Markets had a little wobble this week on Tuesday with the FTSE down over 1% for the first time in a while. As always, these moves are exaggerated in small caps. Lots of recent investor favs that have done well in the last few months, such as SDI, Creightons, Cenkos and finnCap, were down, presumably as some of the hot money flowed out. The idea that you can borrow someone's idea but you can't borrow their conviction comes to mind in times like these.
This is perhaps a warning sign that recent strong gains may be more ephemeral than we would like to admit and that current market conditions will not last forever. Although, in the short term, I see little change in investor sentiment with plenty of investors willing to buy the dip.
In general, small cap markets rebounded during the week as people buy back what they panic sold. This is presumably good news for the market makers, spread bet companies and share-dealing brokers.
There were signs of some good quality companies where ratings still look relatively modest that bucked the sell-off trend. SCS closed at an all-time high on Tuesday despite the market weakness, and Somero reached all-time highs yesterday.
Psychologically, I am the sort of investor who is much happier buying at 52-week lows than 52-week highs. Academic studies have shown that both are market-beating strategies though. The market tends to underestimate the power of a corporate turnaround; meaning that stocks making new lows are more likely than average to be undervalued. But strangely, so are those hitting 52-week highs. The reason is that corporate performance tends to show momentum. (Not least because managements often like to keep something in reserve during very good trading periods.) However, it seems investors often like to take profits at 52-week highs, and stocks become, on average, undervalued versus the future performance of the business.
Note that this works on average though, so buying one or two companies that are performing badly but everyone has bought the story and bid it up to all-time highs is definitely not a good strategy. You either need to buy the basket and trust the averages or do the work to confirm that that the companies you are buying genuinely have strong and underpriced business momentum.
On to this week’s news…
[Discord server invite here, for those who want to check out the full discussion and have not visited before.]
Large Caps Live Monday 19th April
In this week’s LCL, Wayne had some thoughts about the right attitude to bring to investing:
I would profess that you need the right psychology to be a successful investor. I know others have said the same thing in the past but, thinking about the discussion over the weekend, and analysing my own process etc it struck me more than ever.
In particular, I was reflecting on some of the most successful investors I know and some thoughts struck me:
A friend who is amongst the most disorganised people I know. Always enthusiastic and looking at new things. There were several companies he helped found (whilst he was working as a junior analyst at a bank). He was constantly smiling and would get excited and animated with new technology eg I never knew anyone who bought more new phones than him. Always energetic. He spent 10 – 15 years living, with wife and family, in rented accommodation and spending a large chunk of his salary supporting the businesses he founded.
He has moved to LA (about 2018-2019), started an insuretech. Oh! And one of the companies he incubated for about 15 – 20 years has just merged with a SPAC at a valuation of circa $1bn (different articles suggest $1 – 1.5bn).
A hedge fund manager (ok – one of the greats – featured in one of the Market Wizard books) who is always smiling, always enthusiastic, has been known in the market for his bear trades (ie shorts) but actually, I think he has made more money over the years on his longs. Sometimes, when I used to work for him, would be struck by his energy and enthusiasm. (This is a guy that the FT has reported at times as being in the top ten paid HF managers of the year.)
Vin Murria interview on Mello last week. She was smiling, had energy & enthusiasm.
And, as I reflected, I realised that it is a common trait amongst successful people. I think we all, need to be aware that we do not ourselves become a 'cult of pessimism'.
Small Caps Live Wednesday 21st April
Zoo Digital (ZOO.L) - Trading Statement
We kicked off looking at a trading statement from this supplier of translated subtitles citing “accelerated growth”:
“Revenues for the full year are now expected to be $39.5 million (FY20: $29.8 million), an acceleration of growth over the prior year of 33% and ahead of previous management guidance of at least $38 million.
EBITDA (adjusted for share-based payments) is expected to more than double from the prior year to approximately $4.5 million (FY20: $2.1 million).”
Mark commented that at a 100x forward P/E the company needed not just acceleration in its earnings but ‘jerk’, for which there was little evidence of either in the past.
Leo put the final nails in the coffin:
Not much of a clear trend there and extrapolating high profitability growth out for significant periods to justify a 100x P/E is problematic. And there’s another problem:
“Net cash on 31 March 2021, prior to the receipt of proceeds of the recent share placing, was $2.9 million (FY20: $0.7 million) reflecting strong cash generation and tight management of costs.”
What the hell does that mean? Strong cash generation yet a share placing. Here was the rationale for the placing:
Growing the R&D team including establishing a longer range research function
Establishing regional hubs for media services (India, South East Asia)
Expanding international business development
Expanding the service delivery teams
Increasing capital expenditure
Providing general working capital.”
So only cash-generative before investment and working capital requirements!
I think we can all guess why Zoo Digital they've had a good year, mainly catchup:
“The past year has seen an accelerated evolution of the entertainment sector as the pandemic temporarily stalled the production of new titles and consumer take-up of on-demand streaming services has grown considerably. Some film and TV productions have started to resume and the second half of calendar year 2021 is expected to see the completion of significant numbers of new titles.”
Concluding:
I see some revenue still to come from catchup production and then from the translation of pre-existing shows. But then I see a gap. And that EPS history is hardly inspiring. On the face of it this looks like a short, but further investigation would be required.
Progressive have a new note out on the company. However, with no commentary on valuation, and noting that they have increased their revenue forecast for 2022 but cut the EPS forecast, this is hardly a ringing endorsement for ownership.
System1 (SYS1.L) - Trading Statement
Mark took a look at one of the biggest risers on his watchlist:
System 1 refers to the model that psychologists use to describe how we make decisions. The idea is that we have two ‘systems’ going on in our brain. A fast, reactive and always-on system that makes instinctive decisions using rules of thumb called heuristics, and a slower more deliberate one that is less easily fooled but requires much more energy. Hence we use it less.
System 1 is the fast, reactive one and the company System1 is intended to make advertising more effective by exploiting our tendency to use these heuristics.
As the author of a book that enables investors to overcome the tendency to inappropriately apply System 1 thinking to investing decisions, I am aware of just how powerful this can be.
However, System1, when it was an advertising agency called Brainjuicer, had a lead in this area, a lot of the industry has caught up with the science and System 1 has been struggling for the last few years to generate any revenue growth. They invested a lot of money in a tool to analyse the effectiveness of adverts, but this has struggled to generate any meaningful revenue so far.
The rise today is caused by the following training statement, which starts off well:
“Our Interim Statement released on 17 November 2020 reported that Revenue and Adjusted Profit had recovered substantially since Q1 and that the sales pipeline was strong. This improvement was maintained throughout the second half-year such that Revenue in H2 was approximately 8% above that of the equivalent prior year period, compared with a 26% decline in H1. As a result, the full year Revenue reduction was 11%.”
So impressive to see H2 above last year, although perhaps some aspect of catch up from projects postponed in H1. However, at £22.7m revenue this appears to be a miss vs broker forecasts of £26.9m.
Cost-cutting has improved profitability though:
“Profitability was stronger in H2 than in H1 as sales picked up faster than adjusted operating costs which were 16% lower than last year in the second half…
We expect to report a pre-tax Adjusted Profit (which excludes impairment, share-based payments, government support, bonuses, loan interest and certain provisions) of some £2.9m for the full year (FY 2019/20: £2.0m).”
I think this increase in profitability, despite reduced revenue is what has led to the rise today. However, again this appears to be a miss vs broker forecasts. (Having Cannacord as the house broker means we cannot see the details sadly.) And perhaps more importantly when you exclude “impairment, share-based payments, government support, bonuses, loan interest and certain provisions” then you can make you profit pretty much what you want!
Perhaps the best news is that their ad measurement investment is finally starting to generate some meaningful revenues, although this is a long way from paying back what they have invested in this so far.
The outlook sounds positive:
“System1 is focused on achieving Revenue growth over the short and medium term…
… We plan to remain profitable and to continue to generate cash in the 2021/22 financial year, notwithstanding that we are targeting revenue growth to be at least matched by the rate of cost growth as we prioritise scaling our automated predictive products.”
However, when you go through what that actually means, then if costs are growing in line with revenue growth that means profits grow at best in line with revenue.
The cash balance is strong at £6.4m, but no dividend is proposed. In lieu of this the share buyback program is restarted. Having a large buyback authority and actually using it are two different things, however.
The P/E today is around 13x a highly-adjusted EPS figure, with limited forward growth, at least in the near term. And this is still largely a people business which tend to be lowly rated for good reasons.
I can’t help thinking any buyback at current prices would be value-destructive for shareholders in the long term....as would not selling into what appears to be an system1-driven reaction to a fairly average trading statement.
Parity (PTY.L) - Final Results
Leo looked at this IT recruiter that has tried to recreate itself several times over the years:
Highlights: Transformation begun in 2019 is complete and the business returned to an Operating Profit in 2020 of £23k (2019: Operating loss of £725k).
So it looks like they repositioned themselves. Anyway, we knew these figures already. Here's the new bit:
“Post period end and outlook:
Encouraging start to 2021, with new business wins including a contract from the Scottish government representing a total opportunity of up to £5m over the next three to six years, plus a number of other public and private sector wins amounting to an estimated £400,000 in External contribution during the financial year.
Having significantly improved its working capital management over the past two years the Group has secured a new debt facility from Leumi ABL that will support its future growth ambitions.
Investment in technology has enabled greater efficiency, stronger margins and supports the growth opportunity, with more future plans in this area.
While the short-term economic impacts of the pandemic have affected performance, in the longer term it has accelerated the trends that underpin Parity's new strategy.
If the pandemic eases as expected, anticipate more growth in H2 2021 as business confidence returns.”
Sounds ok, but like most recruiters, they have had a strong share price run and now look much more expensive than before covid, despite the economic and employment outlook appearing much more uncertain:
Hunting (HTG.L) - Q1 Trading Statement
Mark took a look at this oilfield services supplier
“Trading in Q1 2021 has been broadly in line with management expectations, with a small EBITDA loss being recorded, predominantly driven by subdued offshore drilling activity throughout H2 2020 and into 2021. Activity at the Group's facilities in Texas was also impacted for a week in February 2021, due to the severe weather across the state.”
So perhaps a little bit disappointing there. However, with onshore now growing again:
“Revenue within Hunting Titan has reported improvement in Q1 2021 compared to Q4 2020, as US onshore activity continues its return to growth. Hunting Titan's March 2021 result was also its best performance since April 2020, when global lockdown measures were implemented.”
And overall good forward trends:
“Revenue within the Group's other operating segments has also stabilised as the WTI oil price has improved. As previously indicated, management believes that most of the Group's segments will see a stronger performance from late Q2 2021 onwards.”
Then I am expecting the numbers through the rest of the year to start to look good. And perhaps more importantly this still looks cheap:
“The Group's Balance Sheet remains robust with good liquidity, including undrawn core bank borrowing facilities of $160.0 million committed until December 2022, and a cash at bank position of c.$96.1 million at 31 March 2021, compared to $101.7 million at 31 December 2020. Inventory levels continue to reduce and were approximately c.$274.3 million at the end of Q1 2021, compared to $288.4 million at the 2020 year-end.”
This is likely to still be on a P/TBV of c.0.8 where the vast majority of those assets are liquid. Inventory write-downs have already taken place & significant cost-cutting been implemented. I don’t see why this should trade at a premium to TBV with the recovery of its core markets in 21H2. This is a cyclical business, but this looks like a good point in the cycle.
City of London Investment Group (CLIG.L) - Q1 AUM
Mark looked at the trading of this asset manager:
Overall AUM shouldn’t be a surprise to anyone since these are published on their website. But the details are in here:
Got to admit being slightly disappointed here too. Clients continue to rebalance away from them due to the strength of recent performance and their ability to see to new clients has not yet been proven. The good news is that AUM in Karpus part of the business appears stable now with only very small net out flows.
As usual, they give all the details to work out the profit, apart from profit share:
“The Group's income currently accrues at a weighted average rate of approximately 73 basis points of CLIM's FuM and at approximately 77 basis points of KIM's FuM, net of third party commissions. "Fixed" costs are c.£1.6 million per month, and accordingly the run-rate for operating profit, before profit-share is approximately £3.3 million per month based upon current FuM and a US$/£ exchange rate of US$1.3783 to £1 as at 31 March 2021.”
This is likely to be at least 50p EPS for 2021. So with a P/E of 11 and a 6%+ yield, this still looks like solid value in the current market, with the re-balancing effect likely to reverse if EM's take a tumble, adding some stability to the returns.
There is a risk that the profit share might drift up after the departure of the founders from executive management of the businesses, but with both Oliff & Karpus as big shareholders, they will much prefer dividend increases to increasing profit share and will surely make that clear to management.
Warpaint London (W7L.L) - Trading Update
Finally, we were impressed by the resilience of this cosmetics company, but again it came down to valuation:
This is a good update, but again it is a company whose price is now above the start of the pandemic. Stockopedia shows a forward P/E of 15.6. Whereas our preferred company vaguely in this space is Creightons. This is also trading near highs but is under a PE of 15 on a historic basis.
Small Caps Live Friday 23rd April
Wey Education (WEY.L) - Scheme of Arrangement
Leo spotted a potential arb opportunity here.
Effective Date of the Scheme: 25 May 2021
Latest date for despatch of cheques or for settlement through CREST: by 14 days after the Effective Date
You can buy in the market for 46.75p in reasonable size vs the 47.5p cash bid.
This is only about 1.5% return, but pretty much the only thing that will derail the bid is a higher bid! So this isn’t bad for a month or so’s return.
Universe Group (UNG.L) - Board Changes
Mark spotted that this board change has been well-received by the market:
“… is pleased to announce the appointment of Adrian Wilding as Chief Financial Officer and Graham Bird as a Non-Executive Director.”
They previously had an interim CFO and sounds like the new guy has perhaps been brought in by the new CEO:
“Adrian Wilding is an experienced CFO with experience in B2B and B2C financial services, with experience of working in both listed and private equity-led businesses. Adrian has worked with the Company on a consultancy basis in recent weeks and will formally join the board on 1 May 2021. Carmel Warren, previously interim CFO, leaves with the board's thanks for her contribution as interim CFO.”
They also announce that the official CEO hand over will be 1st May after they release results next week.
Graham Bird bought UNG when he managed the Gresham House Strategic £GHS, so this is a business that he knows well. He is still an adviser to GHS and they recently bought a further stake in the company so shows that his successor at GHS is a fan too. I wonder if Graham Bird might be stretching himself too thin though. 2 non-execs, as well as an FD and a consulting role, means that I doubt he will be committing serious amounts of time here. Still, the Escape Hunt share price has done phenomenally well since he joined, despite being closed for most of that time!
For UNG we know the results next week will be around break-even at best with revenue on a major contract delayed into 2021. However, I expect a strong outlook given that tailwind for 2021. This always had a bit of a feel of a business that was well-run but needed a bit more ambition. If the new management team can provide that, I still think there is a lot of hidden potential here given the quality of the clients & products.
Fulham Shore - Trading Update
Leo looked at this restaurant group that has done pretty well from re-opening hopes:
I wouldn't say that their business model was broken, but they did have a setback, opening too many suburban restaurants at once (cannibalisation). Fulham Shore's trading is much more representative of full reopening. Basically, they're doing the same thing as they will be from May 17th, except with a smaller capacity. Therefore this update bodes well:
“Currently, 37 out of the 52 operational Franco Manca pizzeria and 16 out of the 18 operational The Real Greek restaurants have outside tables. The opening of these outside spaces has been combined with continued social distancing and test and trace measures to comply with government guidelines.
Group sales in the week ended Sunday 18 April 2021 were very encouraging, being not only ahead of the previous week, but also ahead of the same week two years ago in April 2019 (as April 2020 was in the first lockdown, it is not comparable). These trading results were achieved without any inside seating and our colleagues in the restaurants deserve great credit as demand has far exceeded the number of seats available at peak times.”
But the trouble with the company is that as per the earlier graph it has already massively recovered. It never looked very cheap, but in mid-October, before the idea that we'd be locked down for the best part of 5 months, the share price was 7.6p.
They make 40% margins but have been subscale until recently, and then they hit the cannibalisation issue and then covid. In normalised conditions, they'd still struggle to make much money due to lack of scale and due to pre-opening costs etc. So they really need to grow and do so cheaply.
My view was previously that they needed to raise more money to scale up, but now I'm not so sure. I'm going to do a full write up for Small Caps Life to be released around 24th May, including full reopening trading. And an attempt at a valuation.
Centamin (CEY.L) - Q1 Report
Mark looked at this gold miner, even though it is slightly too large for our small cap remit, but with good reason:
Centamin is worth following both given its own relatively lowly rating in the gold-mining sector and since it is the biggest customer of Capital Ltd.’s services. One of the only companies that we both agree appears to be materially undervalued in the current market. It is therefore particularly pleasing to see the following comments from CEY’s CEO about Capital’s performance from the conference call:
“And importantly, for us as well, Capital has made an excellent start...So they mobilized early and have got moving early. And in fact, they're slightly ahead of the curve as well... continue to sort of ramp up from this great start that they've had…
…Our teams are working very well together...So delighted with how that's going. And they are ahead of where they thought they would be, both in terms of mobilization and dirt move. So certainly, some of the outperformance is around capital…
…And the GM at sites actually sort of warned our guy. He said, look, Capital outperformed you. I'm going to bring Capital into all the open pit work boys. So the pressure is on.”
[H/T to Musashi on twitter for doing the transcription.] And high praise indeed for CAPD.
On Centamin’s results, these were in-line:
“Gold production from the Sukari Gold Mine ("Sukari") for the first quarter ("Q1"), was 104,047 ounces ("oz"), in line with 2021 guidance.
Cash costs of US$733/oz produced and all-in sustaining costs ("AISC") of US$1,091/oz sold.”
Although, capitalising waste stripping confuses costs here:
“Group free cash flow of US$9 million, after US$37 million of capital expenditure ("capex") and US$27 million distributed to the Egyptian government in profit share payments and royalties.”
The waste stripping is needed to access future resources rather than current production, so will presumably be depreciated into the costs of those ounces when produced. Overall, this should be a wash, apart from it reduces the NPV as the cash out is much sooner than the cash back in. I’m not complaining though, since a good chunk of that cash is ending up in the CAPD bank account. Although Capital effectively funded the fleet expansion capex.
Novacyt (NCYT.L) - R&D Update
Leo saw no reason that this update should cause the market reaction that it did:
Their last update was a bit of a bombshell for investors (I imagine) and the share price was badly hit. It is unclear what the purpose of today's update is, except perhaps to reassure shareholders who have doubtless been bombarding them with requests for good news.
On the R&D side I don't see anything new. Two-genes: They had one of these for at least a year, but this is the faster one. As with Avacta, Lateral Flow Tests are commodity items and China is already in the lead. Some may be better than others, but nobody seems to care much and I don't even think it matters
That the market loved this update says more about the investors that follow the company than the merits of the update!
Photo-Me (PHTM.L) - Trading Statement
Mark was surprised to see an ahead statement from this photobooth & laundromat supplier this morning:
“In the first five months (ended 31 March 2021) of the 2021 financial year the Group performed better than expected, driven by stronger than anticipated trading momentum…
Consequently, the Board has revised its expectations for the financial year ending 31 October 2021 and is pleased to announce that it now expects to report revenue of between £190 million to £200 million (previously £175 million) and profit before tax of between £15 million to £19 million before exceptional items (previously £9 million before exceptional items).”
That is an almost doubling of the PBT so you can see why this would be well received. The initial excitement of this meant the share price was up about 20% but has since fallen back. The reason for the ahead statement is given as:
“due to an increase in applications for the My Number card, the Japanese government's social security and taxation photo identification card scheme. In Japan, the Group's photobooths are equipped to scan the unique My Number card QR code that every Japanese citizen has received, and match the ID photo to the card application”
But the sting in the tail is that this appears to driven by a short-term government incentive. Therefore, I’d treat this as a one-off gain of around £5m after tax, which is effectively immaterial to a £250m market cap company. The rest of the business is said to be in-line.
This also shows the perils of relying on stockopedia forecast numbers. The forecasts for 2021 are clearly out of date.They match the £175m revenue that was the company’s previous guidance but had £36.9m PAT. Whereas, the company have guided £9m PBT previously, and £15-19m today. The numbers are out by a factor of around 5 yesterday and maybe around 3 today. This is an 18x forward P/E not a 7.8 forward P/E stock.
This would likely affect all three of the stockrank measures materially. Meaning that anyone who has invested based on the superstock designation has made a mistake:
Not that it has mattered, since they probably still made money in this market. It does go to show that Stockopedia isn’t set up for a market where many forecasts are withdrawn and investors need to do their own research.
That’s it for this week. Have a great weekend!