. So a huge listing discount - possibly to stop a day 1 rout? But still down today and now with a market cap of about £170m. Which is only just above the cash that Anglo put into the business as a dowry. I think the 230p was an earlier target price.
There are a lot of institutional investors who were given shares in Thungela whether they wanted them or not. Many will not be able to hold a pure thermal coal operator and will be required to sell for portfolio mandate reasons.
These are the reasons Boatman thinks the liabilities her may be understated:
Anglo/Thungela is required to clean up its mess when its mines reach the end of their lives. It has to provision for that while still operating. But Thungela has provisioned using old rules governing environmental protection.For example, it doesn't include water treatment. 45% of the provisions that Thungela has identified are funded (in a cash trust fund). That means 55% are unfunded and provided for with guarantees.
These guarantees used to be provided by Anglo. But will now be provided by financial institutions - at a cost obviously. The issue is really the scale of the provisions, which we estimate at 3x the amount that Thungela has provisioned for. The main reason for this is a change in South African law. The new rules were due to come into force on 19 June. That's in 12 days.
But Anglo was still using the old rules and did not provide an estimate of future liabilities under the new rules. All the company said was that it would result in a "significant increase" in liabilities. So we crunched the numbers for them. Using their own data!
The data comes from the Thungela prospectus (deep in the small print obvs) and from competent person's reports written by SRK Consulting; There were more than 3000 pages of SRK docs. So a lot of detail that nobody else had bothered to read we suspect.
One of the big liabilities that Thungela has not accounted for is water treatment. It has to ensure that water coming out of its mines isn't toxic. Anglo/Thungela wants to do this using passive techniques - things like marshes and lime beds. This is much cheaper than having a facility that actively processes and cleans the water. But the problem is that passive is unlikely to work at scale. We spoke to several mining and environmental engineers who know the assets and they conclude there is no chance of using passive. Water treatment has to be done for decades. In perpetuity sometimes. That's expensive!
We think assuming long-term coal prices at $80+ is extremely optimistic given how quickly energy generation is changing. They do, their coal is not as energy-rich and has a discount priced in. Given that Thungela needs prices at $75-80 to break even (according to analysts), that does not bode well. We can't see where they are going to get enough cash to pay dividends in the future. Revenue down while costs go up is not a good combination in our experience!
Sounds like this is one spin-off that may not provide a good investment opportunity.
Small Caps Live Wednesday 9th June
Driver Group (DRV.L) – HY Results
Results were ou this week for Driver Group. Driver is interesting since it is one of the only small-cap stocks not to have a significant bounce with the rest of the market, has over a quarter of its market cap in cash and is on a fairly low historical rating. Given that it does construction dispute resolution and there has been lots of disruption due to COVID, you would expect that there is a lot of pent-up demand here.
In light of this, the first reading of these results leaves one slightly disappointed:
· Underlying* profit before tax at £1.0m (2020: £1.3m) resulting in an underlying* profit before tax margin of 4% (2020: 4%).
· Profit before tax at £0.9m (2020: £1.3m).
· Revenue down by 11.0% to £25.0m (2020: £28.0m) as a result of the impact of COVID-19.
Understandable perhaps, however, the outlook doesn’t read much better:
Activity levels during April and May were broadly unchanged from those witnessed during the first half…
…the prospects of a meaningful uptick during the remainder of the current financial year are now limited.
Doubling the 1.4p EPS to give 2.8p EPS makes a forward P/E of 19. Not exactly stand out for a people business, even if you adjust for the net cash.
Looking further out though things are looking brighter:
Looking beyond the current financial year, recognising that Driver typically operates with limited forward revenue visibility, our expectation is that the very significant constraints on routine business development which have existed throughout the last twelve months will start to abate.
However, the lack of revenue visibility does make this hard to value.
Indeed, adding to the disappointment, the company has commissioned paid for research from the usually bombastic Equity Development. However, when paid for research fails to generate an EPS forecast this has to be worrying.
The company had an earnings call yesterday, however, and, following this, my view changed somewhat. Obviously, we have to be careful about falling for management speak in these sort of things, but here the management came across as straight, with a good handle on the business and more importantly specific about the issues they faced and the mitigations implemented plus future opportunities:
They expect the pent-up demand to start to come through in Autumn ‘21 to Spring ’22. Too late for this year’s results but providing a tailwind going forward. This view is backed up by their discussions with litigation financers such as Burford.
Perhaps more importantly, this pent-up demand continues to accrue and they expect this tailwind to be blowing for the next 3-4 years. So this is not a short term effect.
All this means nothing if they can’t deliver the work. And one of the recent ominous signs was a senior staff member in Singapore leaving for a competitor and taking their team with them. However, the company have now replaced that team, and at an overall lower cost base than the old team.
An LTIP is now in place with the aim to help retain staff. The CEO Mark Wheeler suggested that this is not a business that usually sees high turnover and he is often handing out 15-20 year long-service awards to staff. Most of us on here are not fans of free shares to employees, particularly when they get ‘adjusted’ out of the profits, as Driver have a tendency to do. However, in this case, I think share awards to long-term non-board member staff is a good thing.
Having been market down early on yesterday, the price rose during the day as investors perhaps caught up with the longer-term story. The price was given a helping hand this morning by a Simon Thompson article in the Investors Chronicle that was published last night. This highlighted the company is “primed to deliver bumper profit growth in the new financial year” with a 100p price target.
The volumes today suggest this is not just retail buyers coming in, though. A couple of % of the company has changed hands this morning. This will have given plenty of opportunities for stale bulls to exit.
Perhaps AB Traction could be in the market for stock again? I've always thought that in the long-term AB traction will act as a matchmaker between Driver and one of the larger construction consultancies such as FTI. As they have in several other investments in the sector.
The weak outlook for the rest of the year may cause short term volatility, as tip buyers are typically not known for their long-term outlook, and this won’t be attractive to those who like to trade on short term news. However, if you consider that investing is finding anomalies where the future is not yet priced in, this could be a good long-term bet.
Perhaps the best strategy is to buy slowly on weakness over the next year or so. The biggest risks being further tips or a takeover coming unexpectedly. But this is a risk we take with almost any stock that is lowly-rated.
Later in the week, there was an Equity Development presentation with even more detail. Leo commented that:
management came across as much more open and honest in the Equity Development presentation than they have been in written statements. They also said all the right things about margins, focus and longer-term prospects. I certainly came away with a more positive impression than I started with.
However, he still had issues with how some of the outcomes were presented in the RNSs.
The video is available here, so investors will be able to judge for themselves:
Newmark Security (NWT.L) - Trading Statement
This is another company whose valuation has not recovered since covid:
At £6m market cap it is rather small and with >40% insiders. For a growth company, this would not be a problem as liquidity will improve over time, but I don't think anybody would argue this is a growth company. They have a history of having to exit businesses at a loss and making investments that don't pay off.
Today we get a trading update for H2:
Trading for the second half of FY 20/21 continued broadly in line with management's expectations
I initially read this as: "Trading for the second half of FY 20/21 continued badly, in line with management's expectations" But it is actually worse than that - basically this is a miss.
with the Company showing an improved performance in H2 as compared to H1.
However, I should point out that historically the pattern has been for a slightly stronger H1, so this is indeed a recovery of sorts.
As a result, subject to audit, the Company expects to report revenue for FY 20/21 of c. £17.7m, 6% lower than FY 19/20 (£18.8m), and a marginal profit for the full year.
I am sceptical that I will call it a profit once they issue the full results. They have such a long history of exceptionals that I wouldn't adjust out. Also, in FY 2020 they recognised a tax credit on the basis they expected to make profits in future. In my view, this was a bit premature. In any case, don't be fooled if Stockopedia claims 0.24p EPS last year - it isn't a true reflection of the underlying business.
This reduction in full year revenue is significantly lower than what was achieved at the half year (23% reduction in revenue compared to H1 19/20), demonstrating the improved trading in H2.
So, no catch up yet. They then cherry-pick some good points out of the individual businesses.
Outlook With the expectation that the COVID-19 pandemic will continue to become more controlled with the successful roll out of vaccinations, the Directors of Newmark are optimistic about future trading. HCM is expected to continue growing from the continued onboarding of Software Houses and the further roll out of its Software-as-a-Service ("SaaS") and Clock-as-a-Service ("ClaaS") subscription services. Further focus is being placed on the transition from Legacy Access Control sales to Janus C4 and in Safetell we anticipate steady growth from a more considered and targeted approach to the market.
OK, two rather obvious points:
* ClasS is not a recognised industry term
* Clock as a service is not a new concept. The Speaking Clock was introduced in the UK in 1936. (Yes, I know these are timeclocks!)
Just to reiterate this point:
Further focus is being placed on the transition from Legacy Access Control sales to Janus C4
This has been a longstanding issue - they invest in a new system, but nobody wants to switch to it. Also, this is important:
Increases in sales from existing and new HCM customers outstripped the expected reduction from the merger of Ultimate Software with Kronos Incorporated as anticipated, resulting in year-on-year growth of 6%.
So there seems to be a structural headwind here. And they are more subscale than ever, making investment difficult. And I think this is how their high-margin business will eventually go - obsoleted by an inability to invest.
Dewhurst (DWHT.L/DWHA.L) – Interim Results
Back to the topic of pent-up demand, Dewhurst produced interim results today:
We are pleased to report a growth in sales and record profits for the first half of the current financial year. Overall, Group revenue increased by 3% to £28.9 million (2020: £28.2 million) and adjusted operating profit (before acquired intangible amortisation) increased 28% to £4.4 million (2020: £3.4 million). Profit before tax increased 36% to £3.4 million (2020: £2.5 million) and earnings per share improved to 26.4p (2020: 20.8p). Although some Covid-19 restrictions remain in place in the countries in which we operate, we have been fully operational at all our sites throughout the first half of the year.
36% profit growth looks very good. However, this is looking like being exceptional, in both senses of the word:
There was a release of pent-up demand during the first half of the year as some of our markets gradually relaxed restrictions. However there are now signs of some of that peak petering out. We expect there to be a lull in demand until economies fully open up again and customers start commissioning new projects. In the meantime we expect sales could be a bit choppy and unpredictable, particularly in regard to timing.
As with a lot of businesses at the moment stock availability and cost pressures are an issue:
The Group balance sheet remains strong with cash at the period end of £17.6 million (2020: £15.1 million). Since 30 September 2020, the Group has generated £2.4 million from operating activities but spent a further £1.0 million towards developing Dupar's new property which is now complete and in use. The sale of Dupar's previous property was completed at the beginning of June.
That balance sheet is particularly strong with net cash of about £16.5m excluding lease liabilities and the property sale post period end. A pension deficit of £7.5m is the only thing that takes the shine off, although that is down by almost £4m for the September year-end.
If we assume H1 was exceptional, then maybe we get to 45p EPS for the Full Year? Stockopedia has 71.9p forecast for FY21, so clearly expecting a H2 bias there, or simply out of date. I don't think those forecasts have been updated in over a year. Anyway, looks the FY may not be that strong to me.
The slightly bonkers part is the share price has almost trebled in the year and even on these dubious forecasts is on a P/E of 29. Punchy for a supplier of lift buttons!
There is more to this tale though. The DWHT are voting shares that are tightly held by the founding family. DWHA is the non-voting share. There is no extra value in a vote since this is family-controlled anyway and they are economically identical. On the A shares the price is a third of the voting shares and looks a more reasonable forward P/E of 10 - however again you have to trust the forecasts which look way off to me.
This looks to be an affront to the Efficient Market Hypothesis with one economically identical instrument trading at 35% of the other. Logic would say that you short DWHT and go long DWHA - however, this arb would have gone against you recently. Showing that that rarely is a risk-free profit in the market.
Getech (GTC.L) – Final Results
Getech’s results are as bad as you would expect from a company that provides databases of seismic data and tools to interpret it, and suddenly decides to pivot to a hot market sector where they have no experience:
Revenue £3.6 million (2019: £6.1 million)….
Adjusted[*] EBITDA £0.5 million loss (2019: £0.9 million profit)
Outlook is lots of non-specific green energy fluff and no real guidance. The sceptic may conclude that 2021’s financial results will therefore be equally bad.
We shouldn’t mock the fluff too much though, since it has allowed them to raise £6.25m from the market this year at a generous valuation. This at least will keep the lights on for a few more years.
Small Caps Live Friday 11th June
Van Elle (VANL.L) – Trading Update
Ground engineering contractor Van Elle issued a positive trading update this morning:
Trading during the final quarter of the Period continued to improve alongside the easing of Covid restrictions, with strong performances in March and April, and exit rate revenues at the end of the financial year returned to pre-pandemic levels. The Board is encouraged that this increased level of activity has continued into the new financial year, albeit remaining mindful of industry-wide supply chain pressures which are, in some instances, impacting material costs and availability.
Of their areas of operation, only rail remains depressed:
Activity in the Rail division has been the slowest to recover and continues to lag pre-pandemic levels, due to delays on key projects, but is now experiencing increased tendering activity from CP6 regional work banks and importantly, the first of the next generation of electrification programmes.
Unfortunately, this is the most specialist area they operate in and therefore the highest margin. This perhaps explains why they are guiding a beat on revenue but a loss (albeit a smaller one than expected):
Revenue for the Period, subject to completion of the audit review, is now expected to be c.£85m (2020: £84.4m) and the Board expects the adjusted loss before tax to be slightly ahead of consensus forecasts.
Koyfin shows a £78m revenue estimate, presumably from house broker Peel Hunt:
So £85m is 9% above estimates. Perhaps FY22 forecast now looks light? The EBIT forecast shows an expectation for a rapid return to profitability:
Perhaps helped by the acquisition they recently completed. 2.1p EPS for 2022 doesn’t exactly make them look cheap on 22x forward P/E. So the market is either pricing 2022 forecasts to be beaten or looking forward to 2023.
The P/TBV is just 1.15, though. Which highlights the main issue: those assets have been unproductive of late. There was a good management presentation post-interim results showing what they intend to do to make these more productive again. Again management came across well, with a clear plan to get the company growing earnings again.
But sadly this highlights another issue in the announcement:
Notice of Results and Analyst Briefing:
Van Elle expects to announce its final results on Tuesday 17 August 2021. A briefing for Analysts will be held at 9.30am on the morning of the results.
Investor Presentation: 3.30pm on Thursday 19 August
So private investors have to wait 2 and a half days to get the same info as the analysts. Not good.
Universe Group (UNG.L) – Contract Win
Universe Group announced a contract win this morning. Well, the full title includes a change of management roles but this is just the transition from interim CEO to the newly appointed Neil Radley which is already well-known.
In terms of contracts:
Universe Group…is pleased to announce a three year extension of an existing contract with a major UK based supermarket involving the provision of forecourt payment capabilities (as previously referred to in the Group's final results). This material contract extension provides further visibility for the Group over future revenues. As previously indicated, the Group had prepared for its fulfilment by acquiring inventory in anticipation which will now unwind as the contract is implemented.
Although technically a win, more of an extension really. As was their other recent announcement:
The contract is in addition to the recent five-year extension of an existing contract with a major international oil and gas group (announced in April) and provides a positive outlook for the Group as COVID-19 restrictions look to ease further in the coming weeks.
Both of these were clearly expected since they say they had acquired inventory ahead of the contract award/extension and that:
The Group has continued to trade in line with the Board's expectations for the year to date.
There are no forecasts in the market with finnCap perhaps not willing to commit to specific numbers given the recent management changes. However, with the delay of revenue recognition on these major contracts from last year into this year, these are expected to be strong.
In their morning note, finnCap point out that
…using FY19 as the most recent ‘normal’ year, the group is trading at 2.6x EV/EBITDA for that year
In the current market that is outstanding value, however, you have to remember this is a microcap with lumpy revenue so would not normally be highly rated.
Longer-term performance will depend on the strategy of the incoming management and their ability to win new customers not just renew existing contracts. The pedigree of the incoming management suggests that they do have the ability to do this, whereas I was never convinced the old management had the drive to make that happen.
On this topic, I was sure we were meant to get an update with the AGM on 29th June but that seems to be pushed back. The New CEO saying:
Adrian [the new CFO] and I continue to review the business and its strategy and we look forward to providing more detailed guidance on the route map at the time of the release of the Company's interim results in September 2021.
I note that:
…the AGM remains subject to social distancing restrictions and limitations and physical attendance at the meeting is not encouraged.
So they seem to have not much faith that the Government will deliver ‘freedom day’ on 21st June either! In light of this, a full strategy presentation with results perhaps makes more sense. The old management were a bit patchy with shareholder presentations. E.g. they presented at Mello, but didn’t hang around for a chat afterwards. Plus their online presentations have been very limited. Hopefully, something else that will change with new management too.
CMC Markets (CMCX.L) - Final Results
These were great results but were well-flagged given the relatively simple business model and detailed trading updates.
In this case, outlook matters most. And like Driver, the immediate outlook was a slight disappointment here - this is the first statement without an upgrade to expectations for the first time in what seems like years. They have recently been conservative with guidance, so if anything it felt like trading has deteriorated:
The monthly active client base has remained strong at the start of 2022 representing ongoing trading appetite, however client trading activity has moderated from prior elevated levels. Nevertheless, the Group continues to have confidence in the robust underlying performance of the business and in conjunction with further progress on its strategic initiatives, looks forward to continuing to generate long term business growth and value. As a result, the Board remains confident in achieving net operating income in excess of £330 million for 2022.
However, we did get a lot more detail to support this £330m estimate. They told us the exact trading for the first two months of the period (albeit in graph form), plus guidance for all the other factors. Plus they emphasised customer numbers and average revenues for the longer term, and the behaviour of these customers.
Longer term, a big factor continues to be the stockbroking side, as we have repeatedly emphasised here. The stockbroking beat our expectations in terms of net income and continues to grow, plus they are taking our advice and expanding from Australia to the UK.
And I have every confidence they will succeed in disrupting Hargreaves Lansdowne & AJ Bell. These have no incentive to disrupt themselves or significantly cut costs - much better to just profit from customers who don't get around to leaving.
Also, CMC has been executing better than IG Group recently. It is starting to look like IG have lost their way a little - a platform not coping, insufficient capital and chasing lower-quality business/customers.
Also, it was implied that IG merely uses stockbroking as a funnel into their spread betting / CFD business, whereas CMC are setting out to make this a serious standalone business. And while I think Hargreaves Lansdowne is overvalued at 28x and AJ Bell at 40x forecast earnings, there is no doubt that CMC Markets would justify a higher rating than currently with a larger HL-style business.
In the short term, though, things look uncertain and I don't expect much more clarity in the Q1 update since April / May are already known. So yet another one where waiting may pay off. There are a lot of uncapitalised development costs that should drive longer-term returns.
While they may beat on EPS slightly going forward, the days of them regularly beating on net fee income are probably over in the short term. And the share price seems to move fairly nonsensically at times, so maybe one to add on weakness.
Warpaint London (W7L.L) – AGM Trading Statement
Warpaint London issued an upbeat AGM statement this morning:
Trading in the year to date has been encouraging and we are particularly pleased with the performance in the UK where sales of our brands for the first five months of the year are up 64% compared to the same period in 2020 and up 18% compared to the same period in 2019, one not impacted by the Covid-19 pandemic.
I think quoting the 64% is a little bombastic, but up 18% on 2019 is very credible. Being in Tesco, which has remained open throughout the pandemic, seems to have been a strong positive for the group:
The growth in W7 UK sales has been assisted by our roll out into Tesco. In June 2020 the Group's W7 products were in 56 Tesco stores, today they are in over 1,300 across the various store formats, with a further expansion of the W7 full cosmetic displays in Tesco planned for later this year. The Group's other brands are also performing well in the UK.
The outlook is also good:
I am optimistic that these positive trends will continue and with cash today of approximately £6.6 million and no debt, I believe we are well placed to deliver profitable future growth.
The only issue I have, like with a lot of companies, is with the valuation. The price is now double what it was for most of 2019. Koyfin has 8p EPS for 2022 so 20x forward P/E may be considered a little punchy. N+1 justifies the valuation thusly:
The stock has understandably witnessed rating expansion on the back of successful strategic and operational execution over the last year. It now trades on 15x cal’22 EV/EBITDA. With risk potentially to the upside and having traded on 15-20x previously, this is well supported.
This is another share that seems to have gone from loved to hated to being loved again in hsort order. Oh, how fickle a game we play. Anyway, I'm not sure 15xEV/EBITDA is stand out value, even for a company that is clearly managing to execute well in the short term. As usual, we tend to prefer Creightons in this space, although with no broker forecasts and a high share price volatility I'm not a buyer of this either at the current prices.
That's it for this week. Have a good weekend all.